CalPERS has long been falling back on the Democratic Party strategy of thinking that every problem can be solved with PR.
The problem is that CalPERS isn’t very good at PR.
Today’s example is how CalPERS beneficiaries are up in arms about the offensively false claims the giant fund made in an e-mail about its plans to blow its brains out, um, load up on risk in an overvalued market in a desperate effort to earn its way out of its underfunding hole. We’ve provided a high-level treatment about why this gamble is likely to end badly; we plan to post on additional less obvious but just as important defects in this scheme.
The announcement of the CalPERS plan, which is to lever the entire portfolio so the fund can increase its investments in private equity and make a new plunge into private debt, elicited mainly skeptical and often outright critical responses from the press.
The CalPERS response is to try to attempt to drown that out via messaging to beneficiaries, which in this case was through e-mail. One of the core tenets of marketing is not to fundamentally misrepresent your product. CalPERS appears not to have gotten the memo that the Big Lie works only when you are in a position to dominate communications and keep hammering your false idea, as the Bush Administration did with WMD in Iraq.
Yet the giant pension fund has repeatedly acted as if bogus notions it has sold successfully to its captured and clueless board will go over as well with the press and general public. For instance, CalPERS doggedly maintains it can meet a 7% return target in a super low investment rate environment. Yet CalPERS overall return for the past year was 6.7%. Its annualized returns for the past five years was 5.8% and for the past 20, again 5.8%. Its 10 year results, of 9.1%, do make its target seem more plausible, but recall the starting point was the depressed post-financial crisis market. And that’s before factoring in the fact that top investors such as Warren Buffett and Mohamed El-Erian, see this market as wildly overvalued, which means future returns are likely to be lower than ones in the past.
CalPERS also has an unfortunate tendency to talk down to its beneficiaries, which only further alienates them when they can see through CalPERS’ misrepresentations.1
This e-mail, which was already unusual (only the second of what CalPERS may intend to be a monthly missive) had the subject line “Our Strategy to Secure Your Retirement”. It appears many recipients skipped over the first item, “Will Covid-19 Impact My Retirement Check?” with its “Read the FAQs” button underneath. They instead went to the one that keyed off the subject line:
At CalPERS, our mission is to deliver the benefits that members have earned through their years of public service. To do that, we invest in assets to help grow the fund so we can pay pensions for generations. That’s important because 58 cents of every dollar spent paying benefits comes from what we earn on our investments.
That long-term mission requires long-term vision. The goal is to deliver a 7% risk-adjusted return over the next 10 years. The plan to get us there is two-fold: better assets and more assets.
- “Better assets” refers to assets with the potential for higher returns and less risk and volatility, which increasingly are rooted in private equity and private credit. We must diversify our assets to include these opportunities.
- “More assets” means increasing the base of the assets generating returns in the portfolio, specifically through thoughtful, careful leveraging, also known as borrowing. While interest rates are low, we intend to borrow and acquire more assets for higher returns.
Our investment leadership team has been developing this new plan over the past few years. We designed an investing horizon that stretches decades, but the approach can also weather shorter-term market volatility, such as the economic recession caused by COVID-19.
Last year, we redeployed $64 billion in capital to reduce risk, saving $115 million in fees every year going forward by cutting the number of outside money managers we use. Nearly 80% of the fund is now managed more efficiently and at significantly lower costs by CalPERS investment professionals rather than third-party managers.
And, by taking advantage of different investment approaches involving treasuries and public equities, or stocks, we were able to offset $11 billion in losses during the time financial markets were falling sharply in late February through March. The CalPERS investment portfolio is currently valued at more than $390 billion.
Finally, we will fulfill this plan through a total fund approach, which means each asset class, such as fixed income or public stocks, works together to achieve the 7% return target. The total fund collaborative effort allows us to capitalize on our strengths: our fund’s size, our diversification across asset classes, and our ability to concentrate on investing for the long term.
We will take advantage of our strength as an investor, as the largest defined benefit public pension fund in the U.S., to focus on a strategy that will secure our members for many years to come.
Embarrassingly this short missive can’t even get the basic story straight. CalPERS’ target is a nominal 7% return, not a 7% “risk adjusted” return.
Virtually every paragraph is false but it isn’t clear how far readers got before they started choking. One simply said, “It’s ridiculous.” Another recipient said to multiple CalPERS contacts via e-mail, “I guess someone at calPERS is going to get a Nobel Prize in economics. Higher returning assets with less risk. CAPM is dead.”
If Chief Investment Officer Ben Meng had tried making his “better assets” claim in a finance course, he would have flunked, but here he and CalPERS are working hard to misinform CalPERS beneficiaries.
