CalPERS' investment committee on Monday voted to recommend that the board approve a new total fund investment policy that would increase the maximum target for its opportunistic strategies to 5% from 3% and give the staff discretion to invest with opportunistic strategies external managers without board approval.
The $386.9 billion California Public Employees' Retirement System's new investment policy would also focus investments in the opportunistic strategies on private and some public credit strategies. Sacramento-based CalPERS had $1 billion in the strategy as of March 31, which is currently called "trust level portfolio management."
The investment committee also boosted its buyout target allocation by 5 percentage points to 70%, with a range of 60% to 80% and reduced its credit allocation by 5 percentage points to 5%, with a range of zero to 10% of its $27.2 billion private equity portfolio. Steven Hartt, principal, private markets consultant at Meketa Investment Group, CalPERS' private equity consultant, made the suggestion during Monday's meeting because the buyout portion of CalPERS' portfolio has been growing and is expected to continue to increase.
"I think that the continued deployment of capital in private equity is going to be continued to be focused on the buyouts area," Mr. Hartt told the investment committee. "And that as they (staff) continue to think about co-investments, those will be primarily in the buyouts area."
Mr. Hartt suggested the reduction to the credit allocation because under the proposed total plan investment policy, opportunistic strategies would include "exposure to parts of private credit that could have … otherwise been considered part of private equity."
Currently, trust level portfolio management contains, among other things, multiasset, completion overlay and absolute-return strategies. The existing policy limits non-publicly traded investments, excluding fixed-income securities, to no more than 1.5% of the total pension fund. What's more, the existing policy states that no program strategy or type of asset could exceed 2% of the total fund and limits the aggregate market value of assets of a single country other than the U.S. to no more than 1% of the total fund.
The opportunistic strategies portfolio still does not have a specific target allocation weight and the portfolio's investments are "an active position relative to the asset allocation," according to a memo to the investment committee from Wilshire Associates, the pension fund's general investment consultant.
The new investment policy would allow up to 80% of the opportunistic strategies portfolio to be invested in middle-market lending, up to 50% in public market dislocation and up to 40% of the portfolio in each of bank loans and collateralized loan obligations, specialty lending, liquidity finance and real estate financing. Up to 20% of the portfolio can be invested in structured products and whole loans. There are no longer any geographic limits in the investment policy proposal.
The total fund investment policy proposal would give the CIO discretion of up to $3 billion for each fund commitment, $3 billion for each co-investment and $6 billion for each customized investment account commitment. The deputy CIO would be able to commit up to $2 billion per fund, $2 billion for each co-investment and $4 billion for each customized investment account.
The managing investment director has fiscal-year limits for his or her opportunistic fund commitments of $7 billion to funds, $5 billion to co-investments and $6 billion to each customized investment account. The CIO and deputy CIO do not have aggregate fiscal-year limits on their discretionary opportunistic strategies commitments or investments.
The existing investment policy does not give the staff investment discretion over the opportunistic strategies portfolio.
In his memo to the investment committee agreeing with the proposed changes, Thomas Toth, managing director at Wilshire, said the increase in the opportunistic strategies maximum limit to 5% is "in recognition of the increased market opportunity set, as the COVID-19 pandemic has impacted the global economy to an unprecedented degree."
The portfolio will continue to have a tracking error limit of 1.5%, Mr. Toth told the committee Monday.
During a report to the investment committee, CIO Yu "Ben" Meng explained that the opportunistic strategies program was created to invest in opportunities such as credit that arise from structural market changes not incorporated into its benchmark, as well as investment opportunities from market dislocation from a crisis such as COVID-19.
"These types of opportunities tend to be the result of extreme market dislocations and the transitional in nature," Mr. Meng said. "It's important to be ready to act quickly to capture such opportunities."
To that end, he said that in early 2020, CalPERS had made commitments to two funds structured with triggers so the mandate would be activated only when a set of conditions was met. The triggers were met immediately thereafter, Mr. Meng said. The mandates were $1 billion each to Oak Hill Advisors' OHA Black Bear Fund and Oaktree Capital Management's Oaktree Latigo Investment Fund. CalPERS' initial commitment to the Oak Hill strategy was in February and to Oaktree in March.
In his comments, Mr. Meng also mentioned CalPERS' use of an aggregate 20% leverage on the total fund leverage approved by the board in September. The investment policy allows the staff to leverage the fund when the staff directly controls the exposure.
Direct control by the staff is defined in the investment policy as when the staff applies debt to in-house portfolios or when the staff has authority over a money manager or a limited partnership that uses debt. Leverage embedded in alternative investments or limited partnerships where irrevocable authority has been given to a third party to invest on CalPERS' behalf and non-recourse debt are not included in the aggregate leverage calculation.
At Monday's meeting, Mr. Meng said the staff plans to "deploy leverage gradually." The use of moderate leverage allows CalPERS to take advantage of low-cost debt in today's environment and acquire assets with higher returns — either private or public, he said.
Mr. Meng acknowledged that leverage can exacerbate negative as well as positive returns. He said leverage is being added to CalPERS portfolio to offset future low return expectations.
"We have carefully factored in these risks and had implemented a comprehensive forward-looking plan," Mr. Meng said." Over the last several months, we have meticulously planned a major shift, improving liquidity management, installing of proper controls and a centralized government framework."
Mr. Meng did not provide the plan details.
No member of the investment committee — which met in closed session for more than five hours before opening the meeting to the public — had any questions for Mr. Meng concerning the use of leverage.