This page has been archived and commenting is disabled.
Oh Dear, CalPERSfornication Goes Global!
Submitted by Leo Kolivakis, publisher of Pension Pulse.
A couple of days ago, Jack Dean of Pension Tsunami posted a link to an article by Arleen Jacobius of Pensions & Investments, How CalPERS strategy backfired (hat tip, Bill Tufts):
Behind CalPERS' staggering real estate losses lies a strategy that took on too much risk and lacked adequate oversight.
Once
the fund's star asset class, the real estate portfolio of the $201.1
billion California Public Employees' Retirement System lost nearly half
its value during the one-year period ended Sept. 30. The fund's real
estate consultant, Pension Consulting Alliance Inc., predicts losses will continue for at least another year.
At
the heart of the problem is a freewheeling approach that took on
massive leverage, gave enormous discretion to staff and experienced
poor timing with its investments.
The
decision-making process and risk management need to be much more
rigorous, acknowledged Joseph A. Dear, who joined CalPERS as chief
investment officer earlier this year. The control over leverage was not
as robust as it needs to be, he added. The system will focus more on
income-producing, less risky core investments in the future, he said.
“We're
inclined toward investment vehicles where we have control,” Mr. Dear
said. “This does not rule out fund investing,” he added.
“Hindsight
suggests that a large number of CalPERS' real estate investments were
extraordinarily ill-timed and inadequately underwritten,” said Stuart
Gabriel, professor of finance and director, UCLA Ziman Center for Real
Estate in Los Angeles. Mr. Gabriel is not connected with CalPERS.
In
recognition of the portfolio's problems, the CalPERS board has imposed
new limits on staff's independent investment authority, system
officials are revamping its $13.5 billion portfolio and they might ax
some of the fund's roughly 70 external real estate managers. (Already, MacFarlane Partners has resigned its account after a nearly $1 billion failed land deal.)What went wrong?
Just
more than two years ago, CalPERS' real estate portfolio was valued at
$20.1 billion and staff estimated it would grow to $30 billion over the
next five years.
What went awry? In the first half of this
decade, when the real estate market was soaring, CalPERS began selling
off its least risky, higher-income-producing core properties and
shifting the portfolio emphasis to non-core, riskier investments. In
particular, the system went after value-added real estate, taking on a
bit more risk in the major property types, hotels, student and senior
housing, and investing in opportunistic transactions, those taking on
the most risk and leverage, according to CalPERS' 2007 strategic plan
for real estate.
Some 61% of the
portfolio now is in non-core investments as of June 30, the most
current information available. So far, some of these strategies have
been the worst performers. For example, the system's California Urban
Real Estate portfolio lost 40.9% for the quarter and 56.7% for the
year, ended June 30. Senior housing dropped 68.2% for the quarter and
71.9% for the year.
In addition, the 2007 strategic plan calls
for increasing the portfolio's international exposure to 50% of the
portfolio, with a range of 10% to 60%. CalPERS is expected to retain
that global focus.CalPERS is a global investor, Mr. Dear said.
“We look worldwide for the best opportunities,” he said. “Some are in
California and some are worldwide.”
In
short, real estate's role in the portfolio morphed from one of adding
diversification — cushioning the impact of volatility in other asset
classes — to a “return enhancer.”
CalPERS focused the real
estate portfolio on riskier, non-stabilized (meaning properties that
were not fully leased or needed some improvements) and
non-income-producing properties that were highly leveraged, according
to a report by Portland, Ore.-based Pension Consulting Alliance, which
has been the system's real estate consultant for years.
The fund also increased leverage across the portfolio.
According
to definitions in CalPERS' 2007 strategic plan, core properties, which
include real estate investment trusts and substantially leased
properties, had up to 50% leverage; value added investments, which
require some improvements, could have 50% to 70% leverage; and
opportunistic, such as development, could include 70% or more leverage.
But CalPERS' problems didn't stop
there. The board delegated enormous authority to its senior investment
officer for real estate and to its CIO to invest billions without board
or investment committee oversight.
By February 2007, the
senior investment officer for real estate could invest up to $1.8
billion in a single deal with an existing manager in a core property
and $2.7 billion if the chief investment officer also approved the
deal. The senior investment officer could invest close to $900 million
with a manager new to CalPERS in a core property and around $450
million in a non-core property such as housing, senior housing, REITs
or natural resources.
This meant that very few deals needed board approval.
What's
more, the fund did not begin an external due-diligence process, which
it has had in its private equity portfolio for years, until January
2008, according to a December 2009 investment activity report.Damage control
CalPERS
was not alone. Between 2005 and 2007, many institutions sold off core
real estate holdings and invested in riskier investments, such as
opportunity funds and overseas properties, said Dennis Yeskey, senior
adviser to AlixPartners LLC, a Detroit-based restructuring firm. Alix
Partners does not have a relationship with CalPERS.
“It's a
boom-and-bust scenario. During the boom they (institutional investors)
invest in more managers and more product types, and there's a bust,”
Mr. Yeskey said. “Then they do damage control and consolidate
managers.”