Other recipients also circulated their objections to the obviously bogus “better assets/more assets” patter to other CalPERS beneficiaries. And these statements would be violations under securities laws, as one expert pointed out:
I got this piece of junk email from CalPERS today. It’s pretty disturbing, in that if you click on the “review the plan” button under the investment plan portion of the email, it takes you to a webpage that makes what are just clearly false claims about the investment plan, in a way that would subject them to sanction by the SEC if they were a private-sector investment manager.
Here is the first bad thing they say:
“Better assets” refers to assets with the potential for higher returns and less risk and volatility, which increasingly are rooted in private equity and private credit. We must diversify our assets to include these opportunities.
For them to describe private equity as having “less risk and volatility,” when it is by their own numbers the highest risk, highest volatility asset class in their portfolio, is just unbelievably false.
Here is the second bad statement:
“More assets” means increasing the base of the assets generating returns in the portfolio
Nobody can promise that non-guaranteed investments are going to generate returns! Investment managers get into big trouble for not stating clearly that there is a risk of loss! All that CalPERS can really say is that leverage allows them to expose more assets to the market, where they believe that returns should occur over time.
Troubling, yet unsurprising.
We need to underscore how insultingly dishonest the “better assets” claim is. For starters:
Private equity is high risk. Academic studies for decades, as well as the benchmarking of every professional investor in private equity, including CalPERS itself, explicitly treats private equity as higher risk than public stocks. And stocks in turn are higher risk than other major asset classes. So it’s not just false, but phenomenally so, for CalPERS to make statements that are at odds with what its expert consultants, its Chief Investment Officers, and its own metrics maintain.2
Private equity is no longer high return. Oxford professor Ludovic Phalippou has documented that since 2006, private equity has only performed on par with the S&P 500. This is the apparent result of too much money chasing too few deals, and the eagerness of desperate investors to throw money at private equity has not changed of late.
A big reason CalPERS is so fixated on private equity is that it has been a crappy investor in public equities. CalPERS for years has underperformed in public equities because it made a bad bet on the dollar and put nearly half its public equity portfolio in foreign stocks. This pattern of botching public equities continues. From the Wall Street Journal:
Calpers’s stock portfolio earned 6.1%, just short of the fund’s equity target. The S&P 500 was up 8.22% for the 52-week period ended June 28…Private equity in 2019 returned 7.7%.
Consistent with Phalippou’s analysis, CalPERS’ private equity performance fell short of the S&P 500.
As for the “more assets” claim, CalPERS seems unable to get its messaging straight, which creates the worrisome impression that CalPERS is actually improvising its supposedly very deliberate “We’re in this for the long haul” strategy. Recall how CalPERS similarly couldn’t get its story straight on its “private equity new business model” because it was making it up as it went along and kept revising its plans (if you could even call them that) on the fly.
CalPERS is almost certainly borrowing against its Treasuries, since that would be its cheapest source of funding. But where is that money to go? CalPERS first and loudly said it would all go to private equity and its new salvation, private debt. They then did a 180 and tried saying they wouldn’t use the newly-raised additional monies for that. Here they have third message, of muffing the issue.
Let’s continue with the howlers. CalPERS seems almost constitutionally unable to stick to the truth.
“Our investment leadership team has been developing this new plan over the past few years”. Huh? Ben Meng arrived in January 2018. He hasn’t operated in a consistent manner, expect for forcing out senior CalPERS professionals with strong credentials, like Ron Legnado and Paul Mouchakkaa. Since CalPERS has not had the same “investment leadership team” driving the bus in “recent years,” the assertion can’t be true on the basis of turnover alone.
But this assertion is also demonstrably false by virtue of the way Meng has changed course, for instance first by increasing CalPERS commitment to emerging managers, and then cutting it. The plan to commit big to private debt similarly wasn’t an idea incubated over the years but seems to be something CalPERS seized on when Howard Marks of Oaktree Capital pitched them on his new distressed debt fund.
As one CalPERS insider told us earlier this year:
Ben’s track record in his first stint at CalPERS was not very good . Why did we bring him back as CIO in light of this?
Ben’s real interest is in Private Equity, probably mostly to secure himself a job in that field once he abandons CalPERS. Now CalPERS has close to $30 billion invested in Private Equity with another circa $21 billion committed but uninvested on which it is paying a 1.5% fee. CalPERS can’t put enough to work in PE to make any significant difference in hitting its 7% discount rate (assuming its capital market assumptions are even reasonable and private beats public) and yet Ben keeps touting it as CalPERS’s savior. You and I know the math doesn’t work. CalPERS’s PE staff are reluctant to put more money to work because they know it just means buying into inferior deals and yet Ben is relentless in the press about the benefits of it.
