Vistria Senior Partner, Co-Chairman and Co-CEO Marty Nesbitt, speaks with Marcie Frost, CEO of the California Public Employees Retirement System, America's largest pension fund. Marcie oversees CalPERS’ roughly $400 billion global investment portfolio and speaks with Marty about CalPERS’ strategy to meet the firm’s fiduciary responsibility while driving sustainable markets.
Vistria Senior Partner, Co-Chairman and Co-CEO Marty Nesbitt, speaks with Marcie Frost, CEO of the California Public Employees Retirement System, America's largest pension fund. Marcie oversees CalPERS’ roughly $400 billion global investment portfolio and speaks with Marty about CalPERS’ strategy to meet the firm’s fiduciary responsibility while driving sustainable markets.
Intro:
John Maynard Keys, Milton Friedman, two Nobel economists, two competing theories about the nature of capitalism and a debate that never seems to end. Is it better to optimize company spending and management to generate better returns, more jobs and growth, which in turn benefit society? Or better to focus on long term gains, which will drive important investments that will improve society? With rising income inequality, reckoning on race and a recognition within the business community that the status quo is unsustainable. The ultimate question becomes what is the future of capitalism? Welcome to the Future of Capitalism Podcast presented by the Vistria Group.
Guest Introduction:
In this episode, Vistria senior partner, co-chairman and co-CEO, Martie Nesbitt speaks with Marcie Frost, CEO of the California Public Employees Retirement System, America's largest pension fund. Marcie oversees CalPERS roughly 400 billion global investment portfolio, and with Martie about CalPERS strategy to meet the fund's fiduciary responsibility while driving sustainable markets.
Martie Nesbitt:
Well, hello, Marcie.
Marcie Frost:
Hello.
Martie Nesbitt:
Thank you for having this conversation. I think it's an important one. Capitalism and democracy all over the world are under duress. The wealth gap is widening, people's upper mobility is challenged, democracies are gridlocked and it feels unsustainable. But my perspective is that the capitalism is a powerful force and a construct that was invented by mankind to make us all safer and more prosperous, higher standard of living and mankind made it up and we can modify it.
Martie Nesbitt:
And a perspective we developed early on was that if we didn't, we might be in trouble that we might find ourselves among pitch forks and torches. So we started having this conversation about how can capitalism sort of go under a modification, a tweak to make some society stronger. A strong society is the golden goose. It lays the golden egg, it creates a platform that allows all of us to prosper. And we actually built an investment thesis around that notion that a companies that behave that way in a way that not just serves customers, employees, and investors, but also contributes to the strength and stability of the communities they're in, it should be worth more. Love to hear your perspective on that, because I know you guys at CalPERS have given this a lot of thought.
Marcie Frost:
We really have. CalPERS is a very long term investor and we represent over two million people in the State of California and a very diverse set of individuals who are working in the public sector, who really want their capital, their funds that they're contributing toward their retirement to be representative of the communities in which they live. We hear that and we also are starting to see more of this, not just a stakeholder sentiment about these topics, these really important topics, but really a shareholder sentiment that I own a share of this $450 billion portfolio that just happens to be managed out of Sacramento, California. And we're seeing that, that voice, we're seeing that sentiment continue to grow and develop over time. And we have a fundamental belief at CalPERS and we do this through our corporate engagement processes, but we firmly believe that the more diverse the board is in those companies, the better the performance.
Marcie Frost:
And there is so much research out there that supports it. It's almost correlated to the climate research that was denied for so long. We have the same amount of research and data and analysis, empirical data that proves that diversity pays in performance, yet we're still struggling to see that diversity being represented in the decision making layers of companies and the decision making layers of boards and that's what has to change.
Marcie Frost:
And I think consumer sentiment is going to propel that forward, that piece is going to quicken. I think all of the social issues that we're all seeing today in order to be responsive, we have to take action and CalPERS is no different than any other investor around the world, other than we've got these long term liabilities, IER people, we need to pay retirement security, we need to get growth on our portfolio at 7%. And we think that the way to get sustainable returns is to have sustainable markets that are represented by the people who are doing the work, that human capital piece.
