Reforming CalPERS: A Case of Fixing What Ain’t Broke

Gov. Pete Wilson wants to shake up the state pension fund, in the name of “taxpayer accountability.”

But to look at the investment performance of the fund since the mid-1980s, you have to wonder whether this is a case of trying to fix what isn’t broken. This fund seems to work.

The California Public Employees Retirement System, or CalPERS, is a gigantic investment pool whose $62.4 billion in assets represents state workers’ current and future retirement benefits.

Those billions are broadly invested in stocks and bonds here and abroad, as well as in real estate and other assets. The goal is to wring the best return from the investments, without undue risk.

It’s a simple plan: The better the fund performs, the lower the ultimate cost to taxpayers of funding state workers’ golden years.

On that count, taxpayers don’t seem to have much of a beef with CalPERS. As the accompanying chart shows, the fund has been handily beating the median return of 30 state retirement funds tracked by pension consulting firm SEI Corp.:

* In the five years ended last June 30 (the end of CalPERS’ fiscal year), the CalPERS fund’s average annual return was 13.3%, versus 12.15% for the typical state fund.

* CalPERS beat the typical state fund in all three major investment segments--stocks, bonds and real estate.

* Measured against market indexes, CalPERS also shined. Its stock portfolio, which by law can’t include shares of companies doing business in South Africa, returned 15.9% annually in the five years through last June 30, compared to 15.8% for the benchmark Standard & Poor’s 500-stock index with South African firms removed.

Does a tenth of a percentage point matter? On $62.4 billion, you bet. And generally speaking, the money management business is mostly about beating the averages. If you can do that, you’re considered a pretty sharp player.

For a fund the size of CalPERS, the managers’ ability to beat the market mostly depends on picking the right investment mix--not so much individual stocks (because CalPERS ends up owning nearly all the big names), but how much to keep in stocks versus bonds versus other assets each year. That’s where you get the edge.

Now comes Gov. Wilson with the argument that CalPERS needs an overhaul. He wants to replace the fund’s current 13-member board of administration--most of whom are picked by the workers or retirees themselves--with a nine-member board dominated by the governor’s appointees.

Why? Wilson’s spokesman, Franz Wisner, says the issue is taxpayer accountability. The CalPERS board certainly has a responsibility to its beneficiaries, he says, but Wilson also believes that the board has a responsibility to taxpayers.

If CalPERS were looking out for both groups, Wilson argues that the fund could work harder to reduce the state’s cost of funding the plan. Right now, state and local government units make two-thirds of the required annual contributions; employees contribute the other third.

Who would Wilson place on the board? “Sound financial experts,” Wisner says. As for the way the fund’s billions are actually managed, though, “you’re not at all going to change the way that they make money.”

There seems to be a problem here, however. What if the people now on the board have fostered an environment that has allowed the CalPERS investment staff to beat the averages? If that’s been the case and you change the board, you could also change the environment and the staff’s motivation to produce good returns.

Which means Wilson could end up hurting taxpayers’ cause by reducing CalPERS’ returns--thus requiring more funding from taxpayers rather than less.

David Tirapelle, head of the state’s personnel department, a Republican and a CalPERS board member, admits that a central question is whether CalPERS’ staff has invested well “because of the board or in spite of the board. . . . And I don’t know the answer to that.”

But he too argues on Wilson’s behalf that the board would benefit from having more members with “an investment background.”

Some outside observers, however, believe that Wilson’s plan to dominate the board with political appointees is a mistake. Leave well enough alone, they say. “Mixing politics and investment management doesn’t work,” argues Budge Collins, head of Newport Beach-based Collins Associates, a consulting firm that advises pension managers.

Like many outsiders, Collins gives credit for CalPERS’ performance to Dale M. Hanson, the outspoken chief executive of the fund. “I think everyone agrees that Dale Hanson has done a great job,” Collins says. “To manage $60 billion is almost an impossible task.”

Hanson has charged that Wilson’s plan is nothing but a blatant power grab. Hanson’s staff has painted Wilson as unhappy with CalPERS’ strong activist role in monitoring the performance of corporate managers whose stocks are in CalPERS’ portfolio.

Hanson has angered executives of such major California companies as Lockheed and Occidental Petroleum by attempting to use CalPERS’ leverage as a big shareholder to effect changes in the companies’ business plans. Hanson says he simply wants companies to work harder for shareholders, so that their stocks rise--and with the stocks, CalPERS’ investment return.

The governor’s office denies that Wilson has any problem with CalPERS’ activism. Of course, to say otherwise would fly in the face of Wilson’s stated goal of saving taxpayers money.

Even so, Hanson’s high-profile jawboning raises a valid question: Does it boost CalPERS’ stock returns? Or would his time be better spent hunting for brighter investment managers or exciting new investment vehicles worldwide? (In that sense, Hanson’s time is also his beneficiaries’ time, as well as taxpayers’ time.)

Obviously, the answer can’t really be quantified. But Collins and other outsiders doubt that Hanson’s corporate activism translates into much of a payoff in the short term. “My guess is that for the amount of (effort) he spends relative to the value added, he’s wasting his time,” Collins says.

Still, as the nation’s largest public pension fund, Hanson’s activism is viewed as important for American shareholders large and small. By virtue of CalPERS’ size and the amount of stock it controls, Hanson gets heard, and he forces companies to confront their performance, or lack of it.

Ultimately, that should be good for all shareholders and by proxy for CalPERS’ beneficiaries and the state’s taxpayers.

Whether Gov. Wilson buys that concept isn’t clear. But at the very least, CalPERS’ healthy returns in recent years suggest he needs to prove why the fund truly needs major surgery.

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Does CalPERS Make the Grade?

Despite controversy over its management, the $62.4 billion California Public Employees’ Retirement System investment fund has produced above-average investment returns for its members since 1985. A look at how CalPERS stacks up against the median return of 30 state pension funds tracked by SEI Corp.

Annualized returns, five years ended June 30, 1990:

Total Portfolio 30 STATE FUNDS: 12.15%

CALPERS: 13.30% Stock Portfolio 30 STATE FUNDS: 15.65%

CALPERS: 15.90% Bond Portfolio 30 STATE FUNDS: 10.26%

CALPERS: 12.50% Real Estate Portfolio (Equity) 30 STATE FUNDS: 7.39%

CALPERS: 8.30% Source: SEI Corp. (pension consultants)

Where CalPERS Invests

The CalPERS fund’s asset mix as of March 31: U.S. bonds: 39.2% U.S. stocks: 36.8% Foreign stocks: 9.5% Real estate: 8.7% Foreign bonds: 4.6% Cash: 1.2%

Source: CalPERS