The world’s biggest sub-national public pension fund, the US$496 billion California Public Employees’ Retirement System (CalPERS), has finally appointed a new Chief Investment Officer, 18 months after Yu Ben Meng resigned amid allegations of conflicts of interest and costly investment misses.
Looking to Canada
Canadian national Nicole Musicco has joined from the US$5 billion RedBird Capital Partners where she was head of its Canadian business. Previously, she managed the private markets portfolio of the Investment Management Corporation of Ontario (IMCO) from 2018 to 2019. Before IMCO, Musicco had a distinguished career with the Ontario Teachers’ Pension Plan (OTPP), which she joined in 2002. She led both private and public equity teams at OTPP and established its Hong Kong office to develop its Asia-Pacific footprint, serving as regional managing director.
Yet, the new investment chief at the half-trillion dollar fund is still one of only nine female CIOs of a state-owned investor in the world. CalPERS is also notable in being led by a female CEO, Marcie Frost – appointed in 2016 as the fund’s second female leader. On 1 March, Global SWF will be publishing our annual survey of female leadership and staffing of sovereign wealth funds and public pension funds in our subscribers-only bulletin, to mark International Women’s Month.
CalPERS seems interested in learning from Canadian success – not just from Musicco herself, but also from its PPF cousins north of the border. Last month, Edwin Cass, CIO of Canada Pension Plan Investments spoke to CalPERS on how the C$542 billion fund uses its leverage strategy to add diversification and maximise returns without increasing risk. Presently, CPP’s leverage is 22%, which is well below the 40% limit for total financing liability.
Addressing the Funding Gap
The Canadian experience is particularly important for US state-level PPFs like CalPERS, which overall suffer a far worse funded ratio than Canadian PPFs. Global SWF research found that the US average ratio is 75% with a US$ 1.3 trillion total shortfall across the PPF sector. Most Canadian pension plans are fully funded, with a 105% national average. To make things worse, the working population is expected to decrease from 64% to 57% by the end of the 21st century. In this context, US PPFs may have no choice but to apply more aggressive investment strategies in the years to come.
Musicco will be under pressure to improve performance from the get-go. In FY2021, CalPERS reported a 21.3% return and a US$ 92 billion growth in assets for FY21 – which increased its funded ratio by 10 bps to 80%. Yet, due to expensive long-term care policies, the fund has warned that it needs to raise premiums to ensure their solvency with plans for rate increases that will raise premium costs by 90%. As such, it will be a hard task to maintain the 80% funded ratio, let alone close the gap.
Private Market Diversification to Boost Returns
The new CIO will be leading the investment strategy of a fund that has been compared to a mega cruise ship, lacking agility in changing course. A low interest rate environment has made fixed income unattractive (CalPERS returned -0.1% in this asset class in FY2020/21), while the torrid pace of growth in listed assets will not be sustained. A bull market saw public equities rise to 50% of AUM, but should markets turn bearish the fund will be reliant on other asset classes for growth.
CalPERS is aiming to follow PPFs like CPP in boosting allocations to private equities, which produced a 43.8% return in FY2020/21 – well above 36.3% for public equities. CalPERS is a highly activist fund, that has made the news for dropping the hedge fund program altogether or creating a new private equity model with less external dependency and fees. It is already one of the largest private equity investors with US$44 billion of investments. Considering the projected growth in AuM, this figure would need to double in less than four years, requiring an additional US$ 11 billion in investments per year.
Through a boost in private equity allocation, the Californian fund hopes to achieve the double-digit growth it needs to meet its obligations to policyholders, by raising asset allocation to private equities from 9.2% to 13% by 2026 – back to 2011 levels. The strategic move would require at least US$46 billion of fresh commitments to the asset class, entailing a massive step up in a saturated market with high risks. The new strategy, agreed in late 2021, also allows the fund to leverage up to 5% to increase diversification – a factor that led them to turn to Ed Cass to learn from CPP’s experience.
With private and public equity assets widely regarded as over-valued, it is likely to take far longer to meet the ambition to become fully funded – and banking on the out-performance of private equity and private debt markets is a big gamble. CalPERS is likely to sell its liquid assets to achieve its allocation targets, but ultimately fixed income and public equities will still need to grow in nominal terms if the fund is planning to be fully funded by 2026.