For 'PERS, Not Personal, Use

A year ago, the giant California Public Employees' Retirement System said it would pressure Apple Computer and nine other companies with lagging stock prices to improve their corporate governance practices.

Since then, Apple's stock has jumped 46%. Too bad the others haven't followed suit. In fact, none has come close to the 33% price gain of the Standard & Poor's 500 stock index, and four have fallen in price.

What's the lesson for individual investors? CalPERS may be the 800-pound gorilla of "activist" pension funds, but if you think buying stocks targeted by CalPERS is a good investment strategy, be careful.

Every year, the nation's largest public pension fund unveils to great fanfare a "hit list" of roughly 10 underperforming stocks. Hoping ultimately to improve financial performances and stock prices, CalPERS uses the glare of publicity to agitate for changes such as revamping the working of company boards.

The goal is to make directors and executives more accountable to shareholders.

A number of academics have studied whether CalPERS and other activist big pension funds actually succeed in boosting the shares of companies they target. And, quite frankly, the reports are inconclusive. Some have shown the funds make a difference whereas others indicate they have no effect.

Regardless of whether CalPERS gains from its efforts, it's doubtful individual investors can profit significantly by piggybacking on CalPERS' target stocks, experts say.

"Can outside investors make money on this?" said Margaret Blair, a senior fellow at the Brookings Institution who teaches corporate finance at Georgetown Law School. "I'd think that is unlikely."

Investors should stay away for several reasons.

Despite all the breast-beating by the funds, critics say pension funds can't solve the complex problems of companies in highly specialized markets. Some troubled stocks might right themselves, but that probably will have little to do with pension-fund pressure.

"If I took the 10 worst-performing firms and compared them to the S&P; 500 over the next five years, I know the firms are going to [improve] whether CalPERS is there or not," said Mark Huson, a finance professor at the University of Alberta, Canada.

It's also important to understand what the list is and why CalPERS publishes it. It isn't a list similar to some brokerages' recommendations of undervalued stocks. Instead, CalPERS is targeting stocks it owns but can't sell because the bulk of its portfolio is indexed to the market and held regardless of performance.

"It's a different perspective than an individual investor looking for undervalued stocks," said Michael Smith, a vice president at Economic Analysis Corp. in Century City who has studied CalPERS' returns.


Finally, the historical performance of CalPERS' targets, which the fund began to publicly name 11 years ago, itself casts doubt on whether individuals would gain.

CalPERS points to a study showing the average targeted stock has beaten the S&P; 500 by 34 percentage points, or better than 6 percentage points a year, in the first five years after being placed on the list.

But some academics criticize the way the study was done and suggest a conflict of interest because the author was Wilshire Associates, a Santa Monica-based firm that does consulting work for CalPERS.

What's more, though the average return was impressive, the report also showed that the bulk of target stocks have trailed the S&P.;

Of the 69 stocks the study looked at, almost two-thirds underperformed the S&P; in the first five years after making the list. The record is more dismal for the last five years: More than three-quarters of the targets have lagged the index. (For stocks without five-year records, the study assessed their returns through Oct. 31.)

The 34-point average return over the S&P; appears to spring chiefly from spectacular gains in a handful of stocks. For example, Hercules Inc., on the 1991 list, went on to beat the S&P; by 523 percentage points; Chrysler and Ceridian, on the 1992 list, each topped the S&P; by more than 420 percentage points.

Stephen Nesbitt, the Wilshire senior vice president who wrote the report, says his work shows that when "corporate governance is effective, it can add a great deal of value." But he likens CalPERS' efforts to being those of a venture-capital investor--that is, a handful of investments will earn huge gains but most will disappoint.

"It doesn't depend on the number of winners," Nesbitt said. "It's how well the winners do, the magnitude of the success of the winners."

Added Bob Boldt, CalPERS' senior investment officer: "It takes a while for some changes we're trying to put in place to work."

The methodology of the Wilshire study also has come under fire.

