Long criticized for putting politics before profits, the California Public Employees’ Retirement System is taking a step toward a less ideological approach to investing. In August the largest U.S. public pension fund, with more than $245 billion in assets, is expected to lift a seven-year ban on investing in emerging-markets countries that fall short in areas such as workers’ rights, freedom of the press and adequate market liquidity and regulation. The move was signaled in June, when CalPERS’s board voted to suspend research by outside consultants who assessed developing countries. Emerging markets represent about 3.5 percent, or $5.5 billion, of CalPERS’s $156 billion in global equity investments.
“This is a recognition that we’re in a global economy and that standards in many emerging markets have gone up a lot,” says CalPERS global equity investment chief Christianna Wood. When the fund implemented its policy in 2002, 14 of 27 developing nations CalPERS examined were deemed off limits. This year only seven fell short of the requirements — among them, Russia and China.
The move is part of an ongoing effort by CalPERS to give its activism more nuance. The new emerging-markets policy will be less rule-bound: It will permit fund managers to invest in companies even if they are based in countries that don’t make the grade. Fund managers will, however, have to consider a set of country and market principles similar to those in the current policy.
Still, the subjective nature of these criteria and the proposal that managers consider them holistically could be unwieldy. “Without a stated context as to what constitutes a minimum level of satisfaction with any particular principle, the managers may find it difficult to apply them to CalPERS’s satisfaction,” Michael Schlachter, managing director of Wilshire Consulting, wrote in May to CalPERS CIO Russell Read.
Cost-consciousness has played a part in the shift. The move would save CalPERS about $1 million annually in consultants’ fees. More important is the $401 million opportunity cost — the extra amount the pension plan’s emerging-markets investments would have returned had their fund managers not been restricted between July 31, 2002, and December 31, 2006, according to an analysis by Wilshire Consulting. “The costs were just one consideration, but we must acknowledge that constraining the opportunity set has never been a recipe for investment success,” says CalPERS’s Wood.
The most significant result of the change in policy is that it would allow investments in Russia and China. Not investing in these markets was the biggest source of opportunity cost. Both countries failed to make the list of permissible equity markets this year, in large part because of low scores for political stability and labor practices.
Phil Angelides, the former California state treasurer and CalPERS board member who had pushed for adoption of the restrictions, says the policy has been successful in getting developing countries to improve their economic practices for the long term. “The question now is, what’s the best way to continue to apply positive pressure? It would be a mistake to walk away from an activist policy,” Angelides asserts.
“No one’s walking away. If anything, we’re dialing it up,” insists Wood, noting that in February the board allocated $500 million for its first-ever emerging-markets corporate governance investments, which seek to boost companies’ share prices by agitating for improved governance.
In any event, the policy change is likely to mean more to companies in emerging markets than to CalPERS. “Ultimately, the slice invested by CalPERS in emerging markets is small,” says Brad Barber, director of the Center for Investor Welfare and Corporate Responsibility at the University of California, Davis. “But it could make a difference to companies in those countries that need capital, particularly if others follow suit.”
