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CalPERS to finalise alternative asset classifications

CalPERS’s investment committee is expected to make a decision on its alternative asset classification at a November asset liability management workshop.The $218 billion fund has identified five broad asset classes under the alternative classification: growth, income, real assets, liquidity/hedge, and inflation.

The liquidity/hedge bucket consists of Treasuries and provides interest rate exposure and serves as a risk hedge as well as a source of liquidity; the inflation bucket consists of inflation-linked bonds and commodities, providing tradeable asset exposure to inflation; while the growth bucket consists of public and private equities, providing an exposure to economic growth risk as the key return driver.

These five asset classifications were determined in September, and are a refined version of the March classifications which were: growth, income, government bonds, market neutral, inflation-linked, and liquidity.

The September version does not include absolute return as a strategic asset class as it is being implemented as an active strategy and has some market exposure to other assets, such as equity and fixed income.

At the November workshop, staff will present a more clearly defined description of the role of asset classes in the strategic portfolio so that implementation strategies and decisions are consistent with the strategic roles of the asset classes.

The main intent of the alternative asset classification was to more clearly define the strategic role of asset classes in the portfolio.

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In a note to the investment committee, investment staff outline the key insights drawn from the process:

* that the current asset class structure masks underlying common fundamental risks across the portfolio;

* the CalPERS portfolio has economic growth-sensitive assets across the current asset classes that sum to a higher percentage allocation;

* nominal government bonds (Treasuries) have a unique strategic role in providing a hedge against equity market draw-down risks, a partial duration match to liabilities and a source of liquidity; and

* the AAC provides a better framework for understanding and managing to these macro risks particularly in light of the “unusual uncertainty” surrounding the economic environment.

Under the direction of the investment committee chair, CalPERS staff have begun to report the asset exposures and returns according to the March 2010 asset classification to the investment committee.

The chair, George Diehr, has also directed staff to advance a factor-based approach, and these recommendations will be presented to the committee in 2011. Staff will then conduct an annual review of economic and capital market conditions along with return expectations so the committee may consider changes as needed.

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