CalPERS in radical rethink of company engagement

Giant fund to relegate governance from initial screening process

CalPERS, the $221.5bn (€160.3bn) California Public Employees’ Retirement System, is rethinking the way it builds its renowned Focus List to develop what it hopes will be a more effective strategy for engaging with companies.

At the heart of the proposals – to be discussed by its Investment Committee on November 15 – is the idea of selecting companies where the fund has a larger ownership position. Thus it plans to change the screening universe from the existing Russell 1000 to its own top 500 domestic equity holdings.

CalPERS reckons the financial crisis demonstrated the limits of the current way of constructing the list.

One feature of the new approach is that corporate governance factors will no longer be included in the initial screening process, which will instead focus on total stock returns.

Issues like environmental, social and governance (ESG) factors and engagement obstacles and opportunities will form a secondary screen.

CalPERS argues the new method should be “more reactive to market developments” with the addition of one year total stock returns to the existing three and five year returns.

This is a major shift from the current system where the Focus List’s intitial screen combines stock returns, governance and financial performance. According to CalPERS’ analysis, the existing approach underplaysunderperformance and allows “check box” governance.
Also under the new regime, there will be more emphasis on board quality, skills and diversity – with the revamped Focus List being used as a “conduit” for CalPERS proxy access and shareholder proposal activity.

The scheme also proposes developing relationships with other investors and using the press “as a tool to garner investor support for shareholder proposals” – a shift from the previous “name and shame” stance.

The Focus List, which dates back to 1987 and whose criteria have changed over time, has long been associated with the “CalPERS effect”.

CalPERS cited a study by consultant Wilshire Associates which found that privately engaged companies “significantly outperformed” those on the public Focus List – and that all companies engaged via the Focus List returned almost 16% above benchmark over three years.

In 2010 the Focus List engagements were successfully undertaken without any company being publicly named.

Under the new proposals, the fund will now be able to engage with firms where it has $15m-$1bn equity ownership position, which compares to the current $2m minimum threshold. Fixed income will be considered “where appropriate”.
If the fund’s board approves the new method, the new list will be presented in March 2011 for approval by the Investment Committee. Staff will report back in August 2011. Link