CalPERS Board Reduces Fund's Investment Return Target to 7.5%

Acknowledging lower returns and higher costs, the board of the $235 billion California Public Employees' Retirement System has approved reducing its rate to 7.5% from its longstanding rate of 7.75%.

(March 15, 2012) — The California Public Employees’ Retirement System (CalPERS) Board of Administration — the largest public pension in the United States — heeded advice to lower its assumed rate of return to 7.5%.

The pension fund’s assumed rate of investment return — also called the discount rate and calculated based on expected price inflation and real rate of return — was last changed a decade ago when it was reduced to 7.75% from 8.25%. Since then, critics have continued to claim that the scheme’s return target was overly optimistic to keep up over the long-term.

The decrease of its rate is expected to cost the state an extra $303 million a year, with about $167 million coming from the general fund. Meanwhile, it increases the overall annual state contribution to CalPERS to $3.8 billion, or about 4% of the overall general fund budget for the coming fiscal year.

“This was a difficult, but important, decision for the board to make,” said Rob Feckner, CalPERS’ Board President. “We understand the impact this will have on our employers in meeting contribution requirements. However, current economic conditions impelled us to make this change now, and our actuaries will continue to evaluate the discount rate in the coming years.”

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Last week, the actuary who advises CalPERS’ board, Alan Milligan, recommended lowering the rate for this year either to 7.5% or 7.25%.

“It is important that we periodically review our assumptions to ensure that we remain focused on the long-term health of the Fund in order to protect the benefits that our members and employers rely on us to provide,” said Committee Chair Priya Mathur in a release, posted on the fund’s website yesterday. “This new discount rate reflects our expectations of what the markets will deliver in the future.”

The fund’s decision to lower its assumed rate of return comes three years after Joe Dear, the scheme’s chief investment officer, arrived at the fund when the value of the scheme’s portfolio reached its lowest point during the recession — a value of about $160 billion, down from a peak of about $260 billion in October 2007.

In September of last year, Dear expressed that a 7.75% return may be tough to meet. In an interview with aiCIOfeatured in its Summer Issue, Dear commented on the fund’s stellar returns at the time, lowering expectations of future similarly stellar performance by saying: “Honestly, and not taking anything away from the team here, our 20.7% returns in fiscal 2011 were largely the result of market beta. Public equities are about half our $234 billion portfolio, and it is no secret that public equities significantly increased in value over the past year.”

Summarizing his perspective on CalPERS’ 2011 investment return and his future outlook, Dear told aiCIO: “Obviously, a 20% return undermines the statements of public pension fund critics—that we are unable to reach our target. I think that’s important—that there is still a lot of earning power in these assets—but let’s be clear: There won’t be a string of 20% years in a row.”

Investors have lowered their holdings in equities and sovereign debt, increased allocation to credit and alternatives, not private markets – yet, bfinance has found.

(March 14, 2012) — Investors have yet to attain their desired exposure to private markets, despite acknowledging the benefits it could bring to their portfolios, a pensions consultancy firm has found.

Newly released research by bfinance shows that in the second half of 2011, investors lowered their holdings in equities and sovereign debt, while increasing allocation to credit and alternatives (especially real estate and infrastructure).

The firm found 82 institutional investors, with a combined €300 billion in assets under management, were overweight cash and corporate bonds and underweight equities and sovereign debt.

“Interestingly, after having added to real estate, private equity and infrastructure to their portfolios during the second half, investors were still underweight in these asset classes at year end. Coupled with positive investment intentions both over a six month and three year horizon, these tactical positions reveal that investors have yet to attain their desired exposure to private markets,” the study said.

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In practice, changes to asset allocations in the second half of last year were restrained because of extreme volatility and uncertainty due to the euro crisis which resulted in the freezing of investment decisions, bfinance said.

“Contrary to some gloomy shorter term expectations for the macroeconomic outlook, the survey found that equities were generally most favored by investors to generate returns to cover long term liabilities, despite investment intentions vacillating in the wake of a negative trend for some three years,” the study noted.

The heightened allocations to real estate, private equity, and infrastructure have been apparent among institutional investors. In September, for example, the Tallahassee-based Florida State Board of Administration (SBA) allocated up to $6 billion in alternatives, the scheme revealed at an investment advisory council meeting.

The fund revealed late last year that it was seeking mangers to run the alternatives allocation, which will be divided into private equity, hedge funds, real estate, commodities, and infrastructure. Within hedge funds, the board said it was targeting equity-oriented managers to focus on absolute return and long-short strategies, running up to a total of $800 million over the next year. Meanwhile, in private equity, the board said it was is seeking to commit roughly $2.5 billion over the next three years to venture capital and other private equity firms. “These would be additional commitments per our 2011-2012 work plan,” SBA spokesperson Dennis MacKee told aiCIO at the time.

Meanwhile, in June, China’s $300 billion sovereign wealth fund said it was targeting mining, real estate, and infrastructure investments in the Americas.

At the same time, South Korea’s roughly $314 billion pension fund said last year that it was aiming to diversify its investment strategy, flocking toward riskier assets in order to meet its new 6.5% investment return target for the next five years. The South Korea’s National Pension Service (NPS) — which updates five-year targets annually — emphasized its goal of increasing its allocation to equities in the next five years, with at least 30% of assets in stocks by the end of 2016. The fund said it would up its allocation to alternatives to above 10% from its current target of 5.8%.