Calpensions

After historic losses, the nation’s biggest public pension fund, CalPERS, says a riskier overall investment strategy is not part of its recovery plan.

But a New York Times story says CalPERS plans “potentially high-risk investments,” including more money for private equity firms, a tactic that helped make the reputation of the new head of CalPERS investments.

Joseph Dear, the new CalPERS chief investment officer, disagrees with the characterization, saying the widely circulated newspaper story is “causing some anxiety among our beneficiaries.”

He told the California Public Employees Retirement board last week that revised investment allocations adopted by the board in June slightly lower the risk, as measured by volatility, from 13.34 to 13.13 percent.

Instead of assuming high rewards for high risks, the expected rate of return from the revised allocation remains basically the same, actually dropping slightly from 8.33 percent to 8.3 percent.

Joseph Dear

“So your policy action, despite the popular characterization of it, was to slightly reduce the risk and the return of the portfolio,” Dear told the CalPERS board during his monthly report.

The revised investment plan, among other things, increased the target for private equity from 10 to 14 percent of the portfolio. The plan also will reduce the proportion of stocks or “equity” in the portfolio.

“Yes, we did reduce the equity allocation from 56 to 49 percent,” Dear said. “But that is because we were also upping the amount allocated to private equity. We think we are going to get a superior return there.”

The newspaper story said that the Washington state public pension fund, where Dear was the investment chief before moving to CalPERS in January, was known as a “daring investor” that put more than 25 percent of its portfolio into private equity.

The Washington fund was a top performer during the years before an historic stock market crash last fall. The performance of the CalPERS investment fund has been mixed in recent years, but not near the top.

In March, Wilshire Consultants said a CalPERS loss of 27 percent last year ranked near the bottom third among public pension funds with $10 billion or more in assets.

The CalPERS performance over the previous five years was better, ranking in the top third. But losses in the last two years have been devastating.

The CalPERS investment portfolio, valued at $250 billion or more in the fall of 2007, dropped to $167 billion or lower last March before rebounding by last week to $191 billion.

Now CalPERS must raise the contribution rates for state and local governments to help rebuild the investment fund. And there is skepticism about whether the CalPERS fund can earn 7.75 percent a year, as assumed in the rate calculations.

Despite the biggest losses in its 77-year-history last year, Dear told the board, the average annual CalPERS return on investments during the last 20 years is 7.75 percent, right on target.

“So a long-term perspective is important for all of us to maintain — and maintain the courage of our conviction in our planned strategy,” he said.

Private equity is a type of investing mainly available to pension funds and other institutional investors with large sums of money. The money is often used for corporate takeovers or a “leveraged buyout.”

New managers cut costs and take other steps to boost profits. The private-equity firms charge hefty fees, usually 2 percent a year of the assets and 20 percent of any profits.

Private equity has produced a number of billionaires. The long-term investments have what some call a “J-curve,” sometimes producing losses in the early years and delaying actual profits in a way that makes returns difficult to calculate.

Some private-equity firms also pay “placement agents,” middlemen who help the firms connect with pension funds and other sources of money. Placement agents are at the center of a public pension scandal in New York and some pension probes in California.

The Sacramento Bee reported last week that a state agency is investigating the campaign account of CalPERS board member Charles Valdes, who received donations from a placement agent, former CalPERS board member Alfred Villalobos.

Still, many regard private equity as an attractive investment. The nation’s second largest public pension fund, CalSTRS, adopted new asset allocations this month that are roughly similar to CalPERS.

The California State Teachers Retirement System, with a portfolio valued at $124 billion at the end of last month, increased its long-term target for private equity from 9 to 12 percent of the fund.

(The CalSTRS target for equity or stocks dropped from 60 to 47 percent The real estate target increased from 11 to 15 percent. A new inflation-linked asset allocation, “absolute return,” has a target of 5 percent and will begin with bonds and infrastructure.)

An investment business plan adopted by the CalSTRS board this month gives one rationale for increased investments in private equity. A boom period with easy credit from 2004 to 2007 was followed by write-downs and declining values.

Private equity firms now have more than $800 billion in committed but invested capital. Many high-quality companies are, or soon will be, in need of capital to carry out their operations.

“These companies will find it very difficult to to raise capital due to the weak conditions of both the public equity markets and debt markets,” says the CalSTRS plan. “Many will be forced to turn to private equity sources.”

Meanwhile, CalSTRS has since 2007 been making short-term purchases in the “distressed debt” segment of the private equity market, which currently represents about 11.6 percent of the portfolio.

Christopher Ailman, the CalSTRS chief investment officer, told the board that he is often asked if CalSTRS is taking on more risk in an attempt to get higher returns on investments.

Christopher Ailman

“Our answer, and my answer, is ‘No, we are not,’” he said. “It does not make sense to try and overreach the risk factor.”

The CalSTRS goal is to earn about $10 billion a year. Ailman said he expects a debate about whether the annual earnings assumed by CalSTRS in its long-term projections, 8 percent, is realistic.

“It’s worth debating,” Ailman said. “I would still argue it is the accurate number when you take that long-term, 100-year picture of the markets.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 24 Aug 09

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