While private equity has taken a pummeling recently, the long-term performance of two civil servant pension funds at the opposite sides of the world indicates that the asset class - along with real estate, infrastructure and private credit - will remain crucial to covering long-term pension liabilities.
Japan’s Pension Fund Association for Local Government Officials (Chikyoren) published its returns for FY2022 with all pension funds and mutual aid associations under its remit reporting positive returns of below 2%. Total AUM was a shade under JPY52 trillion (US$372 billion), according to Asian Investor.
Chikyoren was established in 1984to stabilize the foundation of pension finance by integrating different units, and to ensure appropriate and smooth management of operations the maintain the pension arrangements of civil servants, teachers and police.
The Employees’ Pension Insurance Benefit Adjustment Fund (EPF), which mirrors the portfolio structure of Japan’s Government Pension Investment Fund with an even split between domestic and foreign bonds and equities, reported a return of 1.63% - above GPIF’s 1.5% - and boasted a portfolio worth JPY14 trillion (US$99 billion). In terms of asset classes, domestic equity returned 5.72%, foreign equities delivered 1.99% and foreign fixed income was 0.2%, but domestic fixed income reported -1.64%. Asian Investor reported that “the EPF had hired two active domestic equities managers, a private debt manager within alternative investments and two ESG active funds in foreign equities area.”
Chikyoren follows a highly conservative asset management strategy due to restrictions on investments, which have prevented it from taking advantage of long-term growth from inflation-hedged assets such as real estate and infrastructure as well as the potential high yield from private equity. Japanese institutional investors are traditionally reluctant invest in real estate following the bursting of the Japanese property bubble in the 1990s. Yet, they have not been well served by low and negative interest rates over the years, particularly in their large holdings of Japanese bonds and cash. The ability of Chikyoren to cover long-term liabilities in terms of pension-fund payouts is increasingly in doubt due to relatively low returns.
Over in California, the California Public Employees' Retirement System (Calpers) reversed the 6.1% loss it reported in FY2021-22 to register a 5.8% in the latest fiscal year (to end-June), beating its benchmark by 0.3%, amid a rally in financial markets as well as private debt. Its AUM now stands at US$463 billion. Yet, despite a more diversified portfolio than those overseen by Chikyoren, it still only covers 72% of future obligations. While the Californian fund suffered a hit in private equity (-2.3%) and real assets (-3.1%), its public equity holdings surged 14.1% and private debt grew 6.5% - private equity, private debt and real assets are reported on a one-quarter lag, so reflect end-March values.
Calpers is relying heavily on alternative assets to meet an annual return target of 6.8%; the five-year average annual return was 6.1% in FY2022/23 while the 10-year average is 7.1%. If it misses its target, local governments may have to slash pension obligations. Higher interest rates have cast a pall over private equity with the recent loss following gains of 3.3% and 44% in the two previous years – and Calpers is managing expectations to anticipate poor returns for the April-June quarter.
The pension fund manager’s approach to private equity has been somewhat mercurial. In November 2021, the Board of Administration confirmed a new investment strategy for the next four and a half years, which seeks to 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. Yet, in June 2022, it sold a huge slice of its private equity portfolio at a discount and cut ties with external managers, despite its stated objective to raise its allocation to the asset class. The sale of US$6 billion of assets represented a whopping 11% of its private equity portfolio. According to Bloomberg’s sources, the holdings were sold at a 10% discount compared to their September 2021 value, implying the portfolio lost US$650 million of its value.
Appointed in February 2022, CIO Nicole Musicco is seeking more deal origination by the fund’s own teams rather than rely on external managers, to gain greater control. While the sale discount seemed steep, pundits suggested the opportunity cost would have been more pronounced if Calpers had held on, leaving the portfolio to continue to depreciate and leading to higher discounts in the medium-term.
