Mr. Dear wants to embrace some potentially high-risk investments in hopes of higher returns. He aims to pour billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure.
This guy and his ideas are the epitome of everything that's wrong with modern pension fund management. First of all, by his own admission, he's not an investment expert. His formative experiences were all in political appointments. He even thinks "the fun part is the investment part," in his own words, as if it should be secondary to things like organizational design and political relations. Secondly, his big bet on bold ideas is nothing more than a rehash of the Swensen Yale model. Remember that one? The one that delivered outsized returns during David Swensen's tenure at the Yale endowment until it blew up spectacularly last year? Yeah, that one. This dude didn't get the memo that the Age of Leverage is over, so all of those years that private equity delivered alpha of 3% are long gone. He also thinks that political tricks like asking investment firms to sequester the state's money in separate accounts will help manage risk. News flash: Sequestering money is of zero benefit if the manager's investment philosophy fails, because you'll have a heck of a time getting it out if other claimants to that failed fund litigate the manager.
I have no philosophical objection to investment vehicles like real estate partnerships and private equity funds. When used judiciously, in severely limited amounts that are restricted to areas within a manager's natural sphere of competence, they can diversify a very large portfolio. The problem comes when illiquid structures become a huge allocation within an investment philosophy that must be liability-driven (i.e., significantly liquid!). Year after year into perpetuity, a pension fund must cough up enough cash to pay its retirees according to tables designed by actuaries. If any one of those sequestered, illiquid investments blows up, CalPERS will risk defaulting on its legal obligations to pay pensioners and the state of California will be forced into a legal crisis. Taxpayers will of course have to fill that hole.
The funny thing is that I was just about to turn cautiously optimistic on California muni bonds now that the state's elected leaders have reached a budget compromise. CalPERS' stupidity is going to blow that right out the window within two years. The risk of a muni bond default is increased dramatically if state taxpayers have to make up shortfalls in CalPERS' payments to its retirees. Maybe a sovereign bankruptcy will ultimately be necessary to sort out whether muni bondholders or state retirees have a senior claim on California's tax revenues.
The NYT article ends on a telling note. This dude plans to spend a third of his precious time on "outside issues," as if the job of running the nation's biggest state pension plan isn't important enough to warrant all of his time. Note to Joseph A. Dear: Quit thinking of this job as some kind of extracurricular activity with a fun investment part. There is nothing more important to you right now than the security of retirees' money.
Nota bene: Anthony J. Alfidi does not receive a pension from CalPERS or hold California muni bonds. He is in fact a taxpayer to the state of California and is very interested in that state's financial solvency.
