CalPERS walking its own path on asset allocation

As CalPERS officials guide the plan toward a new four-year asset allocation cycle in 2022, a Pensions & Investments' analysis reveals that the plan has been bucking a trend among other U.S. pension plans — moving more assets into equities and fixed income rather than cutting those asset classes in favor of alternative investments.

The $384.4 billion California Public Employees' Retirement System, Sacramento, had 80% of its portfolio invested in stocks and bonds as of Sept. 30, according to data from P&I's annual survey of the largest U.S. retirement plans. That was up from 68% as of Sept. 30, 2016, when the board began the process leading up to the adoption of its latest asset allocation.

Some 18% of its assets were in alternatives as of Sept. 30, down from 21.8% in 2016. Only real estate, accounting for 11% of assets, increased from Sept. 30, 2016, when it stood at 9.1% of assets.

By comparison, the pension plans of the top 200 plan sponsors surveyed had 72.1% in equities and fixed income as of Sept. 30.

CalPERS officials declined to be interviewed for this story. However, since he joined CalPERS as chief investment officer in January 2019, Yu "Ben" Meng has promoted investing in private equity and private credit. CalPERS has an 8% target to private equity but a current allocation of 6.9% in the asset class.

"We need private equity to be successful, we need more of it, and we need it sooner rather than later," Mr. Meng said at a March investment committee meeting.

More recently, Mr. Meng guided a discussion on the topic of private credit, noting that private debt was currently not an asset class in the system's portfolio. "I think that's something we overlooked in the past, particularly given the changes in regulation after the global financial crisis," he said late last year. "So currently, it's not in our portfolio. We think it should be."

CalPERS typically conducts an asset-liability study every four years and a midcycle review every two years. CalPERS' latest asset allocation went into effect July 1, 2018.

CalPERS' most recent strategic asset allocation increased its equity allocation to 50% from 46% and boosted fixed income to 28% from 20%.

But pension officials also eliminated its 9% inflation assets allocation, which had also invested in some fixed-income-type instruments and commodities. The inflation portfolio was liquidated as of February 2019, according to CalPERS agenda materials.

Real estate and private equity retained their target allocations of 13% and 8%, respectively, while its liquid portfolio, made up of cash and other short-term instruments, was cut by 3 percentage points to 4%.

A month before the investment committee adopted the strategic asset allocation in November 2017, it lowered the credit quality of its liquid portfolio to BBB from predominantly BBB+.

The change was intended "to expand the investment universe around government-guaranteed instruments," said Wylie Tollette, who was then CalPERS' chief operating investment officer. "And the fundamental logic is that a government-guaranteed instrument has a fundamentally lower level of credit risk than a corporate instrument."

Cash accounted for 0.8% of CalPERS' total plan assets as of Sept. 30 vs. 4.3% as of Sept. 30, 2016, P&I data show.

On balance, CalPERS' strategic asset allocation increased the pension plan's combined stock-and-bond target to 78% from 75%, which is reflected in the asset mix shifts CalPERS has reported to P&I over the past three years.

CalPERS staff and investment consultants have stressed in open sessions that it is difficult for the system to increase its exposure to alternative investments, in part, due to its size.

At a recent meeting, Mr. Meng repeated that CalPERS' size is "a double-edged sword." CalPERS cannot invest in private asset classes, including private equity, at the scale it needs with the traditional commingled investment model, he said.

"In general, institutional investors are allocating more money toward private assets and less money toward public assets. And real estate is one of the places to which that new increased allocation goes," said David Glickman, executive vice president at Meketa Investment Group Inc., CalPERS' real estate consultant, at investment committee's February 2019 meeting. "In addition, the performance of real estate has been reasonably good."

But while CalPERS has advantages in the market, particularly scale and structure, it is not alone seeking real estate projects in which to invest, he noted.

"There are a lot of people who are also bidding for the same properties that you have," resulting in CalPERS' real estate portfolio being smaller than its allocation, Mr. Glickman said.

By the end of its 2019 fiscal year, CalPERS had completed the transition to the strategic allocation adopted in December 2017, Eric Baggesen, managing investment director, trust level portfolio management, told the investment committee.

"The primary accomplishment is moving the structure of the asset allocation to what was approved by the board in December of 2017," Mr. Baggesen told the investment committee at its August meeting. "There was almost $150 billion of trading activity that took place over the (fiscal) year of 2018-'19. There were quite a lot of changes that happened in the structure of the investment portfolio."

The pension fund's strategic asset allocation implementation included 15% to a new factor-weighted equity portfolio as well as 35% in capitalization-weighted equities and 8% in private equity, which together make up its 58% growth portfolio. CalPERS funded its factor-weighted equity portfolio from its cap-weighted portfolio.

CalPERS also carved out a new 3% allocation to high yield from its 28% fixed-income portfolio. Fixed income also includes 15% in long-spread issues and 10% in long Treasury bonds.

CalPERS had $72.4 billion in factor-weighted equities as of Sept. 30, up 478.9% since Sept. 30, 2017, when the pension fund first reported assets invested in the strategy. The second-largest factor-based allocation in P&I's survey was the $82.4 billion Oregon Public Employees Retirement Fund, Tigard, with $8 billion.

Active emerging markets debt was up 603.8% to $14.9 billion from a year earlier, when CalPERS first reported emerging market debt assets. CalPERS has no passive emerging markets debt.

CalPERS reported zero in inflation-protected securities, down from $11.1 billion a year earlier and $17.4 billion as of Sept. 30, 2016. Meanwhile, consistent with its new strategic asset allocation, cash was down 75.6% to $3.2 billion in the three years ended Sept. 30. Commodities dropped to zero from $4.5 billion as of Sept. 30, 2016.

Real estate investment trusts, which are part of the equity portfolio, dropped 69.6% to $8.2 billion from Sept. 30, 2017. CalPERS had not reported REIT assets as of Sept. 30, 2016.

In alternatives, infrastructure increased the most, by 57.1% to $4.8 billion in the three years ended Sept. 30, followed by international real estate, a 52.1% increase to $2.9 billion. CalPERS does have some exposure to private credit, with a 731.1% increase in bank loans to $374 million in the two years since Sept. 30, 2018.

However, direct hedge funds are down 45.5% to $181 million during the three-year period ended Sept. 30 and its timber portfolio is down 33.3% to $1.3 billion from three years earlier. The drop in timber reflects a sale of its Crown Pine timber portfolio.

At an educational investment committee meeting in December, Mr. Meng had explained how for many asset owners, the late part of an economic cycle is exactly when they should be investing in income-producing assets such as private credit, fixed income and real estate.

"The later part of the cycle probably you prefer more income-driven strategy than capital-appreciation strategy," he said.

"For example, our real estate is core U.S. real estate," Mr. Meng said. "The bulk of the expected return is coming from income — an income-driven strategy."

CalPERS' real estate assets rose 29.1% to $35.8 billion, while private equity was up 2.8% to $26.3 billion in the three years ended Sept. 30, P&I data show.

Investors would probably want to be in capital-appreciation strategies such as private equity and distressed debt at the early part of the cycle, Mr. Meng said.

CalPERS' distressed debt assets have dropped by 34.6% to $1.8 billion in the three years ended Sept. 30.