By Britt Erica Tunick
Photographs by Jonathan Sprague
Is it any wonder that Kurt Silberstein is frustrated? "I can't stress enough how disappointed we were with what happened in 2008," says Silberstein, the boyish-looking 47-year-old senior portfolio manager who has been running Calpers' hedge fund activities since 2003.
Charged with providing retirement benefits for 1.6 million California public employees, Calpers a decade ago became one of the most vocal proponents of alternative investments, including hedge funds, in the hope that such allocations would bolster its fortunes. Calpers' hedge funds have fared better than its other investments. But last year, the hedge fund portfolio-$7.5 billion at its peak-lost 19%. Not only did the funds lose money, but like many other investors, Calpers found itself unable to get its money back as a result of redemption suspensions or gates. Now, the pension plan is firing hedge fund managers, demanding more control over its investments and planning to run some of the money itself. Calpers isn't just trying to boost returns—though it clearly needs to do so to help out the underfunded pension system. As has long been the case, Calpers wants to use its political clout to shift more power to investors and away from hedge funds. The pension plan wants to reduce the management fees its pays, increase the transparency managers provide on their trading activities and ensure that funds' strategies are truly aligned with the pension system's own performance goals and needs.
"If we cannot find a better alignment of interests with our partners, then we're just making it clear that we no longer want to have a partnership," says Silberstein, who runs Calpers' hedge funds from an eco-friendly glass-enclosed office in the heart of Calpers' three-year-old, Sacramento headquarters. The modern glass structure stands in stark contrast to the 160-year-old clapboard buildings in the nearby historic Old Town, a neighborhood reflecting the city's emergence during the state's 1849 gold rush.
Like many residents who came to California at that time, Calpers has unearthed its own share of fool's gold. Of the 35 hedge fund relationships Calpers had at the end of 2008, nine have already been eliminated from the portfolio, with redemptions totaling more than $1.1 billion. Calpers is exiting such big-name funds as Farallon Capital Management and Canyon Capital Advisors—both California firms in which it held huge interests—along with Platinum Grove Asset Management and Tosca. Calpers is redeeming from funds that unnecessarily locked up investors' money and those unwilling to adopt the new investment requirements that the pension plan recently introduced. With the sole exceptoin of Och-Ziff Capital Management, the system also has soured on multistrategy funds.
"In some cases, where you thought you had a read on someone's character, you were wrong," says Silberstein, whose youthful appearance belies the seasoned investor he is. Silberstein's previous investment experience includes a four-year stint with the Los Angeles County Employee Retirement Association and three years at pension consulting firm Strategic Investment Solutions before joining Calpers in 1999. "We never want to be sitting in a position again where we say to hedge fund manager X: 'We'd like our assets back,' and they say: 'Sorry, but you can't have them.'"
Performing triage for the damage from 2008 is a major concern for Calpers' hedge fund investment team, yet it is by no means the group's sole focus. As early as the first quarter of next year, Calpers plans to introduce its own hedge fund seeding program, dubbed Sprout, to nurture emerging talent and innovative investment ideas. The group also hopes to eventually eliminate fund managers as middlemen and have its own traders replicate certain strategies inhouse. While controversial, Calpers' visibility and political clout are expected to be major contributors to its success in these efforts.
Though Calpers' hedge fund portfolio took a big hit last year, it wasn't the pension fund's worst-performing portfolio, nor its biggest problem. At $191.5 billion, Calpers' overall portfolio lost 23.4% in the fiscal year that ended June 30—the largest decline in any single year. Other alternatives—real estate and private equity—lost 35% and 31%, respectively. As a result, some California politicians, including Governor Arnold Schwarzenegger, have begun questioning Calpers' long-term sustainability. Nearly every aspect of the fund's investment portfolio is being picked apart.
