CalPERS urged to pull back commodities risk

CalPERS’ internal commodities team should enforce a tracking error limit for the portfolio it manages, and prepare to boost headcount and resources as investment opportunities evolve and funds under management grow, the fund’s primary asset consultant, Wilshire Associates, found in a review.

Following an on-site review, Wilshire recommended the fund’s investment committee provide a clear mandate to the commodities team with a target tracking error of no more than an annualised 2 per cent. Currently, the fund does not specify how much of the commodities’ portfolio can be invested in alpha strategies – but a tracking error policy would provide this.

In the beginning, the team gained exposure to commodities through an index swap. Its portfolio sits within the inflation-linked asset class (ILAC) program, which accounts for a maximum of 5 per cent of total funds under management, and also invests in infrastructure, timberland and inflation-linked bonds to achieve returns above inflation and provide diversification.

But as the commodities program grew, the team, led by portfolio manager John Kowalik, introduced alpha strategies which increased tracking error, and “while these strategies have added value, continued growth of these alpha-seeking strategies could undermine the intent of the commodities program – broad exposure to the commodities market”.

The team currently has a monthly maximum target to keep its tracking error around 100 basis points, or 3.5 per cent annualised. But this may be too high, given the team’s investment objectives. Wilshire wrote that its proposal of an annualised 2 per cent tracking error implied that about 34 per cent of one-year periods will include performance – either positive or negative – that deviates by more than 2 per cent from the benchmark.

Sponsored Content

Given the volatility of commodities, keeping the tracking error in check would benefit the fund because it would help curb significant deviations from the index, which may not fulfil the investment committee’s inflation-hedging aims.

“Wilshire recommends the alpha-seeking strategies should constitute a minority of the exposure of the commodities program, such that the program continues to provide broad exposure to commodities – hence, the link to inflation – but allows for some alpha to be pursued,” the consultant wrote.

The commodities program accounts for 1.5 per cent of the fund’s capital, and 30 per cent of the ILAC program, meaning that its performance exerted a “meaningful effect” on the success of the portfolio, Wilshire wrote.

Most of the commodity exposures were achieved through inexpensive index swaps, but 25 per cent of the portfolio was devoted to active strategies, including long and short strategies. Wilshire found the team ran appropriate strategies and managed risks well, but should increase headcount – particularly research and risk management resources – as the program grows beyond its current scale.

“AsCalPERS’ various programs continue to grow and the scope of the commodity program expands, additional staff members are likely to be needed.”

The program’s reliance on Kowalik also introduced some key-person risk, and prompted Wilshire to echo its concern that CalPERS, as a governmental operation, could not incentivise talented staff through equity ownership, as private organisations often do.

“The breadth of research required to find innovative approaches to capturing alpha is likely to require additional resources. As such, while the current portfolio manager is an experienced commodity professional, there is key-person risk associated with the lack of depth in staffing.”

Wilshire noted that Kowalik preferred strategies with high Sharpe ratios “which are diversified and have shown consistent performance across different market regimes”.

The consultant also assessed the program’s exposure to counterparty risks, given that its investments often involved swaps. While the team deals with various counterparties, its highest exposure to any one was about 25 per cent – well below the 40 per cent limit stated in the investment policy.

Leave a Comment

Sort content by

Rethinking investment performance attribution

As asset owners move away from silo-based investment decision making, their performance attribution systems also need to evolve. The Alberta Investment Management Corporation AimCo, the C$70 billion arm’s length investment manager for public sector assets in Alberta, Canada, has implemented a new performance attribution system based on how managers actually make their investment decisions.  

Benchmark design for an active investment process

Choosing the appropriate benchmark for active managers is a common debate among institutional investors. Norges Bank Investment Management has produced a “discussion note’ on the benchmark design for an active investment process, in which it introduces a flexible modelling framework that aims to incentivise each portfolio manager to utilise their stock-picking skill.   The benchmark

SSgA focuses on innovation not assets

For Scott Powers, president and chief executive of State Street Global Advisors, assets under management is not a measure of success – the manager is currently the world’s fourth largest with around $2.5 trillion. Instead it is the ability to provide value for clients in meeting their objectives – whether it be matching liabilities, creating

Pension funds put pressure on G20 tax reform

Pension funds are becoming vocal ahead of the G20 leaders summit next week, reiterating the need for action over tax reform, and encouraging world leaders to consider financial reform that encourages long-term investing. The UK’s Local Authority Pension Fund Forum, which is a collaborative shareholder engagement group of 61 local authority pension funds with combined

G20 urged to develop policies to support long-term investment

The Fiduciary Investors Symposium (FIS) at Harvard University has identified several of the key barriers to pension funds, endowments and sovereign wealth funds adopting more effective long-term and sustainable investment strategies, and is preparing a communiqué to the upcoming meeting of the G20 to convey its concerns and its policy requirements. FIS, organised and hosted

Future Fund focuses on finding the best people

Australia’s sovereign wealth fund, the A$101 billion Future Fund, has just upped the stakes in not only attracting the best co-investment deals from fund managers, but in its bid to attract the world’s best investment professionals. Two months ago the fund’s long serving chief investment officer, David Neal, become chief executive in name (following the

Previous