Russell Read knows the importance of carefully laying the groundwork for new initiatives. When he was a portfolio manager at Oppenheimer Funds in the mid-’90s, Read came up with the idea of introducing a then-novel mutual fund that would track commodities prices in part by investing in futures contracts — only to have to spend the bulk of the two-and-a-half-year development process securing approvals from securities and commodities regulators before actually launching the fund in 1997.
Read wanted to avoid similar delays in his effort to expand into commodities investing as the new chief investment officer at the California Public Employees’ Retirement System, the nation’s largest public pension plan, with $216 billion in assets as of September 26. So the 43-year-old fund manager arrived at CalPERS’s Sacramento offices several weeks before taking up his post on June 1 to learn the lay of the political landscape.
“This board is very different from my other boards, and they give the principal mandates,” says Read. “Getting to know them, and the history of the organization, is important.”
By all accounts, Read has gotten the ear of the board, which includes Philip Angelides, the state treasurer who is running for governor against Arnold Schwarzenegger. After just three months on the job, Read organized a board workshop on commodities last month, and later this year the board is expected to approve a pilot program to invest in commodities, to be followed by a decision next summer on whether to make a significant push into the sector.
The timing might seem odd, given that oil and other commodities have declined from their recent highs and hedge fund manager Amaranth Advisors was forced to close after taking a $6 billion hit on natural-gas prices. Those events reinforced the wariness some investors have about the volatility of commodity markets. As Read puts it, “The conceptual battle is that everyone has a Great-Uncle Frank who lost all his money in two weeks in 1925 speculating in commodities.”
Read plays down short-term events, however, and insists that the asset class makes sense in the long run for CalPERS. “In general, a diversified and unleveraged allocation to commodities can have absolute risk similar to that of a diversified basket of stocks,” he says.
Read’s interest in commodities runs deep. He wrote his dissertation on the impact of natural resources on growth; he’s also a farmer who has planted 10,000 trees on the 500 acres he owns in Maine, part of a reforestation project he is conducting with the University of Maine’s Forest Bioproducts Research Project.
Before moving to Sacramento, Read worked in New York as deputy chief investment officer for Deutsche Asset Management, overseeing more than $250 billion in retail and institutional investments. Read succeeds Mark Anson, now CEO of U.K. fund manager Hermes. During his four years as CIO, ending last December, Anson grew CalPERS’s fund from $127 billion to $196 billion, adding more than $8 billion in excess returns. Institutional Investor Senior Editor Steven Brull recently spoke with Read in his sun-filled corner office at CalPERS’s headquarters.
Institutional Investor: Why would you take a big cut in compensation and move to Sacramento to accept a job in the public sector?
Read: It wasn’t for the paycheck, which, you know, is more than the governor or the president gets. This is a means to give back to the public in a way that uses my skill sets. I believe I can develop and transform an extraordinarily important organization in a way that has disproportionate benefits to our investors and to the capital markets. Without that belief, I wouldn’t have taken the position. Another key factor is that, even compared with the largest asset managers, such as Fidelity and UBS, we have access to the finest investment managers in the world. That is really a unique and captivating opportunity.
What’s your sense of the markets?
The capital markets are undergoing a very significant transformation. The role of natural resources is particularly important. In 1980 energy and raw materials constituted some one third of the S&P 500 in terms of capitalization. That number dropped to 7.8 percent in 2000. The ratio is now about 12.5 percent but could grow to 20 percent or more in the next ten years.
Where are the best opportunities?
Between 1980 and 2000 the most important thing was to be invested in the capital markets. The wind was at our backs. As long as you were investing in bonds and stocks in an appropriate mix, that was the single most important investment decision you could make. But from 1964 to 1980, we had essentially the same level on the Dow. The lesson was that you couldn’t rely on the capital markets themselves in a broad way to meet your investment goals. You had to find the opportunity and capitalize on it. Going forward, I think it’s much healthier from a pure investment standpoint to say that you cannot count on the capital markets themselves to provide investment returns. You have to find where the opportunities are.
To whom do you look for guidance?
We are looking at major plans both in the U.S. and abroad. We think this is particularly important because many of the largest plans in Canada and overseas actually have a very intuitive and long-standing investment sensibility related to commodities and infrastructure investment. We believe we have things to learn from plans outside the U.S.
Why are natural resources a good bet?
In most markets there’s a very quick adjustment mechanism: Prices go up, and more is produced. In energy or in mining, that’s not the case. It can take ten or 15 or 20 years to build up major infrastructure in energy. We have had accelerating demand in places like China and India, and the implications for producers of energy and materials are significant.
How so?
Unlike the period from 1980 to 2002, there is a need for an enormous amount of capital, and in time, that will have to be focused on the natural-resources sector in a manner similar to what we saw most recently in the period from 1964 to 1980. Whereas we saw essentially no IPO activity in the natural-resources sector from 1980 to 2002, we’re expecting perhaps as much as half or more of IPO activity over the next ten years to be in this sector.
Although prices have moderated in the past couple of months, commodity and natural-resources stocks have been on a tear for years. Isn’t it too late to make a big move?
We are already investing in this area through our clean-tech program, through real estate and IPO activity. We’ll place more emphasis generally on securities market opportunities for companies involved in the production and distribution of natural resources. There are also compelling projects in the energy and raw materials sectors for which commodity futures contracts can represent an important means for reducing project risk. For example, providing funding for a new ethanol facility may make sense only if crude oil prices remain above $50 a barrel, so selling crude oil futures contracts forward, in this particular example, could represent the judicious use of commodity futures contracts for project risk and reward management.
What sort of weighting will commodities have in CalPERS’s portfolio?
I wouldn’t want to presuppose where we end up; I can’t get ahead of the board. But we’ve seen that other endowments and pension plans have used a 5 percent allocation to improve the risk-reward characteristics of their portfolios.
How would this affect the rest of the portfolio?
It doesn’t necessarily portend a dramatic change in asset allocation among public and private equity, real estate and fixed income. However, we do anticipate significant changes within each of those asset classes. We’ll take a matrix view of opportunities. There will be an increasing amount of inter-asset-class investments. Consider the implications of high prices for liquefied natural gas. This will create a need for larger ships, larger ports and larger reliance on rail and intraregional trucking. We’ll also make some allocation decisions based on our buoyant view of opportunities in the health care sector.
CalPERS shook the pension and hedge fund worlds in 2001 when it invested $1 billion in hedge funds. Today 1.5 percent of the portfolio is in such funds, shy of the 1.8 percent target. What are you doing to increase your exposure?
A core part of our hedge fund strategy is to identify and develop superior emerging managers, both in North America and abroad. It’s a way for us, in effect, to create our own capacity to find alpha generators. We are committed to alternative asset classes, but only to the extent that we can maintain our advantages.
