CalPERS shifted $150 billion in fiscal year 2019 as part of its implementation of a new strategic asset allocation adopted in December 2017 and an interim strategic asset allocation adopted in closed session in March 2018, Eric Baggesen, managing investment director for asset allocation, told the investment committee Tuesday.
The $376.3 billion California Public Employees' Retirement System, Sacramento, expects to conduct a midcycle asset liability review, Mr. Baggesen said.
Wilshire Associates, CalPERS' primary general investment consultant, oversaw the transition process, moving exposures and targets to the new strategic asset allocation over the 15 months ended July 1.
The pension fund's strategic asset allocation implementation includes 15% invested in a new factor-weighted equity portfolio, as well as 35% in capitalization-weighted equities and 8% in private equity, which together make up its 58% growth portfolio. CalPERS funded its factor-weighted equity portfolio from its capitalization-weighted equity portfolio.
CalPERS also carved out a new 3% allocation to high yield from its 28% fixed-income portfolio. Fixed income also includes 15% in long-spread fixed income and 10% in long Treasury bonds.
In response to board members questions, Mr. Baggesen noted that CalPERS' 1% liquidity portfolio, which has a wide allocation range of 3% to -6%, has the ability to add leverage to the entire portfolio, which CalPERS calls borrowed liquidity.
CIO Yu Ben Meng said that borrowed liquidity means that in a market drawdown, CalPERS staff will be able to borrow against assets to take advantage of the market dislocation.
CalPERS also instituted a new opportunistic program, which has an allocation of not more than 3% of total assets. The opportunistic program has three components: execution services and strategy, which is a new team for all of CalPERS' trading operations, as well as securities lending, liquidity and leverage management; enhanced beta, a LIBOR and futures-based strategy using structuring and synthetic securities; and opportunistic investing in shorter-term market valuation or structural anomalies.
In fiscal year 2020, CalPERS staff will also be reviewing its use of active risk — including weight variances and staff veering from the strategic asset allocation — to increase the discipline in using active risk, Mr. Baggesen said.
Mr. Baggesen noted that in fiscal year 2019, the staff's use of active risk resulted in negative returns. He did not tell the committee how much the use of active risk cost the portfolio. However, in the year ended June 30, CalPERS underperformed its benchmark in the one-, three-, five- and 10-year periods.
Most of the active risk was taken in CalPERS' $106.3 billion fixed-income portfolio, amounting to 28.7% of its portfolion.
"We are utilizing risk and taking variances from the structure of this strategic allocation," Mr. Baggesen told the investment committee. "It can be weight variances from the strategic asset allocation."
Staff members should take on active risk if they "believe that somehow that variation is going to result in a positive return. For the fiscal year, that did not happen, it resulted in a negative return," Mr. Baggesen said.
The investment committee also took a first look at a new investment policy.
The new policy changes the leverage limits to a total fund leverage limit of 20% from specific guidelines on the type and amount for each asset class. For example, under the existing policy, notional leverage in equities, calculated on a net exposure basis, shall not exceed 10% of the portfolio's market value. Fixed-income leverage also is limited to 10% of portfolio value under existing policy, while total leverage in the liquidity (cash) portfolio is to not to exceed 5% of total fund value.
Another proposed change would give staff more discretion in making investments. The proposed investment policy statement would increase the threshold requiring staff to get a prudent person opinion from a third party for real asset transactions to $100 million from $50 million and to $200 million for private equity co-investments transactions from all co-investments requiring a prudent person opinion. The proposed investment policy also states that co-investments between $101 million and $200 million would require either CIO approval or a prudent person opinion.
"As a result, co-investments of $100 million or less may be approved by the private equity managing investment director without a PPO (prudent person opinion)," a letter to the board from private equity consultant Meketa Investment Group stated. "We believe it is a best practice for public plans to have separate oversight of staff work on all private equity investments. We have reviewed the investment policies of several of the largest U.S. public pensions and note that investment staff are either required to obtain a third-party opinion or that individual investments are subject to board approval and/or oversight. Co-investments can involve significant undiversified risk and that separate oversight can provide additional checks and balances in the investment process."
Meketa concluded that the change was reasonable due to the short time frame for which co-investments need to be made.
Meketa, which also acts as the pension plan's real estate and infrastructure consultant, in a separate letter supported the increased threshold for a real asset transaction to $100 million even though it noted that the lower, $50 million threshold had not posed a significant constraint on the real asset program "given its lower risk core investment strategy and its business model which relies in large part on separate accounts governed by an Annual Investment Plan process."