Pension Funds’ Returns Diverge, Sparking Debate
The investment officers of California’s two big public employee pension funds are taking two very different approaches toward investing their huge asset pools--and the results may cost one of those individuals his job.
The $68-billion California State Teachers’ Retirement System fund, under Chief Investment Officer Tom Flanigan, has become increasingly wary of the U.S. stock market’s heights, and has reduced its stake in U.S. shares to 32.9% of total assets from 41.3% three years ago.
In contrast, the $108-billion California Public Employees’ Retirement System fund, under Chief Investment Officer Sheryl Pressler, now holds 41.8% of assets in U.S. stocks, and has taken a much more positive view of stocks overall since 1994--just in time for the market’s surge since then.
For CalSTRS and CalPERS, as the two funds are known, the differing strategies produced sharply divergent returns last year: CalSTRS earned 9.9% overall on its portfolio, while CalPERS earned 12.9%.
The performance gulf between the two now has become a political issue. State Controller Kathleen Connell, a trustee of both funds, has attacked Flanigan in recent days, contending that his conservatism is causing the fund’s teacher beneficiaries--and the state, which also contributes to the fund--to forgo too much in potential returns. “I certainly think there’s a problem when a fund underperforms as much as CalSTRS has,” Connell said Tuesday.
In fact, given the spectacular returns earned in the U.S. market over the last two years, Flanigan does look like Wrong-Way Corrigan. But he is unrepentant.
“We are erring on the side of caution,” he said Tuesday. Managing a pension fund, he said, “is not a performance race,” but rather a systematic process of earning returns needed to pay current and future beneficiaries without putting their nest egg at significant risk. “I am following a long-term, risk-averse investment policy,” Flanigan said.
Rather than commit more of his members’ dollars to U.S. stocks, Flanigan has maintained a heavy investment in bonds, while many other large pension funds have slashed their bond stakes in the 1990s. CalSTRS now holds 37.5% of assets in bonds, down only modestly from 41.2% three years ago.
In contrast, the average public pension fund’s bond stake has tumbled from 39.6% in 1993 to 33.4% now, according to pension consultant Greenwich Associates.
In this decade, bonds have been been a poor investment relative to stocks, as the bull market has barreled ahead at a rate few experts foresaw in 1990.
Flanigan, who was called in to restructure CalSTRS in the mid-1980s after a scandal and has directed the fund’s assets ever since, for the most part must maintain investments within broad ranges set by the trustees. But he also has discretion over 10% of CalSTRS’ assets--and he has used that discretion in recent years to continue buying bonds, while shunning U.S. stocks.
That has irked Connell, who maintains that CalSTRS’ consultants have recommended an “increased exposure to equities” in their regular reviews of the fund’s investment policies, as a way to boost long-term returns. “Why didn’t we listen?” Connell asked.
But in fact, CalSTRS does have more in stocks overall today--50.7% of assets--than it did three years ago, when stocks accounted for 47.8% of assets. The growth, however, has stemmed from a sharp increase in the fund’s commitment to foreign stocks. Like many big pension funds, CalSTRS has boosted its investment in overseas shares since 1992, but the returns so far have been far less than those of the streaking U.S. market.
Nonetheless, Flanigan insists that lowering the U.S. stock portion of the fund’s assets has been the prudent thing to do, because he believes the U.S. market may be at “its most overvalued [level] ever.” CalPERS’ Pressler, in contrast, has chosen not to try to time the market, but to maintain a heavy permanent commitment to stocks because their returns, over the long run, beat those of all other major assets.
Of course, if the U.S. market declines sharply any time soon, Flanigan will look like a hero. If the market continues to soar, however, Flanigan’s policy will probably become impossible to defend. In any case, he may not get the chance: Connell and other CalSTRS trustees decided last year to invite others to compete for Flanigan’s job. That process is underway.
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Tale of Two Funds
The California State Teachers’ Retirement System, or CalSTRS, holds far less in stocks than its sister fund, the California Public Employees’ Retirement System, or CalPERS. Mainly for that reason, CalSTRS’ returns have lagged in recent years.
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Asset CalPER SCalSTRS U.S. stocks 41.8% 32.9% Foreign stocks 18.4% 17.8% Private equity 2.6% 4.5% Bonds 30.5% 37.5% Cash 1.4% 3.4% Other 5.3% 3.9%
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Data as of Dec. 31, 1996
Source: CalPERS, CalSTRS
