CalPERS’ first review of ILAC results in benchmark appraisal

CalPERS has conducted its first-ever annual review of the inflation-linked asset class (ILAC) program and has made a number of changes including moving the responsibility of the asset class to real estate. Amanda White looks at the fund’s plans for ILAC in the coming year.

Inflation-linked asset class has only been a separate asset class at CalPERS since January 2008 and while it has a strategic asset allocation of 5 per cent, the total fund allocation currently sits at around 2.4 per cent.

This review, the first for the fund, has produced a number of structural and implementation changes to the management of the asset class.

One of the consequences of the review is to hand responsibilities of the asset class to the senior investment officer of real estate (SIO-RE), away from the asset allocation team.

This year the fund will commit up to $900 million to funds and $400 million to direct infrastructure on a selective basis and will also build a direct investment capability within infrastructure.

It will also review the benchmark of the ILAC program – which is currently CPI plus 400 basis points – based on the asset mix and results.

Wilshire Associates, the fund’s consultant, is encouraging a rethinking of the benchmark.

“While CPI+$ is an appropriate long term target for inflation-linked assets in general, the substantial investment in commodities is causing quite a bit of tracking error in the total program.

“Depending on the preference of the SIO-RE after he integrates ILAC into his team, the benchmark could be changed to a roll-up of each program’s benchmark or he could decrease the weighting to commodities.

“Although the prior CIO believed strongly in managing the entire asset class against CPI+4, we believe the more pragmatic approach is to change the benchmark to better reflect the considerable volatility of commodities.”

Wilshire Associates says the SIO-RE should present to the investment committee his plan for how to manage this portfolio and how he intends to allocate assets among the various programs as soon as practical.

“We believe it is paramount that the SIO-RE has a clear methodology in place for managing these new assets,” the consultant said in a letter to the investment committee.

ILAC includes infrastructure, commodities, forestland and inflation-linked bonds, and the fund is well below its allocation to infrastructure with a current commitment of 0.11 per cent, against a benchmark of 1.5 per cent of the total fund.

Similarly commodities is 0.41 per cent, compared to 1.5 per cent, while inflation-linked bonds sits at 0.74 per cent (target weight of 1 per cent), and forestland at 1.12 per cent (compared to 1 per cent).

The total ILAC allocation of 2.4 per cent represents about $4.84 billion.

Meketa Investment Group, the fund’s infrastructure consultant, said that CalPERS had some internal resource constraints, which are being addressed, that contributed to the slow pace of commitments in 2009. The fund made one new partnership commitment only during the year, bringing the total number of partnerships to four, and $88.5 million only was committed across those partnerships throughout the year.

In a letter to the investment committee, the consultant goes on to say the most meaningful development to the infrastructure program in 2009 was the development of its internal investment capabilities.

Last year it hired two portfolio managers, and now has five in the team, and began developing internal processes and external sourcing capabilities focused on executing direct infrastructure investments.

This is a step in the right direction to support CalPERS’ objective of pursuing direct investment opportunities.
CalPERS only made its first infrastructure commitment as part of this program, only two years ago.

The ILAC asset class has performed well with a return for the year to December of 5.97 per cent, compared with the benchmark (CPI plus 400 bps) of 4.99 per cent.