As the state treasurer of California, I serve as an ex-officio member of the California Public Employees' Retirement System's board. It is my fiduciary duty to ensure retirement security for our 2 million active and retired members. Fulfillment of that responsibility requires careful consideration of the organization's investment strategies, oversight and results.
When weighing these decisions, I must also consider the impacts on our state's budget and how CalPERS' performance could weigh on municipal and local governments whose employees are CalPERS' members — and, by extension, the California taxpayers who are obligated to provide the financial resources to assure retirement security to those employees.
With that in mind, I believe that CalPERS' new "toward a 7% solution" investment strategy based on "better assets" and "more assets" could go a long way toward securing the benefits that California public employees depend upon now and in the future, while protecting California's taxpayers.
Allocating more of CalPERS' nearly $400 billion portfolio into private equity and private debt, thereby investing in "better assets," is a reasonable strategy. This approach is specifically designed to overcome the challenges of low interest rates, high asset valuations and low economic growth that are pervasive in the investment markets today. By taking on these better assets, CalPERS is in a much stronger position to achieve its goal of a risk-adjusted return of 7% within the next 10 years.
"More assets" is an important companion to "better assets." It simply means that CalPERS will consider using a moderate amount of leverage, or borrowed capital, to acquire more base assets that can generate additional returns for the portfolio. I understand any discussion of leverage to purchase assets can sound risky, and some commentators have disagreed with this concept. I appreciate this and agree that any type of borrowing carries some level of uncertainty. However, not all investors possess the demonstrable expertise to manage leverage the way CalPERS can. Fundamentally, what works best about this strategy is that it plays to CalPERS' strength of being an asset owner with a long-term investment horizon and not one forced to focus on quarterly results.
There's nothing novel or exotic about the use of leverage by large pension funds. The Canada Pension Plan Investment Board, and others, all use it to enhance portfolio efficiency and diversification — as do many professional private-sector investors. CalPERS, in fact, has had some level of leverage in its portfolio for years.
More importantly, CalPERS expects to deploy leverage gradually, prudently and opportunistically. The two components of the proposed strategy, better assets and more assets, are independent of each other. CalPERS is not proposing to leverage the portfolio immediately, but rather to thoughtfully, modestly increase borrowing as opportunities arise. In this way, enhanced leverage becomes an option in increasing expected returns.
Healthy debate is productive, but there is a valid reason every CalPERS board member approved the use of leverage last year. Simply put, it supports CalPERS' long-term goal.
As the state's banker, it is my duty to carefully weigh the financial decisions that impact the 40 million residents of California. My role includes assisting with the prudent management of California's $200 billion-plus budget and the $99 billion Pooled Money Investment Account (PMIA).
Through the PMIA, my office invests taxpayers' money to strengthen the financial security of local governmental entities. These responsibilities grant me a unique view of our state's comprehensive financial situation. It is with this perspective that I believe the CalPERS new investment strategy, unveiled last month, is a worthy approach at the right time.
Given the challenges that large public pension funds face today, CalPERS must do everything in its power to thoughtfully drive returns so that members can retire as they deserve and as promised, and to minimize further strain on public agency budgets. And CalPERS is uniquely suited to manage the risks that necessarily go with that mission.
Since joining CalPERS' board, I have not lost sight of the important role I play in the lives of our members and society. I feel reassured that CalPERS' new investment strategy will deliver for our members in the future.
Fiona Ma, Sacramento, is California's 34th state treasurer and sits on the CalPERS' board of administration. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.
