Soon after real estate developer Philip Angelides was elected California's treasurer, he began to probe the lousy returns on the some $2 billion that CalPERS, the giant pension fund for state employees, invests in emerging markets. That led to a $1 million study of 27 developing nations, ranking them on eight different criteria ranging from financial transparency and oversight to political stability and labor standards. The study also led Angelides to study theories of sustainable development in emerging markets.
CalPERS decided to keep investing in only the 13 high-ranked countries in the report, which was supervised by Wilshire Associates and drew on studies by other consulting firms (the full report is available on CalPERS Web site). The move caused shock and outrage in Asia, since Thailand, the Philippines, Malaysia, and Indonesia all dropped off CalPERS' list. Also off the list were countries CalPERS already was not investing in, including China, Russia, and India.
In an interview with BusinessWeek's Pete Engardio, Angelides recently explained the genesis of the study and why it focused on the factors it weighed. Following are edited excerpts of their conversation:
Q: First, can you clarify your position on overseas investing? Some might see this as the beginning of a withdrawal from poor countries.
A: This is still an evolving document. CalPERS is a global investor and will continue to be one. What we did is significantly up the degree of due diligence. We're invested across every asset class, in 60 countries. We want to invest in countries that are clearly making progress.
Clearly, the value potential is being in a country that is going from being an emerging market to a fully developed one. Also, I believe it's in our national interests to be engaged in developing the marketplace in emerging markets. But as fiduciaries we also have a responsibility to our shareholders.
We're long-term investors. This isn't about getting in and out for the short-term. So it behooves us to make sure the elements are there for long-term investment. The era of blind investment in emerging markets is over.
Formerly, we had passive management [relying on outside fund managers to handle investments in emerging markets]. We adopted a policy that from this point forward, we would move to an active set of managers. We want to make sure there are people on the ground who understand these marketplaces.
Q: What prompted CalPERS to review which emerging markets it will invest in?
A: This really started out of a concern for performance for our shareholders. When I joined the board in January, 1999 [after taking office as California treasurer], one of the things I looked at was our investment performance in different asset classes. What struck me in emerging markets was that our performance was a not happy one. The returns were mixed at best.
We looked at the Philippines. The returns were -30% annualized over five years for the period ended Dec. 31, 2001. Indonesia was -34.7%, Thailand -27%. The simple fact is that the policies we have been pursuing as investors have not borne fruit. What we had was a lot of investments that were high risk and low return.
Q: What did you do next?
A: We began looking at whether blind investment in the indexes of these countries should be continued. This led to a study of countries that, as of today, are meeting our minimum standards of investability.
Myself and several other board members put together a proposal. One piece of it looked at the countries themselves, to see whether they have the basic characteristics so that prudent investors can make prudent decisions. That led to a really engaged discussion in our system of what is the smart way to make investments. How do we invest in developing markets that are stable and have companies that can achieve sustained growth for our investment portfolio? Some countries, like India and China, already were not on our recommended list. But Indonesia, Thailand, the Philippines, and Malaysia dropped off.
Q: Why did you assign half of the weight to what you call country factors, such as political stability, labor standards, and transparency?
A: As I started to look at emerging-market investments, it became clear that institutional capital had invested blindly in these markets without any regard for whether they were showing progress in developing as markets. Would their underlying characteristics lead to long-term economic growth and investment returns? The whole premise of these markets is that they are emerging. They would eventually acquire a fair judicial process and transparency, which includes a free press.
In this country, we take transparency as a given. It doesn't makes sense to invest in a country without transparency, without a free press that lets investors learn at least the basics of what is really happening. That has no political stability. We also take for granted that if we are wronged as investors, we have recourse in a court system that is fair and protects our investments.
So a lot of this is looking at whether the elements are there for making investments. We also need to look at liquidity in the market. What is the ability to settle transactions and get your money back out of the country?
Q: Your ranking formula gives much weight [17%] to labor practices. Why are social issues so important?
A: One thing we always want to be concerned about is whether we are being put at risk. Investing in companies that are exploitative or have practices that are inimitable to our values is risky in the long term. The work of [Nobel laureate economists] Amartya Sen and Joseph Stiglitz shows that social issues are important to sustainable, long-term development.
Q: It's curious that Argentina ranks on top of your list of investable countries. How can that be?
A: We had a discussion about that in the board. We know that these countries will continue to have market volatility. One board member noted that even though Argentina went through four Presidents in four weeks, the political system worked. He noted that New Jersey went through several governors before the current governor was sworn in.
One of the things that came out of this is that, for all their troubles, some emerging markets may have the institutions in place to survive. And they are transparent enough that we can see what is going on. This doesn't necessarily mean we are investing in Argentina now.
Q: Would you invest in companies from these countries that are listed in New York, Hong Kong, such as China Telecom or Infosys of India?
A: We are trying to move away from blind practices. Clearly, if stocks are traded in New York or Hong Kong, they meet some legal minimum. If you get listed on the New York Stock Exchange, you've cleared a set of hurdles that give investors comfort.
Q: Do you hope your study will influence the investments of other institutions?
A: We do hope others will look at it. Emerging markets are places of growing potential investment. This review took two-and-a-half years, and we are one of the few institutions big enough to devote the resources for a such a study of these countries. Our goal first and foremost is to get the best returns for our investors. If in the process we can set benchmarks, some good guideposts for other institutional capital, that's even better.