Last year's troubles also spurred the April resignation of Calpers' chief investment officer Russell Read, whose departure from the position after only two years highlights the high turnover Calpers has experienced recently. Read's replacement, Joseph Dear, left his position as the executive director of the Washington State Investment Board to take the post in March. Meanwhile, Calpers recently found itself embroiled in pay-to-play allegations against Sean Harrigan, its former board president, who is believed to have used his position to pressure companies given large deals with Calpers to make donations to the United Food and Commercial Workers Union.
Despite Calpers' long-term funding problems, legal concerns and political activities, Silberstein and his staff enjoy a fairly insular existence within the plan. "Joe Dear is a big supporter of what we're trying to do," says Silberstein. "He's given us support in that we want to restructure the terms and the alignment of interests that we're currently undertaking with all our existing relationships." (Dear was unavailable to comment for this article.)
Alongside Silberstein, day-to-day management of Calpers' hedge fund investments is handled by Eric Baggesen, senior investment officer in charge of global equity, Craig Dandurand, portfolio manager in charge of internal trading within global equity, and Leon Shahinian, senior investment officer in charge of the alternative investment management and private equity group.
In a March 11 memo to Calpers' hedge fund and fund of fund managers, "Improving the Relationship Between Calpers and its Hedge Fund Partners," Silberstein and Dandurand outlined the plan's new investment requirements. "Calpers is a long-term investor and they don't want investors with shorter-term time horizons forcing them to sell things at the bottom," says Jane Buchan, chief executive officer of Pacific Alternative Asset Management Company, one of Calpers' advisers. "If you're in a commingled fund, your performance can [be] affected by the behavior of others."
Calpers has been trying to use its muscle to coax fund managers into lowering fees and providing more transparency for years—with mixed results. Though Calpers was rarely able to convince managers to provide it with separately managed accounts, a source close to the plan says it was frequently able to negotiate the best terms for the funds in which it invested. In 2005, Silberstein attempted to foster change by bringing together a consortium of high-profile players in the pension and endowment world that included individuals such as Utah Retirement System deputy chief investment officer Larry Powell, who was then with the Teacher's Retirement System of Texas.
Four years ago, Silberstein's efforts went nowhere. Now, things are different. "In 2005, you couldn't get any traction. There was so much capital flowing into the marketplace that any hedge fund would say 'Hey, these are the docs. Sign them as they are or get out of the way, because there [are] another 10 people behind you with money just as green as yours,'" says Silberstein. "But then 2008 happened, and it gave us a little more of an opportunity to right the wrong." Calpers is no longer asking—but demanding—that funds accept its new terms.
"Calpers has always been, quite properly, a leader in the institutional space, and they will perform that leadership role in helping make terms more limited-partner-friendly," says Orin Kramer, chair of the New Jersey state pension system. "Hedge fund terms in many instances will become more limited-partner-friendly, and I expect Calpers will be one of the leaders in defining the framework that will exist."
In the past, Calpers' demanding reputation has turned off some of the biggest hedge funds, and it will remain an obstacle. "There are always going to be some funds who'll say 'Well, we don't need Calpers' money,'" says Silberstein. But with more hedge funds than even Calpers expected willing to accept its terms, the plan doesn't foresee trouble finding qualified funds. "People that we never thought would want to work with us are actually calling up cap intro and saying 'Can I get a meeting with Calpers? I understand what they said in their memo, and I believe it, so can I get a meeting?'"
Silberstein set out to change the image of Calpers as being difficult, and he believes Calpers has proven that it is a strong partner for its fund managers. He credits part of the plan's image improvement to its relationships with UBS and PAAMCO, which serve as the plan's respective primary and secondary advisers, and says the plan has been able to get full security-level transparency from the majority of its hedge funds for the past couple of years.
Calpers' dedication to hedge fund investments is also making it a more attractive investor than ever. Because so many hedge funds' problems were exacerbated by investors who fled at the first sign of trouble, fund managers have become more accommodating for those willing to stay the course. Unlike other institutions, Calpers doesn't have limitations as to how large a percentage it can be of any one fund, which makes the plan's size particularly attractive.