Martie Nesbitt:
Well, this is interesting. I think it's fascinating when I think about your organization and the impact and perspective you have because of your size, because of your members and because of your responsibility to deliver return. So many participants in this sort of investment community can to think pretty myopically about got to deliver returns as quarterly results, it's like profits at all costs. And it's harder to have a longer term perspective when you're just trying to meet your next quarters forecast. But for you, as I think about it, you have an obligation to meet the needs of your members over a very long period of time, that's a powerful perspective. Is that how you kind of got to this position on feeling so strongly about ESG?
Marcie Frost:
No, you nailed it. That's exactly it. So on ESG, that we believe there has to be an F in that ESG, which really stands for the financial markets. When you are a public pension plan, the growth assumptions in these pension plans range between six and a half and seven and three quarters. And that growth target is intended to be over the 20, 30 year period of time. Creating value in those companies over the long term is ultimately what we focus on.
Marcie Frost:
So it's about that engagement with those companies, how are you thinking about these risks? We see these risks, they're known unknowns today, but we're not getting enough data, we're not getting enough transparency from these companies to, one, know whether they are mitigating that risk, whether it's climate, human capital, governance issues, say on pay or diversity, we see those as absolute elements of having long term value creation.
Marcie Frost:
So, yes, you got it exactly right. But that F has been missing from too many of the conversations that the financial markets and making sure that these financial markets can, predictable may not be the right word, but these large swings that are happening that really cause problems back in 809 is one example, many of these systems are having a difficult time recovering, and a lot of that was a lack of transparency about what was happening in the financial sector. That transparency, that data is absolutely critical for us to manage our risk longterm.
Martie Nesbitt:
How do you get your managers, GPs to us see the world the way you see them and come to grips with how critically important they are?
Marcie Frost:
The LPs have a significant responsibility of making sure that the GPs interests are aligned with ours. We've really lost sight of what does create value. And I think the LPs have a unique responsibility to make more of those requests to our GP friends, and we rely on our private equity partners. It's extremely important, you can't have a growth assumption of 7% without having significant relationships in the private markets.
Marcie Frost:
And so that's very important to us, but I've yet to see us have a conversation with a GP that says, "What are you doing with women in your carry level?" That used to be a question I would ask as a trustee in Washington State. And remember, most of the GPs are going to these boards of trustees to do your fundraising, and if you can't answer these basic questions with data, I think over time, that's going to become more problematic.
Marcie Frost:
But I also think that the GP community wants to work with these pension boards and that the work that the GP community is doing, that there's something in there, beyond profits or something in there about helping Middle America. And people are not getting wealthy off of receiving a public pension. This is basic deferred compensation. At CalPERS, the average benefit is around to $33,000 a year. Certainly not something people are going to get wealthy on, and personally, I don't know how they're living in California on that wage, and we're going to have to figure that out over time. But I think that alignment, those conversations are beginning to happen, we're in the early stages of those conversations as well, but we don't sense any resistance.
Marcie Frost:
I think the GPs understand that this is something that's going to need to occur, and they're going to want the LP standing side by side with them as they move forward. I just agreed to lead a small cohort, a GP and an LP us leading it on this alignment issue, and it's being done through the World Economic Forum and what really does create value, private companies, public companies, and how do we make sure that we're aligned long term? Sometimes we get stuck on the vintages, but it's this long term nature of our liabilities and those relationships with the GPs are really important for us to be able to realize that growth assumption over time, over that 20, 30 year time horizon.
Martie Nesbitt:
What's interesting, the idea was that when we made an investment in the company, we would measure the diversity across the company at the time we make our investment. And at the time we sell the business, we'd measure diverse. If the company was more diverse in a measurable, significant way, management team gets more money. This dialogue came back as sort of the analyst all started working on, okay, so how much is that incentive? And they came back and said to me, "We don't know how to quantify it. We don't know what it's worth." And I said, "We got to take the leap of faith. We know intuitively that this whole enterprise is more valuable if it's more diverse, it's more valuable to the community as a whole, it will be more valued by investors."
