Calpers and Risk: Together Forever?

Leo Kolivakis's picture

Via Pension Pulse.

Roane of Fortune reports, Calpers
and risk: Together forever?
(HT: Bill Tufts, click on link for full article):

clocking a $100 billion loss in early 2009, the California Public
Employees' Retirement System, known as Calpers, had the swagger of a
hedge fund and the certainty of a saint. Other pension funds followed
its lead, loading up on leverage, investing in unrated CDOs, shoving
money into high-priced private equity deals and barreling into
commodities and real estate.


The question
now is whether a loss of nearly 40% of its market value -- the worst
loss in the system's 77-year history -- has brought Calpers
sufficiently back down to earth to avoid another such debacle, and
whether other chastened pension systems have followed suit. In truth,
not all of the evidence of a rebirth at Calpers is comforting. And in
the case of some other underfunded pension funds, their latest
financial bets look downright scary.


"Some pension plans are
evidently hoping to make up losses by taking more risk," says Olivia
Mitchell, executive director of The Pension Research Council at the
University of Pennsylvania's Wharton School, whose research has shown
many pension funds to be poor asset pickers. But, "pension plans that
take a risky position to try to 'earn their way out of underfunding'
are quite likely to bear big downside risk when the market tanks."


is not to say that Calpers, the nation's largest pension fund, hasn't
made some strides in the right direction. Facing billions in unfunded
liabilities and increasing anger from California taxpayers who are
ultimately stuck with the bill, it would be tempting for Calpers to
double down. But Clark McKinley, a Calpers spokesman, says the pension
system "took some bitter medicine" and has learned important lessons
from the recent financial crisis.


is preparing a new asset allocation strategy after finding that its
diversification efforts failed to cushion much of the stock market's
fall. Calpers is also reining in its exposure to equity derivatives,
moving to reduce leverage in its real estate portfolio, terminating
under-performing partnerships, tightening the review process for real
estate investments and bringing together its diverse investment groups
to poll their knowledge about investment risks and opportunities.


McKinley says, information tended to be stove-piped, meaning the
retirement system's fixed income department was selling off mortgages
even as the real estate department was shoveling money into the sector.


of bad bets catch up


Most of Calpers investment losses came
from its largely passive investments in baskets of equities, which
still account for about half of the system's assets. But the retirement
system also got into trouble by adding leverage, reducing oversight
and by chasing other hot markets.


After maintaining a low-risk
real estate strategy for decades, studies commissioned by Calpers show that it switched
gears in 2002, embracing higher levels of risk even as the real estate
market began to top out in 2005. By mid-2009, Calpers had a one-year
loss of 48.8% in its real estate portfolio and was reporting among the
lowest returns of any large pension fund in the country.


In early 2006, it said it would invest $6 billion in commodities,
particularly through index futures, news that caused Grants' Interest
Rate Observer to respond: "On the timing of this demarche, we hand
Calpers the gold medal for Being Late.


Calpers showed even worse timing in the
mortgage market. Just before the market tanked, it invested
approximately $140 million in unrated collateralized debt obligations
(CDOs) and $1.3 billion in complex buckets of loans and debts called
structured investment vehicles (SIV). A Calpers lawsuit puts the SIV
losses at "perhaps more than $1 billion."


If the investment losses
weren't enough, questions have also been raised about why certain
asset managers were chosen by Calpers during this period. The state
brought fraud charges against the pension system's former chief
executive, Fred Buenrostro, and a former board member named Alfred
Villalobos, who later became a money-manager placement agent trying to
steer pension system business. Both men have denied the allegations.


Calpers is clearly a better managed pension
system these days, and has gained with the market rebound over the
last year -- although its $202 billion market capitalization still
falls roughly $60 billion short of its 2007 high and the plan remains
under-funded by many measures.


