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

The cost of bad asset allocation

A study of 300 US pension funds by CEM Benchmarking reinforces the importance of asset allocation, highlighting the performance of asset classes, as well as new evidence on correlations between asset classes. Alex Beath, author of the study, discusses the implications for asset allocation with Amanda White. A CEM Benchmarking study “Asset Allocation and Fund

The OECD’s plan for long-term investment

G20 financial ministers and central bank governors welcomed the findings of the G20/OECD roundtable on institutional investors and long-term investment last month, which included clear plans to incentivise institutional investors to undertake more long-term investments. The roundtable, “From solutions to actions: implementing measures to encourage institutional long-term investment financing”, held in Singapore recognised that long-term

Why long-horizon investors should adopt factor-based asset allocation

Long-horizon investors can withstand macro-economic volatility and so should tilt towards strategies that are exposed to that, including value, small cap and momentum. Oleg Ruban, vice president in the applied research team at MSCI says this validates factor-investing and factor-based asset allocation for these investors.   Appropriate asset allocation requires explicit attention be paid to

The case for long-termism

Keith Ambachtsheer’s lead article in the Fall 2014 edition of the Rotman International Journal of Pension Management, takes readers through an historical and logical journey that supports the case for long-termism. Importantly he validates this with four high-profile investor case studies which demonstrate that a long-term view benefits society but also the investors, willing to

Investors alter allocations because of climate risks

A number of large institutional investors, including AP1, the Environment Agency and AustralianSuper, made changes to their strategic asset allocation as a result of Mercer’s 2011 study on climate risks, and now the consultant is working with a new raft of investors to assess forward-looking climate change scenarios against their current allocations. Meanwhile one of

Real estate sector continues to lead on sustainability: GRESB

This year’s Global Real Estate Sustainability Benchmark (GRESB) reveals that sustainability reporting has improved in coverage and quality of data, with the average overall score increasing due to increasing implementation and measurement. The average score is now 47 (out of 100) which is up nine points this year. The benchmark collects data from 637 listed

Previous