Martie Nesbitt:
I said, "Let's pick a number that's reasonable, that's meaningful, and let go with it." I think there's got to be a certain point, there's got to be this leap of faith that people take around all these issues, environmental, because they're so hard at some point to measure, especially on a investment by investment basis. To quantify that stuff, how do you push those GPs to take that leap of faith?
Marcie Frost:
Well, I think calling it a leap of faith, I don't know that it gives enough credit to all of the research that's been done in this area. I truly I've read a lot of research papers, both on climate and diversity. I believe whether it's a leap of faith or this is common sense that when you have people who have different views, different backgrounds, different thoughts, that those decisions coming out of that company are going to be better quality, which should produce better results. So to me, that correlation is really easy to make. And so if you need to take a leap of faith to try it, then yes, we would be encouraging GPs, try it. You've tried it the old way, let's do it. I think we've got some great examples on the public side, let's create some great examples on the private side.
Martie Nesbitt:
Yeah. I think the challenge when you're a GP is you set up that incentive, you reward the management team, you sell the company, there's no way to empirically say, "But if I hadn't done that, I would still gotten the same price and I wouldn't have paid that." You know what I mean? It's just, I think you get that macro data that supports it, but at that sort of micro level, there's kind of this leap of faith. So I just put my foot down and said, "We are doing it. You have no choice."
Marcie Frost:
This is what we need to be doing. We need inclusive communities. And one of the commitment is, even in my own organization, we were going through our diversity, equity and inclusion framework. And I have a good relationship with the employees in the organization where they feel very comfortable in asking me pretty tough questions, and I take live questions during my every two week web chat. And I recall as we were rolling out our DEI framework, we had a lot of questions about why, and I remember responding to one individual in-person is that, "Today, I can't say that every process in this organization is fair and equitable to everyone. And until I can say that through the use of data and the use of information and actually have some experience there, then our work isn't done." And I think that explanation made sense to people.
Marcie Frost:
Sometimes it's just, I call it common sense, doing the right thing. So take that leap of faith, you can manage the outcome in the same way, but incentives matter. And especially in our communities, in the financial sector incentives really matter. They shouldn't be the only thing that's used, because that data is based on a system that we know is biased. And we're not going to get that bias out of the system until we do something different and create new systems. And maybe again, I do like your term leap of faith, but to me, this is about transition and transitioning these companies, transitioning the financial sector, the financial markets to be inclusive and incentives will work. People follow money, so let's put the money where it needs to be to have the whole community, the whole system feel more equitable and inclusive.
Martie Nesbitt:
It's interesting you all, and other big allocators of capital are leaders in that in a way you're a consumer of financial services and you are starting to say, "We have a taste and preference." For GPS, for whom these issues are important, that changes behavior, but also think there's a dynamic on the consumer side, where consumers are saying like, "Wait a minute, are you contaminating the water when you make this product? I'm not so sure I want to buy that anymore." And so I do think this rate of change will accelerate. The question is, measurement and standards of measurement across these companies. How do you come up with a systematic way to measure and be able to compare them across an industry or a sub-sector or even more broadly?
Marcie Frost:
It really is our biggest priority, getting the right data, not everything that can be measured is meaningful. And so it's finding the right data that can be made transparently publicly available to investors. First piece is just getting information. Once we have information, then we can determine the measurements or the metrics to know whether things are getting better or getting worse. And I think it has to be different by sector. I think we have to start small with what's material and meaningful, and we can build upon that over time. The problem we have in the industry is that too many things are being measured, many of those are not material, none of them are normalized, none of them are standardized and you have an investor like CalPERS, who's going to a group of companies saying, "We'd like to have this presented in the TCFD format."
