On Monday this week, the Board of Administration of CalPERS – the world’s largest state-level pension fund – confirmed the new investment strategy for the next four and a half years. And the new target asset allocation represents a substantial change from the current mix.
First, it will bring the level of Private Equity back to 2011 levels, at 13% of the total portfolio. The fund’s investment managers have argued for the past few years that this is a necessary move if CalPERS wants its assets to catch up with the liabilities. This was precisely the investment thesis of former CIO Yu Ben Meng (more assets and better assets), who exited the fund in August 2020.
Now, this may be trickier than it sounds. According to its latest update, CalPERS currently holds US$ 44 billion in private equity. Considering the projected growth in AuM, this figure would need to double in less than four years, requiring an additional US$ 11 billion in investments per year. And the team has been gearing up accordingly: a year ago, the plan recruited Yup Kim from Alaska PFC to drive the growth of the 31-year-old PE program. Yup now reports to Greg Ruiz, Managing Investment Director of Private Equity.
Second, the new strategy allows the fund to leverage up to 5% to increase diversification – again, one of Meng’s key recommendations. The former CIO was heavily criticized for a strategy that was seen as fairly aggressive only a year ago, and now his replacement – whenever he or she would join – will have to abide by his allocation bands and targets.
The hedge fund program continues to be missing since it was eliminated in 2014 in an effort to reduce complexity and costs. According to a recent analysis by Global SWF, public pension funds have been reducing their average allocation to hedge funds from 1.7% in 2015 to 1.2% in 2021. CalPERS’ counterpart in New York, the Common Retirement Fund, spent US$ 158 million in hedge fund fees in FY21 alone.
As shown by the chart below, CalPERS’ assets have been increasing at an average pace of 7% for the past 10 years. In fact, the fund’s market value is just shy of US$ 500 billion today. There is only one problem, and it is that liabilities are increasing at an even faster rate, given the increase in life expectancies and in California’s population. The 21.3% return earned in FY21 improved the plan’s funding ratio significantly, but the road to 100% levels (aka Canadian levels) will be certainly longer and harder.