The Wind of Change

Raquel Pichardo-Allison: You've got off to a very vocal start, particularly in the area of shareholder rights. How do you plan to put CalPERS' weight behind that?

Joe Dear: CalPERS has always had an interest in corporate governance and has always had a very strong programme. It's one of the elements that attracted me to this job, in fact. Institutional investors, indeed all investors, have an incredible opportunity to reshape the regulatory environment of the financial services industry. That could either go to protect the status quo and leave us vulnerable to another disaster, or reshape the environment in a way that protects investors.

Raquel Pichardo-Allison: There's been some debate in the UK about what role institutional investors played in the downturn and whether or not they were vocal enough about corporate governance. Do you think institutional investors are partly to blame?

Joe Dear: A collapse of the dimensions that we've experienced takes more than one element to fail in order to achieve the magnitude that it already has. There are a lot of lessons for investors to draw... particularly in respect to risk management. But I think it would be a huge error to attempt to lay the blame on what happened on investors and away from failed regulation and misaligned incentives of objectives in the financial service industry, along with unreliable credit ratings.

Raquel Pichardo-Allison: Should ratings agencies be more heavily regulated?

Joe Dear: The performance of the ratings agencies is one of the major contributing factors to the financial debacle with respect to the scope in which they are allowed to operate, their freedom from accountability for their recommendations and the reimbursement structure which exists. (This) has created a situation that is untenable. Large institutions like CalPERS with our own research capabilities don't have to depend on the ratings agencies. If all investors were like us, the solution would be to say, ‘Let's get rid of them.' But that's not realistic. Other investors do require services that a rating agency can provide, and under that circumstance, we need to provide an environment that is free of conflict and as transparent as can be.

Raquel Pichardo-Allison: Will that have to be done through government regulation?

Joe Dear: It has to be, because government is creating the demand for the regulation by demanding reliance on ratings. Even in the current TALF (term asset-backed securities loan facility) programme, the agencies are baked in.

Raquel Pichardo-Allison: Do you have any themes or objectives on where you want to take CalPERS going forward- investment or otherwise?

Joe Dear: CalPERS has a completely developed investment and advocacy programme. It's not missing anything. There's nothing we're not doing that we should be doing. So the question for me as a new CIO is how can I get CalPERS to perform more effectively, how can we pursue the opportunities which exist more aggressively and how do we generally seek to do a better job on behalf of our beneficiaries. It's an investment, it's a management, and it's a policy challenge.

Raquel Pichardo-Allison: You've already made some changes to your hedge fund programme.

Joe Dear: With respect to the hedge fund programme we have a major initiative. It's a restructure not of the portfolio, but of the relationships we have with our managers. We're seeking three fundamental changes. One is better alignment of interest, which is to say compensation that rewards the investor and the manager... We'd have a longer-term horizon...and create an arrangement where the investor, us and the partner make money at the same time. Second, we want control of assets so that we're not dependent on the manager for when we can buy or sell. Third, we want transparency of positions so we can manage the risk of our total portfolio.

Raquel Pichardo-Allison: How have your managers responded to that?

Joe Dear: We're having very good discussions with our managers about how to achieve these three objectives. The discussions are going on, we're right in the middle of that.

Raquel Pichardo-Allison: When all is said and done, what will your hedge fund line-up look like?

Joe Dear: The intention here is not changing the structure of the portfolio, it's changing the structure of the relationship. If the portfolio changes, it will be because of market conditions and not the strategies. We're going to get these things worked out before we embark on new investment relationships.

Raquel Pichardo-Allison: How is the Sprout Programme (a proprietary seeding programme for start-up hedge fund managers) going?

Joe Dear: It's just getting started.

Raquel Pichardo-Allison: Will you be asking other pension funds to co-invest?

Joe Dear: There's no intent at this point to offer a hedge fund of funds service to other investors. We're trying to develop a programme that not only has relationships with the best hedge fund managers, but that is capable of identifying and helping launch the great managers of the future.

Raquel Pichardo-Allison: What are some of the highlights of your new placement agent policy?

Joe Dear: The policy CalPERS adopted provides for comprehensive disclosure of the activities and compensation of placement agents used by existing and potential investment partners. Along with that it provides disclosure to the public so that everyone can be aware of who's doing what.

Raquel Pichardo-Allison: Do you think managers will continue to use placement agents in the same way they have in the past?

Joe Dear: I think there's a viable role for intermediaries in the investment process. I think smaller or newer firms will particularly benefit from the service they provide.

Raquel Pichardo-Allison: What do you think of the pension funds that are banning the use of placement agents?

Joe Dear: We did what we did, which was to create comprehensive disclosure.

Raquel Pichardo-Allison: The board has decided to change its asset allocation. The common denominator among the potential new allocations was an increase in private equity and a 2% allocation to cash. Why was it important to have that allocation?

Joe Dear: It's important to see this asset allocation change as a mid-course adjustment, not a wholesale change in the composition of the portfolio. The next (major asset liability study) is in 2010. Because of the drop in the value of publicly traded equities, the percentage of the portfolio taken up by the private equity portfolio reached the top limit of the pan. So this was a reallocation of equity. The creation of the cash allocation was a direct product of the lessons we had in 2008 to maintain a view towards liquidity needs and if we were to maintain any cash, to put it in the asset allocation.

Raquel Pichardo-Allison: Where do you see the most opportunities in the next six to 12 months?

Joe Dear: Oh, I don't want to get too specific. There certainly appears to be opportunities with credits and mortgages to take advantage of distress and mispricing. It appears there are opportunities in fixed income that are offering equity-like returns with slightly better risk in terms of where you are in the capital structure. The government's TALF programme has the potential to create some interesting opportunities. We've participated in two of the auctions, so far. And we're looking to see how the PPIP (Public Private Investment Program) develops and whether attractive opportunities are created there.

Raquel Pichardo-Allison: Where do you stand on the bull market/bear market debate?

Joe Dear: Short term, I don't know... If this is the turnaround, it's messy. If this is not the turnaround, when it comes, it'll be a lot like now. There's two things that are fundamental, the credit markets have to return to something like normal function, and in the US, the housing market has to stabilise. Until those two things happen, investment conditions will remain extremely difficult.