CalPERS traded $55 billion in fixed income securites last financial year as it implemented its new internal structure apportioning fixed income assets across three groups: treasuries, spread and high yield.
Each of the new segments in the board-approved structure has defined purpose and role.
More than half the income allocation ($56.7 billion) is in long spread, which seeks to provide a reliable source of income and an additional source of liquidity; $11.7 billion is in high yield which provides exposure to economic growth and acts as a reliable source of income; and $37.8 billion is in long treasury which seeks to serve as an ecnomic diversifier to equity and is a reliable source of liquidity.
The idea is that this level of granularity allows for a higher level of flexibility in the asset allocation process to help the fund achieve its objectives.
Speaking at the September investment committee meeting managing investment director global fixed income, Arnold Phillips, said the fixed income group had assisted in the set up of a more centralised capital allocation framework to manage plan level, total fund, leverage and liquidity in a cost effective, transparent and risk aware manner
“Trust level liquidity is [CIO of CalPERS] Ben’s highest priority,” Phillips said. “The balance between too much and too little is important. As we try to reposition the portfolio from a top down perspective, it is paramount we know where we stand. I’m not sure we have a more important project, alongside our work on private equity, as a launching point for what we want to do. We are in a strong liquidity position now, the point is what we want to do with it.”
Over the year to the end of June, the net return for fixed income was 9.6 per cent with an excess return of 31 basis points. The portfolio benefited from its duration exposure, and provided a “meaningful ballast when equity risk markets sold off sharply in the fourth quarter of 2018” according to Wilshire.
For the five years to June 30 it returned 4.08 per cent, adding an excess return of 56 basis points.
The fund manages 96 per cent of fixed income internally, and has 31 full time employees with about seven vacant positions.
“The global fixed income five years excess return $1.7 billion, which is about $40 million per fixed income employee,” he said.
Internal management has been a cost effective way to manage the portfolio, with the internal fees coming in at $10.1 million for the year, or about 1 basis point. External management fees were $14 million or about 23 basis points on the 4 per cent of assets managed externally. The fund spent a further 1 basis point on technology and operating expenses.
Phillips was appointed managing investment director global fixed income in July, a position he was acting in from May 2018. He’s been part of the team since 2001. The fund invests 28.7 per cent of the portfolio, or $106.3 billion, in income, making it the fund’s second largest allocation. Global equities is around $185 billion and it returned 6.1 per cent for the year.
“We have shifted to a total portfolio view and away from a siloed approach. We continue to focus on the total fund and how global fixed income fits in. Its purpose is to provide income, as a steady source of liquidity and as a shock absorber to global equities.”
He said the performance for the year was strong due to the interest rate sensitivity in the portfolio, which was a deliberate design by Phillips and the asset allocation and risk management group, headed by Eric Baggesen, to “ward off equities”.
On reviewing the global fixed income results, one of the investment committee mmbers Stacie Olivares asked “as we move into darker times where do we move?”.
“There is $13-17 trillion trading on negative rates, that doesn’t sound like investing, paying someone to hold your cash. As we shift closer to zero rates we may have to rethink the assumptions that go into asset allocation, everyone will,” Phillips said.
“This is a legitimate concern. The creation of our centralised research group helps to look at this from a top down asset allocation and portfolio construction view and will be extremely important as we get into these unchartered waters.”
The fund’s consultant Wilshire gave the global fixed income program a B ranking, putting in the third decile, saying it believes the global fixed income program is managed in an effective and risk-conscious manner, leveraging the deep expertise of the senior management team.
The consultant said the permanent appointment of Phillips added to the score indicating the organisation can cultivate and retain talent.