CalPERS gained more than $11 billion by relying on a risk mitigation strategy that includes long U.S. Treasury bonds and factor-based equity investments, after switching from tail-risk hedge funds, CIO Yu "Ben" Meng said.
Mr. Meng told the investment committee of the $375.7 billion California Public Employees' Retirement System, Sacramento, on Monday that staff decided to terminate two tail-risk hedge funds after conducting an active-risk review in 2019.
The two hedge funds, LongTail Alpha and Universa, together managed $200 million, after suffering a -82.1% loss in the year ended June 30. Six months later, the strategy managed $100 million and returned -78.1% for the year ended Dec. 31, board meeting documents show. As of Dec. 31, the pension plan, not including other pools of capital managed by CalPERS, had $51.2 million invested in the Universa Investments' long-tail strategy and $38.7 million with LongTail Alpha.
The tail-risk strategy is not a viable long-term strategy for CalPERS, Mr. Meng said, noting that he didn't regret staff's decision to terminate the hedge funds.
"This is clear in that had we known COVID-19 was coming we would have terminated this strategy," he said.
Typically, tail-risk strategies charge fees averaging 3% to 5% of the protected amount, which is about half of the expected return on the assets.
In a video posted for investment staff last week, Mr. Meng said the reason CalPERS invested in these tail-risk funds was to insure against market drawdowns of its global equity portfolio, and that the average capital market assumption for global equity returns is about 6% to 7%.
Mr. Meng also said the tail-risk strategy is not scalable for the size of CalPERS portfolio because these strategies are executed on the options market, which is not large enough for CalPERS to gain enough exposure to be meaningful.
"Our own experience indicates that even $10 billion of assets under protection would put the market capacity to a test, let alone handle the $100 billion that would need such protection in our portfolio," Mr. Meng said in the staff video.
By comparison, CalPERS' $43.2 billion Treasury portfolio earned 12.1% for the year ended Dec. 31, flat with its benchmark, and its $59.2 billion factor-weighted equity portfolio returned 22.5% for the same period.
However, Mr. Meng acknowledged that its Treasury portfolio had not performed as anticipated.
Indeed, investment staff is currently discussing whether the Treasury portfolio can continue to provide downside protection once interest rates are reduced to current levels.
Board members on Monday voiced support for Mr. Meng's strategy switch but said that staff should be more transparent. Mr. Meng acknowledged that he had not informed the board about the termination of the tail-risk hedge funds because the investment was not material.
The termination decision was made as part of the active-risk review in which staff redeployed $60 billion in capital, and the tail-risk hedge funds were just a small percentage of the total, Mr. Meng said.
"It doesn't rise to the level to report to the board," he said.
Board members chastised the media for misreporting CalPERS decision to terminate the tail-risk hedge funds and fellow board members who spoke to the press. However, they also asked staff to be more transparent about their investment decisions.
"I really appreciate Ben's explanation and walking us through all the thinking just on why we abandon that (tail-risk) strategy. But I'm wondering if there's a way to ... heighten transparency going forward," said Betty Yee, California state controller and CalPERS board member. "I think we will see more judgments being cast with funds in these volatile times."
She said that CalPERS should be upfront about the actions it takes in the future.
Ms. Yee suggested regular updates by staff with investment committee, as staff is taking actions that can be sensitive. "We are spending more time trying to manage the misinformation than stabilizing the whole affair as a whole," she said.
Separately, Mike Inglett has been named interim managing investment director, real assets, following the departure of Paul Mouchakkaa, said Megan White, CalPERS spokeswoman, in an email.
Mr. Mouchakkaa will be joining real estate manager BentallGreenOak as a managing partner effective June 1.
