CalPERS' investment staff is recommending that its investment committee keep its asset allocation similar to its current allocation to maintain a 7% expected rate of return and avoid more contribution increases for municipalities and school districts, show board meeting documents.
The investment committee of the $345.1 billion California Public Employees' Retirement System, Sacramento, is expected to approve the recommended three-year asset allocation at its Dec. 18 meeting. That decision, at least for now, should help prevent further alienating cities, towns and school districts already upset with rising contributions as the result of a decision by the board in December 2016 to lower the rate of return over three years to 7% from 7.5% by July, 1, 2019.
A lower return rate increases the system's unfunded liability — now estimated at more than $138 billion, a 68% funding ratio — and requires the governmental units to increase contributions to fill the gap.
Government entities have already said they will be struggling to make the increased contributions of 20% or more because of the decision.
The investment committee was considering four asset allocation scenarios. One would have lowered the assumed rate of return to 6.5% and another to 6.75% over a 60-year period, both by reducing equity exposure and increasing fixed income. The investment staff also rejected a plan to increase the expected return to 7.25%, which would increase risk by building its equity portfolio to almost 60% of its total portfolio from the current 46% weighting..
The proposed new asset allocation calls for 50% weighting to equities, a 4 percentage point increase from the current allocation, and a 28% allocation to fixed income, up from 20%. But a current 9% allocation to inflation assets, which is largely made up fixed-income instruments such as inflation-linked bonds, is being merged with the fixed-income asset class.
Real assets, which includes real estate, will keep the current 13% weight under the new allocation, and private equity will remain at 8%.
CalPERS' liquid portfolio, made up of cash and other short-term instruments, will fall to 1% from 4%.
CalPERS investment staff in a staff memo for the Dec. 18 meeting, says the proposed asset allocation keeps the 7% expected rate of return, does not increase exposure to interest rate risk and won't further increase contributions from employers. But staff noted that the allocation retains the current level of equity risk.
Critics have contended that CalPERS set its expectations too high. The system's own estimate shows the portfolio being adopted would have a 6.1% rate of return annualized over the next 10 years. If true, that would mean unfunded liabilities would most likely increase in the near term because the system would not be making the expected 7%. From 11 years to 60 years, CalPERS anticipates the portfolio would return 7.5%.