CalPERS Sets New Asset Allocation Strategy

According to the California Public Employees’ Retirement System (CalPERS), the pension fund will manage its $220 billion portfolio mainly by focusing on such key drivers of risk and return as economic growth, inflation, liquidity (availability of cash), and interest rates.

The New Allocations

The new allocation plan will place CalPERS assets in five major groups according to how they function in high- or low-growth markets, and the prevailing inflation environment.  Those groups – and target allocations as a share of total CalPERS market value are:

• Liquidity: cash, government bonds like Treasuries that can be quickly converted to cash to reduce deflation risk and insure against having to sell assets like real estate and stocks when credit is tight; 4%
• Growth: public equity (stocks) and private equity that provide positive exposure in rising markets, 63%
• Income: TIPS and other fixed income securities to provide income return in falling equities markets, 16%
• Real: real estate, infrastructure and forestland to provide long-term income returns that are less sensitive to inflation risk, 13%
• Inflation: Commodities and inflation-linked bonds that provide protection against inflation, 4%

According to the announcement, CalPERS  Board also set ranges for investing.  Relative to each asset class target allocation, ranges are; +/- 7% for growth (public and private equity); +/- 5% for income and real estate; and +/-3% for inflation and liquidity.

“We learned in the financial crisis and the past recession that a liquidity crunch or inflation can have a significant impact on portfolio performance in ways that many investors didn’t anticipate,” said Rob Feckner, CalPERS Board President. “We focused on assets and returns, but not enough on the risk of our allocations. We’re majoring now on careful study, reaching out to the best-informed professionals of the financial world and taking all viewpoints into account.”

After a nearly year-long review, CalPERS said it changed its traditional asset allocation structure to better reflect varying market conditions, citing as examples the growth and low inflation conditions of the 1990s, the falling markets and liquidity constraints of the recent recession, and the rampant inflation of the late 1970s. “In each case, growth assets like equities, high-yield and corporate bonds perform differently in those different scenarios than inflation hedges like commodities and Treasury inflation-protected securities (TIPS),” said CalPERS, in explaining the move.

No Specific Timeline

Having established the new allocations, CalPERS noted that there is no specific timeline for deploying funds, “…since investments will depend partly on market trends and opportunities”. CalPERS said its investment staff will use new risk management tools as they review the asset allocation mix and “shift funds to take advantage of opportunities, depending on market conditions, keeping close tabs on risks and allocations”.

“While the allocations won’t change much, we’re going to be looking at these assets differently than we did before,” said George Diehr, Chair of the CalPERS Investment Committee. “We now have a better way to look at risk and account for what’s happening in the markets and to re-categorize our assets according to what drives them. We’ll be able to better anticipate overall performance and its potential impact on employer contribution rates and our retirement system’s funded status.”

With pension funding levels drawing a greater degree of scrutiny in recent months, CalPERS noted that “historically, investment earnings have paid 64 cents to 75 cents of every pension dollar. The remainder comes from employers and active employees.”

“You can’t get solid returns without taking risk, but we want to make sure we know what that risk is and that we’ll be paid to take it,” said Joseph Dear, CalPERS Chief Investment Officer. “We have applied the best thinking and our best judgment to the challenging questions about how to uphold the promises we made to our beneficiaries to make their retirement secure.”

The next step is adoption of CalPERS actuaries’ recommendation for an assumed rate of return on investments, scheduled for early 2011.

CalPERS provides retirement benefits to approximately 1.6 million State and local public agency employees and their families. More information is available at http://www.calpers.ca.gov.