"The hedge funds that they are invested in generally have an overwhelmingly positive relationship with them," says Bill Brown, UBS Alternative Investment Solutions' chief investment officer. "They really understand what they're doing, they have very well-identified objectives and they go in explaining that very clearly."
Some of Calpers' fund managers support its recent moves. "They can be more demanding and, yes, they are a client who does hold you to the highest quality in terms of the service that you deliver. But at the end of the day, I don't necessarily disagree with most of the things that they're trying to accomplish," says Jerry Wang, CEO and chief investment officer of Vision Investment Management, whose Vision Blue Diamond Fund is among Calpers' hedge fund holdings. "Not everything they want, in my opinion, can be successfully accomplished with all managers—for example the fee-restructure issue. But by and large, the managed accounts and the transparency are things that we ourselves thought we needed to address in running our business."
AsCalpers revamps its hedge fund portfolio—now $5.7 billion allocated to 26 single manager and funds of funds—it's not just getting rid of those funds unwilling to take on the plan's new investment terms. Funds still below their high-water marks or those that have, in Calpers' opinion, unnecessarily side-pocketed or locked up investor capital are also being ditched. Once Silberstein and his colleagues are done taking their pickaxes to Calpers' hedge fund holdings, the remaining portfolio will be drastically different than it was at the end of 2008.
In addition to Canyon and Farallon, other losers in Calpers portfolio last year include Atticus Capital Management, Knight Capital's Deephaven Capital Management unit (which was sold to Stark Investments for $7.3 million in January following losses of nearly 36% in its multistrategy fund), Platinum Grove Asset Management, Tosca and Tremblant Partners. Calpers is pulling all of its allocations to Platinum Grove and Tosca, even though the latter has rebounded this year.
Oddly enough, Atticus, the one firm Calpers planned to stick with despite being side-pocketed last year, just decided to throw in the towel on its own last month, closing its U.S. fund, Atticus Global. Atticus side-pocketed investors' cash following losses of 25% to 32% in its two largest funds in the month of August of 2008. Calpers redeemed $53 million from Atticus Global in January, but had planned to stay invested.
Calpers is pulling from those vehicles it thinks suspended redemptions or side-pocketed securities when the funds could have given investors their money—but just didn't want to sell at market prices. Silberstein says Calpers proposed that some of its managers meet its redemption requests with payments-in-kind representing a slice of their entire portfolios, but not all would agree. When they did, Calpers was able to absorb the PIKs into its own equity index fund to avoid triggering sudden price changes.
Silberstein won't identify which funds he believes could have given investors their money back but didn't. However, a review of the portfolio easily identifies the culprits. When Farallon's fund lost roughly one-third of its value last year, partly as a result of bank debt bought at the end of 2007 and early in 2008, that firm held tight to investors' money. Farallon exercised its gate once redemptions reached the 15% threshold, despite the fact that it had enough cash to fund redemptions, angering investors. The firm made one concession, lowering its management fee to 1% for investors who chose to stay. Though Farallon's performance has since rebounded somewhat, Calpers holds tight to its decision to exit the fund.
Calpers also pulled out of Canyon Capital's Canyon Value Realization fund, a distressed-debt strategy that was down 29.51% in 2008 and initially side-pocketed roughly 40% of the fund's capital before selling off some of the securities early this year to meet redemptions. Calpers is maintaining its allocation to Canyon Special Opportunities fund.
Platinum Grove's flagship Platinum Grove Contingent Capital fund, a fixed-income strategy, lost roughly 46% last year, leading the firm to temporarily suspend redemptions. Similarly, Tosca fund, by far one of Calpers' worst performers in 2008, lost 67.54%. Tosca's losses spurred that firm to restructure.
Calpers in January redeemed $11.7 million from Tremblant Partners, a long/short equity fund that was down roughly 35% in 2008, but it still maintains exposure to that fund. Other funds eliminated from Calpers' portfolio or in the process of being removed are Carlyle Multi-Strategy Fund, Liberty Square Offshore Partners, Tennenbaum Multi-Strategy Fund, Wayzata Recovery Fund and the Zaxis Institutional Partners fund.
