FIS Digital – November 2021

CalPERS gets ready to settle discount rate and SAA

At US pension fund CalPERS’ board meeting next week, the investment team hope to settle on a new discount rate and begin structuring a strategic asset allocation to support it. Interim chief investment officer Dan Bienvenue is due to explain the different risk implications for the giant portfolio, about to surpass $500 billion, if it targets a 6.5 per cent, 6.8 per cent (it’s current discount rate) or a mighty 7 per cent assumed rate of return year after year.

Leverage will be a key discussion topic as the investment staff press again for leverage in the strategic asset allocation to help reduce risk. It’s possible CalPERS could reach its return target via equity, but a leverage element will enable the fund to own more diversifying assets, said Bienvenue speaking at FIS Digital 2021 ahead of the November 15th meeting.

“We are recommending a total exposure of 105 per cent going into this ALM cycle – total assets at 100 per cent with that extra 5 per cent used to purchase diversifying assets. Through this lens, it’s a risk reducer.”

Mindful of board concerns that leverage adds operational risk and brings extra hazard in market environments where both equity and bonds sell off, the investment team have spent months exploring the fund’s ability to manage leverage – and liquidity. It has involved centralising the strategy at a total fund level rather than at an asset class level, running scenarios around what the portfolio would look like and modelling diversified pathways to liquidity during times of market stress when the pressure of leverage makes finding liquidity harder.

“Leverage and private assets make the premium on liquidity even greater,” said Bienvenue who joined CalPERS as a portfolio manager 17 years ago and replaced Ben Meng as interim CIO when Meng stepped down last year.

CalPERS’ board is as familiar with the investment team’s argument for a larger private equity allocation as they are its support of leverage. Building out the current 8 per cent allocation to around 13 per cent is a critical part of the return seeking allocation and central to the new strategic allocation.

“We get a higher return per unit of risk in private equity on a modelled and realised basis,” says Bienvenue.

Still, he told FIS delegates that deploying private equity at scale and gaining the cost advantage of co-investment all the while ensuring robust underwriting remains CalPERS’ enduring challenge.

“There is a tension between getting capital deployed and underwriting,” he said. “You can always get someone to take your assets; you just might not like what you get.”

He wants to make more of CalPERS co-investment strengths, shaping a decisive brand and acting quickly when the call to co-invest comes.

“It’s about knowing we don’t have a no risk or low risk option.”

He said CalPERS is a sought-after Limited Partner but needs to ensure it is also a consistent partner of choice; able to move quickly and leverage its strengths.

CalPERS’ bid to build out private equity sits within a wider push into private markets. In a new move it is seeking to add a 5 per cent strategic allocation to private debt – historically seen as an active risk.

“$25 billion is quite a lot of capital for that space,” reflected Bienvenue. Large funds like CalPERS raising their threshold to the asset class has begun to spark concerns amongst other investors with several FIS Digital chief investment officer’s voicing their concerns at the amount of money flowing into private credit.


Efficiencies in public equity

Other areas of recent change at fund include narrowing the equity benchmark which used to comprise some 11,000 securities. Many of the companies in the bottom half of the benchmark added complexity in trading and sub custody accounts, but little diversification benefits, said Bienvenue.

Narrowing the benchmark has involved finding a sweet spot between the additive value of additional securities and diminishing marginal returns. The change was part of CalPERS broader ambition to increase efficiencies in how it harvests public market risk premium, both operationally and by instilling cost and risk efficiencies to maximise the return per unit of risk. Elsewhere in public markets, the investment team is looking at adding exposure to emerging market sovereign debt.

“It adds risk but it also adds diversification in public markets.”

He concluded that CalPERS is also spending time integrating sustainability into decision making across public and private markets, aware that sustainability and regulation will affect assets differently.

Lastly, Bienvenue sounded a wary note on investment in China citing “stroke of the pen” unpredictability as a key risk. Despite Chinese economic growth and Chinese assets adding important diversification, he said the accuracy of data, shadow banking, real estate and challenges around finding the right partner make investment challenging. “There are lots of questions; the challenge is finding good answers.”

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