CalPERS’ new investment strategy is a plan to deliver retirement security for its members

The recent economic downturn has thrown a fresh spotlight on the challenges that public pension funds face in delivering retirement security to public employees. The discussion on how to meet obligations represents an important debate for policymakers, who worry about burdening state and local governments — and future generations — to secure the benefits that pensioners have earned.

We've developed a strategy to achieve our 7% investment return target necessary for the long-term health of the fund.

Why is 7% important?

7% is the discount rate and what we assume we will earn on our investments. The goal is to achieve a rate of return of 7% in a prudent way on a nearly $400 billion portfolio, over the long-term.

What are the challenges to achieving 7%?

When we surveyed Capital Market Assumptions in 2019, the expected average annualized return of our portfolio over the next 10 years was about 6%, with a less than 40% probability of achieving our assumed rate of return of 7% over that period.

What key changes has our Investment Office made over the past 18 months?

• We improved our liquidity management. We began preparing for an economic downturn well in advance of the recent market volatility brought on by COVID-19. That included making sure we increased the cash coming into the fund, ensuring that we could pay benefits and take advantage of opportunities that downturns present.
• We centralized our governance structure. We conducted a comprehensive evaluation of our portfolio to ensure that our investments complement each other and contribute together to achieving our investment return target of 7%. We're constructing a portfolio focused entirely on that target while prudently managing risks.
• We focused on our comparative advantages. Our size, influence, and long-term investment horizon give us advantages in the market. We are leveraging our brand to implement investment strategies that are scalable to our size, repeatable, and that add value to the fund.
• We eliminated costly fees. Last year, we terminated relationships with about 30 external managers, redeploying $64 billion in capital and saving $115 million in fees on an annual, go-forward basis. Our Global Equity Program is now 95% internally managed (up from 80%), while about 78% of our entire fund is managed in-house by our investment professionals.

What’s the plan going forward?

We need “better assets” and “more assets” to capitalize on our structural advantages: a long-term investment horizon and access to private asset classes. We must diversify and increase exposure to private assets, such as private equity and private credit. 

What is meant by “better assets”?

Given the current low-yield and low-growth environment, there are only a few asset classes with a long-term expected return clearing the 7% hurdle. Private assets stand out with the potential higher returns relative to the more efficient public markets or less-speculative assets such as fixed income. We refer to these as “better assets" because they have the potential for higher returns and lower expected volatility when compared to publicly traded assets. 

What is meant by “more assets”?

“More assets" refers to our plan to thoughtfully utilize “leverage,” or borrowing, as a tool to increase the base of the assets generating returns in the portfolio. The use of leverage allows us to take advantage of the low-interest rate environment by borrowing and using those funds to acquire assets with potentially higher returns. 

What are the risks?

We recognize this approach carries risks. Private debt can reduce liquidity and leverage can exacerbate some short-term volatility. However, prudent use of leverage can actually reduce risk over time, by allowing us to keep more exposure in diversifying assets like Treasury bonds, while pursuing higher returns in other parts of the portfolio.

With the proper controls, careful planning, a comprehensive balance-sheet liquidity management framework, and a long-term commitment, we can mitigate the corresponding risks.

Our balance-sheet liquidity management gives us the ability to be a long-term investor because we will not be forced out of positions due to liquidity reasons. However, we also need to have the will to not abandon our positions due to the lack of commitment to a long-term plan.

How long will it take to implement this plan?

Given our assessment of market opportunities in better assets (e.g., private debt and private equity) and our ability to build governance around deploying more assets (e.g., incorporating leverage into strategic asset allocation), we can realistically implement a “more and better assets” portfolio over approximately the next three years.

Has COVID-19 affected our ability to achieve our return?

COVID-19 is likely to have long-term impacts on all aspects of our society, such as economic growth, labor market dynamics, productivity growth, international cooperation, deglobalization, income inequality, corporate behavior and consumer behavior. But the exact impacts are difficult to predict as this pandemic continues to evolve. Our continued effort to understand the global investment environment better, understand our unique capacity, and design a strategy that incorporates our structural advantages and reflects our long-term investment horizon is front and center for our Investment Office.