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We’ve repeatedly described CalPERS as a governance train wreck by virtue of its board ceding power to staff and engaging in oversight theater rather than the real thing. And now the chickens are coming home to roost in terms of self-serving abuses becoming visible.
Mind you, it would be perfectly fine for CalPERS to decide that its Chief Investment Officer Ted Eliopoulos needs to be paid at least $700,000, even though he has a very limited investment background and is sorely underqualified for his job, because even that much pay is well below what private sector investment managers who oversee large private sector funds are paid.
But that isn’t how CalPERS has gone about it. To get Eliopoulos to this overall pay level, it has ponied up a bonus well in excess of what his bonus plan permits. CalPERS is under strict California Constitutional requirements in terms of the duty it imposes on board members to conserve fund assets; that part of their fiduciary duty is arguably more stringent than ERISA norms. Yet the board member in charge of CalPERS’ Performance, Compensation, & Talent Management Committee, Michael Bilbrey, has been derelict in his duty, as demonstrated by the Eliopoulos bonus fiasco.
Notice in this 2014 document that CalPERS then stipulated that the CIO bonus could be zero (see page 28). So why has a big CIO bonus become a virtual matter of right, to the degree that the board will just ignore its own elaborate bonus determination procedures despite regularly going through a costly and time consuming pretense with an outside consultant?
With that background, let’s work through the math.
Eliopoulos’ salary for fiscal year 2015-2016 was $503,500. His bonus plan targets him to receive 50% of that as a bonus although the range is 0% to 75%. He was just awarded a $248,026 bonus. That means he got almost all of the targeted bonus.
But that is clearly, flagrantly in violation of his bonus plan (you can also view it here):
15-16-CIO-performance-plan-copy-1
15-16-cio-performance-plan-copy
The document shows that 70% of the CIO’s bonus is to be based on investment performance. As you can see, the CIO is to get 0 on this component if he does not beat the performance target. As you can see here, on page 3, CalPERS missed its target for the fiscal year just past by 41 basis points on this component. So Eliopoulos should get zip for this part of his computation.
That leaves a remaining 30%, with 20% for “sustainability”. It’s hard to see how Eliopoulos did well on that score, since late in 2015, CalPERS insisted on sticking with a 7.5% return target, and as we discussed, implemented a Rube Goldberg formula for reducing it to 6.5% over the next 20 years. Critics saw this position as indefensible in light of central banks around the world pushing monetary policy into negative rate territory, making it hard for the Fed to raise rates. Investors believe it will be difficult to exit the super low interest rate regime and even with the Fed anticipating the process to be attenuated, it has repeatedly had to push back its hoped-for dates for rate increases.
So a mere year after this Great Step Forward for sustainability, CalPERS is throwing in the towel and moving to lower its benchmark. Pension & Investments describes how far CalPERS is retreating:
Unlike other public plans that have leaned toward modest rate of return reductions, a key CalPERS committee is expected to be presented with a plan in December that’s considerably more aggressive.
That was set in motion Nov. 15 at a committee meeting when Mr. [Andrew] Junkin [of Wilshire Associates] and CalPERS CIO Theodore Eliopoulos said 6% is a more realistic return over the next decade.
At that meeting, it also was disclosed that CalPERS investment staff was reducing the fund’s allocation to equities in an effort to reduce risk.
Only a year earlier, CalPERS investment staff and consultants had agreed that CalPERS was on the right track with its 7.5% figure. So confident were they that they urged the board to approve a risk mitigation plan that did lower the rate of return, but over a 20-year period, and only when returns were in excess of the 7.5% assumption.
While this is a bold and desirable move, it strongly suggests Eliopoulos should get kudos for his next year bonus determination in this category, but a so-so rating for the year just passed.
But even allowing for undue generosity on the part of the board, here’s how the computation should have worked. Even if the board determined Eliopoulos deserved a “consistently exceeds high expectations” grade, he gets a weight of 1.5x. 30% x 1.5x = 45% x of a target bonus of 50% of his base salary of $503,500 would be $113,288.
So the $248,000 he is to be paid makes a joke of the pretense of having disciplined process. Per CalPERS’ own formula, roughly $135,000 of the total is an impermissible present.
Going forward, the board is even more permissive. The Performance, Compensation, & Talent Management Committee approved a questionable change in Eliopoulos’ bonus formula for next year in August, recommended by outside comp consultants (the lead comp consultant currently is Grant Thornton), which nominally work for the board However, they are screened and therefore effectively selected by staff and work closely with them, not the board, to develop proposals that CalPERS’ board rubber stamps.
Among the changes approved this year for next year’s plan is that the Chief Investment Officer, is to be paid 100% of the investment performance component of his bonus if he beats CalPERS’ investment performance benchmarks by a mere basis points. That means that if he merely had his team do a good job of matching the indices used to set his benchmarks, he and his team could all go to the beach and gamble on collecting their full performance bonuses. In fact, that sort of auto-pilot approach would probably be a big improvement, but aside from CalPERS’ domestic equity portfolio, where CalPERS runs a large in-house index fund, this sort of passive approach is not how CalPERS operates. Its in-house fixed income operation is active, and in private equity, it still tries to engage in the fool’s errand of out-picking other private equity limited partners. Trying to avoid the really crooked operators on fees and tricky practices and otherwise stealth indexing would likely do no worse than they are doing now with less managerial effort.
The flagrant overpayment to Eliopoulos proves the very worst we have suspected about CalPERS’ lack of meaningful board oversight. This is precisely the sort of thing you expect to see when you have a large pot of money and no one minding the store.