"One of the biggest disappointments in 2008 was that the multistrats were our biggest losers," bemoans Silberstein. "That's a strategy you would expect to be best equipped to handle a 2008 type of environment, being that they have a variety of different strategies and for the most part are global in nature. They were a core part of our portfolio and failed miserably." Silberstein believes the size of the funds, excessive directionality in their portfolios and the managers' confusion in the changed market environment led to the losses.
Och-Ziff is the only multistrat Calpers is keeping, because the pension fund has confidence in that firm's focus on capital preservation and aggressiveness in hedging out its portfolio. OZ Domestic Partners II fund is Calpers' largest single holding, representing 8% of its hedge fund portfolio.
However, Calpers' largest allocation is with $10 billion Black River Asset Management—9.2% split between Black River Commodity Multi-Strategy Fund and Black River Fixed Income Relative Value Opportunity Fund. Chatham Asset Management represents Calpers' second largest allocation, with 8.8% of the portfolio split between Chatham Asset High Yield Offshore Fund and Chatham Asset Leveraged Loan Offshore Fund.
Calpers is already scouting potential additions to its hedge fund portfolio and is meeting with managers. The plan won't start hiring until later this year or early next year when it completes restructuring the terms of its current hedge fund investments; no more than five are added in any given year.
Silberstein may be disappointed in his hedge funds' performance, which was below the median InvestHedge Funds of Funds Composite Index, which lost 16.02% in 2008, but its performance was in line with its peers. In the one-year period from June 30, 2008, through June 30, 2009, public funds with more than $5 billion in assets reported a median loss of 18.76%, according to Wilshire Associates' Trust Universe Comparison Service. Calpers' hedge fund portfolio also outperformed the Standard & Poor's 500 index, which was down 37% in 2008. But it was below its own benchmark—the one-year Treasury Bill plus 5%, which was at 5.55% at the end of June. "All in all, for the first six-and-a-half years our program was outperforming the fund of funds index quite well. In 2008, we slightly underperformed, but over the long term we're still ahead of the passive alternatives," says Silberstein. Calpers' portfolio also lost money in 2002, when it was down 1.26%; it gained 9.25%, 13.44% and 9.45% in 2005, 2006 and 2007, respectively.
Last year's losses demonstrated some of the weakness in Calpers' hedge fund portfolio and led some people close to the fund to question whether Calpers has been taking too many risks in its quest for returns.
In 2003, Calpers renamed the hedge fund program Risk Managed Absolute Return Strategies, a political decision to show its caution. "Semantics matters a lot to people like Calpers," says an individual close to the plan. "Risk managed is something they added on there to show that they were not just chasing hedge fund returns, but had a higher focus on arbitrage strategies and stuff like that which wouldn't be quite as risky." Nonetheless, this individual says Calpers moved into riskier strategies in recent years. "I was shocked to discover how much of their underlying funds of funds were macro or commodities—not absolute return, but high volatility. If their mandate truly is zero or better in all environments, then why are they in macro?"
Silberstein says the group has been cautious about the risks it has taken and that all of its strategy selections play a part in the fund's big-picture goal. The majority of the plan's hedge funds are not big users of leverage and Calpers' book was levered only 1.7 times at its peak, he says. "We're fairly conservative in terms of how we invest in hedge funds."
Calpers began investing in hedge funds in 1999, a year after the high-profile collapse of Long Term Capital Management. Characteristically, the pension made a bold move. Instead of going the funds of funds route, Calpers invested $300 million directly into Pivotal Asset Management's Pivotal Partners fund—a strategy run out of San Francisco dedicated to investments in technology companies. That initial hedge fund investment was made by Bob Boldt, a senior investment officer for Calpers at that time who set the plan's initial hedge fund target at $11.25 billion. While Calpers' board was prepared to commit to the strategy, it wasn't yet ready to do so in such a grand way.