But Calpers isn't alone in facing
funding difficulties. In one influential study last year, researchers Robert
Novy-Marx and Joshua Rauh, of the National Bureau of Economic Research,
found that pensions are undercapitalized by $3.12 trillion if one
assumes the states have to make good on all of their obligations.


with such possible shortfalls, some pension funds have begun to swing
for the fences again. Last year, North Carolina passed legislation
allowing its state pension to invest in assets such as junk bonds,
commodities and real estate. Wisconsin recently decided to increase its
pension's bond exposure by levering the portfolio, with one proposal to
add leverage up to 120% within two years (in theory this could reduce
the portfolio's stock risk and slightly increase overall returns, but
only if interest rates stay low). The San Diego County Employees
Retirement Association -- which lost about $150 million when Amaranth
Advisors went bust -- is among other public pensions ramping up similar
schemes; it plans to borrow up to 35 percent of its assets and invest
the money in treasury futures, and sock other funds in emerging market


And a recent review of the Illinois Teachers Retirement
System by Alexandra Harris of the Medill Journalism school at
Northwestern University found that more than 80% of the system's funds
were now seen as risky and that it had added leverage by taking the
predominantly risky side of over the counter derivative contracts, such
as credit default swaps.


Although Calpers has remained active in
many potentially risky markets, so far it has refrained from turning to
the sort of concentrated bets undertaken in Illinois or Wisconsin.
That said, economists say Calpers could still do more to safeguard its


Will Calpers follow
Wisconsin and other pension funds leveraging
up their portfolios
? In a world where pension funds will be lucky
to obtain 5% annual return, there is simply no way they will attain that magic 8%
investment return without taking on more risk.

But one thing 2008
taught pension fund managers was that asset class correlations are
notoriously unstable, especially in a liquidity crisis, and that you
have to have safety measures in place to protect against downside risk.

and foremost, pension funds need to do a better job at managing their
liquidity risk. In fact, I think 2008 was a watershed year because
people will look back and say that was the year where illiquid,
complex, structured strategies died and liquid, easier to understand
strategies took off.

But be careful with liquid leveraged
strategies. I know the smart folks at Bridgewater know what they're
doing, and that a lot of the thought process comes from their work on engineering
targeted returns and risk
, but I get very nervous when the pension
herd moves into replicating a strategy/process without
thinking of the consequences of their collective actions, adding more
leverage to the entire financial system (bond bubbles can go on longer
than you think!).

Large pension funds like Calpers, CalSTRS, the
Caisse and CPPIB need to rethink their entire approach to mitigating
downside risk. The focus should primarily be on strategic asset
allocation, with enough wiggle room to make opportunistic tactical
decisions when markets shift abruptly.

These large funds
should also be intelligently multiplying their sources of alpha, both
internally and externally. My bias remains with liquid strategies.
Reuters recently reported that Macro hedge
funds best despite May dip - Lombard Odier

funds taking directional bets on markets will be among the best
performers in 2010 as concerns over the health of major economies
continue to dominate markets, said Lombard Odier's head of hedge funds


Cedric Kohler said on
the sidelines of the GAIM hedge funds conference that strong trends in
currencies, equities, debt and commodities could help the strategy known

global macro to prosper into 2011 despite a disappointing May.


"The overall environment has been driven
by macro events in 2010, and I believe it will continue to be the case
because of economic imbalances in the largest markets," said Kohler,
whose team at the Geneva-based private bank oversees a fund of hedge
funds and advises clients on hedge fund investments.


markets highly volatile, he said macro managers benefited from their
ability to take long or short positions in most markets, trade in very
liquid products and change positioning nimbly if their view of the
economic outlook changes.


"That's not the same for all asset classes; there has been a
significant drop in liquidity in areas like credit, making it difficult
to turn around portfolios when the market moves against you," he said.


CS/Tremont data show global macro
strategies lost 0.63 percent in May, which Kohler said was
disappointing, because such strategies should have performed well in a
month when pressure on euro zone economies triggered heavy market
declines and sent the euro into tailspin.


"The losses were caused because
people were worrying about liquidity and simplifying their trades, with
many ending up in the same trade for different reasons," he said.


