Yu Ben Meng not afraid to add risk if and when market moves dictate it
Updated with correction
CalPERS appears poised to add risk to its portfolio and the $348.7 billion pension plan's new chief investment officer, Yu Ben Meng, seems to be just the one to take the plan in that direction.
During his first presentation to the pension fund's board on Jan. 22, Mr. Meng said he is a big booster of tactical and opportunistic strategies when the market allows, as well as alternative investments. He also said he backs CalPERS' new private equity investment plan, which includes two outside partnerships.
"We have to be nimble, dynamic," Mr. Meng said in a subsequent interview. "If the market dictates to be more opportunistic, we should be more opportunistic. If the market dictates to be more tactical, we should be more tactical."
The objective for CalPERS is to take a long-term investment view, a process that could take five years.
"Success for CalPERS is achieving the required (7%) rate of return," said Mr. Meng, who started his new role Jan. 2. And the public markets won't get the fund there, he added.
The California Public Employees' Retirement System, Sacramento, did not achieve its assumed return for the 10- and 20-year periods ended June 30. The pension fund earned an annualized 5.6% for the 10-year period and 6.1% for 20 years. Although according to more recent return data supplied by CEO Marcie Frost, CalPERS' 10-year return for the period ended Dec. 31 was 7.9%.
Public markets are increasingly efficient, providing fewer opportunities to generate excess returns, Mr. Meng saiddded.
He estimated that due to the fund's recent performance, CalPERS is around 65% or 66% funded, compared with an estimated 71% as of June 30.
Hard look at asset allocation
Mr. Meng said he plans to take a hard look at CalPERS' asset allocation process, and sources expect him to view asset allocation through a quantitative analysis, tactical strategy lens.
CalPERS needs to improve its investment capabilities by including tactical strategies, investing in less efficient markets and scaling up private equity, Mr. Meng said.
He also sees alternative investments as a better investment bet than public markets to push CalPERS toward meeting its 7% expected rate of return. He declined to say how much of the portfolio he would invest in alternative investments. Some 11.4% of CalPERS' assets was invested in real assets and 8.1% in private equity as of Oct. 31.
Investing in stocks and bonds "may not be the best way to spend our risk budget," Mr. Meng said. Instead, public market investments should be the beta or core of the portfolio.
"We're focusing on getting the tracking error down," he said.
Investing again in hedge funds, a strategy CalPERS exited in 2014, is not on the table right now, he said.
"Looking back, that was the right decision to make," Mr. Meng said. "Going forward, I have not seen much change" in the factors that gave rise to CalPERS' decision.
He did not say whether he is leaning toward a model in which public equities and fixed income would be used to fund alternative investments. Funding for alternatives would depend on the portfolio at the time investment opportunities arise, he said.
CalPERS staff members are in the process of consolidating portfolio characteristics of the private equity program with global equity, according to Eric Baggesen, managing investment director, asset allocation and risk management, and a November report by private equity consultant Meketa Investment Group.
Under that approach, CalPERS would have a single asset segment focused on growth with a 58% target allocation, made up of CalPERS' current 8% private equity target allocation and 50% global equity allocation, Meketa's Nov. 13 report states.
Indeed, echoing earlier statements by other CalPERS executives, Mr. Meng noted private equity is one of the only asset classes that could provide the pension plan excess returns.
At the same time, he indicated CalPERS' new private equity investment plan could be tweaked.
The model has four parts: two evergreen investment strategies that would be run by separate partnerships set up by — but not owned — by CalPERS; a portfolio of commingled funds; and a fund-of-funds type portfolio that invests in emerging managers.
"I applaud you and staff for exploring the private equity model," he said during the January meeting. "The markets do not stand still, competitors do not stand still."
But more separately managed accounts could be added to the mix.
"We continue to explore different models," Mr. Meng said. "We don't have a specific time table … We don't have a specific outcome either."
Even so, CalPERS officials are in the midst of interviewing a number of candidates to run the two outside private equity partnerships. Mr. Meng declined to provide the number of executives being interviewed.
A schedule provided to CalPERS' board at a December meeting showed investment staff would be coming to the board with outside partnership terms for the private equity model by the Feb. 19 investment committee meeting.
No stranger to CalPERS
Mr. Meng's new role marks his return to CalPERS, which he left in 2015 to serve as deputy chief investment officer of China's $3.2 trillion State Administration of Foreign Exchange.
Before that, he was a CalPERS portfolio manager in fixed income focused on quantitative analysis and then investment director of asset allocation.
Part of Mr. Meng's 180-day plan is to evaluate CalPERS' asset allocation process. He also plans to perform an attribution analysis to understand the drivers of past performance, evaluate the decision-making process and develop an understanding of CalPERS' competitive advantages.
Board members already seem to be cued up to take more risk.
"We can't afford low or flat returns," said CalPERS board member Dana Hollinger during a presentation at the Jan. 22 investment committee meeting by Howard Marks, Los Angeles-based co-chairman of alternative investment firm Oaktree Capital Management (OAK) LP (OAK).
Indeed, Mr. Marks, whom Mr. Meng has known for a decade and introduced as "one of the greatest investors of our time," told the board members they were not going to get where they need to go without taking risk. However, he cautioned they need "to do it wisely."
"More than anything, the job of the CIO and investment office is that the risks you are taking are prudent," Mr. Marks said. "Risk cannot be quantified, you can only estimate it."
Mr. Marks then quoted investment advice given to him by a professor: "Index the core and manage the hell out of the periphery … It's probably a good piece of advice for you."
Risk a big topic
Whether CalPERS should take more risk was a big topic of discussion when the board adopted its current asset allocation in December 2017.
Back then, board members wanted to choose an asset mix that would have had a higher target allocation to equities and a lower target to fixed income. Also during the asset-liability study process, the board discussed adding financial leverage to the portfolio. Instead, the board adopted what was described as a balanced portfolio.
Henry Jones, a board member who was named president last month, summed up the feeling of the board at that 2017 meeting: "I echo the comments about the sustainability of the fund is the priority. And I think under different situations when we were more fully funded, I would be also willing to take that risk."
But CalPERS' liquidity position has improved since then, Mr. Meng told the investment committee last month. The state contributed $6 billion to CalPERS in 2018, causing the portfolio to be cash positive. It would have been cash negative without the cash infusion, he said during a break. In addition, California Gov. Gavin Newsom's budget proposal includes a supplemental $3 billion contribution to CalPERS this year to pay down the state's share of unfunded liabilities.
"The increased liquidity profile allows us to be in private markets … markets with higher returns," Mr. Meng said.
But he prepared the board for bad outcomes. He noted it could take five years to shift CalPERS' investment approach to a long-term view.
"Focus on the long term and don't succumb to outcome bias," Mr. Meng said. During the five-year process of changing CalPERS to a "long-term investor ... there will be challenges, growing pains and setbacks. We may not get a good outcome but should keep calm and carry on."