CalPERS mulls tying climate KPIs to incentive pay

CalPERS is considering tying the incentive pay of its staff to meeting climate KPIs. For now, the $485.3 billion Californian pension fund continues to monitor trends among peer funds in this area. But in a recent board meeting, members discussed how integrating climate change and environmentally focused performance metrics into CalPERS’ annual incentive plan will likely make board level discussion soon.

Executives from Global Governance Advisors, GGA, CalPERS’ compensation consultant, pointed out that more asset owners are starting to use pay to incentivise staff to hit climate targets. Speaking in a recent board meeting, they said metrics could include climate disclosure and reporting, or allocations to low carbon assets.

“As your advisor we are keeping track of this and when it gets to the point where we can establish what metrics might look like from an operational perspective, we can review it as a committee,” said Brad Kelly, partner, Global Governance Advisors.

CalPERS board members responded to the idea with enthusiasm. “In our proxy voting we hold companies responsible and ask them to report and hold their higher- ups accountable to environmental standards. It’s a good idea,” said Theresa Taylor, president of the board.

Current performance metrics at the pension fund cover investment performance (both from a returns and cost perspective) as well as customer service and stakeholder engagement. However, unusually, CalPERS doesn’t place any weighting on asset class investment performance – investment performance measures remain solely based on total fund results.

GGA suggested that CalPERS new chief investment officer, Stephen Gilmore, who joins the fund this July from New Zealand Super, may want to review the current structure and consider the addition of an asset class investment performance weighting in the annual incentive formula for investment staff. Not only will this put CalPERS more in-line with its public pension fund peers. It will also create alignment between pay and performance within the investment team.

“Over time, CalPERS should look to phase in more weighting towards asset class performance with a corresponding decrease in total fund performance for these team members,” GGA suggested.  “A lack of weighting on asset class investment performance within the annual incentive formula for investment professionals working within a specific asset class is the biggest misalignment we see to current best practices.”

CalPERS moved toward a total fund approach in fiscal year 2019-2020 in a bid to break down silos and encourage the investment office to work together. CalPERS also focuses less on alpha generation than typical pension funds in the marketplace. But it has led to a misalignment in today’s competitive hunt for talent which notably includes funds such as CalSTRS.

“Incentives should always retain a strong link between performance expectations and elements that participants have connections and influence in enhancing,” said GGA. “If all investment professionals are rewarded solely on total fund performance, there is much less ability to differentiate between higher and lower performers on the team or recognize and reward certain asset classes that have materially or disproportionately contributed toward the positive performance of the fund.”

Another way to introduce a total fund metric could be via Long-Term Incentive Plans (LTIPs), they suggested. Focused on forward-looking total fund investment performance over three to four years, typically, this model helps align investment and executive staff toward earning a meaningful LTIP payout at the end of each extended performance period.

“Our opinion is that CalPERS’ LTIP will have this impact going forward as it begins to annually complete the associated long-term performance cycles and provide the potential to generate additional payout opportunities for eligible plan participants.”

Quantitative v qualitative

GGA also suggested CalPERS consider linking incentive pay to more quantitative factors.

“Since the commencement of our engagement with CalPERS, GGA has fielded concerns that too much weighting is placed on qualitative performance within the CalPERS incentive plan, which is tougher to measure, and reward, realized performance. As well, truly qualitative measures can possibly increase headline risk because it is often associated with subjective judgments which can also open the fund up to criticism and increased levels of scrutiny.”

Typically, market practice sees incentive pay in investment positions weighted 70- 75 per cent to quantitative performance with no more than 25- 30 percent weighting allocated to the qualitative performance of the individual in their role.

“An adjustment to increase the weighting on quantitative performance would better align these positions with the market, including CalSTRS,” they concluded.