CalPERS is attempting to increase allocations to infrastructure investments and timber, assembling what is believed to be the largest infrastructure investment staff among U.S. pension funds.
For the $277.3 billion, Sacramento-based California Public Employees' Retirement System, expanding investments in both areas is part of a continuing effort to diversify assets, serve as an inflation hedge and provide a cash yield for the pension fund.
The initial infrastructure investments were made after the financial crisis, when executives searched for investments not correlated to plunging stocks and bonds.
CalPERS had purchased and sold some timber assets (which officials of the pension fund call forestland) before the financial crisis, but made new investments as part of the asset diversification effort in 2008. However, CalPERS executives have not made any new forestland investments in five years and instead have put more focus on increasing infrastructure assets.
The fund has more than doubled its infrastructure investment team in the past 15 months to 13 staff members. Randall Mullan, the retirement system's senior portfolio manager, infrastructure and forestland group, said in an interview that he knew of no other pension plan in the U.S. with such a large infrastructure staff. It is a point backed up by several consultants.
But the infrastructure team is still struggling to find suitable investments. CalPERS made more than $930 million in infrastructure investments in the year ended June 30. Still, total infrastructure investments stand around $1.4 billion, or 0.4% of total assets; CalPERS has a target of 2%.
As the pension fund added infrastructure staff, it has seen additional competition for those investments, said Mr. Mullan. He said the low-interest-rate environment has pushed institutional investors toward infrastructure and other alternative investments.
“So you're seeing new allocations to infrastructure popping up all the time, either in pension funds or with various insurance companies around the globe,” he said.
In addition to intense competition, CalPERS has had difficulty finding projects that would meet its target of 7% annually, Mr. Mullan said. He said of 129 projects CalPERS examined in the 12 months ended March 31, only three were funded.
CalPERS wants to commit another $2 billion to infrastructure before the end of its fiscal year June 30, said Mr. Mullan. That would bring the retirement system's infrastructure assets to about 1%.
He said the new team is aiming for direct and separate account investments because fees are lower than in infrastructure funds and CalPERS has control of the investments. He said performance generally has been better than in infrastructure funds in which CalPERS is a limited partner.
The majority of CalPERS infrastructure investments, 55%, are in funds; Mr. Mullan said CalPERS would like separate accounts and direct investments to predominate instead.
He said his expanded infrastructure team, with expertise in transportation and power projects, is looking at power plants, airports, parking facilities and toll roads as potential investments.
Plans for expansion of the fund's forestland investments are not as advanced. CalPERS has $2.2 billion invested in timber, just two-tenths off its 1% allocation.
While infrastructure has produced overall robust returns — an annualized 18.9% for the three years ended June 30 compared to its custom benchmark of 6.7% — timber has fared poorly, producing an annualized -2.8% vs. 3.6% for the benchmark NCREIF Timberland index during the same period.
Mr. Mullan said the forestland portfolio, almost 80% of which is in the southern part of the U.S., has been severely affected by the downturn in the housing market.
Mr. Mullan said the timber program has been understaffed; until recently, there was only one staffer, working part time on the portfolio. He said an additional, dedicated employee was hired for this month, but acknowledged that might not make an immediate difference because substantial tracts of timber rarely come onto the market.
He said one option he and the new staffer will be exploring over the next year is to expand the timber program to include other investments, such as agricultural, water or other natural resources.
CalPERS is the largest U.S. defined benefit plan and one of the largest institutional investors in the world, making its consultants and executive staff question whether its allocations to infrastructure and timber are too small to make a difference in the fund's overall performance.
“Significantly, it does not really move the needle,” Allan Emkin, managing director of Pension Consulting Alliance, said at a CalPERS investment committee workshop last month. ”You're looking at a basis point in one direction or another and there's resources, there's time, there's oversight; why do it?” PCA is one of CalPERS' investment consultants.
Eric Baggesen, senior investment officer for asset allocation and risk management, said at the same meeting that CalPERS still has not figured out a formula to significantly increase infrastructure investments, noting a lack of quality projects that meet the pension fund's investment requirements.
In an interview, Mr. Emkin said he is not against starting small with infrastructure, but said it's not going to be worth it in the long term if CalPERS cannot get its allocation to at least 5%.
Mr. Emkin said he believes the same about timber.
Mr. Mullan said he agrees growth needs to occur in both asset classes. While a new plan needs to be developed for timber, he believes the infrastructure team can grow its assets substantially over the next decade.
He said CalPERS is looking in particular for “defensive” investments that provide essential services, face minimal competition and have a contracted or regulated cash flow.
He cited as an example Gulf Pacific Power LLC, a CalPERS custom account managed by Harbert Power, a subsidiary of Harbert Management Corp., Birmingham, Ala. Mr. Mullan said CalPERS staffers have a significant voice in what assets are purchased.
He said through the account, CalPERS in September closed on a 36% interest in Astoria Power Partners LLC, which runs a power plant in the New York City borough of Queens.
Mr. Mullan would not disclose the purchase price for the share in the power plant, but he said CalPERS contributed 97% of the capital for the account and Harbert Power contributed 3%.
He said the power plant has long-term contracts to supply power.
Mr. Mullan said CalPERS committed $582 million to Gulf Pacific Power and that CalPERS and Harbert Power are looking to make additional investments.
CalPERS' other infrastructure investments include a 12.7% stake in London's Gatwick Airport and a stake in a 65-mile submarine electric power transmission line that runs from Sayreville, N.J., to Hicksville, N.Y.
Ryan Bisch, Toronto-based principal and head of North American infrastructure research for investment consultant Mercer LLC, said the infrastructure investment climate has changed over the past few years as more institutional investors have made allocations to the asset class.
Now the supply of projects is limited and demand is outstripping supply. “There is a relatively small opportunity set,” Mr. Bisch said.
Statistics from alternatives data provider Preqin LLC back that up. The London-based firm surveyed more than 300 pension plans globally this year and found the average current allocation to infrastructure assets was 2.9% compared to a target of 4.8%. n
This article originally appeared in the December 9, 2013 print issue as, "CalPERS pushing on infrastructure, timber".