Marcie Frost:
And you have another group of investors are saying, "Well, we'd like to have this done in the SAS B format." We're really agnostic to who does it, but it needs to be consistent within the sector, and you have to be able to audit it. But sometimes we jump to the measurements and the metrics before we look at the data and we need to know what problem we're trying to solve, what does the data show, and then what are the measurements to know that things are improving.
Martie Nesbitt:
And you haven't gotten to that threshold on the human capital question yet. How do we measure this? How do we create a bar that we expect companies to at least clear over time? Yeah, what's coming?
Marcie Frost:
Yeah, that's coming. That's the updated part of our research that we're really looking forward to.
Martie Nesbitt:
Well, as more allocators of capital sort of reach that level, it'll change the way the world looks pretty fast, that profit incentive and the access to capital incentive is pretty powerful. So I imagine that you guys will be accelerating the rate of change.
Marcie Frost:
Agreed. Yeah. And you think about engagement, I am a very strong culture person. The leadership behavior is really determine the culture of your organization, highly engaged workers, much more productive, higher levels of performance, morale, satisfaction, et cetera. So those human capital metrics part of it is to measure employee engagement because we know companies have a thriving culture, higher employee engagement are going to be productive and their performance will be better as well. So that would be one metric that we would like to see more of these companies put out there for consumers as well as investors.
Martie Nesbitt:
How do you compare the way GPs respond to you today versus when you first started having these conversations?
Marcie Frost:
I would say the relationship between the GP and the LP has always been strong, but the topics of conversation are evolving around ESG. And I think there's a couple of reasons that's happening, one is the consumer sentiment, but the other is many of the GPs, unlike CalPERS, when you come to CalPERS to do fundraising, you're meeting with our investment team, many of the public pension funds, at least here in the United States, you're meeting with boards of trustees, you're meeting with representatives of the membership where these issues around climate and human capital and diversity and inclusion are critically important to them in order to say yes to capital. They also carry fiduciary responsibility, which is also the F in the ESG, but not being able to answer those questions or answering those questions only through brochure that you put together about what you're doing with climate, that bought a little bit of time for the GPs to start figuring this out.
Marcie Frost:
But I think there are a large number of GPs like yourself who are really thinking about these matters. And can you get the LPs to support this leap of faith or this change in a way that you want to manage these companies differently? And we're going to be supportive of that. We think that your thesis, you've obviously have an investment thesis on this, that's what matters to us and that relationship between the GP and the LP is really the most important thing in this space. It's a relationship business, and we want to make sure that we're an LP of choice, but we also want to make sure that we have this nice alignment of interest between us. And I think we are becoming more fully aligned, and I think that's a little bit of a change over the last, I would five years.
Martie Nesbitt:
These companies that strengthen our overall society, and this is important for you. You need to have a strong society because you need to have a platform to put that 450 billion to work so that those two million plus members can have a high quality of life. And so if we don't all incrementally invest in making this place better, the whole system starts to-
Marcie Frost:
That's a very important point that I did not make, but you just illustrated it quite well. In order to pay a pension benefit, so we receive contributions from the employee, we receive contributions from the employer, but for CalPERS, we're at about 60 cents of every dollar that's paid in a retirement benefit, is done out of the earnings on the investment portfolio, it's not done via contributions. That number can change and vary across the structure, across the pension plans, but for CalPERS, where roughly 60 cents of every dollar paid is done on investment earnings. So you're absolutely right. We have to have strong capital markets, we have to have places that we can deploy this capital and meaningful amounts that are material, including the private markets in order to hit that 7% growth in order to pay these benefits.
Martie Nesbitt:
Right. Well, thank you so much for your time. We really appreciate it. I look forward to further dialogue and exploring the evolution of this way of thinking over time with you. Be fun.
Marcie Frost:
[inaudible 00:19:51] enjoy that. Thank you.
Intro:
Thanks for joining us. Stay tuned for our next episode with Shawn Wooden, treasure of Connecticut. Learn more about Vistria Group at vistria.com.