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WALL STREET, CALIFORNIA | STREET STRATEGIES / WALTER
HAMILTON

For 'PERS, Not Personal, Use

Think CalPERS' Laggard List Could Be a Stock-Buying Tip? Be Careful

March 03, 1998|WALTER HAMILTON

A year ago, the giant California Public Employees' Retirement System said it would pressure Apple Computer and nine other companies with lagging stock prices to improve their corporate governance practices.

Since then, Apple's stock has jumped 46%. Too bad the others haven't followed suit. In fact, none has come close to the 33% price gain of the Standard & Poor's 500 stock index, and four have fallen in price.

What's the lesson for individual investors? CalPERS may be the 800-pound gorilla of "activist" pension funds, but if you think buying stocks targeted by CalPERS is a good investment strategy, be careful.

Every year, the nation's largest public pension fund unveils to great fanfare a "hit list" of roughly 10 underperforming stocks. Hoping ultimately to improve financial performances and stock prices, CalPERS uses the glare of publicity to agitate for changes such as revamping the working of company boards.

The goal is to make directors and executives more accountable to shareholders.

A number of academics have studied whether CalPERS and other activist big pension funds actually succeed in boosting the shares of companies they target. And, quite frankly, the reports are inconclusive. Some have shown the funds make a difference whereas others indicate they have no effect.

Regardless of whether CalPERS gains from its efforts, it's doubtful individual investors can profit significantly by piggybacking on CalPERS' target stocks, experts say.

"Can outside investors make money on this?" said Margaret Blair, a senior fellow at the Brookings Institution who teaches corporate finance at Georgetown Law School. "I'd think that is unlikely."

Investors should stay away for several reasons.

Despite all the breast-beating by the funds, critics say pension funds can't solve the complex problems of companies in highly specialized markets. Some troubled stocks might right themselves, but that probably will have little to do with pension-fund pressure.

"If I took the 10 worst-performing firms and compared them to the S&P 500 over the next five years, I know the firms are going to [improve] whether CalPERS is there or not," said Mark Huson, a finance professor at the University of Alberta, Canada.

It's also important to understand what the list is and why CalPERS publishes it. It isn't a list similar to some brokerages' recommendations of undervalued stocks. Instead, CalPERS is targeting stocks it owns but can't sell because the bulk of its portfolio is indexed to the market and held regardless of performance.

"It's a different perspective than an individual investor looking for undervalued stocks," said Michael Smith, a vice president at Economic Analysis Corp. in Century City who has studied CalPERS' returns.

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Finally, the historical performance of CalPERS' targets, which the fund began to publicly name 11 years ago, itself casts doubt on whether individuals would gain.

CalPERS points to a study showing the average targeted stock has beaten the S&P 500 by 34 percentage points, or better than 6 percentage points a year, in the first five years after being placed on the list.

But some academics criticize the way the study was done and suggest a conflict of interest because the author was Wilshire Associates, a Santa Monica-based firm that does consulting work for CalPERS.

What's more, though the average return was impressive, the report also showed that the bulk of target stocks have trailed the S&P.

Of the 69 stocks the study looked at, almost two-thirds underperformed the S&P in the first five years after making the list. The record is more dismal for the last five years: More than three-quarters of the targets have lagged the index. (For stocks without five-year records, the study assessed their returns through Oct. 31.)

The 34-point average return over the S&P appears to spring chiefly from spectacular gains in a handful of stocks. For example, Hercules Inc., on the 1991 list, went on to beat the S&P by 523 percentage points; Chrysler and Ceridian, on the 1992 list, each topped the S&P by more than 420 percentage points.

Stephen Nesbitt, the Wilshire senior vice president who wrote the report, says his work shows that when "corporate governance is effective, it can add a great deal of value." But he likens CalPERS' efforts to being those of a venture-capital investor--that is, a handful of investments will earn huge gains but most will disappoint.

"It doesn't depend on the number of winners," Nesbitt said. "It's how well the winners do, the magnitude of the success of the winners."

Added Bob Boldt, CalPERS' senior investment officer: "It takes a while for some changes we're trying to put in place to work."

The methodology of the Wilshire study also has come under fire.

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