CalPERS’ investment committee meeting on Monday approved a new investment policy that, among other things allows aggregate leverage of up to 20% when the staff directly controls the exposure and gives staff greater latitude in making co-investments.
Direct control by the staff is defined in the proposed 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.
During the meeting, Dan Bienvenue, interim chief operating investment officer and managing investment director, global equity, estimated that CalPERS’ total portfolio has had about 10% leverage in the past.
“We’re not looking to lever the plan up,” Mr. Bienvenue said in response to questions from the investment committee members. “We’ll come back to you as we ... explore that ... but right now the leverage is, I would say, (it) stops at 10%.”
The prior investment policy of the $380.7 billion California Public Employees’ Retirement System, Sacramento, had leverage limits for each asset class. Leverage limits for each asset class are no longer in the investment policy but instead are now under the consultants’ purview, Mr. Bienvenue said.
Leverage of individual asset classes will no longer come before the investment committee unless the staff wants to add more debt than the asset class maximums in the consultants’ guidelines.
It is up to the consultant to bring the matter to the investment committee, Mr. Bienvenue said.
The new investment policy provides that the staff will report total fund and asset class portfolio leverage metrics once a year. The report will include unfunded capital commitments for private asset classes.
When CalPERS board member Margaret Brown asked what would be considered a material benchmark change that consultants would bring to the board, Mr. Bienvenue said it is a change that takes something that looks like a fish and turning it into a fowl, rather than an administrative modification — from fish to fish. Under the new investment policy, it’s the consultant’s decision.
“We’re essentially stepping into your shoes ... in that case and saying on behalf of the investment committee this is significant enough that they need to make the final decision rather than it being a ministerial change,” responded Andrew H. Junkin, president of Wilshire Consulting.
The new investment policy gives certain staff members the ability to co-invest without requiring them to seek a prudent person opinion or board approval.
Yu Ben Meng, CalPERS’ CIO, said that his main concern is to be able to make co-investments in a timely fashion. Obtaining a prudent person opinion slows down the process.
Under the new policy, private co-investments of less than $200 million are at the discretion of the managing investment director and no longer require a prudent person or board opinion is required. For co-investments of $101 million to $200 million the managing investment director must obtain either CIO approval or a prudent person opinion. The prior version of the policy called for a prudent person opinion for co-investments of $200 million or less. Prudent person opinions but not board approval are required for co-investments of more than $200 million.
The policy also doubles the amount of real asset co-investments staff can make without seeking board approval or a prudent person opinion to $100 million from $50 million.
The new investment policy also includes revised benchmark including a lower private equity benchmark of a custom benchmark using the FTSE All-World and FTSE All Cap indexes plus 150 basis points.
In response to a question about the reason for selecting the benchmark from board member Stacie Olivares, Wilshire’s Mr. Junkin explained that in the past most asset owners used the S&P 500 plus 500 basis points as a benchmark but most investors have lowered the benchmark to 250 to 300 basis points, with a median of more than 300 basis points.
CalPERS benchmark is lower due to the difficulty of investing 10% of a $380 billion portfolio, he said. Investing that much money means that CalPERS ends up with some third quartile and fourth quartile funds because CalPERS has to “pull a capital across a much broader spectrum,” Mr. Junkin said.
Larger asset owners have a much more difficult time achieving excess returns than smaller institutional investors, such as a university endowment, Mr. Meng said. “That’s the reality we have to face.”
Also Monday, during a review of CalPERS’ equity portfolio, Stephen P. McCourt, managing principal and co-CEO of one of CalPERS’ consultants, Meketa Investment Group, said that in fiscal year 2019, staff moved 29% of equity assets into a new $54.6 billion factor-weighted equity portfolio.
CalPERS has a target allocation of 15% of total plan assets to factor-weighted equities. CalPERS funded its factor-weighted equity portfolio from its capitalization-weighted equity portfolio. CalPERS had $131.4 billion in capitalization-weighted equities as of June 30.
The report also showed that CalPERS’ $185.9 billion public equity portfolio earned 11.06%, outperforming its benchmark by 20 basis points for the 10-year period ended June 30. However, the portfolio underperformed its benchmark for all other periods. CalPERS’ equity portfolio earned 6.08%, underperforming its benchmark by 16 basis points the one-year, 12.26% for the three-years, underperforming by 25 basis points and 6.67% for the five-years ended June 30, eight basis points below its benchmark. CalPERS’ factor-weighted portfolio returned 13.41%, underperforming its benchmark by 10 basis points.
The goal of the factor-weighted equity portfolio is to make sure that in periods of a sell-off in the stock market, CalPERS’ portfolio will hold up, Mr. McCourt said. In the equity downturn in December, CalPERS’ equity portfolio dropped by 11% but the factor-weighted portfolio only dropped by a little over 7%.
“That’s the protection that can happen in some of those market cycles,” he said.
Separately, Arnold B. Phillips, managing investment director of CalPERS’ global fixed-income investment program, noted that 96% of its $106.3 billion fixed-income portfolio is invested in-house as of June 30, up from about 92% last fiscal year. However, total fees paid increased during the year ended June 30 to $39.6 million from $35.2 million in the prior year.
Mr. Phillips said that most of the extra fees were paid to external managers that CalPERS terminated as part of a transition into long government bonds, long spread fixed income and high yield. Some of the managers performed well and so, they were paid incentive fees, he said.
Fixed income exceeded its benchmark in all time periods, earning 9.6% for the one year, 31 basis points above its benchmark; 3.3% for the three years, 62 basis points over its benchmark; 4.1% for the five years, 56 basis points above its benchmark; and 6.6% for the 10 years ended June 30, 137 basis points above its benchmark.
During fiscal year 2019, CalPERS incorporated ESG factors into its fixed-income strategy.
Among other actions, CalPERS increased exposure to water utilities and reduced its investment in Duke Energy because of the environmental costs of coal ash remediation and a bond valuation that is similar to comparable companies. CalPERS also reduced its investment in Edison International and PG&E bonds due to the difficulty in predicting future wildfires caused by climate change.