If a company made CalPERS' list just one year, its five-year performance numbers counted in the study. But if CalPERS was dissatisfied with a company's progress and named it to the list the following year as well, its performance over the second five-year period was excluded.

Doing that makes the numbers look better than they really are, critics say.

"That's really cheating," Blair said.

Nesbitt defends the methodology, saying the stocks would have been over-weighted if counted a second time. "I've been doing this study for five years, and it's passed every academic litmus test you could imagine," Nesbitt said. "It follows [the methodology of] traditional academic studies of this type."


Another study, by Economic Analysis Corp.'s Smith, also showed CalPERS stocks outperforming the market.

He found that the 51 stocks targeted by CalPERS between 1987 and 1993 bettered the market by about 10 percentage points after three years, or roughly 3 percentage points a year. CalPERS boosted the value of its holdings by $18.9 million in those seven years for the stocks it targeted.

But Smith doubts individuals can profit by taking the CalPERS laggard list as a cue, in large part because some gains come shortly after CalPERS announces the list, and small investors can't react quickly enough.

"This is a worthwhile effort by CalPERS because the return of almost $20 million is worth far more than the cost," Smith said. "The question is whether individual investors can expect to get the same returns. I think that's unlikely because the price of the stocks will change as soon as the market finds out CalPERS has targeted them."

In a broader view, other studies have cast doubt on the ability of CalPERS and other pension funds to make a difference in stock-price performance.

Research by Ohio State University professor Tim Opler found that stocks targeted between 1991 and 1994 by CalPERS and other large activist funds beat the market by 7 percentage points within 12 months and 12.5 points within 24 months. But 30 companies targeted in 1995 and 1996 topped the market by an average of only 2 percentage points in the following two years, in part because one company went bankrupt.

Sunil Wahal, finance professor at Emory University in Atlanta, studied 146 stocks targeted by nine activist pension funds, including CalPERS, between 1987 and 1993 and found no difference between their performance and that of the broad market. After one year, the median performance of the funds' stocks actually trailed the market.

Likewise, a 1996 study by four academics found no relationship between activist efforts at 13 funds and risk-adjusted stock performance.

Boldt suggests that small investors thinking of using the fund's list shouldn't buy just a few of the stocks on the assumption that they're sure to go up because CalPERS is involved.

"This is not a buy list," he said. But if investors are intent on seeing it that way, they should purchase all 10 stocks, he said, because though some will rise in value, others will move sideways or fall.

"If they have a portfolio that's large and well-diversified, and they want to put a portion of their money into these 10, that would be an acceptable strategy," Boldt said.


Street Strategies explores investment tactics. Times staff writer Walter Hamilton may use strategies he writes about in his personal account. He can be reached by e-mail at


Tracking the 'Hit List': A Sampling

Last week, CalPERS released its annual list of laggard stocks that it is pressuring to improve performance. The stocks are: A. Schulman (ticker symbol: SHLM), Advanced Micro Devices (AMD), Electronic Data Systems (EDS), International Flavors & Fragrances (IFF), Louisiana-Pacific (LPX), Michaels Stores (MIKE), Stewart & Stevenson Services (SSSS), Sybase (SYBS) and TBC Corp. (TBCC). But stocks named in past years have had mixed results. Performance of CalPERS targets from 1992 and 1996, relative to the S&P; 500:


Stock: Return vs. S&P;*

American Express: +128

Ceridian: +427

Chrysler: +421

Dial: --31

IBM: --57

Polaroid: --45

Salomon Bros: --37

Time Warner: --16



Stock: Return vs. S&P;**

Applied Biosciences: +54

Archer Daniels-Midland: +3

Bassett Furniture: --25

Charming Shoppes: +52

Edison Bros.: --46

Rollins Environ.: +28

Stride Rite: --52

U.S. Surgical: --55

Venture Stores: --104

Note: Returns expressed in percentage points versus S&P; return.

* Through the following five years

** Through Oct. 31, 1997

Source: Wilshire Associates

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