The CalPERS investment portfolio, after losing $100 billion from its peak in October 2007, has rebounded $40 billion since the market low last March and is now about $202 billion.
But a consultant told the CalPERS board last week that the fund’s investment returns, when compared with other large pension funds, ranked in the bottom 7 percent during the last year and the bottom 10 percent during the last five years.
The lagging investment performance was attributed to the unusually large CalPERS investments in two of the riskiest asset classes, real estate and private equity.
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If the two asset classes rebound in the next few years, CalPERS returns may get a surge in comparison to the 40 or 50 other large public pension funds with more than $10 billion in investments.
But there are mixed views of private equity, particularly the debt-laden buyouts of companies that have been lucrative in the past, and widespread worry about commercial real estate, where massive amounts of loans are coming due.
CalPERS officials say they have a long-term investment strategy, can handle ups and downs and have had good returns in private equity and real estate over the long run. And comparisons, they note, can be slippery because of the timing of loss write-offs and other factors.
Still, the nation’s biggest public pension fund, an industry leader that has pioneered the move into hedge funds and other non-traditional investments, is not accustomed to being ranked at the bottom in much of anything.
“I’ll be honest — it’s not great,” Michael Schlachter of Wilshire Consulting told the CalPERS investment committee last week as he turned to a page in his lengthy report titled “Total Fund — Universe Comparison.” (Item 4 a., attachment 4, p. 16)
A chart shows the top 5 percent of big public pension funds had returns of 13.32 percent or more during the year ending Sept. 30 and 6.2 percent during the previous five years.
Schlacter said CalPERS ranked in the bottom 7 percent during the last year (with a loss of 6.69 percent) and in the bottom 10 percent during the last five years (earning 3.91 percent).
“Your performance for years and years was top 20 or 30 percent up until about 18 months ago,” he told the board. “Things like AIM (private equity) and real estate were really pushing your returns. And now, obviously, you have taken some very, very large hits in those.
“You are extremely overweight in both assets relative to any other large public fund. It’s not only hurting your performance, it’s also hurting comparisons relative to your peers.
“As those markets recover, we expect to see a flip side.– again, a little more aggressive positions, riskier long-term asset classes which normally drive superior results, if and when those asset classes begin to recover.”
Private equity and real estate, a relatively small part of the CalPERS investment portfolio, have already been a well-publicized headache for the big pension fund.
CalPERS announced in October that three private equity firms had given the firm of a former CalPERS board member, Al Villalobos, more than $50 million in “placement agent” fees, presumably for helping them obtain billions in investments from CalPERS.
CalPERS has hired a law firm to conduct a “special review” of the fees paid by its outside money managers. The CalPERS board adopted a fee disclosure policy in June and is pushing legislation to require placement agents to register as lobbyists.
CalPERS lost nearly $1 billion after investing in a giant residential project that went bankrupt, LandSource near Santa Clarita, and could potentially lose $500 million in an apartment project in New York City.
The CalPERS investment portfolio has the traditional investments, stocks 54 percent and bonds 24 percent. But about a fifth of the money is now in private equity (11.4 percent) and real estate (6.9 percent).
Wilshire reported for the year ending Sept. 30 CalPERS stocks were about even (minus 0.3 percent), bonds had an impressive gain (up 15.2 percent), private equity had a big loss (minus 24.6 percent), and real estate a huge loss (minus 48.7 percent).
CalPERS officials said part of the real estate loss is the result of a prompt write-off policy. A Pension Consulting Alliance report to the board said some real estate managers are being terminated because of poor “performance and judgment.“
Commercial real estate is said to be troubled because, among other things, businesses whose property value has plunged may lack collateral to renew loans coming due, while banks have tightened lending policies.
The CalPERS chief investment officer, Joe Dear, told the board commercial real estate is his top worry because of the potential for “a new phase of the debt crisis” if billions of dollars of loans cannot be refinanced.
“Although things are considerably better than they were a year ago, we are not out of the woods yet,” he said.
A CalPERS decision last June to increase its private equity investment from 10 to 14 percent of the portfolio has been criticized in the New York Times and other national media as an attempt to replace losses by making riskier bets.
Dear replied that the reallocation slightly reduced the risk calculation for the CalPERS portfolio. He said the CalPERS commitment to private equity was already nearly 14 percent.
And importantly, private equity is expected to earn about 3 percent more than stocks as CalPERS pursues its earnings target, an annual average of 7.75 percent from all investments.
Private equity includes “venture capital” that buys a stake in a growing company. But about 59 percent of CalPERS private equity is in “leveraged buyouts,” which typically include big loans based on the assets of the purchased company.
A Pension Consulting Alliance report to the board last week said leveraged buyouts in the United States have dramatically slowed, $11 billion in the first three quarters of this year compared to $328 billion during the same period in 2007.
Some of the buyout firms may face “significant challenges” as they try to refinance their loans. But CalPERS private equity partners are said to have a lot of “dry powder,” about $15.5 billion to invest in opportunities in a down market.
“I don’t worry about the capacity of CalPERS investment professionals to rise to the challenge of achieving the greater risk-adjusted returns in a difficult market,” Dear said as he listed some things that worry him and some that don’t.
Hitting the 7.75 percent earnings target is important. The board approved a plan last week to avoid a shocking $1 billion increase in the state’s annual pension payment to CalPERS to begin covering investment losses.
But the “smoothing” plan for a $200 million increase results in an unusually low “funded ratio” after 30 years. Another small increase may be proposed in February to bolster funding.
If CalPERS falls short of its earnings target, the state’s annual pension bill will continue to rise in the years ahead.
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 21 Dec 09
Calpensions 