For example, he said, managers who had
been short the euro and long the Australian dollar switched into a
euro-dollar trade, which they thought mirrored their original trade and
offered better liquidity, while managers playing the Greece theme
avoided credit default swaps on worries about a regulatory ban, and used
euro-dollar trade as a proxy.


"So people were using same instruments for
different reasons, exacerbating volatility in those instruments."


While Kohler said funds of hedge funds
should thrive after a difficult two years, he expected their numbers to


"There's going to be
industry consolidation. Those funds of funds which are too small or do
not have a clear strategy will either close or be bought," said Kohler.


"But prices won't be high. People won't
be buying their strategy or their distribution, just their assets under
management," he said.

Kohler is too nice. I
think the majority of funds of hedge funds will shut down their operations in the next three years. In a
deflationary world, fees matter even more, and they'd better be really good at picking
alpha managers if they're going to be charging 1 & 10 on top of the 2 & 20. Even
if they are good at picking winners, most investors will balk at paying
an extra layer of fees.

Finally, I leave you with some
excellent Bloomberg interviews that appeared in the last 24 hours. You
will have to click on the links to watch, and trust me, they're all
worth watching, especially the first one with Lakshman Achutan,
managing director of the Economic Cycle Research Institute (click on
links to watch and hit play to load video):

Achuthan Expects Downturn in Global Economic Growth:

Says China's Economy to Slow on Wage Inflation: Video

Crescenzi Says
Treasuries Offer Insurance Against Crises: Video

And this last interview with Bill Fleckenstein, which I
am able to embed here, is for all you perma-bears who think we're
heading into another depression. You'll enjoy it, but I don't subscribe
to his gloomy scenario.

To be fair to Bill, I agree
with some things he says on how the stock market lost its discounting
mechanism. He rightly blames this on speculative momentum type traders
and computer powered quant traders who have developed algorithms to
exploit market inefficiencies. I call this "algos running amok". It
works fine when things are fairly stable, but when volatility spikes,
watch out below!


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kit roane's picture

Hello all,

Very appreciative of the pickup and the link, but could you not paste the entire article next time? 

Best regards,


Problem Is's picture

Nice Shot of the CalPERS Opulent HQ, Leo
Next time tell your guy to photograph from across the street so ZH readers can see the true scale of the extravagant wasteful pensioner and tax payer funds blown by the CalPERS douche bag directors...

With all the empty office space in downtown Sac... that building is the last thing that needed to be built...

Unless lavish penthouse director floors are a must for the west coast wannabe Jamie and Lloyd crowd...

thirtycaliber's picture


Muir's picture

Leo, please elaborate.

"Large pension funds like Calpers, CalSTRS, the Caisse and CPPIB need to rethink their entire approach to mitigating downside risk. The focus should primarily be on strategic asset allocation, with enough wiggle room to make opportunistic tactical decisions when markets shift abruptly."


Spell it out, should pension funds, engage in short selling, FX, exactly what?


IQ 145's picture

 Yes, the comment is ridiculous. It calls for better human beings; and the horse has already left the barn.

Leo Kolivakis's picture

All of the above & more, including buying protection when they need to (simple option strategies) or increasing their government fixed income holdings when conditions warrant. The size of these large pension funds is a hindrance, but they can do a lot more to protect against downside risk.

pitz's picture

Can they really?  I haven't seen any evidence of that.  Pension funds have no business whatsoever in derivatives, options, or anything other than simple indexxed long positions in stocks and bonds.  Nor do they have any business paying their senior managers more than $150-$200k/year.  Bottom line is that there's no free lunch out there ("protection" against downside comes at a huge cost!), and paying for a fleet of managers and analysts delivers no value whatsoever. 

Trying to hide out in fixed income is a disasterous strategy as well, and actually hurts the economy during downturns, when the markets should be naturally rationing credit to the public sector, to re-build the private sector (after all, who pays the bills and generates the wealth that pays these pensions!). 

