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CalPERS Board Reduces Fund's Investment Return Target to 7.5%

Acknowledging lower returns and higher costs, the board of the $235 billion California Public Employees' Retirement System has approved reducing its rate to 7.5% from its longstanding rate of 7.75%.

(March 15, 2012) --  The California Public Employees’ Retirement System (CalPERS) Board of Administration -- the largest public pension in the United States -- heeded advice to lower its assumed rate of return to 7.5%. 

The pension fund's assumed rate of investment return -- also called the discount rate and calculated based on expected price inflation and real rate of return -- was last changed a decade ago when it was reduced to 7.75% from 8.25%. Since then, critics have continued to claim that the scheme's return target was overly optimistic to keep up over the long-term. 

The decrease of its rate is expected to cost the state an extra $303 million a year, with about $167 million coming from the general fund. Meanwhile, it increases the overall annual state contribution to CalPERS to $3.8 billion, or about 4% of the overall general fund budget for the coming fiscal year.

“This was a difficult, but important, decision for the board to make," said Rob Feckner, CalPERS' Board President. "We understand the impact this will have on our employers in meeting contribution requirements. However, current economic conditions impelled us to make this change now, and our actuaries will continue to evaluate the discount rate in the coming years.”

Last week,  the actuary who advises CalPERS' board, Alan Milligan, recommended lowering the rate for this year either to 7.5% or 7.25%. 

“It is important that we periodically review our assumptions to ensure that we remain focused on the long-term health of the Fund in order to protect the benefits that our members and employers rely on us to provide,” said Committee Chair Priya Mathur in a release, posted on the fund's website yesterday. “This new discount rate reflects our expectations of what the markets will deliver in the future.”

The fund's decision to lower its assumed rate of return comes three years after Joe Dear, the scheme's chief investment officer, arrived at the fund when the value of the scheme's portfolio reached its lowest point during the recession -- a value of about $160 billion, down from a peak of about $260 billion in October 2007. 

In September of last year, Dear expressed that a 7.75% return may be tough to meet. In an interview with aiCIOfeatured in its Summer Issue, Dear commented on the fund's stellar returns at the time, lowering expectations of future similarly stellar performance by saying: "Honestly, and not taking anything away from the team here, our 20.7% returns in fiscal 2011 were largely the result of market beta. Public equities are about half our $234 billion portfolio, and it is no secret that public equities significantly increased in value over the past year."

Summarizing his perspective on CalPERS' 2011 investment return and his future outlook, Dear told aiCIO: "Obviously, a 20% return undermines the statements of public pension fund critics—that we are unable to reach our target. I think that’s important—that there is still a lot of earning power in these assets—but let’s be clear: There won’t be a string of 20% years in a row."

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