In 2000, following Boldt's departure, Calpers' board allocated $1 billion to hedge funds and a year later brought on Blackstone Technology Group as a strategic adviser for the plan's hedge fund investments. When Calpers' hedge fund program officially launched in the spring of 2002, its first substantial allocations were made to Symphony Asset Management's Rhapsody Fund, Pentangle Partners, Tosca, Atticus and Zaxis. With the shutdown of Atticus Global, Rhapsody will become Calpers' only remaining initial investment. Symphony Rhapsody Fund, a convertible arbitrage strategy, lost 15.67% in 2008 but is up 36.73% this year, through July.
From the beginning, Calpers' board was clear that it intended to make a serious commitment to hedge funds, which sit within and can represent as much as 8% of the plan's global equity portfolio. These investments now total roughly 2% of Calpers' overall fund. That's less than some of Calpers' peers, though the plan's hedge fund activities and visibility have still made it a leader among institutional investors. "They will go in early and in size...they've not set up the same kind of boundaries that many of the other pension and endowment groups have," says Emma Sugarman, head of capital introduction for the Americas at BNP Paribas.
When Calpers' hedge fund program was renamed Absolute Return Strategies, it got a dedicated full-time staff and International Fund Services was brought on as administrator. A year later, the program was renamed, its relationship with Blackstone came to an end and UBS and PAAMCO were brought on. Some people close to Calpers say its relationship with Blackstone ended because the pension plan was too difficult. Silberstein says Blackstone bowed out because the firm was unwilling to work with UBS and PAAMCO when Calpers decided it wanted multiple views of the marketplace.
A fund of funds program was launched within the hedge fund unit in 2005. At that time the group's maximum allocation was raised to 5% of the global equity program before climbing to its current 8% limit in 2007. That limit will remain in place until 2010 when the board is scheduled to revisit Calpers' asset allocations.
One criticism that has been levied against Calpers' hedge fund program is the high turnover among its senior investment staff. Since Boldt's departure in 2000, a string of senior investors key to the program have made their way through Calpers, including Mark Anson, Christianna Wood and most recently Read, who is said to have been pushed out when the board became irritated with his focus on pet projects in private equity.
Though Calpers' hedge fund group has its hands full overhauling its portfolio, it is just as aggressively preparing to stake a claim in hedge fund activities it has yet to explore. At the board's next closed-door meeting on September 14, Silberstein and his staff will present members with a proposal for Sprout, the hedge fund seeding platform that has been in the planning stage for more than a year and is similar to an earlier effort Calpers took with private equity, yielding mixed results.
Calpers follows the lead of a handful of institutional investors, such as Harvard Management, that have undertaken similar efforts. Over the years, Harvard's platform has served as the starting point for nearly 30 hedge fund managers who have since struck out on their own, among them Jack Meyer, a former Harvard Management CEO whose hedge fund firm Convexity Capital Management was seeded with $500 million from that program. Calpers is planning to take a different approach, expanding the purview of investments it will seed beyond emerging firms to individuals with innovative investment ideas that the plan can help them put into action.
Like most seeding platforms, Calpers will maintain a financial interest in any firm it finances—even if these managers eventually leave to launch their own firms—and is hoping to take advantage of the talent that has become available over the past year. Silberstein declined to talk about the program, but the idea has already generated substantial buzz within the institutional investment community.
Calpers has the means to launch and support a seeding platform of its own, but not everyone believes it would be the best use of the plan's resources. "We tried to do it and it's a difficult thing to do, in that public plans can only go so far in terms of compensation," says the chief investment officer for another public pension plan. Because the amount of money the plan could invest in any single emerging manager is much more limited than the capabilities of well-established funds, some of Calpers' peers believe that launching such a program would be far too much work for the returns it is expected to generate. Critics also argue that Calpers would be unable to compete with the salaries successful fund managers could command elsewhere in the market, making it likely that managers will stick around only long enough to build up performance records and piggyback on Calpers' visibility and connections.
Calpers reasons that the majority of managers are most profitable when they are small and agile and points out that the plan would retain sizable long-term stakes in any managers it funds, making seeding an attractive proposition for Calpers' hedge fund team.
