Calpers is to move deeper into private equity and private debt by adopting a bold leverage strategy that the $395bn Californian public sector pension fund believes will help it achieve its ambitious 7 per cent rate of return.
In a presentation to the Calpers board, Ben Meng, chief investment officer, said the giant fund would take on additional leverage via borrowings and financial instruments such as equity futures. Leverage could be as high as 20 per cent of the value of the fund, or nearly $80bn based on current assets. The aim is to juice up returns to help the scheme, the largest public pension in the US, achieve its growth target.
The move comes after a 2019 investment strategy review that found Calpers needed greater focus on the excess returns potentially available from illiquid assets compared with public equity and debt. Under Calpers’ previous asset allocation strategy it was estimated to have a less than 40 per cent probability of achieving its 7 per cent return target over the next decade.
Calpers’ assets represent just 71 per cent of what it needs to pay future benefits to the 1.9m police officers, firefighters and other public workers who are members of the scheme.
The US stock market slide this year has increased the long-term structural problems across the entire US public pension system, particularly for the weakest plans that have ballooning unfunded liabilities. The weak funded position of these funds poses a huge long-term risk for millions of US employees and retired workers.
Mr Meng hopes Calpers’ deeper push into illiquid assets over the next three years will help it exploit its structural strengths. Its perpetual nature allows it to make longer-term investments, while its size gives it access to top managers in private equity markets where performance is widely dispersed.
“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 per cent hurdle. Private assets clearly stand out,” Mr Meng said. “Leverage will increase the volatility of returns but Calpers’ long-term horizon should enable us to tolerate this.”
He added that leverage would not “be tied to any specific strategy, asset, fund or deal”.
Mr Meng has terminated relationships with more than 30 external fund managers since 2019, redeploying $64bn of capital with savings of more than $115m in annual fees. Holdings of global equities are now 95 per cent internally managed, while 80 per cent of the total fund is managed in-house. It invests in more than 10,000 public companies.
Mr Meng has faced criticism this year for abandoning a hedging strategy for tail risk, the risk of low probability but highly costly events, before the market crash in March.
He countered that Calpers had developed ways of raising cash at short notice to meet unexpected demands on the fund, an approach that was less expensive than high-cost hedging strategies.
Calpers’ portfolio has also been de-risked by increasing its holdings in longer-dated US Treasuries and switching more assets from capitalisation-related equity indices to factor-weighted equities. These use indices that focus on investment styles such as price momentum or volatility.
According to Mr Meng this strategy protected the fund from losses of $11bn in the pandemic-induced market slide, which far outweighed the $1bn profit forgone on tail risk hedging. He said that unlike in the financial crisis of 2008 Calpers was not forced to sell assets into a depressed market in March. “Too little liquidity can be deadly but too much is costly,” he said.