Déjà vu as Wilshire warns CalPERS of ARS portfolio risks

CalPERS’ absolute return strategies program is over-reliant on quantitative tools, inadequately staffed and may be overweight in certain strategies and risks, according to Wilshire’s annual review of the portfolio.

In its annual review last year, the consultant issued the exact same warning regarding the risks in the portfolio, namely that the program may contain more macro, currency, commodity and directional risk than the investment committee desires.

For the past five years to June 30, the ARS program has returned 3.2 per cent, versus a benchmark of 8.2 per cent.

In a report to be presented to the investment committee next week, it also says the internal portfolio construction process is heavily dependent on quantitative tools and historical performance, and recommends that qualitative decisions be allowed to override quantitative models.

“Our understanding is that staff utilises quantitative tools for a significant portion of the modelling and allocation process and is looking to add to its quantitative tool set via a recent search for a new asset allocation/risk modelling software provider,” it says.

“We remain concerned that staff may be over-reliant on such quantitative models.

“We believe it is important to make sure that the qualitative input of staff and the outside advisors will continue to override the quantitative factors when the aggregate wisdom of all parties involved recommends a different investment approach than what the models dictate.”

The consultant says it is generally pleased with the quality of personnel, systems and processes, but it does have some concerns regarding staffing for the team and the overall reporting and governance structure for managing the portfolio.

“We do have some concern regarding the level of staffing within the ARS team and the oversight of this program within the CalPERS investment office,” it says.

The responsibility of the portfolio has been shifted around in recent months, with the senior portfolio manager of the program leaving the fund in August, and a decision made to shift the responsibility to the chief investment officer rather than the senior investment officer for global equities.

But Wilshire recommends the responsibility and oversight of the program should be within global equities, particularly given that the investment committee decided last month that the global equities division would manage a newly-approved equitisation overlay (see story, What is the future of hedge funds at CalPERS?).

Further, the consultant recommends a new organisational structure, once a new senior portfolio manager or senior investment officer is appointed, where ARS, opportunistic investments, and other fund-wide programs, such as currency, commodities and corporate governance could be located.

Following an extensive review of the ARS program’s purpose – that is, whether to be return-enhancing or risk-diversifying – the investment committee decided last month that ARS should not be included in the policy portfolio, but be funded by a global equities allocation, with an equitisation of about 2 per cent of the total fund to bring the global equities allocation back to the benchmark weight.

The board requires staff to report back with a detailed and comprehensive review of the program within a year.

“We believe that over the next year it is appropriate to have further discussions [on] the desired nature of this program so that it may be properly implemented in line with the investment committee’s interests,” Wilshire says.

Wilshire points out that the ARS program is one of the most complicated of the fund’s investment programs from a governance and management standpoint. Staff make all decisions within the bounds of delegated authority, but receive advice from outside managers regarding any decision it makes regarding direct investments.

In addition, Wilshire monitors the overall program for the investment committee but does not review the direct investments made by staff.