CalPERS: seeking a more global stance

Jenny Blinch: What impact have the recent crises in the markets, especially in the financial sector, had on CalPERS' global equities portfolio?

Eric Baggesen: Where the sub-prime crisis - and I would call it a liquidity crisis on top of that - has had an effect is that when risk premiums are increasing, that tends to be not a very good environment for equity investing, so we've tended to be underweight our equity asset class for about the last year to 18 months given our strategic targets. And part of that, again, is just a reflection of the turmoil that's happening and spreading across all the different market segments.

Jenny Blinch: What is your stance in the debate around accounting standards and the marking to market of assets?

Eric Baggesen: I think as an organisation CalPERS has got some concerns in relation to that potential marking to market - in other words, the returns that are available right now in the market do not equal the 7.75% return estimation that we have for the plan.

I think what the organisation is concerned about is that those numbers can then be used to potentially call into question the investment premise behind CalPERS and also the entire organisation. It's the perpetual nature of the pension fund that allows you to expose it to investment risk, which has been well rewarded over the years in returns higher than you could obtain in, say, just government bonds. At any point in time, anyone who takes any investment risk in their programme can see variations in value and the investment thesis for taking risk is that you have to be able to withstand this.

I don't understand why an organisation like CalPERS or any other governmental sponsored plan would not be viewed in a perpetuity context - I think that aspect comes from corporations, where their existence is much more tenuous, so there's more concern about, 'ok what's the terminal value of the pension fund right now if the corporation were to go out of business?' That liability [would then] fall off to the Pension Benefit Guarantee Corporation.

Jenny Blinch: There are some that are pushing for public plans to come under the same accounting standards as corporate plans. You clearly think this would be wrong, then?

Eric Baggesen: I think right now in the US the things that are closest to perpetuity are governmental structures - they're not subject to the same forces as corporations. To apply a uniform standard - and a standard that would tend to make the investment programme extremely conservative - literally looks like a movement back to where pension investment was 50 or 60 years ago and ignores all of the experience of that intervening time period where pensions have been well-served by being able to take some incremental investment risk.

Jenny Blinch: How much of a role do indices play in what you do?

Eric Baggesen: Indices are extremely important at CalPERS, they form the basis of our strategic asset allocation work and our asset liability modelling. They're also important for establishing a base line as far as risk is attached to the programme - everything that we do at CalPERS is compared to some kind of a benchmark. In some asset classes, such as equities and fixed income, the benchmarks have greater alignment with what we actually are able to invest in. The benchmarks attached to private equity and real estate are a bit more tenuous, they're not necessarily a good reflection of what the investable universe is. In the global equities area, for example, we look at all of our programmes and portfolios relative to benchmark portfolios and that helps us understand risk and it also helps us understand where we're actually able to generate value-added results.

Jenny Blinch: Do you ever see a move away from benchmarking and relative returns to a more unconstrained approach?

Eric Baggesen: It would depend on where the board were to direct the structure of the asset liability modelling; as long as that work is done in relation to benchmark-like return streams, it would seem difficult to move away from them. I don't see us moving completely away from benchmarks at this point, unless the asset allocation is done completely differently.

Jenny Blinch: Climate change has been a key investment trend this year. How active is CalPERS in this area?

Eric Baggesen: This is a big issue for CalPERS. In the global equities area, we have a relatively small portfolio that's being invested in accordance with global themes. Climate change is one of those, but not the only one. We're looking for more ways to incorporate climate and environmental themes in what we do. Part of that is constrained by the actual information and how those aspects relate to investment returns, so it makes it a little difficult to do that in the public markets. I think the climate change aspect of the CalPERS portfolio is the most meaningful in the real estate area - there's a lot of activity that goes on in relation to green buildings, reducing electrical footprint, carbon footprint - and it also is an aspect of our private equity investment as well. Those two areas have more natural resonance to the environmental area and climate change investing - it just hasn't rolled into the public equity area as strongly yet, but we keep looking. A lot of the early ways [of investing in this arena] were based on screening out the bad - what we're trying to find now are ways of positioning portfolios that are not so much based on screening out the bad, but emphasising the good. That's the area we're most interested in, in the global equities space - that's how I would expect our programme to metamorphose in the next couple of years.

Jenny Blinch: What other big investment themes do you expect to see play out over the next couple of years?

Eric Baggesen: We're slowly migrating our portfolio to more of a global stance in the equity space. Last year we adopted a stance where we would tend to weight our portfolio exposures more by global market capitalisation than [allocating] a fixed proportion to the US, so that eases the home market bias. The reason for this is the recognition that economic activity is becoming more global - a lot of the economic activity and development in the world is moving to new countries, in other words it's moving to the emerging markets. As that economic activity serves to increase their capital markets, that would then translate into us increasing our investment exposure in those low caps, so it's just a reflection of where global economic growth is taking place.

Jenny Blinch: You were appointed to head of global equities in May, what do you feel is the biggest challenge facing you in the long term?

Eric Baggesen: One of the primary goals I have is for us to think of the global equities portfolio in a more holistic fashion and do more analysis of how different pieces of the portfolio fit together and really look at the way we carry out activities.

Jenny Blinch: Do you feel there is currently some overlap within the portfolio?

Eric Baggesen: It's more a question of looking at how capital gets allocated. For example, in the global equities portfolio we have a segment of money which gets invested internally, another which uses external managers, another which looks at the Manager Development Programme and environmental stuff, another which looks at corporate governance, and another which looks at hedge funds. When we go and interact with the CalPERS board there has tended to be allocations of capital to specific programme areas and when that happens, you have a harder time [working out] how each programme area interacts with the entire global equities portfolio.

In other words, if I made an allocation to a hedge fund programme a couple of year ago, do hedge funds offer the opportunity today that you might have in another part of the programme? And if capital has been allocated down to the hedge fund programme, that doesn't allow you to look at the trade-off between that programme and other programmes. We need to be more fluid and more explicit about analysing trade-offs between different alternatives when we allocate capital in current markets. In many instances, the portfolio within CalPERS has been built from the bottom up on the premise that if we have the best thing here and the best thing there, [when] you add them all together, you end up with the best thing [overall]. That's not automatically a valid assumption. It may end up that way, but we need to do the analysis both from the bottom up and the top down.