The size of these public pension plans and the unelected nature of their managers and leaders have usurped democracy and accountability, creating dictatorships that have the ability to bind plan beneficiaries, and even taxpayers, to the decision making of a few chosen ones.   For this reason alone, public pension plans including the CPP should be outlawed. 

IQ 145's picture

 "All of the above and more--" Oh boy wouldn't it be something to see the little civil servants speculating in the FX market ! What a spectacle that would make. Might as well send a six year old out to play on the freeway on her tricycle.

Edmon Plume's picture

"But one thing 2008 taught pension fund managers was that asset class correlations are notoriously unstable, especially in a liquidity crisis..."

Did it?  Did they learn anything?  If something is unstable enough to be notorious for it, no teaching should be necessary.

Not that it matters.  Pensions are a microcosm of TBTFs.  If the risks pay off, they reward management with the upside.  If the risks lose, they stick taxpayers with the bill, at least insofar as calpers is concerned.

IQ 145's picture

 If you're tempted to believe human beings are an intelligent life form, all you need to do is look at Calpers. At the same time it's a very sick joke, it's also very serious.

Rainman's picture

Good thoughts, Leo.

One unmentioned area is the supersonic growth in benefit outlays by the State of CA and municipalities. For the State, the liability side has grown 2000% in the past decade. Municipalities, primarily Counties, have granted similar upgrades in benefits. The result is they are doomed to carrying an unfunded balance due to some cases amounting to an entire year of municipal operating revenues. The $600 million bill CalPers sent to the State is an absolute hoax, especially when compared to the total unfunded by the local governments.

The State legislators are once again in budget stalemate for this FY......GOP refuses the tax increase, the Dems refuse the cuts. Looks like they will be breaking out the IOUs again by year's end.

Leo Kolivakis's picture


California is burning, financially speaking. They have got to take control of spending and reform pensions or risk getting sucked into a lost decade. Thanks for commenting.

IQ 145's picture

 Nobody is going to take control of anything; the lost decade started in 2008; pass the popcorn, please.

pitz's picture

2008?  Try more like 2000.  And its 2 decades, not just one. 

the grateful unemployed's picture

sure the market is a casino, the longer you remain invested the more likely it is that you lose everything. (some people have never stopped to consider what a casino is, a business in it for the long haul)

the problem for casinos is their overhead, literally, which is why there is so much opposition to the new online gambling regulation bill. the stock market analogy was the move to online trading, and electronic exchanges. the casinos business plan is to cover expenses, and when expenses fall the casino's revenues fall as well. the casino isn't a profit driven business model. is there a correlation between more efficent trading, lower spreads, and the viability and market cap of the stock market? probably

Magua's picture

Assuming that equities make up half the average pension, bonds 20% and hedge/private equity 30% - here are a couple scenarios.

Equities up 5%, bonds up 5%, hedge/private up 9% - Total return = 6%

Equities up 0%, bonds up 7%, hedge/private up 8% - Total return = 4%

If equities return 0% for the next 10 years, then many pensions and endowments are nearly 50% underfunded


pitz's picture

Bonds could have negative returns over the next decade as well.  Don't discount that scenario.  If inflation picks up into the 5-10% range, stocks could tick up at 15-20%/annum, while bonds could lose 5-10% of their value every year. 

The fad of trying to liability match (immunize) everything in pension-land, over the past decade, may very well backfire, especially as the value of those long-term bonds simply melt away.  What's a 30-year US t-bond worth if interest rates go to 15%?  20 cents on the dollar?

islander's picture

We are in a depression right now. Stop dressing up this farting mud dripping pig we call an economy. Its embarrassing on your part Leo.

Leo Kolivakis's picture

So why don't we all slice our wrists before Armageddon? The only depressing thing is reading all the skewed negative views on ZH which are primarily tilted to the "world is fucked" scenario. We all need a little more balance, including me. There is no black & white. Growth rates are decelerating, but we are not in a Depression.

