Face to Face: CalPERS CEO Marcie Frost opens up on private credit and, yes, sports teams

CalPERS CEO Marcie Frost, hailed as one of the most influential women in institutional investing, talked to Pensions & Investments about America’s largest public pension system’s CIO search and its recent asset allocation increase to private equity and private credit — the darlings of the financial market.

The Sacramento-based pension fund has been searching for a new CIO to replace Nicole Musicco, who stepped down at the end of September. An announcement of the appointment is coming any day now.

“We're putting a lot more emphasis on resiliency because resiliency leads to retention and the retention requirement is a minimum of five years,” Frost told P&I.

Frost, who joined California Public Employees' Retirement System as CEO in October 2016 and oversees a global investment portfolio of $492.8 billion, also discussed CalPERS’ stance on active vs. passive management as well as the allure of sports teams as investments. Frost was named to P&I’s inaugural Influential Women in Institutional Investing list in 2023 and appeared in Barron’s 100 Most Influential Women in U.S. Finance in 2021.

This is the first installment of our two-part interview with Frost. Questions and answers have been edited for style, clarity and conciseness.

Q: I wanted to start off with the CIO search. We know you have a shortlist and CalPERS is about to make an announcement soon.

A: We've been pretty clear about the attributes that we're looking for in the CIO seat: That is, someone who comes in with a very strong investing background and someone who can lead a pretty large team. Someone who has the resiliency really to work in a highly transparent public fund, and as we know, not everyone is in a place that they feel like they can do that.

And some who believe they can, and they get into the seat, and they realize the first time it happens, this is really not what I want to do. But really testing and going through a lot of conversations about resiliency, and tell me times when these situations may have happened to you (and) how did you respond to those. How did you stay on track? How did you stay on message? How did you stay on performance? So the candidates have done very well in that area.

And then, strong communication skills along with being a very public fund. We, CEM Benchmarking, has us as the No. 1 most transparent fund in the United States and along with that comes the need for high communication skills to be able to explain the decisions that we're making at CalPERS.

Why those decisions were made, or it might be a recommendation we were making to the board. Why did the staff recommend this over other options that may have been considered. So being able to explain that to a board, a board with varying background, some having no investment background and some having some investment background, but typically more what we would consider…a number of stakeholders who operate around us who care about what we do, care about their pensions, which we love.

Q: Sometimes you have someone who's fantastic on paper, but sometimes it's not a great fit. Can you elaborate on that?

A: When you are as transparent as we are, there is additional complexity that comes in the role. That is not a role that's simply around investing 100% of your time, it's a role that includes stakeholder engagement, board relations, leading a strong team and obviously, you are going to have some deputies who will help you with that, but it's more than just that big I in the CIO. It is a myriad of responsibilities and skill sets that are needed, but I think for me, in my time here, this will be my fourth CIO in seven-and-a-half years.

I think my time here has shown me at least the two that I was involved in hiring, it is the public nature of the role that became a little more problematic for them. They did not anticipate, No. 1, the demand on their time, but also, none of us are perfect, so when things did not go as planned, the reaction, the very public reaction to that, and some of us have that inner wiring that we can deal with it, address it, compartmentalize it. Until it happens to you for the first time and you're tested in that way, you just don't know. I think both of our former CIOs, that was something that we spent a lot of time talking about, how do you compartmentalize these things versus walking on egg shells all the time. The moment that you're walking on eggshells, it's very difficult to be the CIO of CalPERS, it takes a level of courage and perseverance and grit to get through some of this.

Q: CalPERS recently boosted its private equity allocation and one of your shortlist candidates has that background (LACERA CIO Jonathan Grabel). I know you don’t want to name names. All of your CIO candidates did agree with the private equity allocation that you folks just made?

A::CalPERS, you'll remember, when Nicole Musicco first came in and she and I worked on a presentation that I felt was extremely important to understand the impacts of when we are not pacing our capital into private equity — even at the asset target or the policy targets that we had. We were still struggling after the 2008-2009 financial crisis, and those vintages performed very well and we didn't have capital working for us.

