A sign of things to come (weekly2)

CalPERS’ announcement that it would shed half its external money managers sent shockwaves through the investment community – but was that reaction justified?

When news broke last month that the California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the US, was intending to cut the number of external money managers it relied on to manage its $305 billion portfolio from 212 to about 100 over the next five years, there was talk of ‘shudders’ reverberating through Wall Street amid predictions that GPs would be starkly divided into winners and losers. 

The truth is, because of its size and long history of investing in alternatives, CalPERS is often viewed as a harbinger of emerging trends within the institutional investor community. Similar predictions surfaced last September when CalPERS announced that it would stop investing in hedge funds. Nearly a year later, however, it doesn’t seem as if other public pension plans are heading for that particular exit door.

Intrigued by the latest decision, Infrastructure Investor sought the views of several industry insiders on the subject.

“Given the size and complexity of portfolios the size of CalSTRS, you bet that management costs are a factor,” California State Teachers’ Retirement System (CalSTRS) spokesperson Ricardo Duran said in an e-mailed response. “But because it’s infused in our overall ongoing investment operations, I can’t say there’s a defined initiative along the lines of the type of activity that has been reported in the media,” he added.

According to Duran, CalSTRS’ investment costs are already inexpensive compared with its peer group, which consists of 15 US public sponsors ranging from $41 billion to more than $284 billion in size. For example, CalSTRS’ investment costs for calendar year 2013 totaled $700.7 million compared with the $1.7 billion that CalPERS spent in fiscal year 2013-14, of which 92 percent went towards external management fees. 

Kelly DePonte, a managing director at Probitas Partners, a San Francisco-based placement advisory firm focused exclusively on alternative investment products, reflected: “The real issue is CalPERS’ size and the growth of its portfolio.” He added that he doesn’t think other LPs will follow in CalPERS’ footsteps. 

Another source agreed in terms of CalPERS’ size playing a decisive role in the decision. “CalPERS is the biggest and has the biggest staff, allowing it to go internal,” this person said. “Infrastructure is actually at greater risk as institutional investors somehow think it’s easy and they can do it themselves. Good luck to them,” they added. 

While this is a valid point in general, it does not appear to apply well to CalPERS, which, despite plans to work with fewer external managers overall, actually intends to increase the number of fund managers it relies on for infrastructure and forestland exposure over the next five-year period, from six to about 10.

The above views aside, there is also history to take into account. CalPERS’ most recent announcement is, in context, part of a multi-year restructuring effort that the California pension fund launched in 2007. Since then, it has reduced the number of its external managers from around 300 to 212 currently and achieved savings of $293 million over the last five years. 

Considering that CalPERS’ previous initiative did not have profound consequences for the GP universe, and taking into account the views expressed by those we canvassed, it seems likely that the shudders will subside.