CalPERS CIO: Pension fund missed out on some private equity returns in past 10 years

CalPERS' new CIO, Nicole Musicco, and staff on Monday took a hard look at the last 10 years of performance and concluded that it wasn't a pretty picture, despite the pension plan exceeding its benchmark for the 10 years ended June 30.

Among the past missteps reported by staff were that over the 10-year period, the $439.8 billion California Public Employees' Retirement System, Sacramento, produced returns that were lower than expected and lower than a hypothetical peers, Ms. Musicco told the investment committee Monday.

The pension fund is down $30 billion in the 12 months ended June 30 and closer to $60 billion lower from the end of 2021 to June 30, she said.

The presentation to the committee showed that in the four years ended June 30, 2018, CalPERS' annualized return expectation used for its 2013 asset liability study was 7.6% compared with a realized annualized return of 5.6%. CalPERS' actual annualized returns were also lower than the annualized return expectation of its 2017 asset liability management study, 7% expected vs 6.2% realized.

At the same time, CalPERS earned 7.7% for the 10 years ended June 30, which slightly exceeded its 7.6% benchmark but underperformed the 8.9% of a hypothetical peer group portfolio informed by Wilshire Peer Universe data for U.S. pension plans with more than $10 billion in assets.

Ms. Musicco said that during the period CalPERS was underallocated to growth assets of public and private equity, especially private equity which was "really put on hold" between 2009 and 2018, and there was inconsistent commitment pacing, she said. The inconsistent commitment pace to private equity during the period cost the pension fund an estimated $11 billion to $18 billion in missed opportunities for investment returns, she said.

Looking at the 10-year realized Sharpe ratio of 1.0, "it is frustrating or disappointing, it tells me we're just not getting the return on risk that we should be getting," Ms. Musicco said.

In real estate, the pension fund's legacy opportunistic portfolio did not provide sufficient return in exchange for the risk and the overall portfolio lacked the home-country bias of peer group pension plans that would have increased the portfolio's returns.

"There was no one magic negative bullet, it's really a combination of different decisions," Ms. Musicco said. The "punchline" is that the biggest driver of underperformance was "around CalPERS private markets program or lack thereof," she said.

Separately, the investment committee reviewed a revised investment policy statement that would, among other things, increase staff flexibility to invest without board approval, including increasing delegation limits for real assets and private equity, eliminating fiscal-year limits for the managing investment director and increasing the threshold for when a prudent person opinion would be required. For example, in private equity, prudent person opinions would be required only for staff investments in customized investment accounts, investments that are beyond staff authority and co-investments of more than $200 million. For co-investments of between $101 million and $200 million, the managing investment director must either get CIO approval or a prudent person opinion.

The potential changes tie "back to some of the conversations we had earlier about ways to make us more agile both internally and perceived through the eyes of our investment partners," Ms. Musicco said.

Among the requested delegation changes would be to increase the private equity managing investment director's investment authority to $1.25 billion for a fund from $500 million, to $1 billion for a co-investment from $300 million, to $2 billion for a customized investment account from $1.3 billion, and to $1 billion for a secondary market purchase from $900 million. The proposed policy would add a $2 billion maximum for secondary market sales for the private equity managing investment director.

Board members did push back and requested more clarity on the requests.

"One of the things we were told is we were such a large investor that it was hard for us to do deals in PE (private equity) and real estate. We can't participate in the smaller deals. So now you are saying there's lots of larger deals," said board President Theresa Taylor at Monday's meeting. "I just want to make sure we're giving you the appropriate authority but, at the same time, we're not just chucking our authorities way."