In CalPERS Investing, She’s Definitely Not Retiring Type

One year ago, Sheryl K. Pressler took a good look at the then-$80-billion-asset CalPERS pension fund and decided it needed to own a lot more stock and fewer bonds.

Not bad timing for someone who professes not to be a market timer.

Pressler, chief investment officer of CalPERS--the California Public Employees’ Retirement System--steered the giant fund to hefty gains this year by shifting assets away from bonds and into the far hotter U.S. stock market.

And Pressler isn’t finished raising CalPERS’ equity stake. The fund’s board, at her recommendation, has approved boosting the U.S. and foreign stock percentage of the now-$93-billion portfolio from about 55% currently to 63% by 1998. A year ago, the stock percentage was 49%.

After 18 months on the job as investment chief of the nation’s largest public pension fund, Pressler is well on her way to remaking the portfolio into a much more dynamic mix of public securities and private equity investments.

Long known for its activism in corporate governance--pushing companies with laggard stocks to improve their financial performance--CalPERS has been turning inwardly activist, directing a growing portion of state and local government workers’ retirement savings into nontraditional assets.

The move is unquestionably controversial: CalPERS already has more of its assets in stocks than many public pension funds, which historically have been too fearful of stocks’ inherent riskiness to plunge so heavily into the market.

But Pressler insists that CalPERS’ shift is a necessary response to demographic realities. As more of the 1 million workers covered by the fund retire in the decades ahead, the fund’s annual disbursements will soar from $3.5 billion now to $30 billion in 2023.

CalPERS, Pressler notes, has two primary goals. The first is to ensure that it has enough money to pay mandated benefits. The second is to try to minimize the contributions to the fund by state and local government--which ultimately are taxpayer-borne.

“That only leaves one thing for us to do: earn more money” on the portfolio itself, Pressler says.

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CalPERS, which earned an average annual return of 10.3% on its assets in the five years ended June 30, now estimates that it will earn 9.4% annually over the next 10 years, a decline that largely reflects the fact that yields on bonds (which still make up about 39% of the fund) are far below their levels of the early 1990s.

If Pressler and her Sacramento-based investment staff of 55 can beat that 9.4% estimate, they can potentially lessen the cost to the state of government workers’ benefits. If the returns fall far short, the state’s costs may rise or benefits may be cut--either of which would be politically disastrous.

Pressler, a St. Louis native with an MBA from Washington University, managed McDonnell Douglas Corp.’s $8-billion pension fund before CalPERS tapped her in 1994. She brings to the job strong convictions that are rooted in some basic sensibilities about markets and about the inevitable limitations of giant investment funds.

The starting point for all investors--large or small--is that “the thing that matters most [in determining returns] is the asset allocation decision,” Pressler declares.

In other words, in the long run it’s the way you mix stocks, bonds, cash and other investments that is largely responsible for your return, not the individual securities or short-term market-timing moves.

So Pressler’s recommendation to boost CalPERS’ equity stake was only logical, she says, because stocks have outperformed bonds and other assets over the long term, which is CalPERS’ horizon.

Although some Wall Streeters worry that U.S. stocks’ returns will be subpar over the next 10 years because they’ve been so above-average over the last 10 years, that also was the argument a year ago. Since then, the Dow industrial average has soared 35%.

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Pressler wasn’t willing to bet CalPERS’ money against stocks’ longer-term record a year ago, and she still isn’t. Her personal view of the U.S. market, with the Dow now at a near-record 5,156.86, is that stocks are ripe for a pullback. “I think we’ll see Dow 4,000 before we see 6,000,” she says.

Yet short-term corrections aren’t relevant to a fund that is looking 30 years ahead, Pressler says. So she will continue to raise CalPERS’ equity stake toward the target of 63% by 1998, accelerating the buying if prices pull back.

What’s more, many of the stocks to be added to the fund between now and 1998 will be foreign. Pressler persuaded her board a year ago to raise CalPERS’ foreign stock holdings to 20% of total fund assets by 1998. They are 15% now.

It’s not that Pressler expects phenomenally higher foreign returns compared with the U.S. market. In fact, “there’s no reason to think one market will outperform another” over time, she says.

But she notes that foreign stocks provide the fund with additional diversification and, importantly, with a potential offset to trouble in the U.S. stock market, because foreign market moves often don’t correlate with the U.S. market.

Japan has been a good example of that non-correlation, as its bear market has stretched on for most of U.S. stocks’ surge since 1990. Now, however, “Japan looks to me like the U.S. in the early 1980s,” before the Dow zoomed, Pressler says.

She also admits to a somewhat fatalistic view of Japan, which some economists worry is in a slow-motion depression: “If they can’t turn that ship around, then the whole world is in trouble.”

Fatalism about markets is almost a required trait for managers of huge pension funds, which control so many dollars that they can’t realistically be much more than passive investors: They must buy and hold virtually every major stock, which means their equity returns over time will approximate the average market return.

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But CalPERS, like many big funds, also hands off a small percentage of its assets to “active” private money managers, in the hope of earning above-average returns on that money and thus adding marginally to the fund’s overall performance.

In fact, CalPERS has funneled more to active managers than many pension funds. Roughly 15% of CalPERS’ U.S. stocks, and 25% of its foreign stocks, are actively managed. Those assets have scored higher returns in recent years than the passive portfolio--although Pressler concedes that the value added has lagged CalPERS’ goal.

In any case, Pressler sees little point in increasing the amount of CalPERS public stock assets under active managers. The greater the number of outside managers a fund employs, the greater the likelihood that the active dollars simply turn into a “closet” passive fund.

So CalPERS has been focusing its active-management effort on assets other than public stocks and bonds, a campaign that began three years before Pressler arrived.

Real estate, for example, now accounts for 6% of CalPERS’ assets. And “alternative” investments, including venture capital stakes in private firms, make up nearly 2% of the fund. CalPERS’ goal is to raise the alternative-investment stake to 5% of assets.

The projects so far include 67 separate partnerships with investment managers and typically involve capital investments in small- and mid-size companies.

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Like CalPERS’ decision to raise its public equity stake, the alternative and real estate stakes are controversial. Pressler expects the private-company investments to return 12% to 15% yearly over the next decade, but she concedes that it’s too early to judge CalPERS’ success.

The fund’s real estate portfolio has clearly been a disappointment so far, a function of the depressed U.S. property market. And a major California property investment, via Catellus Development, has been an outright disaster.

The Catellus deal, which preceded Pressler, also has raised questions about CalPERS’ high-profile plan to focus more of its $93 billion in assets on California.

Sensitive to political pressure, CalPERS has pushed to invest more inside the state in recent years and now says its California investments total $10.1 billion--though that is calculated to include the California business of the fund’s public stocks, whether or not the firms are based here.

Pressler, 44, who is paid $183,000 yearly, concedes that many alternative, real estate and California-direct investments are higher-risk. But she notes that they offer the few opportunities for CalPERS to earn above-average returns.

Nor do she or her staff take the risks lightly, she adds: She estimates that 90% of their time is spent monitoring those assets.

Managing her own personal time against CalPERS’ demands is another challenge. Pressler says she, husband Richard and daughter Shelby (age 4) last week agreed to begin keeping dinner time each day free of distractions. But after two days, their success rate was only 50%, she said with a laugh.

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The Pension Pie

How CalPERS currently invests its $93 billion in assets:

U.S. stocks: 39%

U.S. bonds: 35%

Foreign stocks: 15%

Real estate: 6%

Foreign bonds: 4%

Alternative investments: 2%

Note: Total adds to 101% because of rounding.

Source: CalPERS