If you are in California, please write or call CalPERS’ elected board members, the state Treasurer and Controller, and tell them how outraged you are. They share in the responsibility for this breach of their fiduciary and Constitutional duties. If an abuse this obvious is taking place, what other sorts of lapses are taking place behind closed doors? Their contact details:
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
(916) 653-2995Ms. Betty Yee
California State Controller
P.O. Box 942850
Sacramento, California 94250-5872
(916) 445-2636
In addition, if you are a California citizen, please alert your state Assemblyman and Senator, and demand that they look into this serious lapse of governance. You can find you Senate and Assembly representatives here.
Please also contact your local newspaper and television station, as well as the Sacramento Bee. Tell them you think this story is important for all California taxpayers and urge them to take it up. You can find the form for sending a letter to the editor here.
Thanks again for your interest and help.
10 comments
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Aside from whether Mr Eliopoulos’s bonus is appropriate, this aspect of the P&I article is intriguing:
Evidently, Ted Eliopoulos is acutely aware of the extinction risk that a stock bear market would pose to a fund that is cash flow negative and up to its eyeballs in equity.
An essential fact underlying his push for a lower 6.0% return assumption is that after a nearly 8-year rally in which stock indexes have more than tripled, prospective returns are necessarily low.
Beyond that, the NBER’s business cycle dating commencing in 1854 shows but one 10-year economic expansion (Mar 1991 to Mar 2001). Our current expansion is in its eighth year. Monetary conditions are tightening, and the Federal Reserve is about to embark on the next phase of its rate hike campaign. These are classic late-cycle phenomena.
While public pension funds cannot shed all their equity exposure, Eliopoulos’s move to reduce Calpers’ equity to 44% — the low end of its allowable range — is a gutsy and contrarian posture. It goes against the prevailing Cult of Equities, in which pensions have doubled down on equity exposure in a desperate Hail Mary bet which cannot possibly pay off at these valuations.
Go, Ted, go.
That’s the kind of “can do” American attitude we need. When the going gets though we lower our expectations to make ourselves feel better. And why should Ted be given praise for doing his job? The fact that he has moved to reduce equity exposure means nothing unless his decision proves to be correct, which hasn’t yet. What if reducing equities proves to be a stupid decision? Shouldn’t he be praised and financially rewarded at the point that his decisons can be measured against performance? That aside, CalPERS decision to ignore its own rules makes a mockery of the institution and is an insult to its members. The rules are there for a reason; ignoring them or making them as you go along invites corruption and ultimately the delegitimization of the organization, in this case CalPERS.
“When the going gets tough we lower our expectations to make ourselves feel better.”
Better to say that “When valuations get high, we lower our return expectations.” It’s just math; nothing to do with irresoluteness.
How moving the goalposts interacts with bonus formulas is another subject. But if Eliopoulos succeeds in slashing Calpers’ return target to 6 percent, it’s going to be a bombshell for public pensions nationwide, which uniformly have their return targets set too high.
In turn, making public entities fund the full cost of their pensions is going to bankrupt some of them. Push has come to shove, and the pips are squeaking.
Over the past two years CalPERS has significantly under performed realtiave to its benchmark. There will have to be a lot more lowering of the benchmark before Ted and the rest of CalPERS’ investment staff starts looking half decent. And I am not convinced that CalPERS has not exhausted other avenues to improve performance before resorting to lowering its benchmark, take for example fighting PE and other alternative asset managers on fees and expenses; there alone CalPERS could save many millions of dollars.
George Carlin answered the “why” something like this can happen — “It’s a big club and you ain’t in it”. The internal rules of this club (too much is never enough) supersedes anything like a bonus limit.
wow. just when it looked like CalPERS board was starting to see the larger picture they drop back into “private club” mode instead of public fund fiduciary.
Thanks so much for your continued reporting on CalPERS and pensions.
Thanks for the continuing spotlight shone on CalPers. What they do affects all citizens of CA. And beyond that, CalPers is one of the Bigs in terms of pension plans, so a lot of other state and local pension funds look to see what CalPers does. It’s important to keep highlighting them.
Citizens are paying attention.
Once again, I’ll write to Chiang & Yee for whatever good it does. I hope they pay attention but don’t hold my breath.
By gifting Eliopolous’ full performance bonus for returning a measly .6 percent against a 7.5 percent target, the CalPERS board makes a mockery of governance. This is shameful.
They gifted the CIO a sum over double that gifted to departing CEO Anne Stausboll. I don’t doubt he threatened to quit — an idle threat, as there can be little doubt that he will make a cushy landing with some PE outfit as his reward for massively steering assets their way (Sam Zell?).
Disgusting.
Even Trump laughs at this CIOs past real estate transactions, how he ever got the job is a real mystery and he can threaten to quit all he wants, no investment manager would ever hire this entitled prima donna, business class flying SJW
I thought calpers was cash flow negative? Yet these shenanigans are condoned by the board? Extremely despicable
Hey ann and ted why dont you go loot some other disaster areas while youre at it
The 0.6% gain that Eliopolous managed to eke out in fiscal year 2016 is roughly equivalent to the rate of inflation for that period. Consequently the real gain of CALPERS for fiscal year 2016 is closer to zero than the abysmal rate of 0.6% that they reported. During the 2016 Fiscal year, the S&P 500 was up 1.2% and the S&P Bond index was up 8.2%. A blind squirrel might have done better than Eliopolous for fiscal year 2016. In my mind, this raises the basic question beyond Eliopolous’ compensation as to whether anyone is actually running CALPERS.