A shock to the system, or nothing new?

When news broke in early June that the California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the US, would be cutting 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 and predictions that general partners (GPs) would be 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 that other public pension plans are heading for the exit.

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

One obvious place to start was the California State Teachers’ Retirement System (CalSTRS), the second-largest public pension fund in the country, whose portfolio was valued at $188.8 billion on May 31.

Sizing up the situation

“Given the size and complexity of portfolios the size of CalSTRS, you bet that management costs are a factor,” 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.

“Relative to our peer group, which consists of 15 US public sponsors ranging from $41 billion to more than $284 billion in size, we are already inexpensive,” Duran said, referring us to CalSTRS’ annual CEM investment cost report.

According to the analysis, conducted by Canada-based CEM Benchmarking, CalSTRS’ investment costs for calendar year 2013 totaled $700.7 million compared with the $1.7 billion CalPERS spent in fiscal year 2013-14, of which 92 percent went towards external management fees.

CEM concluded that CalSTRS was low-cost because it “paid less than peers for similar services” and had a lower cost implementation style, including less external active management.

Kelly DePonte, a managing director at Probitas Partners, a San Francisco-based placement advisory firm focused exclusively on alternative investment products, also referred to CalPERS’ size.

“The real issue is CalPERS’ size and the growth of its portfolio,” DePonte said, explaining why he doesn’t think other LPs will follow in CalPERS’ footsteps.

“It has both a large internal staff as well as external consultants that spend a lot of time monitoring their portfolio simply because they have so many GPs and individual funds,” he said.

Another source agreed that CalPERS’ size played 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 a greater risk as institutional investors somehow think it’s easy and they can do it themselves. Good luck to them,” the person added.

While this is a valid point in general, it does not appear to apply 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 over the next five-year period.

“Infrastructure is one of our newer programmes,” chief investment officer Ted Eliopoulos said during a conference call explaining the move, adding that after examining the fund’s internal capacities and resources, it concluded that it would need about 10 external managers to achieve its objectives related to these two asset classes compared with the six it currently employs.

Another indication that CalPERS’ decision may not have the far-reaching implications initially thought is the fact that this has happened before without re-shaping the GP landscape.

“Though the announced target is new, this effort is not,” DePonte pointed out.

Indeed, CalPERS has undertaken a multi-year restructuring effort beginning in 2007. Since then, the pension fund 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 divide GPs into winners and losers, and taking into account the views expressed by those Infrastructure Investor spoke with, a significant overhaul of the GP space seems highly unlikely.