The beaches of California may seem an awfully long way from the City, but recent ructions at the top of Calpers, the world's biggest pension fund which is based in the Golden State, could soon spell trouble in the Square Mile.

It was all change at the California Public Employees' Retirement System (Calpers) last week. First to announce his departure was Russell Read, the chief investment officer, who declared he will step down in June.

A couple of days later, the $244 billion (£123.2 billion) fund manager was struck by an even greater blow as Fred Buenrostro, the 58-year-old chief executive, abruptly picked up his cards too.
These high-level exits aren't the only departures to strike at Calpers of late. Not long ago, Christy Wood, one of America's leading fund managers, ditched her Calpers position looking after $150 billion of the fund's investments to take the chief executive's job at a New York investment firm called Capital Z.

Top-level insiders at Calpers believe these three bigwigs might be just the thin end of the wedge, with the pension fund facing a damaging brain drain in the coming months. The management flight would be bad enough for any fund manager, especially one as big and cumbersome as Calpers. The investment group looks after the pensions of about 1.5 million government employees in California, such as police officers and firefighters. It has an impressive track record with returns of more than 19% for 2007.

Calpers claims there is nothing untoward going on, and the departures are merely coincidental.
Well-placed sources say otherwise, however, and claim there have been big disagreements at the top of Calpers about the pension fund's direction, and in particular the future of some of its key partnerships with third-party fund managers in the City and elsewhere. Calpers has something of a reputation as an activist and champion of corporate governance causes, as it has the heft to stand up for investors against even the mightiest of boardrooms.

But it rarely acts alone when it wades into a fight against a big corporation, say on fat-cat pay and perks or environmental issues.

Typically, the pension fund will get into bed with a smaller, nimbler third-party fund manager that can focus more intently on the fight.

In the UK, Calpers is in partnership with two funds, Hermes Focus and Knight Vinke. The latter is run by Monaco-based activist investor Eric Knight, the scourge of HSBC. The relationship between Knight and Calpers goes back five years, during which time he has made a great deal of money for the massive pension fund. But in 2007, Knight Vinke's returns have been less than impressive for Calpers.

As Calpers' last report and accounts note, Knight Vinke's “[full] year numbers were disappointing as the fund returned 7.4% versus the benchmark return of 15.5%”.

Some perspective on this is important. Knight's fund is just a drop in the ocean for Calpers, and many other investments have underperformed similarly in difficult market conditions.

Knight says its returns to Calpers since 2003 have hugely exceeded the benchmark, while the first quarter of 2008 has been strong enough to outweigh the 2007 weakness.

Still, observers argue that Calpers has indulged Knight and say it points to a failed strategy by the pension fund.

Christy Wood, the former senior investment officer at Calpers and a friend of Knight, defends the partnership from her new office at Capital Z.

She notes that Knight Vinke's activist strategy made a great deal of money for Calpers since the partnership began, and it is only recently, as the bear market took hold, that things have gone sour. Her view is said to be shared by Buenrostro and Read. But now all three of these supporters are off.

So what does the future hold? Calpers insiders are quick to point out that Knight Vinke's lack of diversity and, more importantly, its focus on financial stocks have led to poor performances in the past year or so.

It is for this reason that Eric Knight has been unable to score a significant victory in his governance battle with HSBC. It is true that he has convinced the bank to change tack on executive pay, and that some changes have been made in its US mortgage arm, but the share price is hardly likely to show a significant improvement in this market.

Hermes, too, has had a rough time of it of late. The UK fund did slightly better than the benchmark last year but was still down more than 12% on the year before.

The failure of some of Calpers' partners to deliver during a downturn has led to a series of changes in direction at the pension fund.

The new chief executive, chief investment officer and senior investment staff will be required to look for new partners and for a new direction if they are to make their mark on the world's biggest pension fund.