With pension funds and other asset owners increasingly turning to private markets and weighing sustainable investments, Pensions & Investments sat down with the new CIO of the $528.8 billion California Public Employees’ Retirement System for his take on these investment strategies.
In this second installment of a Face to Face interview, CIO Stephen Gilmore also discusses the importance of alignment with general partners and fiduciary responsibility. Gilmore, who took on the role in July, most recently was CIO of the New Zealand Superannuation Fund. He arrived shortly after CalPERS in November launched its Sustainable Investment 2030 plan, which will nearly double the value of assets in climate solutions investments to $100 billion by 2030.
Questions and answers have been edited for conciseness and clarity.
Q: I wanted to ask about some of the conversation at the last investment committee. CalPERS said it planned to gradually increase its exposure to private markets, to 40% from 33%. So what's gradual and what's the appeal there?
A: Let’s turn it around to say what's the appeal and then, what's gradual? Conceptually, we would expect to get paid something for locking up liquidity. Whether or not we do, there's a different question, but conceptually we would expect to earn some sort of illiquidity premium first.
Second, sometimes we will be able to access things through private markets that we cannot access through the public markets. A classic example might be the venture capital space. We've got startups and so on.
I think third, because you have the potential to arrange stronger governance rights through more direct ownership, not necessarily us taking direct ownership, but the ownership structure, it does allow you to perhaps undertake operational efficiencies that you may not be able to do so easily through the public markets.
And fourth, you can potentially negotiate better alignment with some of those private market assets.
Gradually, it depends on a couple of things, right? It depends on whether you're finding good investments. Ultimately you shouldn't just head for a particular target if the pricing doesn't look appropriate. We have to be able to find the attractive investments and it's very hard to say in advance whether we are going to find enough or maybe we'll find more than we expect.
So the pace is going to be partly a function of that attractiveness. It's also going to be a function of our ability to deploy. But I would say the first one, it's about finding those attractive investments.
Q: So not rushing into things?
A: Well, I don't know. If you found something that was super attractive, maybe you would speed up. But it's really more about don't just fill a bucket if the returns don't look good.
Q: OK. Fair point. In private equity, which is going up 4 percentage points under the plan, are there any specific areas in PE that you're excited about or that you think have promise?
A: I'd point to the high-level strategy that we have. One of the big areas of focus that Anton (Orlich, managing investment director, private equity) has is to try to get that strong alignment with our GPs and (he) thinks that strong alignment will also allow us to get more co-investment.
That's important because like I said, it (co-investment) reinforces the alignment, but it also means it cuts the cost for us. The after-fee outcomes can be better. So I'd say strategically, if we've got that alignment and we are the most important LP or one of the most important LPs, that can help with the prospective returns.
But of course, you've got to choose good managers and you've got to be aligned. I would also say that we've been wanting to maybe rebalance the portfolio somewhat because historically we'd focus more on the large cap. So now there's a bit more orientation toward growth and venture. But I would just say those things really at a high level.
Q: In terms of private credit, with interest rates declining, does that make it a less attractive asset class?
A: I'm pausing because it really depends on supply and demand. You're talking about policy rates, probably. It’s probably going to be a function of the excess return you think you're getting over and above the risk-free rate. And you also need to think about what rewards you're getting across other asset classes. Ordinarily if interest rates are going down and it's not a recession, you would expect that assets in general to be bid up. So whether that's credit, whether it's equities, whatever.
I think you need to look at these things holistically. It might be that the look-forward nominal return comes down with interest rates coming down. But it may be, you think that the spread of a risk-free rate is still attractive relative to what you could get elsewhere. So it's not necessarily a straightforward answer one way or the other.
Q: Can you talk a bit more about CalPERS’ 2030 Sustainable Investment strategy?
There are three main (objectives) for me to focus on when I talk with Marcie (Frost, CEO).
I mentioned people and culture. I mentioned technology, which is I think process-related. And then I mentioned the ALM (asset liability management) already, and the portfolio construction.
And for me, sustainable investment gets incorporated within that third area as well.
It's also one of the things that attracted me to CalPERS in terms of the ambition. Certainly, in my previous role, it was a big thing as well. We very much thought about sustainability, and we thought about how to integrate that into how we invested. And I want to think along some lines here: Yes, we have 2030 SI, but (I) want to be at a point where all the investing teams habitually think about sustainability when they are making their investments. So for me, just integrate it into how we do things.
Q: It does seem like there's a tremendous amount of noise around the topic of sustainability, at least in this country.
A: Well, there's noise, but ultimately you want to make good investments, and everything gets looked at through that lens because we have to focus on our fiduciary duty, and it would be remiss of us not to be thinking about some of the risks associated with things like climate change.
You can see it in the insurance industry, you can see it with physical risks. You can see it with some of the regulatory risks. But the other side of it, of course, is there are opportunities — you think about the necessary power generation, and you think of, well, for a while people might've thought that demand would plateau or maybe even decline. But with what's happening in tech and AI, the projections are that you'll see increasing demand and you've got to think about how do you supply that? Then you need to look at the cost curves and so on and renewables have a place there.
Then you need to be thinking about how do you connect to the grid, how do you transmit, all those sorts of things. So for us, it's just part of how we think about investing. We need to be thinking about these elements. Otherwise, we would be not doing our job. We need to think about the risks and the opportunities in the place.
Q: In terms of governance, CalPERS was very public in terms of its talks with Exxon. Is that something that you're going to doing more of?
A: This is one of the things I liked about CalPERS before coming here. The philosophy is that divestment is the last resort and the engagement with some of these companies can be fairly high profile, but there will also be other engagement that you just won't see where you have pretty open conversations with people and those can lead to better outcomes for all. I think engagement is important. If you divest, you basically lose that voice.
Q: So, a last resort?
A: Yeah, a last resort to divest. But of course, some of the results from engagement, you can't publicize.
Q: We've talked about different things that you're looking at, but are there any holes in the CalPERS portfolio that you're thinking about?
A: I think this will be something that comes out of the asset liability management review. And I think we need to ensure that the portfolio that we come up with takes into account that risk appetite that I talked about before, and it takes into account thinking of how resilient the portfolio might be given different scenarios. My expectation is that we would give a fair amount of thought to portfolio diversifiers. I wouldn't say it's necessarily a hole, but I do think that's something that we'll give probably more consideration to as part of that review.
Q: Can you give me an example of portfolio diversifiers that you’re thinking of?
A: Well, typically for portfolios like ours, and for most asset owners, the portfolios will be equity or growth-oriented.
And so when you get into periods of, let's say recession, returns are challenged, or if you get into periods where real interest rates go up in a surprising way, portfolios will be challenged. If you go into stagflation, portfolios will be challenged. And so you want to think about, well, what can you add to the portfolio that will — if not hedge against those things — do less badly than some of those other exposures. So what can you put in that gives you more resilience across a greater range of scenarios? And then you've got to think about the risk and return trade-off.
Q: One last question: If you weren’t doing this job, what would you be doing?
A: I don't know! And I say that because this job is a privilege because it combines so many things I like. It combines the ability to think about the world, and you work with a lot of really interesting people. Ultimately, it's about problem-solving. And I like the problem-solving.
It's also about continuous improvement. And I like that. I get to be, in some ways, a citizen of the world. Yes, I’m based in Sacramento, but I get to think about what's going on in all those other places and to have those conversations.
The other thing, of course, is with this one, it has meaning because we've got 2.2 million members. And so you can say, I'm doing all this, and actually I can be happy that there are people who are hopefully benefiting from that if I do it well.
