CALPERS Takes Two Routes

Kathleen Pender

The California Public Employees Retirement System yanked $1.2 billion in assets from Putnam Investments this week, but it is letting AllianceBernstein — another firm implicated in the mutual fund scandal — continue to manage $1.2 billion in pension money for state workers and retirees.

CalPERS promotes itself as a leader of the corporate governance movement. It pushes companies in which it owns stock to behave ethically and in the best interests of shareholders. Yet it seems willing to tolerate questionable conduct at Alliance.

Unlike Putnam, AllianceBernstein has not been charged with any wrongdoing,

but says it could be.

Its parent company, Alliance Capital, admitted in a federal filing that it had relationships with investors who were allowed to engage in market timing trades in certain Alliance mutual funds in exchange for long-term investments in other funds that generated fees for Alliance.

Alliance said these relationships “created conflicts of interest” and that certain trades “had an adverse effect on some of its mutual fund shareholders.”

Alliance forced four high-ranking executives to resign because of their roles in the trading. It says more resignations will follow.

Alliance, which is facing 22 shareholder lawsuits concerning trading, took a $190 million charge for the third quarter to cover restitution, litigation and other costs related to the scandal.

On Oct. 31, Alliance received a Wells notice saying the Securities and Exchange Commission staff planned to recommend an enforcement action against Alliance.

On Nov. 10, the SEC agreed to suspend the Wells notice “subject to possible reinstatement on short notice,” Alliance said, adding that “an enforcement action may be brought by the SEC and the (New York attorney general) against Alliance at any time.”

CalPERS has 66 outside firms managing assets, but so far, only Putnam and Alliance have been implicated in the trading scandal.

At Alliance and Putnam, CalPERS’ money was in separate accounts, not in the mutual funds where the alleged trading abuses occurred. CalPERS has stressed that its funds were not directly affected by trading improprieties.

So why did it dump Putnam, but not Alliance?

The main reason, says CalPERS spokesman Brad Pacheco, is that at Putnam, the same people handle “compliance and internal controls” for mutual funds and for institutional investors like CalPERS.

At Alliance, there are separate staffs handling these duties for mutual funds and for big investors, Pacheco says.

Another reason: Omid Kamshad, an ousted Putnam manager who was allegedly market timing Putnam funds in his personal account, was listed as a key person on the CalPERS account, Pacheco says.

None of the four employees Alliance forced out were key people on the CalPERS account, he adds.

Finally, the Alliance accounts have performed better than the Putnam accounts, and CalPERS feared Putnam’s performance could worsen.

When CalPERS’ chief investment officer, Mark Anson, visited Putnam’s headquarters in Boston, “It was clear things were in disarray. He walked in there. These people looked haggard, tired. With Putnam, we felt there was an immediate need to sever our ties,” Pacheco says.

A Putnam spokeswoman responds: “We are disappointed about the decision of (CalPERS), but hope that we will have the opportunity to manage investments for them again in the future. Putnam is taking swift and decisive actions to put in place the most rigorous governance, oversight, trading and compliance standards in the investment management industry.”

CalPERS has not visited Alliance headquarters or conducted a separate investigation of the firm.

It has sent a letter to all its external managers, including Alliance, asking them to disclose such information as their code of ethics, internal compliance procedures for portfolio management and trading, whether the firm is part of any government investigation and whether any managers engaged in short-term trading in the firm’s own funds.

In short, it seems CalPERS believes there was some chance the alleged misconduct could have affected its account at Putnam, but not at Alliance.

If that’s true, it’s understandable why CalPERS fired Putnam: Its sole fiduciary responsibility is to its participants.

But how effective will CalPERS be in its corporate governance efforts if it continues to do business with Alliance, a firm that apparently put its own interests ahead of fund shareholders?

Alliance did not return calls.

Funds and the tax man

In response to Tuesday’s column on what might happen to shareholders who remain in Putnam funds if the company continues to bleed assets, several financial experts brought up this point:

“When fund managers are required to liquidate significant holdings to meet the rising tide of redemptions, they may also be realizing capital gains that must be distributed to the remaining shareholders before the end of the year,” writes Dave Yeske, a San Francisco financial planner.

“The result is a tax bill for those who hold the fund in a taxable account,” adds Tad Borek, a San Francisco investment adviser. “It’s conceivable that someone who has held the fund for more than one year could receive a distribution of highly taxed, short-term capital gains.”

Fund managers can offset realized gains and thereby reduce or eliminate year-end distributions, by selling securities at a loss.

It’s impossible to know in advance what the net effect will be, although some funds post estimated year-end capital gains distributions on their Web sites.

Most Putnam funds have done so poorly over the past few years thatthey are sitting on big unrealized losses that could be used to offset gains.

On its Web site, Morningstar estimates the “potential capital gains exposure” for individual funds under the “tax analysis” section.

Morningstar analyst Dan McNeela says this is a very rough estimate, but shareholders should not worry too much about year-end capital gains distributions if a fund’s potential exposure is below 25 percent.

Only three Putnam funds have potential exposure of 25 percent or greater: Putnam Asset Allocation Growth, Putnam Health Sciences and Putnam Utilities Growth and Income, according to Morningstar.

Putnam spokeswoman Laura McNamara says Putnam does not expect that redemptions will affect distributions. Putnam will post distributions on its Web site after a fund has made one.

I asked McNamara a question posed by Yeske: What are Putnam fund managers selling if they need to raise cash to pay off departing shareholders? Are they choosing the largest and most liquid holdings, which would minimize the market impact of portfolio liquidations, or are they choosing securities so as to minimize realized capital gains?

Her answer: “With the exception of Putnam Tax-Smart Equity Fund, our funds are managed primarily for total return, regardless of tax impact.”

Some of the other fund groups implicated in the scandal, notably Janus and Strong, have also been losing assets, although not on the same scale as Putnam. Investors in these funds — and all funds for that matter — should investigate the potential for year-end payouts.

If they want to sell shares in a taxable account and fear there may be distributions, they should consider selling before the so-called record date for distributions.

Companies provide this date on their Web sites and over the phone. Investors who own shares in an IRA, 401(k) or other tax-deferred account should not worry about distributions because there is no immediate tax impact.