And when things went bust, they did so in
spectacular fashion. In some cases, CalPERS defaulted on loans,
returning properties to the lenders.
Among the deals that have gone sour:
•
In October, CalPERS real estate manager PageMill Properties LLC missed
a $50 million mortgage payment to Wells Fargo Bank on rent-controlled
low-income housing in East Palo Alto, Calif. CalPERS' $100 million
investment would be lost if Wells Fargo forecloses.• In July,
CalPERS and joint venture partner CommonWealth Partners LLC defaulted
on a mortgage on an office building in downtown Portland, Ore.•
Also in July, the system, in a joint venture with Hines, also defaulted
on a $152 million mortgage on Watergate Office Towers in Emeryville,
Calif.• CalPERS faced its biggest loss in a core strategy
separate account relationship with CalEast Global Logistics, run by
LaSalle Investment Management. The portfolio had been valued at $3.8
billion in the first quarter, but its value fell to $1.52 billion by
the end of June 2009.• In June 2008, LandSource Communities
Development LLC filed for Chapter 11 voluntary bankruptcy protection
and CalPERS ended up losing its roughly $1 billion investment in the
venture.• CalPERS in the fourth quarter of 2006 invested $500
million in Peter Cooper Village and Stuyvesant Town, a giant
middle-class housing development in New York. Tishman Speyer Properties
and its partner, BlackRock Inc.,
bought the development in 2006 for $5.4 billion; it is now valued at
roughly half that amount. Tishman Speyer and BlackRock are on the verge
of defaulting on their loans.
During the past two years, real
estate went from being CalPERS' best-earning asset class — pulling in a
one-year return of 14.8% and a three-year annualized return of 26.8% as
of June 30, 2007 — to becoming a drag on CalPERS' total portfolio. The
real estate portfolio lost $4.2 billion of its value between the first
and second quarter of 2009 and $8.6 billion in the 12 months ended June
30.Policy revamp
CalPERS staff, board and consultants
are now weeding through its battered real estate portfolio to determine
which properties and managers to keep. Some managers will be terminated
outright, but others will be instructed to wind down or sell off their
properties and quietly fade away, sources say.
“We're
systematically restructuring the portfolio, reducing risk (and)
leverage, and are reporting the results of independent appraisals that
we required,” wrote CalPERS spokesman Clark McKinley, in an e-mail
response to questions. “We're making investment decisions based on a
rigorous process in the best interests of CalPERS members and not
throwing good money after bad.”
The CalPERS board has revamped
its real estate policy, adding stricter controls and oversight that
some observers contend should have been in place all along. It has
gotten independent appraisals.
It is working toward
restructuring the portfolio in stages, starting with relationships such
as separate accounts and direct investments, in which CalPERS has most
control. The first of three phases could be completed early next year,
Mr. Dear said.
This restructuring
includes looking at the terms and conditions in all of its current
investments, he said. That includes such things as fees, profit split
and better alignment of interests, he said.
“Some managers will continue. Some won't,” Mr. Dear said.
The
board also pulled back, at least for the next three to five years, the
authority it had given to staff to make investments on their own. This
discretion has been suspended for new managers and drastically slashed
for existing ones. There is now an annual delegation limit of 20% of
the real estate policy target for core to existing managers and 5% for
non-core or riskier investments, and limits the total amount of real
estate assets that can be allocated to one manager to 20% for core and
10% for non-core.
The system is also clamping down on the
authority it had delegated to the senior investment officer and CIO to
borrow, manage, retire and dispose of debt financing in the portfolio.
For example, before a recent policy change, the senior investment
officer could commit debt financing of up to 5% of the real estate
policy target amount without oversight for a new manager and up to 10%
for an existing manager. The CIO could commit up to 15% of the real
estate policy target with an existing manager.
CalPERS
about three months ago suspended the senior investment officer's
authority to commit up to 5% of the real estate target to a new
relationship and drastically reduced the senior investment officer and
CIO's authority to invest with existing managers without investment
committee oversight.
The fund has now gone full circle, focusing on “lower risk, income-producing opportunities,” Mr. McKinley wrote.
What went wrong at CalPERS went wrong pretty much at every major public
pension fund which took on increasingly riskier bets to enhance their
returns (without proper oversight). I am not exaggerating when I tell
you I've seen it all. You name it, and I've seen it at these large
pension funds. The stupid risks that were taken with hard earned
pension contributions is borderline criminal. At a minimum, it was fiduciary negligence at its worst.
The
cozy relationships that developed between senior investment officers
and external managers were often overlooked by boards who were not
conducting proper oversight of their senior pension officers. When
there is big money involved, a lot of people tend to bend the rules and
set themselves up nicely for life after the pension fund.
Go back
to all the major U.S. and Canadian pension funds to see where many
senior officers have landed after they ran billions at the public funds
they worked for. In the U.S., there are rules against joining a private
fund you allocated money to (minimum three years). Not in Canada, where
I know of a few senior pension fund managers in the private markets
that set themselves up nicely with the private funds they allocated to.
