The CalPERS board started a yearlong review of its $305.5 billion portfolio on Tuesday, exploring whether its four current public asset classes — equities, fixed income, inflation and liquidity — should be expanded into additional asset classes.
Eric Baggesen, managing investment director, asset allocation/risk management told the CalPERS board at a retreat meeting in Monterey that expanding asset classes could offer lower volatility and more diversification. He said it could slightly improve returns while helping with downside protection in the event of a market downturn.
“We can build a more efficient portfolio relative to the level of risk we are taking,“ he said.
The proposal studied Tuesday would break equities into two asset classes — market cap-weighted and non-market-cap weighted, each with its own benchmark. Currently, 17% of the pension fund's $147 billion global equity portfolio is in alternative beta equity strategies, but those assets currently have the same custom benchmark as CalPERS' traditional cap-weighted benchmark.
The proposal would also expand CalPERS' $59.9 billion fixed-income portfolio into several asset classes: U.S. government-related (Treasury and agency-backed securities); fixed-income spread products, (corporate bonds, mortgages and sovereigns); and high yield. Similar to equities, each of the fixed-income portfolios would have its own benchmark instead of the current one overall custom benchmark.
The $17.8 billion inflation asset class, which includes Treasury inflation-protected securities, and the $4.5 liquidity portfolio would remain the same under the plan.
CalPERS will start reviewing its private asset classes and benchmarks in February and adopt capital market assumptions in June.
An invited speaker at Tuesday's retreat meeting, Lionel Martellini, professor of finance at the EDHEC Business School in Lille, France, and director of EDHEC-Risk Institute, discussed whether CalPERS could reduce portfolio risk and increase returns by offering alternative equity benchmarks beyond a cap-weighted benchmark. He said one problem with a cap-weighted benchmark is it tends to overweight large-cap, growth stocks. He said that over the long term small-cap and value stocks have outperformed large-cap and growth stocks.
The new proposal follows the CalPERS board approval of a plan in December to reduce the system's rate of return over three years to 7% from 7.5%.
The California Public Employees' Retirement System, Sacramento, conducts an overall review of its asset allocation once every three years. The current process is supposed to conclude in February 2018 when a new asset allocation is voted on by the board. The asset allocation would go into effect in July 2018.
CalPERS returned 0.61% in the fiscal year ended June 30.
Mr. Baggesen said the steps discussed Tuesday will help CalPERS, but he cautioned that staff and board members needed to be realistic.
“It's not a giant step that saves the fund from disaster,” he said in reference to a severe market downturn. The pension fund lost around 25% of its portfolio during the financial crisis.