Out with the old

The California Public Employees’ Retirement System elected to do away with traditional allocation labels at the end of 2010

In December, the California Public Employees’ Retirement System, the largest public pension in the US, decided to rethink the way it allocates its $220 billion in assets under management to various asset classes. 

CalPERS is casting aside its traditional allocation structure that had been divided by security type and geography and will sort its various investments into five major groups according to how they function in high- or low-growth markets and the prevailing inflation environment, according to the pension.

“You can’t get solid returns without taking risk, but we want to make sure we know what that risk is and that we’ll be paid to take it,” CalPERS chief investment officer Joe Dear said in a statement in December.

Infrastructure, real estate and forestry assets – the so called “real” group – will account for 13 percent of the mix. This group will provide the pension with long-term income returns that are less sensitive to inflation risk, it said.

Public equity stocks and private equity will make up the “growth” group, which will provide the pension with exposure to rising markets, and will account for 63 percent of the portfolio.

The “income” group, comprising treasury inflation-protected securities and other fixed income securities will be 16 percent. 

The other two groups will be “inflation” – comprising commodities and inflation-linked bonds – at 4 percent and “liquidity” – cash and easily convertible government bonds – at 4 percent. 

The change in allocation structure is not an entirely new concept, some will point out, and indeed, it’s too soon to tell if such changes will impact private equity commitment levels very much.

“We learned in the financial crisis and the past recession that a liquidity crunch or inflation can have a significant impact on portfolio performance in ways that many investors didn’t anticipate,” said Rob Feckner, CalPERS’ board president. “We focused on assets and returns, but not enough on the risk of our allocations.” 

The current allocations “won’t change much”, said George Diehr, who chairs CalPERS’ investment committee, but the pension will “now have a better way to look at risk and account for what’s happening in the markets and to re-categorise our assets according to what drives them”.

CIO Joe Dear hinted at a conference earlier this year that the traditional asset allocation model would be discarded by CalPERS, but that illiquid assets such as private equity would continue to make up an important part of the portfolio.

“I don’t know how we make our return objectives without investing in illiquid assets,” Dear said, “so it’s certainly not going to disappear.”