Disgust
doesn't begin to convey the feelings I have for these pension sharks.
They are unscrupulous weasels who should be paying back all the bonuses
they received after taking on excessive risk to beat their bogus private market
benchmarks.
No, what happened at CalPERS grabs the headlines,
but reckless greed is endemic and pervasive in the wider pension
industy. And as long as governance remains weak, this type of nonsense
will continue, putting hard earned pensions at risk. Enough is enough
already.
»
- advertisements -
Some excellent feedback from a wise senior pension fund manager:
the most educated and credentialed generation in history has presided over the most maloderous stench in pension history....
i say bring back the dart boards and take away the frat boys' beer keg...the board should be shot soviet style....
Account churning? Commission Fraud? False Appraisals?
This smells so bad!
Hi Leo, I find your articles deeply engaging - and sad. The pension crisis is almost certainly next decade's catastrophe. As usual, people don't care until it is too late to alter the outcome. I've tried explaining to clients with no pensions that the gap between their savings and the present value of their expected retirement income is a real liability that they need to focus on paying down. If we add this private 'pension gap' to total household debt, the economic implications are severe, both at the household level and in aggregate for the economy going forward.
Keep up the great work. I'm glad to see the bitter cold in Ottawa hasn't dulled your wits! Toronto isn't much warmer these days...
Gestalt,
Close enough. I'm in Montreal where it's currently -9 °C (15 °F) with overcast. The brutally cold winter makes us appreciate spring and summer a lot more. As for pensions, I made a pledge a long time ago to be brutally honest. It's not making me any friends among senior pension fund managers but I have raised a few eyebrows at the highest level of governments, both here, in the U.S. and in Europe. Let's see if they'll do something about this Black Sloth before it's too late.
"I have raised a few eyebrows at the highest level of governments, both here, in the U.S. and in Europe"
By copying articles published by other people?
Yeah, I'm sure the people at the highest level of governments around the world are hanging on your every word.
In 2007, I completed a detailed report for the Treasury Board Secretariat of Canada on the governance of the Public Service Pension Plan. On April 21st, 2009, I was invited to speak at the Standing Committee on Finance on pensions:
Pension Hearings at Parliament Hill
Yes, I copy and paste articles, but I also add my comments and have done extensive posts on pension governance and benchmarks. And what's wrong with copying and pasting articles which you fully credit to other reporters???
Let me remind you that I don't get paid a dime for all this and have taken a huge hit to my personal income by coming out and blowing the whistle on these pension funds. I work full time, come home at night, eat my dinner and then post. And there are some nights where I am dead tired because my MS renders me useless. But I still manage to post because it's important to get the news out.
I don't have to justify my style to you or anyone else. Politicians in power read me regularly and so do the large pension funds, hedge funds and private equity funds. You can criticize me all you want but I am obviously garnering more and more attention among those in power.
"And what's wrong with copying and pasting articles which you fully credit to other reporters???"
It violates copyright law. The link to the Pension and Investment Age article doesn't work for non-subscribers. The owners of that publication made a decision not to give their work away and you decided to override their decision. Zero Hedge apparently doesn't respect copyright law either or they would be taking down your posts that violate it.
To extend your argument, what's the harm if the Chinese infringe on patents and knock off products without investing in the research and development?
What are you babbling about? The link works fine for me and I do not have ANY subscription to any of the articles I post. I think all this "copyright bullshit" is just that. MSM needs feedback from us bloggers who actually worked at the big funds and KNOW the real scoop. Reporters read my blog religiously. Wake up and smell the coffee! We need MORE TRANSPARENCY and we need to share the information to more people. If you want to fuss over copyright laws, go work for Rupert Murdoch. He is trying to take on Google and he will lose in a HUGE way!
"Reporters read my blog religiously."
Why is that? They don't need to read the articles you copy, they wrote them.
Thanks Leo - the looting continues - your vigilance is much appreciated.
CALPERS= massive insider dealings-- no surprise at all that they lose money. They need a lot of bleach and sunshine.
It appears to be a systematic looting of public assets just like the loans-for-sharesin Russia after 1996. The core properties that were producing positive cash flow and were in a stable position were stripped and replaced with speculative properties at the peak of the market. Many of the core properties were probably sold for bad prices to private equity. I would say that there needs to be an FBI investigation into this, but the FBI is just a sad joke these days except that it is so dangerous to liberty.
Leo, I appreciate that you're on the pension file. I know that it can seem dull to some readers because it's a slow motion train wreck but this along with health care is what will bankrupt first cities and (through our governments) the rest of us.
The irony is that for pension funds, lower rate environments cause the cost of the liabilities to increase. Therefore, to cover these costs, the funds are compelled to seek greater and greater risk (either through higher yielding assets or leverage). This has lead to a swinging for the fences.
Added to that, I see many similarities between Calpers and the Pentagon. So many people were making so much money out of them, there was no way they could be providing value for money for those paying the bills.
an excellent article as usual, thanks !