MOORLACH UPDATE — CalSTRS vs. CalPERS — July 24, 2018

During the Dot-Com Boom of the late 1990’s, CalPERS held a 60 percent position in equities and was generating above average total returns. When compared to CalSTRS, CalPERS was rocking, for a while. The Chief Investment Officer of CalSTRS at the time was criticized for having a heavier weighting in fixed income investments.

Then-California State Controller Kathleen Connell demanded that then-CalSTRS CIO, Thomas Flanigan, liquidate his fixed income holdings and reposition into equities. Mr. Flanigan refused. Why sell bonds paying 8 percent when equities were trading at such high levels above the mean that doing so did not make sense? Flanigan was correct and prescient. Connell was ambitious.

Connell wanted to run for Governor and could back up a U-Haul truck in New York City in order to fill it with campaign contributions from money managers salivating at the opportunity to invest CalPERS’ funds. This is a colorful way of explaining “pay to play,” but this obscene behavior has subsequently been strongly curtailed.

How to make the move? Connell summarily had CalSTRS CIO Tom Flanigan fired (see The Pensions & Investments article is quite telling. Mr. Flanigan’s successor was given tragic marching orders:

“Mr. Mitchell’s first major task will be to make significant asset allocation changes to the system. The day before [the] board selected him, members sharply increased the equity allocation of the underperforming pension fund.”

The new CIO purchased equities at the top of the market by liquidating high yielding bonds. Within a few months, the Dot-Com Bust occurred and CalSTRS lost billions of taxpayer dollars. Such is the little-known but ugly legacy of Ms. Connell. If this move had not occurred, CalSTRS would probably be fully funded today. It’s a sad story. And, with ever rising pension contributions staring school districts in the face, achieving above average returns going forward is a must. (I’ll be providing more on California’s K through 12 school districts in the near future.)

Why do I share this history? Because the Naked Capitalism article below provides a comparison of CalPERS and CalSTRS in a rather unique manner. Using benchmarks is important, but between sister organizations it’s a two-edged sword. With Connell, CalSTRS moved too late and at the worst time. So pressure should not be put on a system if the underlying investment strategy may be solid.

With that said, it is still healthy to provide a critique, especially over a recent period of time. The observation that CalPERS has an incompetent board is something that I have shared openly for many years. With two-thirds of the board members being union representatives and lacking extensive investment backgrounds, you can see the obvious deficiencies of the current structure. And, CalPERS has made some strategic timing errors, including reducing its equity position in anticipation of Hillary Clinton winning the Presidency. With Donald Trump in the White House, the equity market improved dramatically. Oops. This caused a major opportunity cost for CalPERS in excess of $1 billion.

The author brings up an assumption that the CalPERS CEO, Marcie Frost, missed our recent Huntington Beach Pension Panel intentionally. This is new news to me and I cannot confirm it (see MOORLACH UPDATE — David Kiff — July 13, 2018).

The author also uses a pseudonym and may have motives that are questionable, but the last time I was mentioned in one of her pieces, the subject matter resigned shortly afterwards (see MOORLACH UPDATE — SB 1297 – COO — April 19, 2018).

Yves Smith may be Susan Webber of Aurora Advisors, Inc. It would seem that Ms. Webber has Ms. Frost in her crosshairs for personal reasons, but that is speculation on my part.

I just want to inform you that my interactions with Ms. Frost started roughly, but have smoothed out quite well. In fact, we have been on a panel together before. And we were notified sometime before the event that she was called to jury duty. So, I will assume that she actually had to serve and that this was the reason she missed our recent forum. I have no reason to believe otherwise.

Why Is CalSTRS Continuing to Out-Perform CalPERS?

By Yves Smith

We had a busy time on the West Coast last week, which included a visit to CalPERS’ offsite in Concord. More on that in due course.

In the meantime, let’s look at what techies would call an anomaly: that CalPERS consistently lags its Sacramento sister, CalSTRS, in investment performance. CalSTRS, at $223 billion in assets, manages the pensions of state teachers. CalPERS, which stands at roughly $350 billion in holdings, should have an advantage over CalSTRS by virtue of its larger size and reputation, which should enable CalPERS to attract and retain higher-caliber investment professionals, as well as occasionally get better terms by virtue of making large commitments and having one of the highest-profile names.

Yet here are the results:

Fiscal year 2017-2018: CalSTRS 9.0% versus CalPERS 8.6%

Fiscal year 2016-2017: CalSTRS 13.4% versus CalPERS 11.2%

Ten year average for the fiscal year ended 2016-2017: CalSTRS 6.81% versus CalPERS 6.45%

In addition, CalPERS long-standing head of fixed income, Charles Ishii, was renown in the investment industry for regularly delivering top 10% performance, to the degree that he was regularly recruited by fund managers. But CalPERS was fortunate in that Ishii apparently had what few possess: enough. His retirement this year is likely to increase the performance gap between CalPERS and its peers.

So why is CalPERS’ performance falling short? Long-standing private equity columnist Dan Primack, who now reports for Axios, attributed it to CalPERS’ habit of jumping on fads late in the game, like divesting from tobacco stocks at the bottom, right before the Federal-state settlement. Primack’s take on CalPERS’ proposed private equity scheme hasbroader implications:

Over the years, CalPERS management has treated its private equity strategy like a toddler treats a Netflix queue. Let’s try this. No, let’s try that. I don’t even know what that is, but it sure looks cool….

Late-stage and Buffett-style strategies are the two hottest trends right now in private equity, which likely means it’s a questionable time to launch new programs that won’t be ready until the first half of 2019. In fact, CalPERS has a distressing private equity history of diving in near market tops and exiting near market bottoms (see: Capital, Venture).

Similarly, as we’ve noted, CalPERS’ public equity performance has fallen short in recent years because the fund made a big anti-dollar bet in the form of putting about half of its equity portfolio in foreign stock during what wound up being a strong dollar period. Oops.

Our view has long been that one of the reasons that CalSTRS does better is that it has a vastly and visibly more capable board. The board members have clearly read the staff’s materials in advance and have a good understanding of investment principles. They push back on the staff and the outside consultants.

By contrast, as we’ve discussed at length, CalPERS has a diseased culture of casual lying and anti-accountability. CEO Marcie Frost has actively enabled it by telling whoppers, like her eye-popping defense of resume fabrications by later-ousted Chief Financial Officer Charles Asubonten, or ducking out of a panel discussion with pension critic John Moorlach at the very last minute. The OC Weekly announced, meaning effectively reconfirmed, her participation in the July `12 event in a July 11 story.

And what was Frost’s excuse for standing up Moorlach and the event hosts? Insiders say Frost claimed she had jury duty. First, you don’t get put on jury duty at the last minute. Second, Frost someone miraculously completed the usual two-week stint in time to join in the CalPERS offsite on July 16, a mere two business days later. So not only does she lie, she appears to go out of her way to insult the opposition by making it clear she can’t be bothered to lie well.

Frost has also fetishized the use of the management baffle-speak “team members” and attributing decisions and action to various teams. This practice undermines accountability and transparency.

With leadership like this, there’s no reason to expect things to get better at CalPERS. And the staff’s dogged pursuit of a corrupt-looking private equity scheme for which it can’t even muster a plausible rationale says there is good reason to expect things to get worse.

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