UBS' Brown acknowledges that the seeding business is essentially a numbers game in which one must seed quite a few shops before coming across any long-term success stories, yet he believes the move would be good for Calpers. "I think their approach is as thoughtful as anyone else's, and if they go ahead and create a mandate to do something like this they're definitely going to follow through on it."
For the past three years, Calpers has also been investigating the possibility of having its inhouse traders replicate some of the more basic hedge fund strategies. "There are some strategies where you can quantitatively replicate the return distribution characteristics and get pretty darn close to what the active manager does," says Silberstein. "If we can [do that], that would actually free up resources to a point where we could deploy those resources to strategies that are very, very difficult to replicate." It also would give Calpers more liquidity because it is a strategy whose assets could be controlled internally.
On the flip side, Calpers' ability to replicate other strategies and start its own funds may lead to more opposition when it demands separately managed accounts and greater transparency from the hedge funds it invests in. "A really good hedge fund is not going to give away that information to Calpers, especially since Calpers will act on it in size," says one institutional investor close to Calpers. "A hedge fund has to be careful that Calpers doesn't arbitrage away the opportunities."
Silberstein says such concerns are groundless. "If we were to copy people's strategies word would travel fast, and it would probably shut us out of a number of good opportunities," he says.
There is also little chance of anyone taking advantage of the information Calpers is required to disclose about its investment activities as a public fund. In 2006, the California First Amendment Coalition, a public interest group devoted to freedom of speech and an accountable government, filed suit against Calpers to force the pension plan to disclose how much it pays hedge fund managers and venture capitalists and to reveal those investments' returns. As a result of that lawsuit, the state legislature passed a law limiting the amount of information Calpers must make public —such as the names of its fund managers, their performance and the market value of those investments at the end of the year. The legislation specifically exempted the plan from disclosing records containing information about portfolio positions for its alternative investments.
"There would be no way we would be able to convince any hedge fund to provide us with the level of information we're seeking without being able to give them a great deal of comfort that that information is contained within these walls," says Silberstein. Only a few people within Calpers are privvy to the details.
All of Calpers' attempts to refashion the hedge fund world in a manner that empowers investors represent the cusp of change. "Because of Calpers' size, because of their professionalism, because of the resources they have and because of the aggressive and active involvement they have in groups like the Council of Institutional Investors, they would clearly be watched by other fiduciaries and watched by the industry," says Dallas Salisbury, president and CEO of the Employee Benefits Research Institute.
"They have generally been an organization at the cutting edge of best practice," he notes, "so when Calpers does something, it at least causes others to evaluate it and ask 'Is this a new best practice and is it something that we need to also be doing?'" Hedge funds take note.
Who’s in, who’s out
• Aspect Alternative Fund
• Black River Commodity Multi-Strategy Fund
• Black River Fixed Income Relative Value Opportunity Fund
• Brookside Capital Partners Fund
• Canyon Special Opportunities
• Chatham Asset High Yield Offshore Fund
• Chatham Asset Leveraged Loan Offshore Fund
• CRG Partners
• Deephaven Market Neutral
• Lansdowne European Strategic Equity Fund
• O’Connor Global Quantitative Equity
• OZ Domestic Partners
• PFM Diversified Fund
• Rhapsody Fund
• SuttonBrook Capital Partners
• Tremblant Partners
• KBC Asian Fund of Funds
• Sparx Blue Diamond Fund
• Vision Blue Diamond Fund
• Ermitage Highbury Fund
• AIS Highbury Fund
• ERAAM Highbury Fund
• 47 Degrees North New Generation 1848 Fund
• Rock Creek 1848 Fund
• PAAMCO 1848 Fund
• Atticus Global
• Canyon Value Realization Fund
• Carlyle Multi-Strategy Fund
• Farallon Capital Offshore Investors
• Liberty Square Offshore Partners
• Platinum Grove Contingent Capital
• Tennenbaum Multi-Strategy Fund
• Wayzata Recovery Fund
• Zaxis Institutional Partners