Report 99138 Summary - December 2000

California Public Employees' Retirement System: Its Policies for Foreign Investing Are Consistent With Its Mission and With Legal Guidelines


The California Public Employees' Retirement System (CalPERS) manages and administers the retirement benefits of more than one million public members. When it invests retirement system funds in foreign financial markets, CalPERS follows its mission-to provide retirement benefits to its members-as well as relevant state and federal laws. State law also establishes as a fiduciary responsibility for CalPERS the requirement that the retirement system act solely in the best interests of its members. For these reasons, CalPERS directs the external portfolio managers that make its international investments to aim for sufficient rates of return within an acceptable level of risk. CalPERS also requires these managers to rely primarily on financial considerations when making investment decisions. To ensure that its external managers adhere to applicable laws and do not risk members' benefits through investments in foreign financial markets that may be legally and financially unsound, CalPERS restricts the international financial markets in which managers may invest. Further, CalPERS foreign investment policies conform to federal law because CalPERS has not made foreign investments based on factors that might conflict with United States foreign policy and because CalPERS does not purchase shares in companies in which the federal government has indicated it does not want Americans to invest. However, in November 2000, CalPERS adopted additional criteria, including considerations of countries' political stability and labor practices, to determine the emerging markets suitable for CalPERS investment.

The largest public pension fund in the United States, CalPERS has net assets of more than $172 billion. Its investment portfolio is divided into asset classes that include international and domestic stocks and international and domestic fixed income investments (primarily bonds). The portfolio's size and diversification require CalPERS to contract with external consultants and portfolio managers to manage some of the assets. Because of the expertise and specialized skills required to invest internationally, external managers make all international investments for CalPERS.

We reviewed how CalPERS manages its international investing and found that CalPERS and its external managers follow its policies on foreign investing. CalPERS uses reasonable methods to select, contract with, and monitor the external managers that manage and administer all foreign investments. Because their contracts stipulate a fiduciary duty to CalPERS, these external managers must follow CalPERS policy, including restrictions on the financial markets in which they may invest. CalPERS, in turn, is responsible to its members. According to state law, CalPERS is required to make investing decisions with the interests of its members in mind. In keeping with this legal duty, CalPERS requires the external managers to make investment decisions based primarily on financial factors.

Although CalPERS adequately monitors the performance of its external investment managers, it does not sufficiently monitor its general pension consultant, an international investment industry expert who advises CalPERS on investment policy. CalPERS has just recently begun the year-end review of its general pension consultant for the year ended June 30, 2000. This review is essential because the general pension consultant's contract does not have a defined duration, but continuation of the contract is subject to the review's results.

Our audit also showed that the CalPERS policy on where the retirement system may make investments follows the stated mission of CalPERS and all applicable laws. Using financial criteria, the general pension consultant created a permissible country list (list) disclosing the countries in which external managers may invest. The list specifies which countries' financial markets are suitable for investment by institutional investors such as CalPERS. Criteria for being on this list include the legal and financial stability of the markets but not national security or social issues.

Because the CalPERS investment committee believes that the screening process used to create the list has possible shortcomings, CalPERS is revising the process. First addressed in April 1999, these possible shortcomings still await resolution. In a recent action, the CalPERS Board of Administration voted to consider certain nonfinancial factors when selecting specific emerging markets in which CalPERS may invest.

By basing its international investment policy primarily on financial factors, CalPERS not only meets its fiduciary duty to its members and abides by state law, but the retirement system also avoids encroaching on the federal government's authority. Under the United States Constitution, the federal government has the power to set foreign policy and could challenge any CalPERS investment policy based on social or political factors that conflict with federal policies. In fact, the Supreme Court recently overturned a Massachusetts law that restricted Massachusetts state entities from buying goods or services from companies doing business in the country of Myanmar, formerly known as Burma.

Recently, questions have been raised about five foreign companies in which CalPERS invested and about the policies behind those investment decisions. A primary concern regarding these companies centered on national security issues. Through the Hong Kong stock market, CalPERS invests in businesses that have parent companies or major shareholders located in mainland China. CalPERS policy directly restricts investments in the Chinese financial markets, but it permits investments through the Hong Kong stock market because the investment community considers Hong Kong, though a Special Administrative Region of China, as separate from China. Hong Kong's regulation of its stock market emphasizes private enterprise, and investors throughout the world have high regard for the Hong Kong market. Also, investment in Chinese companies is not contrary to federal law because the Department of the Treasury's Office of Foreign Assets Control (OFAC), which is the federal office that administers and enforces economic and trade sanctions, allows such investment. Further, none of the questioned companies appears on OFAC's list of Specially Designated Nationals, the document on which OFAC names those individuals and companies in which the federal government does not want Americans to invest.


To ensure that it properly monitors its general pension consultant, CalPERS should finish its review of the consultant for the year ended June 30, 2000, and establish controls so that it performs the review promptly each year.

To ensure that it has adequate, current criteria for determining which countries have permissible markets for investment, CalPERS should finish revising the process for developing its permissible country list and create a timetable for the review of existing criteria.

Further, if the CalPERS Board of Administration believes that the actions of a specific country's government may be contrary to international standards of human rights or may compromise national security, CalPERS should work with the State Legislature to communicate these concerns to Congress through a legislative resolution.


CalPERS agrees that this report accurately presents CalPERS foreign investment practices and concurs with the recommendations. Further, CalPERS is currently proceeding with the implementation of all the recommendations.