CalPERS Approves New Asset Allocation to Guard Against Risk, Rising Inflation

(December 15, 2010) — The investment committee at the $220 billion California Public Employees’ Retirement System (CalPERS), the biggest US public pension fund, has approved a new risk-based asset allocation with an assumed rate of return as low as 7.4%, net of fees, down from the current 7.75%.

Seeking to guard itself from extreme market risks and rising inflation, the CalPERS board has increased the asset allocation of public equity, infrastructure and forest land, inflation-linked bonds and Treasuries. Meanwhile, it has lowered the allocation to fixed-income and commodities. The allocation for private equity and real estate has remained unchanged.

The move after an almost year-long review by CalPERS indicates a continued effort to better protect itself against market turbulence after it suffered huge losses during the financial crisis, when the value of the fund’s assets had plunged to $160 billion from a peak of $260 billion in 2007. Since then, the fund has recovered to about $220 billion. CalPERS has asserted that the new allocation will more accurately reflect varying market conditions, such as the growth and low inflation conditions of the 1990s, the falling markets and liquidity constraints of the recent recession, and the inflation of the late 1970s.

“We learned in the financial crisis and the past recession that a liquidity crunch or inflation can have a significant impact on portfolio performance in ways that many investors didn’t anticipate,” said Rob Feckner, CalPERS Board President, in a news release on the fund’s website. “We focused on assets and returns, but not enough on the risk of our allocations. We’re majoring now on careful study, reaching out to the best-informed professionals of the financial world and taking all viewpoints into account.”

According to CalPERS, the new scheme consist of five “buckets”: growth, income, real, inflation, and liquidity assets. The structure, CalPERS concludes, will provide the fund with improved liquidity and greater flexibility in producing income. CalPERS spokesman Clark McKinley told aiCIO that all of the asset classes, including real estate, will be managed with the same investment officers, as they have been in the past, with separate allocation targets and ranges — including some sub-asset class allocations to be fleshed out through policymaking sessions early in 2011 with the CalPERS Board. “The risk focus is a more holistic way of looking at the entire investment program and making sure that diversification of assets isn’t arbitrary but managed in a way that works better for us in the markets than we experienced in the last recession,” McKinley said. 

Specifically, the CalPERS board approved the following asset allocations:

• Public equity: 49.1%, compared with a current 49%;
• Private equity: 14%, unchanged from a current 14%;
• Fixed income: 15.9%, compared with a current 20%;
• Real estate: 10%, unchanged from a current 10%;
• Infrastructure and forest land: 3%, compared with a current 2.5%;
• Inflation-linked bonds: 3%, compared with a current 1%;
• Commodities: 1%, compared with a current 1.5%;
• Treasuries: 4%, compared with a current 2%.

“You can’t get solid returns without taking risk, but we want to make sure we know what that risk is and that we’ll be paid to take it,” Joseph Dear, CalPERS Chief Investment Officer, said in a statement. “We have applied the best thinking and our best judgment to the challenging questions about how to uphold the promises we made to our beneficiaries to make their retirement secure.”

The next step is adoption of CalPERS actuaries’ recommendation for an assumed rate of return on investments, scheduled for early 2011 (likely February or March), the fund’s McKinley stated.