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

European distressed debt: investors divided by volatility

Last month conexust1f.flywheelstaging.com hosted a thinktank with a group of influential Australian investors to discuss the opportunities in European distressed debt. Participants included the Australian Government’s $80 billion sovereign wealth Future Fund, the $68 billion QIC, and leading asset consultants, with guest speaker sir David Cooksey, former board member of the Bank of England, chairman

Governance, Gonski style

Since becoming chair of the $80-billion Future Fund in March, David Gonski has set an agenda to act like a public company chair. An element of that vision is to very clearly delegate to management. “The general manager has been elevated to a managing director and the six-monthly announcements will be his,” he says. Another

Risk parity manages risk regret

The risk parity approach to portfolio construction might not deliver results in a “bull stockmarket,” but remained a “robust and rigorous” methodology which also “managed risk regret over time.” These are the views of Wai Lee, chief investment officer of quantitive investment at New York-based fund manager Neuberger Berman, who was recently named winner of

African countries come to the sovereign wealth fund party

Many of the countries with the largest oil reserves also boast the largest sovereign wealth funds (SWFs). And yet African producers, like newcomer Ghana, Angola, and Nigeria which has been pumping oil since the 1950s, haven’t saved much of their oil revenue. Now, in an effort to replicate the long-term growth of funds like Norway’s

Regulatory risk in Europe a factor for infrastructure investment

The head of infrastructure at Australia’s $80 billion Future Fund has cited regulatory risk in Europe and the United Kingdom as reasons to be wary about infrastructure investment in the region. Raphael Arndt, the Future Fund’s head of infrastructure and timberlands, told a Sydney conference this week that he was particularly concerned with the situation

Europe’s credit rating crunch

It has been a bad month for credit-rating agency executives who thought they were winning the legal and regulatory arguments about how they conduct their business. In Australia, the Federal Court ruled on November 5 in favour of 12 local councils in New South Wales which claimed that Standard and Poor’s had misled them into

Previous