Boilermaker's picture

Actually, Leo, we are fucked.  I'm fucked, you're fucked, the boomers are fucked, Gen XYZ are fucked.  The question is, are we going to absolutely cornhole future generations so that you can retire on a beach or are we going to be decent human beings and suck it up.  I already know your position, sadly.

IQ 145's picture

 Why don't we all get 100% into Silver bullion; it's more fun than slicing your wrist. Tilted to the "world is fucked" scenario---Leo, the world is fucked. We all need a little more balance;---naw, we just need to buy more Chinese Solar Panel manufacturers.

Muir's picture

It restates the negativeness of the universe. The hideous lonely emptiness of existence. Nothingness. The predicament of Man forced to live in a barren, Godless eternity like a tiny flame flickering in an immense void with nothing but waste, horror and degradation, forming a useless bleak straitjacket in a black absurd cosmos.

Muir's picture

Ehh, that was the Museum Girl Leo, not me.

Magua's picture

If Bill Gross is right, bonds and equities will return about 5% for the next ten years at best. If you figure that hedge funds and private equity in the new reduced leverage world returns 9%, once they stop producing losses currently, then the average pension/retirement fund is looking at a 6% return on investments if all goes right. Most pensions are closer to assuming 8%.


Can you even imagine what will happen when people find out their currently underfunded pension plans are actually underfunded by another 25% or worse.


What if Gross is wrong and equites are flat for the next ten years? Japan has faced 20 years of flat to down equity prices.

ZackAttack's picture

Before, McKinley says, information tended to be stove-piped, meaning the retirement system's fixed income department was selling off mortgages even as the real estate department was shoveling money into the sector.

That's so fucking dumb, their losses should be considered evolution in action. Then they compounded it by sitting tight and taking a bear market up the chute on these dumb buys. You cannot, simply cannot, take The Big Loss.

Another argument for firing every one of these dumbfucks, doing dead-simple index allocations and letting the computers run it for 5 bp a year. Somebody in California's legislature needs to be looking hard at why they aren't doing this.


it would be tempting for Calpers to double down.

Yes, perhaps even California officials recognize that a Martingale only works if you have infinite cash at your disposal.


IQ 145's picture

 State employees, with all that that implies, playing with other peoples money. Why they don't run it with a computer ? It's another fricken civil service swamp; it's very very important that there's someplace to employ Joe Schmoe's semi-literate brother in law.

Problem Is's picture

" Why they don't run it with a computer ?"

State Computer Purchase Failures
Calif has a long history of fuck ups when it comes to over priced purchases, wrong equipment, poor installations and computer system failures. DMV was the latest...

Betting on the State of Cali to effectively buy a major computer system is like betting on the SEC to win a court case...

nmewn's picture

"Large pension funds like Calpers, CalSTRS, the Caisse and CPPIB need to rethink their entire approach to mitigating downside risk."

Couldn't agree more...and coming out of left field, some thoughts.

It's high time to reorganize state/federal employee pension plans and fold them into Social Security. And I include presidents, congressmen and senators in the proposal.

This benefits society in several ways.

1) It would provide disincentive to those who would abuse trust...kind of like the Fed taking away the interest rate punch bowl.

2) It would allow true price discovery of the assets currently being chased by these large pools of fiat paper.

3) It would begin to restore trust in a social contract between government, the courts and taxpayers as it has evolved into an apparent caste system.

4) It would firm up Social Security obligations to current beneficiaries and those who have had their money stolen from them for all these years who are now approaching retirement.

5) It would allow time for proper reflection on an equitable way, for all concerned, to end the ponzi of Social Security.

Thoughts Leo?




Leo Kolivakis's picture

At one level, I agree with you that we need to roll up city and municipals plans, most of which are heavily underfunded, but why into SS? Not sure about that....who will be managing this mega fund? Too much money & power concentrated in the hands of few is a recipe for disaster.

nmewn's picture

We know SS is toast. There is no money in that ponzi so I guess I would disagree as to the mega part...the money put in there is long gone it is now only a "clearing house" for tax reciepts & payments.