There are a lot of lessons learned in 08-09, but we did this 10-year lookback at private equity as an asset class, and where we did well and where we needed to learn from some missteps that had happened. CalPERS, regardless of this current CIO search, CalPERS has been working to increase its private equity or alternatives generally exposure by hiring Anton Orlich (Orlich was named managing investment director for the CalPERS private equity group in November 2022).

That was certainly one of the strategic moves that Nicole made, one of her first hires, and he was a return to CalPERS but had done quite a nice private equity book at Kaiser, and so this is really more of a reflection of Anton and his team, their ability to restart the co-investment program. Their ability to really negotiate structures that allow us to move from some of the concentrated relationships that we had with the larger GPs more into that mid-market, which opened up more venture, it opened up more diversifying the assets across managers, so not only are we seeing a better kind of risk-return, less fee drag, but also the importance that we place on manager diversity. We've been able to find great deals to fund across that spectrum. That was really well, well underway before the recruitment, this most recent recruitment.

Q: Are you folks looking to move your exposure into active vs. passive management? Other pension funds are moving in that direction as we see a lot of volatility in the markets.

A: We are. We've been predominantly passive for a number of years. Back in 2019, I believe that we did a complete active risk review. We took a lot of active risk out of the portfolio at that time, but the intention was always to add it back in when we have conviction about a manager in particular. Markets seem to do a good job of pricing at risk on the shorter term and maybe not as long-dated, two years and above. I think that a benefit that we have at CalPERS is our capital is long term.

We can focus there and find like-minded managers who can align appropriately, and whether that's climate, whether that's where we see risks related to climate, we think some companies are doing better than others and then taking an active bet on that.

We are bringing that into public equity. We just closed out the RFP for manager selection there. There is more active and fixed income than we've ever had in the past, so you do see a slight shift away from being purely passive, outside of the private asset classes, more on the public side. That was a strategy also brought in by Ben Meng was the one who cancelled the active management, again, always intended to bring it back in. Nicole came back in, during her kind of her analysis of where we could do better, this was one of the work streams that she identified. The team has continued to move forward with implementation.

Q: If you have a big internal investment team, why would you be talking about hiring outside managers? And isn't that redundant from a cost perspective. In essence, what happens to your internal investment staffers?

A::I would look at it more as workloads continue to shift and increase and the need for more due diligence and need for more risk awareness, the need for more liquidity management, it's more about shifting of where we're placing resources. And so active management is not just giving our capital and having no oversight, it's making sure that we have the appropriate diligence processes and monitoring processes. As we're increasing assets to private equity and into private debt and credit, we're shifting resources over there, but really not intending to have the headcount increase.

I would see this more as recalibration of the team and alignment with the new strategies that we're moving forward with, whether that's the increase in private assets or the increase in our exposure to active management, it's just more skill set development to be able to move people to where we really see the need.

Q: Going back to the new asset allocation that CalPERS just adopted with increased exposure in private equity and private credit. You’ve spoken to all the CIO candidates, and they all favored the new asset allocation. But trustees noted that CalPERS is scheduled to conduct an asset-liability review starting in February 2025. So why the rush to change now?

A: Every four years we do go through the strategic asset allocation, and that's based on capital market assumptions at that point in time. The world changes more quickly than every four years, which means capital market assumptions are also going to change. So what the team does at the two-year mark of the four-year cycle is ask have the CMAs, Capital Markets Assumptions, changed enough that we think we have opportunities to change that asset allocation, and that's one of the things that they identified.

When we put the strategic asset allocation together, we put a cap on the optimizer for how much private equity it would naturally put into the asset allocation and some of that was just simply based on resources and our availability to really implement; we needed to do some work on liquidity management, to know how much we could actually tie up in illiquid vehicles. That work has been completed. We have the resources we need, we have the head of private equity, so we brought that cap on the optimizer up, so that we could capture more of the private-equity premium as long as we were not liquidity constrained. The team feels very strongly that we are within — far within our liquidity — where we can tie up capital appropriately.

