Public Pension Funds Regain Some Lost Ground in a Good Year, But CalPERS Lags Peers

The markets giveth and the markets taketh away. This was one of those “markets giveth” years, to the considerable benefit of underfunded public pension funds. In a post going up soon, they also got a break from beneficiaries having the good taste to die sooner, but that does not yet seem to be reflected in their actuarial estimates.

However, CalPERS was a laggard, which does not reflect at all well on them. CalPERS is the envy of other public pension funds by virtue of having a large in-house staff and being able to afford consultants galore without incurring undue costs in relation to its fund size. It is big enough to further shave costs by running large in-house index funds and managing much of its bond investing internally.

So what gives? CalPERS is sure to try to blame all the scrutiny it has gotten, which has the causality backwards. CalPERS would not be the target of regular criticism if it had its ducks in a row. More specifically, CalPERS has a clearly unqualified Chief Investment Officer and a CEO who lacks a college degree and does not appear to have gotten much specialized training in finance, accounting, or economics to compensate for that shortcoming, certainly not enough for her to have attained any certifications.

Even more important, the weaknesses at the staff level are the direct result of a successful campaign by the former CEO Anne Stausboll to neuter the board. It’s simply perverse that state officials have allowed this to be the remedy for a pay to play scandal where the CEO, Fred Buerostro, was taking bribes and is now serving a four and a half year term in Federal prison. John Chiang is particularly culpable for enabling this power grab by staff, since who has held one of the two most powerful seats on the board since 2007, first as state controller, then as state treasurer, before the pay to play scandal was unearthed.

We’ve remarked repeatedly that CalPERS’ Sacramento sister, CalSTRS, puts the CalPERS board to shame. Its board is vastly more knowledgeable, far more engaged, and regularly challenges what staff tells them. CalSTRS proves that a more vigilant board does not hurt performance and is likely a contributor to CalSTRS’ better results.

From the Wall Street Journal’s recap:

Large U.S. systems that oversee retirement funds for police, firefighters, teachers and other public workers earned median returns of 12.4% in the fiscal year ended June 30, according to Wilshire Trust Universe Comparison Service. That is their best annual result since 2014.

Yet many of these public pensions remain severely underfunded despite the recent gains, meaning they don’t have enough assets on hand to fulfill all promises made to their workers. Estimates of their collective shortfall vary from $1.6 trillion to $4 trillion….

Even if returns remain elevated, large public pensions won’t be able to reverse their shortfall in coming years, according to Moody’s Investors Service. Large public plans currently have just 70% of what they need to pay future benefits to their retirees, according to 2016 figures from Wilshire Consulting…

The California Public Employees’ Retirement System, the biggest in the U.S., earned 11.2% in fiscal 2017—largely because of stocks and private equity. But the fund, known by its acronym Calpers, noted that it has just 68% of the assets it needs to pay for future benefits. That is up from 65% in 2016…

The California State Teachers’ Retirement System, which sits roughly one mile from Calpers in Sacramento, Calif., reported a fiscal 2017 return of 13.4%. The fund’s chief investment officer, Christopher Ailman, touted the number on Twitter as being higher than Calpers: “BOOYAH!!”

CalPERS will discuss its 2016-2017 fiscal results in more depth in its board meeting next week. The poor comparison with large funds generally and with CalSTRS is odd given that CalPERS ought to be able to invest at lower fee levels than others. In addition, it underperformed CalSTRS in private equity and fixed income. While CalPERS did beat CalSTRS in public equity, with a 19.7% return versus CalSTAS 19.6%, CalPERS has a heavier weighting in foreign stocks than CalSTRS. In a strong dollar year like last year, it should have done better. Similarly, CalPERS is so large an investor in private equity that it should achieve index-like returns, with some marginal improvement due to its size (fund managers often offer breaks on fee levels for larger commitments). However, in the last board meeting, a consultant from Wilshire pointed out that CalPERS has not taken up co-investing, another way to lower fees and potentially increase gross (and therefore net) returns anywhere near as much as it could have.

