The California Public Employees Retirement System has reduced its interim allocation to private equity to 8 percent from 10 percent, according to documents prepared by the investment office.
To offset the cut, it raised its interim allocation to real assets to 13 percent from 12 percent and to inflation-linked securities to 9 percent from 6 percent. CalPERS' interim allocation to global equity was also trimmed to 46 percent from 51 percent.
The proposal to change the interim asset allocation was approved on Monday after a presentation by chief investment officer Ted Eliopoulos during an open session at the CalPERS investment committee meeting.
“The rationale is the belief that it is a low return environment,” said a spokeswoman for the pension plan.
Eliopoulos explained the reasons more in depth at CalPERS' September meeting.
“We'll be facing a very challenging environment going forward,” he said at the September meeting, talking in particular about the pressure on cash flow that will be needed in the years coming to meet benefit payments.
“As our system continues to mature, the need to generate additional cash flow out of the investment portfolio to close this gap between outgoing benefits and costs with the incoming contributions will put additional pressure on an investment portfolio already facing the prospect of a lower return environment with a volatile asset mix,” he said. “Since the depression we hadn't faced this negative cash flow until quite recently.”
Regarding private equity specifically, although the asset class has returned positive free cash flow in recent years thanks to external managers selling at high valuations, it's challenging to project what types of cash private equity will continue to deliver in the years going forward.
“We don't view private equity as a source of income since almost all of it is produced by appreciation and sales of private companies,” Eliopoulos said. “In the last three years, the private equity portfolio has been gushing cash to the system. […] As we look out longer into the future, we're more and more skeptical as to how much of net cash flow the private equity portfolio will produce.”
Regarding real estate, CalPERS has already transitioned toward more income-producing investments in the last few years. “This changed character of the real estate portfolio will be a benefit from a cash flow standpoint,” Eliopoulos said, adding that it has gone from 20 percent of the real estate portfolio being in core funds in 2007 to 80 percent in 2016.
“We think both infrastructure and real estate can play an important role in providing cash yield and at the same providing an inflation protection.”
Sacramento-based CalPERS, which has $301.23 billion in assets under management, has an 8.66 percent current allocation to private equity, a 9.06 percent current allocation to real estate and a 1.35 percent allocation to infrastructure, according to PEI data.