It's two-fold: The last time we did this, we didn't feel like we could implement it the way than it needed to be done. Two years later, a lot has changed, both in CMAs, as well as the ability of our team, the resources and the skill development, and so those two things coming forward.

It's a lot more transparent to do it through our open public meetings and bring our board along with us, allow the stakeholders to give public comment on this, what their concerns might be. That it is to use some of the active risk. Because we could have implemented it that way, even though we have a policy target, say of 13%, we can actually go plus five or minus five. Now, some of that is so as markets change and fluctuate that we don't have to come back to the board every time.

For example, when the markets are reduced to the level that they did where we could have been outside policy range and so that we have one board member who was asking a lot of questions, don't you already have the authority to do this? We do, we do have the authority to do this, but we thought this was a much more transparent way of bringing the board along with us, bringing stakeholders along with us, and explaining all of the why of why we think we need to increase our allocation in both of those asset classes.

Q: What kind of returns are you expecting in private equity and private credit?

A: I'm positive on both. We expect private equity to outperform our public equity by 150 bps (basis points). Hopefully more so than that with our implementation style where we are focused much more on manager selection. We're focused more on co-investments and bringing down the fee drag to performance, so we think we can, over time, outperform that benchmark. Private credit as you indicated is everyone's trying to get what they can.

We happen to be in a place again that we've got strong liquidity, we've got strong relationships. Those deals are coming in, and these are deals that we don't want to walk away from. We really do think that they're additive to accomplishing our 6.8%. We need those asset classes really outperforming when some of the other asset classes are really having a drag on performance, like real estate as an example.

So, I am positive on both, and as long as we have the resources to be able to implement and monitor well. As well as, you saw the board adopt labor principles last November. In June meetings, we will bring back how the private equity team, in particular, is adding our GPs through side letters or through attestation. Really, document that they understand the nature of the labor principles and that they are willing to abide by those.

Now, most of these are just simply laws that they're abiding by, but I think what's more important to the board is what happens when we have a violation of one of these principles. What's our process for engaging with that General Partner. Also, what's our process for engaging with the public company, I mean, some of the public comment has not been just around private equity, it was around Exxon and around Southwest Airlines.

These are just any companies that we're providing capital. There is this expectation that when something goes awry, something that is not mutually agreed upon, that we engage with the company, we understand the root cause of what happened. Do we firmly believe that this company sees this is serious and they are making changes to business processes or governance that will prevent them or give up greater likelihood of prevention. Say chronic issues, say they're not managing the risk appropriately, and we need to bring down our exposure to that GP or to that particular company.

Q: How about other asset classes. We’ve seen the Government Pension Investment Fund issue a request for information on illiquid assets as it weighs new asset classes including cryptocurrencies. Your thoughts on crypto and also sports teams?

A: Crypto, it's interesting. It's become more of an emerging topic that I'm hearing from our members about. For us, we know that we're investing in certain institutions that have some exposure to crypto, we're not doing anything directly. Our new CIO can come in and make that evaluation but today, there's a lot of risk in that. I don't think it has a right regulatory environment around it for a large institutional investor like CalPERS to understand, I'll just call currency risk, for lack of a better term. There are other things around blockchain that we think are interesting. But our new CIO can come in and decide whether he or she wants to make a play.

On sports teams and stakes in sports teams...Well, the valuations of some of these sports teams are getting to the point that ... you're starting to see more of those exits because of the valuations.

We are not opposed to sports teams. I would say we're probably looking at deals today that would include some exposure to sports teams, not directly, but through a fund. That was an area certainly our former CIO had some interest in and and frankly she had background in it. She made a lot of money for her prior firms in that particular area. But it wasn't just Nicole. I know there's a lot of confusion out there that only Nicole was focused on this, and that's just not the case. We've had a team focused on where do we think there are opportunities to really put our capital to work for 2.2 million beneficiaries now, but sports teams would be would be on the table.