Ben is getting paid twice what Ted Eliopoulous was paid and yet his contribution thus far has been to turn CalPERS into an essentially indexed fund in the public markets space. Nice work if you can get it. [CEO] Marcie [Frost], when you talk to her, seems to think it’s a big accomplishment. What it really speaks to is the fact is that in anything outside of Fixed Income CalPERS’s track record in active management was dreadful both outright and in comparison to our major peers such as Florida’s SBA, Texas Teachers and CalSTRS.
Last year, we redeployed $64 billion in capital to reduce risk, saving $115 million in fees every year going forward by cutting the number of outside money managers we use. CalPERS, in a an oblique manner, is still trying to defend its decision to cut its tail risk hedges, because for want of other place to account for the program, it had lumped them in with completely different outside managers. So this $115 million CalPERS is braying about, which includes the few million it was spending on tail risk hedges, was more than offset by the $1 billion in gains it sacrificed this year.
Oh, and don’t try pretending, as CalPERS does, that those hedges were too pricey. That strategy, including the returns of the assets hedged (which actually lowers the total returns for the strategy), delivered over 11.5% annualized since 2008, better than CalPERS overall returns and consistent with its supposedly not-achievable-any-other-way private equity returns.
“… we were able to offset $11 billion in losses during the time financial markets were falling sharply in late February through March.” CalPERS’ own records show this is false. The fund’s market loss in March was $8.1 billion in public equity and $13.8 billion in fixed income as you can see on page 14. Or has CalPERS cherry-picked dates to hide how badly it did?
The $11 billion in fact is what Meng previously claimed to have added via his “drawdown mitigation matrix” (as if a matrix makes or loses money) through holding long-dated Treasuries and using factor-weighted equity investing. But as CalPERS own figures show, CalPERS lost money in both fixed income and equities. So Meng pulls out a bit of each portfolio to declare some sort of victory?
On top of that, Nassim Nicholas Taleb tore apart the claim that these segments were effective hedges, since to evaluate the true cost of a hedge, you need to look at its performance over time. Taleb’s rough computation shows that CalPERS lost far more in good markets than it clawed back in the downdraft, making these components poor choices. As Taleb put it:
Number one, Mr. Meng said he made $11 billion on alternative strategies that sort of offset the losses during this collapse.
I don’t know if you realize that these strategies need to be weighted against what they made or lost before that. Effectively, we think, back of the envelope calculation is so-called mitigating strategy would have lost something like $30 billion the previous year. So you make $11 billion, you lose $30 billion before, not a great trade, and definitely not a great trade if you take that over long periods of time, where you lose in rallies and make back a little bit in the selloff. That’s not a mitigating strategy, that’s something that may work in the portfolio, definitely not comparable to tail hedging.
In other words, Meng is playing investment Three card Monte, having you look at the $11 billion “gain” while not mentioning the previous $30 billion cost, which means the strategy still cost the fund about $19 billion over the longer-term horizon it is supposed to care about.
“….allows us to capitalize on our strengths: our fund’s size…” CalPERS size means it is hard for it to do better than index-level returns in private equity, as its own consultants have pointed out. And CalPERS has not taken advantage on the big benefit its size should confer, that of hiring better people, which should help it deliver better results. Instead, CalPERS’ investment performance has consistently lagged that of its smaller Sacramento sister, CalSTRS. And Meng has been driving out what investment talent CalPERS had, apparently preferring, like Marcie Frost, to surround himself with sycophants.
As one insider summed up: “They must know they have a problem.” And CalPERS lacks the self-awareness to see that is the real message they are sending.
1 Even though the text in question does score as written at the 11th grade level, the reason is the high density of investment and economic terms. Compare the CalPERS text to that of Wall Street Journal or Financial Times, or even the business section of USA Today, and you’ll see the difference.
2 At best, CalPERS is trying to snooker sort-of finance literate people with its “low volatility” claim. This is a Sharpe ratio fallacy. If you have fewer price observations, you will have a lower Sharpe ratio. Private equity is valued only once a quarter. Stocks are liquid, so they can be priced (absent a circuit-breaker-induced or other suspension) virtually as often as you want when markets are open, as HFT traders will attest. On top of that, as we have explained repeatedly, long form, that it is widely understood that the appearance of lower volatility (even based only on quarter end marks) is due private equity firms “smoothing” as in lying about their valuations in down markets.