State Pension Fund Returns Not What They Used to Be : Investment: CalPERS managers are criticized as paying more for advice that is yielding less.

The high-flying California Public Employees Retirement System, praised for its innovations and a source of pride to its hundreds of thousands of members, is drawing unaccustomed criticism these days.

The investment performance of CalPERS’ huge and fast-growing fund of pension money--$73.6 billion at last count--has deteriorated in recent years, even with costly and increasing reliance on blue chip advisers.

Since a particularly poor showing in 1992 led to the second major write-down of its real estate holdings in two years, CalPERS’ five-year investment record is worse than that of most public pension funds, according to its own consultants.

The poor showing in comparison to other funds has prompted a wide-ranging review of the investment approach used for the huge portfolio. CalPERS is the nation’s biggest public pension fund.

“We just haven’t cut the mustard,” CalPERS trustee and state controller Gray Davis said. “None of us are happy.”

A close look at CalPERS reveals an organization whose coffers are overflowing with member funds. Yet it is so short of operating money that it has trouble answering its own telephones. Its nationwide reputation as a shareholder activist has remained intact, however, even as its own investment performance has deteriorated.

CalPERS’ primary responsibilities are managing the enormous nest egg and administering pension benefits for more than 900,000 active and retired workers from the state’s public sector.

Created in 1931, CalPERS has evolved into a complex retirement system for employees and retirees--and not just those from state government. Its members come from the ranks of more than 1,200 local agencies--from the Ojai Valley Sanitary District to the Oroville Mosquito Control District--and non-teaching school employees statewide.

The fund pays an average pension of $784 a month to about 270,000 retirees and other beneficiaries. It takes in about $12 million a day from taxpayer and employee payments and interest earned on the growing portfolio. Membership is growing by 40,000 to 60,000 people a year, a rate that should balloon the size of the fund to $200 billion by the year 2000.

Despite the sub-mediocre investment performance and other problems, such as yearlong backlogs in paperwork servicing its diverse membership, CalPERS seems to have lost none of its glitter for members, legislators and others in the state government community that created it. Cheered for wielding its stock ownership to shake up industrial giants such as IBM and General Motors, the retirement system is also held in awe for its sheer size, and its managers are applauded for steadily adding to the vast pot of gold.

“I’m glad I’m not running it,” said lobbyist Aaron Read, who represents six major organizations of CalPERS members and was surprised to hear that most public pension funds do better. “PERS has done an extraordinary job. It’s been growing almost geometrically. Every time I check, we’re up a few billion.”

CalPERS’ declining investment performance is especially striking in light of the fact that it has tripled--to $53 million in 1992--the fees doled out to more than 40 money-management firms for investment advice over the last three years.

This was considered a prudent way to manage an increasingly sophisticated investment strategy that moved more pension money out of domestic stocks and into more risky areas, such as real estate and foreign securities.

“The fund is a lot larger than it was, and more diversified,” said DeWitt Bowman, the fund’s chief financial officer. “So there has been a tendency to hire more outside advisers, and they charge fees.”

That CalPERS is getting a lot less bang for a buck was highlighted last month in a report from the California Legislative Analysts Office, a nonpartisan state government research arm.

According to the report, the system is now spending about as much for investment advice as it spends on its entire administrative budget, which includes paychecks for 800 and the bureaucracy to run the extraordinarily complex pension operation.

The report highlighted the fact that the outside investment advisers were actually outperformed by an in-house CalPERS staff of about 35 who also manage part of the monies. As the report dryly pointed out:

“What appears on the surface to be a runaway spending situation might be justified if the PERS could demonstrate that the significant expenditures for investment advisers were resulting in higher returns on investments than reasonably could have been achieved without such spending. The record, however, does not demonstrate this case.”

William Crist, an economics professor at Cal State Stanislaus who is president of CalPERS’ board of trustees, said the legislative report “brought a lot of things to people’s attention which we need to address. We are not unconcerned about this.”

It is easy to lose perspective about spending $53 million for investment advice, Crist pointed out, when the size of the investment portfolio is “almost beyond human ken.”

The annual infusions of public funds--this year totaling about $765 million toward members’ pensions--and ordinary investment returns would ensure significant annual growth. Ordinary though the system’s returns have been by Wall Street standards, they have outpaced the rate of inflation.

Still, “they could do better than that in municipal bonds these days,” said Carole Swartz, administrator of the much smaller University of California retirement system.

But that might be too mundane for some at CalPERS, suggests one California retirement system expert: “You get people who forget what the system is there for. They think it is there for investment grandeur.”

