CalPERS CIO unveils leverage-backed push into private equity

The US's biggest public pension is planning to leverage as much as $80bn of its assets in order to take positions in riskier asset classes.

The California Public Employees’ Retirement System‘s chief investment officer has outlined a bold strategy to meet its 10-year investment goals, which could involve leveraging close to $80 billion of the fund to grow its presence in private equity and private credit.

Yu Ben Meng, CalPERS CIO
Meng: [We] can reduce risk over time
“The use of a moderate level of leverage allows CalPERS to take advantage of the low volume cost in today’s low interest rate environment and using those funds to acquire assets with potentially higher returns,” Ben Meng told the investment committee Monday.

This strategy, dubbed “Toward a 7 Percent Solution,” has two major components, which Meng calls “better assets” and “more assets”. “Better assets” refers to the private equity and private credit asset classes.

“More assets refers to our plan to thoughtfully utilise a moderate level of leverage as a tool to increase the base of the asset generating a return in the portfolio,” Meng said.

Meng said that over 2019, CalPERS staff developed this strategy along with ways to create liquidity when the fund required it. He also cited a July 2017 discussion at a CalPERS off-site as when the discussion of liquidity first began.

“This session and other discussions and actions since that time have sought to build a framework by which CalPERS may use a moderate amount of leverage to help offset diminished return expectations,” Meng said.

“Toward a 7 Percent Solution” has been an agenda item during closed session at the last two investment committee meetings as well. Another item titled “The 7 Percent Challenge” was on the closed session agenda for the December investment committee meeting.

CalPERS plans to leverage as much as 20 percent of the $385 billion fund, or nearly $80 billion, the Financial Times reported on Sunday.

The US’s biggest public pension has already made large private fund investments this year. Documents for this week’s meeting reported $1 billion commitments to funds from Oaktree Capital Management and Oak Hill Advisers, two private credit shops. The fund also committed $1 billion to Blackstone‘s second long-hold fund, Blackstone Core Equity Partners II. Staff can make commitments of up to $2 billion without board approval.

On the leverage plan, Meng told the investment committee he recognised the approach carries risk.

“Leverage can exacerbate some short term volatility. However, through the use of leverage, [we] can reduce risk over time, thus allowing us to keep more exposure in diversifying assets such as US Treasury bonds while pursuing higher returns in other parts of the portfolio,” Meng told the investment committee.

The plan drew mixed responses from board members and stakeholders.

“I’m encouraged by his work and support his efforts to help us achieve the returns we need to pay benefits our members have earned,” board president and investment committee member Henry Jones told sister publication Buyouts in an email.

“Leverage is a powerful investment tool. Used prudently, leverage can help CalPERS gain excess returns at a manageable level of risk,” investment committee member Stacie Olivares told sister publication Buyouts. “I support the careful implementation of leverage in the CalPERS portfolio.”

“The risky bet of leveraging the fund up to $80 billion to make private debt and private equity investments is a desperate move that is likely to end badly for CalPERS beneficiaries,” said board member Margaret Brown, who was removed from the committee this year when it was cut down to nine members instead of the entire board.

During public comment, one stakeholder – retired prosecutor David Soares – criticised Meng’s comments from an interview with Bloomberg on Monday in which the CIO had put the chances of hitting its 7 percent target return over a decade at less than 50-50 even if it allocates more to private assets and uses leverage.

“In other words, adding risk of not just missing return targets but adding the risk of actually losing trust assets to creditor failure and bankruptcy during the coming global pandemic downturn, has less likelihood than guessing when a coin flip will turn up heads,” Soares said.

“Mr Meng’s leverage strategy is speculative in nature and by its very nature is an inappropriate strategy for a fiduciary charged with protecting public trust assets to pursue.”

CalPERS did not respond to a request for comment on this statement.

– This report originally appeared on sister publication Buyouts.