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

Complexity: thinking ahead

Complexity is, well complex. And as trite as that sounds, it’s something investors, even professional investors, don’t understand well enough, according to Tim Hodgson, head of the Thinking Ahead Group at Towers Watson. The Thinking Ahead Group (TAG), as has been reported here before, gets paid to think – a gig conexust1f.flywheelstaging.com is envious of.

Study finds greenness equals performance

There is a positive correlation between the investment performance of REITs and the “greenness” of their portfolio holdings, according to a new paper by Maastricht University’s Piet Eichholtz, Nils Kok and Erkan Yonder. The paper – Portfolio greenness and the financial performance of REITs – finds that investment performance of REITs is positively related to

Benchmarking ESG changes behaviour

The power of benchmarking funds on sustainability is demonstrated by the fact 171 property companies and funds surveyed in the 2012 GRESB benchmarking report reduced GHG emissions by 6 per cent – this is a reduction of 432,000 metric tons of CO2, the equivalent of removing 85,000 cars from the road. The Global Real Estate

Taking RI from in-house to front of mind

The industry needs to be better at thinking how responsible investing can be accessed by smaller funds or those lacking sufficient internal resources, David Russell, co-head of responsible investment at the UK’s Universities Superannuation Scheme, says. Russell, who will join a panel at the Fiduciary Investors Symposium in Santa Monica produced by Conexus Financial, publisher

In-house not for
every house: WSIB

While the trend for most large institutional investors is to insource asset management, the $85-billion Washington State Investment Board (WSIB) has decided to take a different path. Much-cited CEM Benchmarking research shows that funds with internal-management platforms are better performers after cost, and this is largely driven by the lower costs of internal management. Many

Three-way shift in investor behaviour

There are three major behavioural shifts occurring among investors that will have significant impact on asset allocation in the next 10 years, according to a year-long study by global head of research at State Street’s Center for Applied Research, Suzanne Duncan. An increase in investor sophistication, re-evaluation of the risk/return trade-off and more discernment over

Previous