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

Disparity in policy portfolio risk profiles

A policy portfolio is a poor reflection of investor preferences, argued Peter Bernstein. This philosophical question has now been empirically tested by MIT’s Mark Kritzman, who shows the inter-temporal disparity of a policy portfolio’s risk profile. He suggests a simple framework for addressing this deficiency. Kritzman encourages investors to replace rigid policy portfolios with flexible investment policies.

Ventures on the risk spectrum

Hershel Harper received an early education in finance when he used to read Business Week in High School. The 43-year old now at the helm of the $27-billion South Carolina Retirement Systems, investing on behalf of South Carolina’s 350,000 public sector workers, says he knew back then he wanted to manage money: “I really am

Getting the commodities mix just right

While commodities are a controversial and problematic asset class to some investors, for others they are an ideal diversifier looking more attractive than ever. A mini-revival in commodity investing among US pension funds suggests the asset class may be enjoying a resurgence. The Los Angeles Fire and Police Pension System, Municipal Retirement System of Michigan

The end of beauty contest active management?

Designing and implementing concentrated, long-horizon investment mandates would support longer term thinking, align pension organisation’s goals with its stakeholders, and reduce transaction costs. This was one of the recommendations of a two-day workshop in Toronto last month, attended by a delegation of 80 pension fund executives from around the globe. Aimed at uncovering the meaning

Italian fund rides out crisis in style

The wrath of the European sovereign debt crisis may have left its mark on Italy in more ways than one, with both its financial and political scenes regularly sliding into crisis mode for the past year or two. However, the nation’s largest private pension investor, the €7.75-billion ($10.1-billion) Cometa fund, has firmly kept on track

Paul Marsh: live with low returns

The London Business School’s emeritus professor of finance Paul Marsh admits that you have to be slightly mad to embark on the kind of research detailed in the latest edition of Global Investment Returns Yearbook. This year Marsh and colleagues Elroy Dimson and Mike Staunton – Marsh describes the three of them, pictured below, as

Previous