Over the last three years--the period of sharpest escalation in its outlays for outside management fees--CalPERS has posted an average annual investment return of 9% compared to a median among all public pension funds of 12%, according to its own consultant reports.

That 3% annual gap marks about $6 billion that CalPERS didn’t earn. In 1992, which investment chief Bowman allows “was not very good,” the return tumbled to 7.2% versus a median of 10.6%.

Over a five-year time frame, the CalPERS’ average annual return of 11.9% also falls below the median of 12.5%. Only when measured over 10 years, encompassing boom times on Wall Street when CalPERS made its reputation for investment skills, does CalPERS rise 1.2 percentage points above the median of 14.5%.

CalPERS’ investment problems coincide with a time of deep change in its political standing. Voters in November narrowly approved a little-noticed ballot proposal that appears to grant public pension funds virtual autonomy from state oversight.

The focus of various political battles throughout the 1970s and 1980s, including several raids on its fund to plug state budgetary holes, CalPERS led the fight for Proposition 162 as a way to head off future attempts to tap its coffers.

While Prop. 162’s ramifications are still being argued by lawyers and legislators, it will apparently free CalPERS to deal with an embarrassing juxtaposition:

Despite its bulging investment coffers, CalPERS is stretched so thin administratively that it needs 10 months or more to answer routine queries from members--a delay that laws wouldn’t permit at a private pension fund. Its outdated telecommunications system manages to answer only 4% of the phone calls that pour into its sleek Sacramento headquarters.

While CalPERS has been free to spend whatever it wants on outside management fees, until now it has needed state permission to hire people or buy equipment to administer its retirement system.

Those requests have been repeatedly denied amid the state’s budget crisis. Now that voters have freed it from such shackles, CalPERS vows to begin hiring some office help to handle its continuing deluge of requests.

To Swartz and other critics, CalPERS’ investment performance raises questions about the time and attention the retirement system spends on the shareholder-rights campaign. The official rationale for that effort is to improve CalPERS’ own investment results.

At a meeting last week, some CalPERS board members strongly reiterated their support for such “corporate governance” efforts and for the leadership of its chief executive officer, Dale Hanson, a leading advocate of shareholder rights.

Yet while standing behind its shareholder rights campaign, the CalPERS board of trustees is now mulling a shift in its investment strategy that would “index” a greater share of the huge portfolio--a simpler and more conservative approach that would require less outside advice and more use of its in-house experts.

“We will be taking action to eliminate some of these contracts,” said Charles Valdes, vice president of the CalPERS board of trustees and head of its investment committee.

Indexing is the practice of choosing investments that are included in such benchmarks as the Standard & Poor’s 500 or the Wilshire 2500 Index. The idea is to do as well as the overall stock, bond or other markets rather than to “pick” favored stocks or types of investments, a riskier but potentially more lucrative approach.

CalPERS miscalculated in the late 1980s when it shifted money out of domestic stocks and into real estate--especially the doomed California variety--and to the ill-fated Japanese stock market and other foreign venues.

Those fields required expertise that CalPERS’ in-house staff didn’t have, so the system increasingly relied on outside advisers to manage those investments. Those are the investments that have done poorly, not only at CalPERS but for anyone else unwise enough to park money there.

Few would quarrel with the need to tap the best available expertise to manage a sum of money so great that it could turn the nation’s trade deficit into a surplus. Failure to do so would be irresponsible, retirement experts say, and grounds for lawsuits when investments turn sour.

Indeed, as a percentage of its assets, CalPERS’ spending on outside investment advisers is actually below the average among public pension funds, said Rodger F. Smith, a partner at Greenwich Associates in Greenwich, Conn.

The chief mistake was in deciding to diversify--a decision encouraged by lead pension consultant Wilshire Associates of Santa Monica, according to state Controller Davis. Officials at the consulting firm could not be reached for comment.

According to Davis, the pension fund passively “followed the advice of Wilshire” to reduce its holdings in domestic stocks: “I believe we were poorly advised and are suffering the consequences.”

While CalPERS was just one of numerous public pension funds nationwide lured into real estate by well-regarded advisers, it was clearly outsmarted by some of its in-state peers.

One example: the $16-billion UC retirement system. Its totally indexed fund, forgoing any “fancy-schmanzy” advice, as administrator Swartz puts it, has outperformed CalPERS four of the last five years. It became fully funded in 1990, and now requires no payments from the university or its members.

To be sure, investing is always tricky, and a case can be made that CalPERS’ real estate holdings and some foreign investments have hit bottom. Meanwhile, the system has enough money to cover about 90% of its current pension obligations--the sign of a strong fund.

“The thing I like about CalPERS,” said a California pension-fund expert, “is the money is there, unlike Social Security.”