California pension funds learning from experience

CalPERS and CalSTRS have been working to keep their plans upright and positioned to attain their expected rate of returns in unprecedented economic, social and political conditions.

And along the way, they and other asset owners are reflecting on what they have learned, practices they may keep after the pandemic passes, and assessing investment strategies.

At the California Public Employees' Retirement System, Sacramento, former CIO Yu "Ben" Meng is credited with pushing the $444.5 billion pension plan to prepare for the pandemic and work from home even before the COVID-19 virus hit the U.S., said CEO Marcie Frost.

Before Mr. Meng resigned in August, he had been tracking the virus' spread in China and persuaded his U.S. colleagues that the virus would spread to the U.S. and require working remotely. That gave CalPERS about a 30-day advance notice before California Gov. Gavin Newsom issued a stay-at-home order in March, Ms. Frost said.

"He had a very strong belief in this and we believed him," she said. The early warning led CalPERS to set up early for remote work and test systems to enable most of its staff to work safely from home and avoid disruption in core services, she said.

CalPERS was also able to order equipment it needed to shift to remote work early, she said.

A few weeks after the stay-at-home order, "we saw supply chains around laptops, external cameras dry up," Ms. Frost said. "We got in orders before the supply chain dried up."

At CalPERS, executives also added 10 positions to the contact center team, which assists members with health care and pension matters including retirement preparation.

To keep up with other U.S. public pension plan experiences, Jack Ehnes, CEO of the $275 billion California State Teachers' Retirement System, West Sacramento, said he has been participating in regular virtual meetings since the start of the shutdowns to trade stories and best practices. And as the pandemic promises to be more devastating and longer-lasting than anyone expected, leaders at both pension funds are grappling with what work will look like in the future, acknowledging that additional flexibility including some form of work from home will remain.

"Months ago, we thought we were heading for a better ending sooner but it got worse," Mr. Ehnes said.

Mr. Ehnes was scheduled to retire but delayed his March retirement until July due to the pandemic. The board is currently searching for his replacement.

Mr. Ehnes said he does not expect staff to move back to the office until this summer, at the earliest. Even then, he expects staff to work at least part of the time from home. Surveys conducted by its in-house team during the pandemic have shown that CalSTRS staff prefer remote work. What's more, the experience has shown senior management that employees are productive working remotely.

"I changed my perception" of the effectiveness of remote work, said Christopher Ailman, CalSTRS' CIO. "For young families, this is a huge win."

The challenge will be creating a hybrid model, he said.

CalPERS' Ms. Frost expects some remote work will continue even after the pandemic has passed.

"What I've learned, on the workforce side, is the flexibility we put in place right away has really been helpful," she said. "We did a spot-check survey and employees felt that safety was being considered in all decisions being made and they took pride in that productivity is really strong."

In the future, she expects CalPERS' jobs will offer a degree of flexibility, including full time, part time and work from home.

"Flexibility has been the most important thing we've done," Ms. Frost said.

As the two plans mull how work will get done, CalPERS and CalSTRS are considering possible investment changes this year.

CalPERS is about to launch its asset-liability cycle in which the board will consider increasing private equity and private debt and including leverage as part of its strategic asset allocation so that it can hold more alternative investments in its portfolio. CalPERS had $27 billion in private equity, $43.1 billion in real assets, $500 million in an opportunistic portfolio and $7.1 billion in a trust level portfolio that includes multiasset class, completion overlay and absolute-return strategies (direct investments only).

The investment committee is expected to review capital market assumptions in June and sample portfolios in September. Selection of a new strategic asset allocation is slated for November, said Dan Bienvenue, interim CIO, at the Jan. 21 stakeholder forum, the first conducted virtually.

Meanwhile, CalSTRS' board starting at its Jan. 28 investment committee meeting is expected to entertain adjustments to the asset allocation plan it adopted in November 2019 due to the Federal Reserve outlook, announced in August, for interest rates to stay "lower for longer," leading to lower expected investment returns than anticipated when the asset allocation was adopted, according to the CIO report for the investment committee meeting. The Federal Reserve's forecast has led Meketa Investment Group, CalSTRS' general investment consultant, to change its capital market assumptions and suggest a number of new ideas to the investment committee, Mr. Ailman said.

"The board may zero in on a couple of those ideas … Right now it's all just talk," he said.

One of the proposals is to create an opportunistic portfolio, Mr. Ailman said.

Meketa has not fleshed out the details but Mr. Ailman stressed that it would not involve opportunistic trading.

"We're not short-term investors," he said. "We would have to invest a large amount of money for that to be worthwhile at our size. It would need to be a long-term opportunity."

CalSTRS will continue to implement its collaborative model, which includes investment strategies to reduce costs, boost returns and possibly provide revenue such as managing more assets in-house, co-investing and, in real estate, acquiring minority or majority interests in money managers. CalSTRS officials will also provide board education on the pros and cons of investing in China. Mr. Ailman said that he wants to position CalSTRS as the leading pension fund in sustainability and climate change.

"Over time, you are going to see more and more investment along the themes of sustainability and climate change," he said.

CalSTRS board is expected to consider a policy for a new private equity sustainability portfolio, with the first draft of the policy to be reviewed at the investment committee's next meeting.

The environmental issue is "right before us. It's dramatic. It's a risk we can help mitigate, and an opportunity," Mr. Ailman said.

While Mr. Ailman said that when the pandemic led to sharp market drop, followed by an equity market rally in the summer, CalSTRS officials let the equity portfolio increase toward its plus or minus 6% allocation range.

"We almost never let it get that wide. We were still fairly conservative, shaving profits and reinvesting them or continuing to hold our cash," he said. "We are still fairly neutral to the asset allocation but we widened the bands and let the equity marks run a bit."

It was not just domestic equities. Aside from emerging markets, non-U.S. equities were just as strong as the U.S. market, he said. Periodically, CalSTRS' officials pared back the equity overweight.

Meanwhile, CalSTRS' $20.6 billion risk-mitigating strategies portfolio, developed after the 2008 global financial crisis to protect the portfolio in down markets, "has done exactly what we wanted," even though the market downturn was historic in its speed, he said.

"It was designed for a traditional bear market that takes its time," Mr. Ailman said. Even so, while the risk-mitigation portfolio struggled, it still achieved its goal of dampening down the downside, he said.

A sizable portion of the risk-mitigation strategies portfolio is in 30-year government bonds, which rallied during the market volatility, Mr. Ailman said. Some of the other strategies couldn't react as quickly, he said.

"It was an hour-by-hour, minute-by-minute reaction. It (the RMS portfolio) wasn't exactly designed for that kind of crisis. We've never seen one like that before."

At CalPERS, Ms. Frost said that work investment staff did before the pandemic, including improving the liquidity profile, positioned the fund well during the volatility.

The liquidity provided CalPERS the ability to invest during the time period, Ms. Frost said.

"We believe because we had liquidity where other LPs may not have had the same liquidity position … it moved us up in the line (with GPs) because we had capital we could deploy," she said.

Last year, as an example, CalPERS committed $2 billion to West Street Strategic Solutions Fund I, a distressed debt fund managed by Goldman Sachs Group.