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CalPERS plays with investment
fire
By Gary LaMoshi
HONG
KONG - The California Public Employees Retirement System
(CalPERS) has been a frontlines fighter for investor
rights in the United States for many years, speaking
loudly and carrying a big stick as the country's largest
public pension fund. The US$131 billion pension fund has
spread the fight overseas along with its money, and last
month updated its controversial emerging markets stock
market investment criteria.
After getting burned
in the Asian economic crisis and other developing-world
debacles, CalPERS debuted a new formula last year to
determine where it would let money managers to play the
stock market in 27 emerging economies (see Unraveling the corporate governance
mystery, January 24).
CalPERS' 2003 list
looks the same for East Asia. South Korea and Taiwan are
still in. (Tokyo, Hong Kong, and Singapore qualify as
developed stock markets.) China, India, Thailand,
Malaysia, Indonesia, and Sri Lanka are still out. The
Philippines has again appealed its failing grade. The
plea succeeded last year, and CalPERS is keeping its $30
million portfolio on the board in Makati, pending this
new review. Aside from the Philippines' potential
removal, the only change from 2002 is adding the
minuscule Jordanian market to the 14 previous eligibles
for CalPERS' $1.6 billion developing-country equity
portfolio.
The CalPERS criteria include expected
financial market standards: market regulation,
settlement times and transaction costs, capital-market
openness, and liquidity and volatility. Those four
factors, weighted equally, comprise 50 percent of the
index.
Uniquely, CalPERS' model also includes
three civil-governance categories: political stability,
transparency, and labor practices. Those factors
comprise the other 50 percent of a country's score.
CalPERS' standards open a new branch in the long-running
debate about whether democracies or dictatorships can
deliver better economic growth: how much stock should
investors place in freedom and democracy?
Investor rights or civil rights?
Civil
governance clearly matters to equity investors, as
shareholders that have tried their luck in the Chinese
or Indonesian justice systems can attest. Beyond the
courts, the free flow of information is also crucial to
portfolio investors. Political stability clearly
matters, since stock markets react badly to uncertainty
and, more fundamental, revolutions tend to be bad for
shareholders.
CalPERS is clearly on to
something. The devil is in the details.
CalPERS'
model, prepared by Wilshire Associates, uses a
three-point scale for each of the seven categories. For
most categories, it relies on expert assessments, such
as Freedom House's index on press restrictions, but
ultimately it compiles subjective observations into
seemingly objective numbers. Once the index assigns
scores in each sub-category, whacks them into an overall
score (3 is best) for each category and averages them,
the real fun begins.
In 2002, with three country
categories and five market categories, Wilshire
Associates recommended rating each factor equally across
the board, except giving a 50 percent greater weight to
Market Regulation/Legal System/Investor Protection and
halving the value for Transaction Costs (in 2003, this
category was combined with Settlement Proficiency to
produce seven categories). Country factors would count
for 37.5 percent of the total score and market factors
as 62.5 percent. Wilshire also recommended a total score
of 1.6 as the minimum for CalPERS portfolio investments.
Under that recommended scoring system, 17
markets would have qualified, including India, Thailand
and the Philippines. However, CalPERS' trustees, a mix
of representative elected by its membership and second
tier California elected officials, chose to set the bar
higher, at 2.0, which would exclude that trio. Fair
enough.
Heavyweights
CalPERS agreed
with the consultant's concept of overweighting the
Market Regulation category, but it wanted country and
market factors to comprise equal portions of the overall
total. So the three country categories were set at 17
percent of the total score (Transparency got knocked
down to 16 percent). That meant each was more important
than any market factor, including the overweighted
Market Regulation category. Using that scoring system,
the Czech Republic, No 1 in country factors (you explain
it) and 20th in market ranking, was deemed a sound
investment, while seven countries with higher-ranked
markets were not.
Things got even goofier in the
2003 charts. The number of market categories was reduced
from five to four, each equally weighted at 12.5
percent, dwarfed by the unchanged values of the three
country factors. Under this scenario, top-10-ranked
markets India (No 3) and Morocco are out, while the
Czechs at No 17 and Hungary at No 20 are in. Perhaps
most incredibly, despite the meltdown of its financial
and political systems, Argentina is not just eligible
but ranked ahead of Turkey and Brazil.
Such
results demand a closer look at what CalPERS is actually
ranking.
The Transparency category, including
accounting standards and stock-exchange regulation,
could easily cross over from the country to the
financial side of the ledger. The Political Stability
category includes pertinent factors for investors, such
as independent courts that protect property rights and
freedom of expression that enables analysts to say what
they think and the media to play a watchdog role.
(Recent US scandals illustrate that press freedom
doesn't guarantee investors either of these advantages,
but lack of freedom helps ensure neither will occur.)
But, for CalPERS, free labor unions and collective
bargaining rights also count as political-stability
factors, as does the absence of torture.
Then
there's the Labor Practices category, which evaluates a
country's acceptance of and compliance with UN
International Labor Organization standards. Some
neanderthals may contend that absence of workers'
rights, as well as unbridled police power, leads to
higher corporate profits and, therefore, better returns.
A more balanced observation is that, as desirable as
these practices may be from several perspectives, they
don't matter much to stock-market investors. You
wouldn't want your children to grow up in a nation where
they'd be more likely to be weaving carpets for pennies
a day than attending school at age 12, but you can be
less picky about where your money grows.
Nanny fine
But some investors do want
to be picky. Socially responsible investing (SRI) has
made headway in the United States and Europe over the
past decade. SRI advisors (and the mutual funds they
manage) generally eschew defense, alcohol and tobacco
stocks. Depending on their particular charter, they may
also shun companies that fail to show proper respect for
women's, labor or animal rights, religious commandments,
or the world's poor. Abercrombie & Fitch's racy
clothing catalogue was enough to get the US retailer
blacklisted in some SRI circles.
Despite
shareholder activism that frequently aligned it with the
SRI crowd, CalPERS never signed on to the SRI agenda.
Its trustees have an obligation to seek returns for
members, period. CalPERS justified its activism strictly
as the pursuit of maximum equity appreciation for its
members; any benefit to other shareholders, the
shareholder rights movement in general or the world at
large was purely coincidental.
Even when CalPERS
divested its tobacco holdings in 2000 it couched the
move as financially prudent given the risks cigarette
companies face, not a social or political issue.
However, the emerging-market eligibility criteria are an
unmistakable step away from unabashed pursuit of returns
toward becoming a global nanny, and CalPERS members are
footing the bill.
CalPERS' assets have fallen
more than 25 percent from their US stock-bubble highs of
early 2000. Emerging-market returns last year under the
new investment criteria in 2002 underperformed the
broader Financial Times Stock Exchange (FTSE)
emerging-markets index by more than 20 percent.
Wilshire's 2003 report urged lowering the eligibility
score to 1.6 to enable greater diversification and
reduce risk. But the CalPERS board brushed aside the
suggestion in favor of maintaining the stricter standard
that excludes countries with decent financial markets
but less reputable governments.
California
pensioners present and future better hope that they
won't continue to pay a high price for the high
principles of CalPERS trustees.
(©2003 Asia
Times Online Co, Ltd. All rights reserved. Please
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