CalPERS CIO Stephen Gilmore made his case for the nation's largest public pension fund to change strategy and become one of the first in the U.S. to use a total portfolio approach, in remarks at the $519.6 billion pension fund's Jan. 14 stakeholders meeting.
The total portfolio approach would be a marked change from the traditional strategic asset allocation.
One way to improve outcomes for the pension fund is to invest the portfolio “as a whole rather than thinking about asset class by asset class,” Gilmore told the group of stakeholders, including retirement plan members, retirees and employers.
Gilmore originally unveiled his signature effort to move toward a total portfolio investment approach to the board last November, after four months on the job at California Public Employees’ Retirement System, Sacramento. His former employer NZ$76.7 billion ($43.1 billion) New Zealand Superannuation Fund, Wellington, uses the approach.
“And there are benefits to doing that. Typically, that sort of approach at higher returns,” said Gilmore, speaking on a panel with other CalPERS division heads moderated by CEO Marcie Frost.
He noted that a survey of 26 large asset owners released by Willis Towers Watson in July revealed that over 10 years, those funds using total portfolio theory outperformed asset owners using strategic asset allocation by 1.8%.
“I don't expect if we adopt a total portfolio approach that it will add that much, but I would expect it could add an extra 50 to 100 basis points per year and that is really meaningful and we can do it,” Gilmore said.
The New Zealand Superannuation Fund earned a return of 14.90% (after costs, before NZ tax) for the fiscal year ended June 30.
Currently, using the strategic asset allocation approach “the board signs off on a fairly specific portfolio and there are benchmarks for 11 different asset classes.”
CalPERS’ portfolio currently is divided into five asset classes—public equity, private equity, fixed income, private debt and real assets, according to its agenda materials for its mid-cycle asset allocation review in March.
That is the last time the CalPERS board made changes to the fund’s target asset allocation, which is 37% public equity, 28% fixed income, 17% private equity, 15% real assets and 8% private debt. Staff can add 5% leverage.
“The management team tends to basically stick with those targets,” Gilmore said. “And so, the question is, who owns the targets because the team is recommending them. The board is adopting them. And the team tends to cling to them.”
With a total portfolio approach, the board is very explicitly charged with coming up with risk appetite and then delegating discretion around that, he said.
“The board currently does delegate a lot of discretion to management but management doesn't really use that discretion,” Gilmore said.
Under the total portfolio approach, the ownership and accountability of the investments is on staff, he said.
“It's actually putting more on management (CalPERS investment team) to explain what it's doing as well. So that's really what we are doing,” Gilmore said.
Board education day
Gilmore made a similar pitch a day earlier at the board’s education day assisted by Howard Marks, co-chairman of credit manager $205 billion Oaktree Capital Management, whom Gilmore said is known for his “thought leadership about balancing risk and return.”
CalPERS has invested with Oaktree.
The board is expected to select its risk tolerance to be used by staff in a total portfolio approach in November, Gilmore said. A survey to elicit the board’s risk tolerance and responses to risk-return trade offs to inform future education on trade offs in order to get to a consensus, he said.
Marks did double duty Jan. 14, both opening the meeting with a question and answer with Gilmore, and sitting at the table during a survey exercise to elicit the board’s risk tolerances.
During his initial remarks, Marks suggested the board think of risk differently.
“I was thinking this morning that what I'm going to try to accomplish, more than any other thing, is to make you think of risk, not as some terrible thing that has to be avoided, but as the raw material with which you have to work,” Marks said.
Marks also stressed that volatility should not be used to measure risk.
“If I accomplish only one thing today, I would like to talk you out of caring about volatility...because it is not risk.... It could be a symptom of risk. A sign that the risk was present,” Marks said.
Sometimes, investments are volatile even though there is no risk present and sometimes “things are serene, even though there was risk present.”
Gilmore said that U.S. asset owners don’t use the total portfolio management approach, which is mainly employed by “the very best-performing, let's say, hedge funds. If you look at Citadel or Millennium, they are exceptionally good at allocating their capital.”
In response to a question by Frost, Gilmore said that the total portfolio theory is more common among sovereign wealth funds than pension funds “because sometimes pension plans have a regulatory environment which can change them more. I think if you don't face those constraints and you're really thinking at how to achieve the best risk-adjusted returns, you would be more open to it.”