Total cost shakedown at CalPERS

Up to 8.9 basis points will be slashed from the total cost of managing the CalPERS’ investment portfolio in the next three years, under a new investment resource strategy which could also see internal administration costs increase by $6.5 million next year, and internal staff accountable for internal versus external management allocations.

The internal investment team is targeting a total cost range of between 50 to 54 basis points, down from the total of 58.9 basis points recorded in 2010.

It has asked for an increase of investment administration costs of $6.5 million in the next financial year to help achieve this.

The argument is that it is important to focus on total cost, and that internal management results in lower total costs, even if the internal costs are higher due to more staff.

It argues that if a total basis point cost target is set, and the investment management team is accountable for that target, they should be able to trade-off across external and internal expenses, making decisions about the use of internal versus external resources based on economics instead of budget process.

The $225 billion CalPERS manages 93 per cent of total public assets and 64 per cent of total assets in house.

While the cost reduction is significant, the total target is still a lot more than the 30.9 basis point total cost the fund recorded in 2006. This is due primarily to the amount of private assets in the portfolio, which has increased from 16 to 26 per cent from 2006 to 2010.

Of the total cost of 58.9 basis points in 2010, 47.7 basis points were attributable to private assets including hedge funds. Reducing complexity is also being targeted as a way to reduce costs and, where possible, it is focused on eliminating small non-value-add programs and reducing the number of managers.

According to papers presented to the board, the reduction in total fees will primarily come from a reduction of external management and consulting expenses, with a reduction between $100 million and $200 million over the next three years.

The vast majority of the total costs, $1.15 billion of $1.26 billion, is from external asset management fees. About 87 per cent of the total external assets management fees come from private assets and hedge funds.

The internal team plans to develop a long-term “resource strategy” for the investment office and reinvest some of the external savings in internal capabilities.

The papers say the target operating-model implementation is to move down the complexity spectrum, but selectively adding complexity where significant value can be added, such as co-investment in the alternative investment management program.

The CalPERS investment office believes there is an opportunity to further reduce external management and consulting costs and reinvest some of those savings in missed internal capabilities.

It outlines three cost drivers of investment management organisations: private versus public assets, external versus internal management, and the breadth and nature of the investment strategies and activities.