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If you're a state employee or a public school teacher in California, you may be wondering why your pension fund owns so many shares of Enron, especially since Enron has been portrayed as wearing a 10-gallon black hat during California's energy crisis.
The California Public Employees Retirement System, or CalPERS, owns 3 million shares in the bankrupt Texas energy trader. On paper, it has lost about $40 million on Enron stock. Separately, CalPERS invested in two private equity partnerships with Enron, including the now infamous JEDI deal. More on that later.
The California State Teachers' Retirement System, or CalSTRS, owns 2 million Enron shares. It won't reveal the size of its loss.
Those sound like big investments in Enron, but let's put the numbers in perspective:
-- CalPERS is the nation's largest pension fund, and CalSTRS is third biggest. Both funds say their Enron losses won't affect their ability to pay retirement benefits.
The two systems' combined holdings -- about 5 million shares -- represent only 0.7 percent of Enron's 750 million shares outstanding.
By comparison, Enron's largest institutional shareholder, Alliance Capital Management, owned 5.7 percent and No. 2 Janus Capital owned 5.5 percent.
-- At the end of June, when Enron was trading at $49.10 per share, it accounted for 0.23 percent of CalPERS' stock portfolio, and about 0.1 percent of its total portfolio. The percentages at CalSTRS were almost identical.
By comparison, the flagship Janus mutual fund had almost 3 percent of its assets in Enron as of April 30.
Today, with Enron trading at less than $1 per share, it doesn't account for much of anything in anyone's portfolio.
Neither CalPERS nor CalSTRS really chose to buy Enron stock. You might say the market chose it for them.
Both funds have roughly 60 percent of their assets in stocks, with the rest in bonds and real estate.
Most of their stock portfolios are passively managed. Instead of actively picking individual stocks, they mostly buy stocks to match a broad stock market index.
CalPERS has most of its stock portfolio tied to the Wilshire 2500 index, which is made up of the 2,500 largest U.S. companies.
At CalSTRS, 80 percent of the stock portfolio is tied to the Standard & Poor's 500 and a Russell index that includes 2,500 small companies.
Both funds say most of their Enron stock was held in index funds.
Today, most large pension funds have some or most of their stock assets indexed, for several reasons.
One, it's hard for large funds to move in and out of stocks without adversely affecting the stock price. An index strategy minimizes trading.
Two, passive management is cheaper than active management.
Finally, studies have shown that over the long term, an index fund will outperform about three-fourths of actively managed funds.
An index fund "can handle a very large amount of money. It's kind of an anchor to windward," says Stephen Nesbitt, a managing director with Wilshire Associates, a CalPERS adviser.
That explains how the two pension funds came to own Enron. Still, after reading about CalPERS' Enron investment in The Chronicle last week, a state employee named Arlene wanted to know, "Why, given the acrimonious relationship between the state of California and Enron, did CalPERS continue to hold Enron?"
CalPERS spokeswoman Pat Macht explains, "CalPERS doesn't look on a monthly basis for bad actors that it could remove from its portfolio. That would defeat the index strategy. We let the market dictate whether a stock should continue to be in the index."
However, the funds have on occasion removed entire classes of stocks from their index funds. In 2000, both funds blew tobacco stocks out of their portfolios. And in the 1980s, a state law required them to dump stock in companies that did business in South Africa.
But the funds don't sell individual companies from their index funds. Instead, they try to influence individual firms through "corporate governance" programs.
Each year, CalPERS comes up with a short list of companies that have had putrid performance compared with their peers for three to five years and shareholder-unfriendly corporate governance practices. CalPERS publishes the list each year, then tries to improve the companies' performance by negotiating with them and/or participating in shareholder resolutions.
That wasn't possible with Enron, which unraveled over two to three months. "Their demise was very quick," Macht says. "In normal circumstances, if a company is going down the tubes, there's usually a warning signal."
Macht says the Enron debacle proves that indexing works. "Nothing that happened at Enron would suggest anything is wrong with the discipline. The whole concept is that it can withstand any company's financial demise," she says.
But CalPERS' investment in Enron wasn't entirely passive. It was also a limited partner in two private equity partnerships that were disclosed by the two parties, but kept off Enron's books.
In 1993, CalPERS invested $250 million in a partnership with Enron called Joint Energy Development Investments LP, or JEDI.
In 1997, Enron bought back its stake in JEDI from CalPERS for $383 million and immediately sold it to another limited partnership called Chewco, named after the Chewbacca character in "Star Wars."
After the transaction, Enron continued to treat JEDI as a separate entity, even though Chewco, run by a former Enron executive, was largely financed by Enron.
To make a long and sordid story short, on Nov. 8, Enron said that Chewco and several other limited partnerships it had treated as separate should have been consolidated on Enron's books. As a result, it restated its financial statements going back to 1997, which reduced its previously reported net income during that period by $586 million -- or 20 percent.
That disclosure hastened Enron's demise and is part of an investigation by the Securities and Exchange Commission.
The questions surrounding JEDI started after CalPERS got out of the partnership, and no one has suggested that CalPERS was involved in any wrongdoing.
In 1998, CalPERS entered another private equity limited partnership with Enron, called JEDI 2. CalPERS committed $500 million to that deal but only invested $156 million.
In June 2000, around the time the energy crisis broke out, CalPERS stopped investing in JEDI 2. "We wanted to wait and see how the energy situation was developing," Macht says.
So far CalPERS has recouped $171 million from JEDI 2.
"JEDI 1 proved to be a really good investment. JEDI 2 worked out because were were able to get a return on our investment. We were lucky we suspended it when we did," Macht says.
CalPERS does not expect any legal problems arising from the JEDI partnerships, but "we are monitoring the situation closely," Macht says. "Until forensic accountants complete their review and unturn every stone and pebble, no one will know what they (Enron) were doing. But everything we did in those deals followed great due diligence with third-party review."
Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.
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