Calpers Rethinks Its Risky Investments
The largest U.S. public pension plan is considering a dramatic retreat from some riskier investments, as it tries to simplify its $295 billion in holdings and better protect against losses during the next market downturn, according to people familiar with the matter.
California Public Employees' Retirement System is weighing whether to exit or substantially reduce bets on commodities, actively managed company stocks and hedge funds, the people said.
The pension, which manages investments and benefits for 1.6 million current and retired teachers, firefighters and other public employees, is a bellwether for investment trends at other public plans. Any shift it makes will likely influence others because of its size and history as an early adopter of alternatives to stocks and bonds.
"When Calpers makes a decision, it has a ripple effect through the state and local pension community," said Jean-Pierre Aubry of the Center for Retirement Research at Boston College.
The discussions are taking place between the fund's interim Chief Investment Officer Ted Eliopoulos and Calpers's other top investment executives. The Calpers board hasn't yet been informed about any possible changes and no final decisions have been made, the people said.
The potential moves would constitute a major strategy change for a pioneer of public investments in so-called alternative assets. It isn't clear where Calpers would shift money pulled from these investments.
The retrenchments also could mean a reduction in external managers who are paid millions of dollars to make these bets for Calpers, these people said.
Many state and local pension funds were badly battered during the financial crisis and haven't yet recovered, leaving them struggling to meet obligations to 19 million workers and retirees nationwide. A run-up in the stock market has allowed Calpers to partially recover from the crisis, but it only had enough assets to cover 76% of guaranteed benefits to retirees as of June 30.
Calpers also is putting some new investment ideas on hold. Executives recently shelved internal discussions about whether to make a deeper push into securities backed by risky debt.
The Sacramento-based retirement system is wrestling with how much risk it should take as it follows one of its best performances since the financial crisis. The fund reported investment gains of 18.4% for the fiscal year ended June 30. That exceeded internal goals as domestic and international equities rose nearly 25%, real estate was up 14% and private equity increased 20%.
A top Calpers executive declined to discuss specific areas under review but acknowledged that a number of big questions are up for discussion, including whether the pension's most-complex investments are too small to make an impact on the fund's overall returns. Another issue is whether the fund can rely on individual trading bets to beat the overall market.
"What you have to ask yourself is, can you trade your way to success with $300 billion?" said Eric Baggesen, the fund's senior investment officer for asset allocation and risk management.
Until somewhat recently, pension funds invested almost exclusively in stocks and bonds. Calpers was among the first to invest heavily in real estate in the 1990s and then hedge funds and private equity in the early 2000s.
By October 2007, Calpers's assets hit a precrisis high of $260 billion. During the financial crisis of 2008-2009, they dropped to $165 billion as some of those alternative investments didn't perform as expected, particularly real estate and private equity.
Just one bad year can have serious consequences, since Calpers relies on its returns and contributions from local governments to fund pensions. Calpers has to request more money from municipalities if its investments decline in value, and cash-strapped cities then are forced to cut services or raise taxes to cover the bill.
Calpers hinted at a shift away from complex investments last fall when it released a set of investment principles that included a warning that the fund "will take risk only where we have a strong belief we will be rewarded for it." In February, it approved a new set of investment goals that reduced future exposure to equities and private equity while increasing allocations to bonds and real estate.
One of the more-dramatic moves under consideration is a complete pullback from tradable indexes tied to energy, food, metals and other commodities, according to people familiar with the discussions. Calpers began making such investments in 2007 as a way of diversifying its portfolio and it currently has $2.4 billion in such derivatives, or less than 1% of total holdings.
Executives on Calpers's investment staff also are debating whether it would be better to shift $55 billion it currently invests in individual company stocks and link those investments to broader market targets such as industries or countries, said people familiar with the discussions.
Another topic of discussion is what to do with Calpers's $4.5 billion hedge-fund portfolio, which amounted to 1.5% of the pension plan's total holdings as of June 30. Calpers in 2002 became one of the first public pensions to invest in such funds, which charge higher fees and typically bet on stocks, bonds or other securities using borrowed money. But over the past year, staff members have clashed over whether the investments are too complicated, can truly act as a buffer during a crisis or are large enough to affect Calpers's overall returns. The Wall Street Journal reported last month that Calpers already is reducing its hedge-fund stake and expects to take it as low as $3 billion as compared with $5 billion earlier in the year.
Former chief investment officer Joseph Dear was in favor of increasing Calpers's hedge-fund stake, but he died in February. In March, the board asked Mr. Eliopoulos to review the program, and he gave that task to fixed-income chief Curtis Ishii, said people familiar with the moves. Mr. Ishii's recommendations to the board are due in the fall.