And apart from the falling short relative to CalSTRS, CalPERS also failed to meet its benchmarks. So it has a lot of ‘splaining to do. But given the giant pension funds’ track record, its beneficiaries are likely to get obfuscation instead.

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  1. Sinecure in Sac

    “Wilshire pointed out that CalPERS has not taken up co-investing, another way to lower fees and potentially increase gross (and therefore net) returns anywhere near as much as it could have”

    Not true. The coinvestments theyve done have performed abysmally. hopefully the board has noticed and will stop this assanine talk of creating a “private company to do direct PE investments”

    1. Yves Smith Post author

      I agree that among other things CalPERS got burned with Caesars (and on Silver Lake, see details here, which was not a co-investment in the classic sense but a “special opportunity” outside its normal “commit to funds as a LP along with lots of other investors” drill).

      But CalPERS has also never been serious about co-investments, as the Wilshire consultant effectively said. CalPERS staff proposed doing co-investments to the board in the mid 1990s, which means virtually at their inception, and has never followed through in a concerted manner.

      It’s not just a matter of CalPERS needing some upskilling. It also seems to have managerial issues it ought to be able to solve but apparently hasn’t. And bad management also means the good people it has are likely to be not well deployed.

      Clearly other funds, in particular ones with smaller staffs, have figured out far better than CalPERS how to manage the need to have enough personnel slack and/or flexibility to handle the lumpiness of the opportunities to look at co-investments. The state of Wisconsin, for instance, has a standout record in this regard.

      Other LPs have typically gotten results at least comparable to if not better than for their fund commitments, hence the enthusiasm at most LPs for doing even more (although there is now the risk that too many LPs wanting to do co-investments will dent performance).

      Having said all that, I agree 100% with your bottom line that CalPERS is putting the cart before the horse in a huge way with its scheme to form a private company to do PE. However, having listened very carefully to the offsite last month, I am pretty sure that this isn’t what you assume it is, a plan to have CalPERS’ staff pull the trigger in PE.

      This supposed “new business model” looks to be largely if not entirely about evading transparency. Despite now being the 100% owner, CalPERS staff has nada to do with the management of CenterPoint. It doesn’t even have any staff or board members on the board of CenterPoint. It has a firm called GI Partners acting as is “fiduciary manager”. CalPERS has been very secretive about its structure and arrangements, so I’m loath to speculate further.

      But basically, a CenterPoint type deal would replicate the worst elements of CalPERS’ investing in funds: a passive relationship when there is no reason to preserve that bad feature in a vehicle you control, while reducing accountability to the board and public.

      This scheme looks to be solving Ted Eliopoulos’ supposed Big Problem that led to his pity party earlier that year: that CalPERS can’t deal with the scrutiny it is getting in PE because it refuses to clean up its act, so the solution is to find a way to hide even more from public scrutiny and accountability.

      If you have another perspective on this, I’d be very interested to hear it.

  2. flora

    “The poor comparison with large funds generally and with CalSTRS is odd given that CalPERS ought to be able to invest at lower fee levels than others. In addition, it underperformed CalSTRS in public equity, private equity and fixed income. Since CalPERS has a heavier weighting in foreign stocks than CalSTRS in a strong dollar year, all other things being equal, it should have done better. …”

    How long will the CalPERS board go on “resting on its laurels” while falling behind? More secrecy isn’t the answer to the problem.

    Thanks for continued reporting on CalPERS and pensions.

  3. Jim Haygood

    A 60/40 mix of the S&P 500 index and the Bloomberg Barclays Aggregate bond index [mirroring a typical pension fund portfolio] returned 10.34% from June 30, 2016 to June 30, 2017. How the median public pension fund managed to beat this bogey by two full percentage points is a story I’d like to hear about. Mirabile dictu, as we are wont to say.

    During this period, the US dollar index DXY was essentially flat, falling from 95.95 on June 30, 2016 to 95.64 a year later. Overseas stocks outperformed the S&P’s 17.9% return: MSCI’s World ex-USA index of developed country stocks gained 20.1%, while the ACWI ex-USA index (including emerging markets) returned 21.0%.