We know we need to decelerate the payroll taxes going into SS and at some point stop it altogether and let the income earner provide for themselves through their own investments with the money that used to go into it.

What got me going on this tangent were remarks by Alan Simpson & the minority leader yesterday about extending retirement age to 70 and trimming benefits to delay (again) the day of reckoning with SS.

Which got me pissed. In other words Joe Sixpack is screwed (again) and government employees will be shitin in tall cotton (again). I'm sayin NO! I'm sayin HELL NO!

Look, I've known since I was 20yrs. old I would never see a dime of what I paid in at the point of a gun (I'm 50 now) this is not about me, I've made/making other arrangements.

This is about fairness & stopping the extortion of future generations. And there is a pile of money sitting over in the government kitty that can help defray the costs of transitioning away from this system...and in my view it is only proper that the government employee's who I paid via OTHER taxes for their wages, vacation, healthcare AND RETIREMENT be lumped into the same retirement bucket.

The only exception for a government retirement would be for the military. And no, I'm not a vet.

As to who would administer the wind down program I don't know. The trust has evaporated on alot of levels.

poorold's picture


"Facing billions in unfunded liabilities and increasing anger from California taxpayers who are ultimately stuck with the bill, it would be tempting for Calpers to double down."

Says it all really...

I believe the current status of things is as follows:

1. The private sector has retrenched and is managing to operate profitably ('cept of course it took buckets of make-believe money to keep the auto and financial sectors looking alive.)

2. The private sector, though it will undoubtedly exhibit signs of health, is faced with its "profits" being confiscated to support an evergrowing public sector.

3. The public entitlements are growing out of control in 2 segments--the number of people receiving entitlements and the number of entitlement programs.

Given the public sector's cannibalization of the private sector, it is simply not possible for any entity (read pensions here) to lay claim to future profits of the private sector other than the Government.

Calpers and every other pension fund is dead.  They just haven't acknowledged it yet.

exportbank's picture

Pension Funds are just play things for their managers (paid very well to risk value). I haven't seen one anywhere that wouldn't be better off just buying government guaranteed fixed income instruments. Chasing yield over decades is a dangerous game and the risk generally is never born by the fund manger or the plan member but by the taxpayer. Pensions need to be fully funded from the get-go and not pretend on an impossible to achieve 8% annual return every year for 25-years. Pensions are the most obvious case of actuarial accounting fraud to foist a gigantic problem onto the taxpayer. 

Boilermaker's picture

Actually, wouldn't they have been better just keeping it in a passbook?

IQ 145's picture

 Correct. It's a shame they can't sue the fund managers.

sangell's picture

There seems to be a ( worrying?) trend for states to use their public employees pension funds for bridge loans to help the legislatures balance their budgets.

Calling state debt an asset able to meet pension obligations seems at least as risky as any hedge fund investments.

knukles's picture

Mayhaps CalPers "call" on the treasury of the California Republic has something to do with their assumed risk profile; aka, a Moral Hazard needs addressing.

Nihilarian's picture

I think you embedded the wrong video. Nothing that came out of his mouth sounded bullish to me.

Leo Kolivakis's picture

I got to throw you perma-bears a bone once in a while. :)

(I edited to make it clear, depression is not my scenario)

Boilermaker's picture

Nobody is a perma-bear, per se.  We just see the numbers for what they are.  They are unmanageable, unsustainable, and completely unserviceable.

So, the glass isn't half empty of half full.  It's just twice as big as it needs to be.  Stick with the data and leave the My Little Pony play time to the 10 year olds.

Grand Supercycle's picture


On May 4th I called the end of the March 2009 bear market rally.

The proprietary indicators I use in my technical analysis can identify trend changes before they occur.

homersimpson's picture

Great article (no joke). However, if only your rationale to "buy the dips" were as thoughtful and reasoned...