Stung by Scandal, Giant Pension Fund Tries to Make It Right After a pay-for-play scandal tarnished its reputation, the nation's largest public pension fund turned to a courtly native of Quebec to help it restore order and improve performance in a crucial investment sector. One of the main tasks for Réal Desrochers, the Quebecer who has been head of private equity investments at the pension fund, the California Public Employees" Retirement System, since 2011, is to reduce the number of outside management firms, which now stands at 389. The portfolio is "overdiversified," hurting its ability to generate above-average returns, he told fund board members last month. In an effort to achieve returns that exceed those of the overall stock and bond markets, many large public pension funds like California's, which is known as Calpers, turn to so-called alternative investments like private equity, real estate and hedge funds. Private equity firms, for example, acquire companies, make changes outside the spotlight of public ownership and then profit by either selling them or selling shares of their stock to the public. While such investments usually carry higher fees and may often be less liquid, their long-term returns can be lofty. Because Calpers uses stock index funds, which aim to mirror overall market performance, for more than one-third of its investments, it depends all the more on alternatives like private equity, which accounted for $31.2 billion, or 11 percent, of the fund's $272 billion in assets as of Sept. That percentage has more than doubled in the last decade. Calpers aims for the private equity category to beat stock market returns by three percentage points annually. For the 10 years that ended Sept. 30, the category returned 12.9 percent a year. While that was well above the stock market's performance of 8.5 percent, it still slightly trailed a custom Calpers benchmark that changed twice during the period. In a progress report to the investment committee of the Calpers board on Dec. 16, Mr. Desrochers (pronounced day-row-SHAY) said the fund should have only 100 to 120 private equity managers, implying drastic plans to cut the number by two-thirds or more. But winnowing the field takes time because, as he noted, private equity funds typically have a life of 10 years, often with extensions of two to three years. The plan to cut managers was first reported by the publication Pensions & Investments. Mr. Desrochers, 66, previously was the head of private equity investments at the California State Teachers Retirement System and also managed private equity at Caisse de Dépôt et Placement du Québec, a giant Canadian pension fund manager. He joined Calpers in the wake of a scandal over fees paid to placement agents for certain private equity investments. In May 2010, the California attorney general brought a civil fraud case against Calpers's former top executive, Federico R. Buenrostro, and a former board member, Alfred J. Villalobos, accusing them of sharing in more than $47 million in undisclosed fees. The Securities and Exchange Commission filed a related case in 2012. Last March, the United States attorney in San Francisco charged the two men with criminal fraud, accusing them of falsifying documents for $14 million in fees paid by one of Calpers's private equity managers, Apollo Global Management. Apollo was not accused of any wrongdoing. All three cases are pending, with a trial set for March in the federal criminal case. Mr. Desrochers's predecessor at Calpers, Leon Shahinian, resigned in August 2010 after it emerged that, in connection with a Calpers business trip, he had accepted travel on a private jet and perks including attendance at a black-tie event honoring Apollo's founder, Leon Black, according to a report on the placement agent issue by a Calpers outside counsel, Steptoe & Johnson. In all, four private equity managers, including Apollo, agreed in 2010 to cut their fees for Calpers by $215 million over five years as part of the Steptoe legal review. Without going into detail, Mr. Desrochers says his own restructuring program has saved fees of $90 million to $250 million. Joseph A. Dear, Calpers's chief investment officer since 2009, said that the placement agent imbroglio had injected "undue influence into the investment decision process" without necessarily affecting the outcomes and that the large number of managers had tended to drive performance "toward the median." Mr. Dear announced last week that he was taking a new medical leave to battle a previously disclosed prostate condition. Mr. Desrochers has also had to contend with political pressure to hire "emerging managers," which include many firms owned by minorities and women, as well as managers who invest partly to create jobs and promote economic development in "underserved" California areas. "When you have that many managers, you're going to wind up with average performance," said J. J. Jelincic, a Calpers board member elected by the pension plan's participants. Calpers has a stake in 741 private equity funds. Generally speaking, if each fund had investments in 20 companies on average, the resulting stakes in more than 14,000 companies would "act like an index fund," and each individual commitment "wouldn't move the dial" in delivering outperformance, said Michael McCabe, a pension fund consultant at the firm StepStone in New York. Other big public funds have also sought to cut manager head counts for similar reasons. Lawrence Schloss, former chief investment officer of the $148 billion New York City Employees" Retirement Systems, said he tried to trim the manager ranks during his nearly four years at the fund. Results for smaller commitments of $100 million or less "really have no impact on a fund that size," said Mr. Schloss, who is now president of Angelo, Gordon, an alternative investment firm. In his December report, Mr. Desrochers made several comments that seemed to point to a few underperforming areas where some managers may be cut. One is in so-called funds of funds, which make dozens of smaller investments that drive up the manager head count. Another is venture capital, where fund sizes may be too small to move the needle on returns. Funds of funds are expensive because they charge two layers of fees but do not outperform, Mr. Desrochers said, and do take control of manager selection away from Calpers's own staff. With long-term annual returns of just 4.1 percent, he called them "a drag on the portfolio." The dozen funds of funds listed on the Calpers roster have among them more than 200 different managers, so eliminating them could trim the managerial ranks by more than half. Many of the funds of funds managers are in venture capital. Calpers has already mapped plans to cut its venture allocation to 1 percent of the portfolio from the current 5.4 percent. Venture returns have also lagged, at 4.3 percent annually over 10 years. By comparison, buyouts, which represent three-fifths of the portfolio, have returned 17.2 percent. While the going may be slow so far for Mr. Desrochers, he "is doing a good job getting hold of a program that is quite frankly out of control," Mr. Jelincic, the Calpers board member, said.