    Calpers’ slug of international stocks should have benefited it this fiscal year. The explanation for its shortfall compared to CalSTRS must lie elsewhere. Real estate, which had a lackluster year, may be one culprit.

    Meanwhile, underfunding is the monster that will slither out from under the rug to terrorize us all in the next recession. In neighboring Arizona, cities are piling on sales tax hikes to bail out the severely underfunded PSPRS (Public Safety Personnel Retirement System) … and this is an economic expansion, with frothy markets. When Bubble III dies, losers like PSPRS will crawl in a hole to die.

    1. Jim Haygood

      Wilshire’s 60/40 benchmark uses different indexes. Stocks are represented by the Wilshire 5000 Total Market Index, which gained 18.54% compared to 17.89% for the S&P 500 large cap index. Likewise, the Wilshire Bond Index, introduced last year, trounced the venerable Bloomberg Barclays Aggregate, returning 1.64% versus a 0.31% loss in the BarAgg.

      Accordingly, Wilshire’s 60/40 benchmark returned 11.85%. The median large fund earning 12.4% beat it by 55 basis points, which is still impressive.

      Wilshire’s new bond index, which they describe as “mirroring the actual holdings of US institutional investors,” is a story in itself. With only a 27% weight in government issues according to its fact sheet, Wilshire’s bond index holds much fewer govies, and correspondingly more corporates and securitized issues than the conservative, investment grade BarAgg.

      What is truly weird and strange is that Wilshire’s fact sheet completely omits any description of credit ratings, a basic aspect of any bond index. I’m betting there’s some junk debt concealed in there. Just fired off an email to Wilshire asking them to fess up. :-)

      1. Jim Haygood

        Response from Wilshire: a credit breakdown of the Wilshire Bond Index will be included in the next fact sheet update, in the first week of October.

        Since the WBI purportedly is based on institutions’ actual holdings, it will be revealing to see how much credit risk they’ve taken on.

    2. Yves Smith Post author

      Being in more asset classes improves your risk/return tradeoff. A mere 2 asset class portfolio is way way way away from the efficient investment horizon. So being in foreign stocks, real estate and any “alternative investment” that genuinely were not much correlated with the “asset classes” would help.

      And of course, there is the leverage and exaggerated returns in PE (goosing valuations around fundraisings, which many funds happen to be doing now) also helping.

  4. Jim Haygood

    Here is how the CIO of the failing PSPRS pension fund [which was 47.3% funded last summer at a delusory 7.5% assumed return] rationalizes his exquisite plight:

    [Our] five year annualized returns were about 5.4%. This is representative of the current low return environment which persists in most markets.

    Our Asset Allocation is designed to return our assumed earnings rate over long time periods
    even though we, like our peers, currently have lower returns.

    Under Sarbanes Oxley, a corporate exec who signed off on an utterly counterfactual forward-looking claim like the bolded sentence — contradicted by the plain math of 2 percent bond yields and the S&P 500’s 1.97% dividend yield — would be facing jail time.

    The bubbly 2016-17 fiscal year gives the cornered rats a temporary reprieve. With a true funded status probably in the high 20s using an appropriate state bond yield, PSPRS faces a near impossible task of climbing out of its deep hole. For a nationwide view, multiply this sorry anecdote times 1000.

  5. Sluggeaux

    Thank you for calling-out so stridently the lack of qualifications on the part of the CalPERS CEO (no college degree!) and CIO (a lawyer with no training in finance). A functioning board, led by a functioning state treasurer, would replace them both after failing to meet their benchmarks or even the returns of smaller state funds. One can only conclude that these executives are acting in collusion with elected officials and the board to hide the extent of the bad deals entered under the leadership of their now-imprisoned former CEO.

    BOOYAH? For shame, Jerry Brown, John Chiang, Betty Yee, and Kamala Harris. Your inaction leads to the conclusion that you are hopelessly and completely corrupt. As a current beneficiary, I’m already scrambling to figure out how I’m going to live when my CalPERS pension disappears.

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