The California Public Employees’ Retirement System (CalPERS), the largest US pension plan, missed its expected 7% investment return goal by a small 300-basis point margin in the just completed state fiscal year ending June 30, show system statistics.
The 6.7% results are expected to be discussed today at the system’s semiannual retreat meeting in Santa Rosa, California, as investment staff and board members gather for three days of discussions on charting a future course for the $350 billion-plus retirement system.
At the end of 2018, midway through the 12-month fiscal year, CalPERS investment returns were just at a break-even point, but an upward trending stock market and interest rates drops over the last six months helped the retirement system nearly catch up.
“This was a very volatile year for financial markets, but I’m pleased with how we focused on the performance of the total fund,” Ben Meng, CalPERS’s chief investment officer, said in a statement.
By key asset classes, fixed income saw the biggest return of 9.6%. This was followed by private equity, which showed a 7.7% return. Public global equities or stocks saw a 6.1% return. CalPERS real assets portfolio, which includes real estate, returned 3.7%.
“We saw good returns in several key areas,” Meng said. “Our long-duration fixed income portfolio contributed positively as interest rates fell.”
CalPERS is the first public pension system to report for the June 30 fiscal year and its results are usually considered an indication of how other pension systems will do in terms of their investment returns.
The 2018-2019 fiscal year returns come after CalPERS saw an 8.6% investment return in the 2017-18 fiscal year, and 11.2% in the year before that.
The pension’s plan worst recent returns were in 2015-16, when it produced a .61% return.
The question is, can CalPERS keep it up, earning 7% or very close to it on an annual basis?
The answer, unfortunately, may be no, based on CalPERS’s own projections, and those of its consultants.
A video stream of the retirement system’s June 17 investment committee meeting show Meng telling the committee that projections show the system’s expected annual return for the next decade will be 6.1% per year, 900 basis points below the 7% investment return target set by the committee.
CalPERS’s own analysis and that of consultants show that in the long term, years 11 to 60, CalPERS would earn on average 8.3%, which accounts for the long-term expected rate of 7%. That won’t help in the short term, however, for the next 10 years, Meng says.
The CIO said there are no easy answers. He has proposed expanding the system’s best-producing long-term asset class—private equity—by creating CalPERS-backed investment companies. The asset class is the only one that is expected to produce more than a 7% return over the next decade, CalPERS assets show.
CalPERS’s private equity asset class is approximately $27 billion, and Meng would like to expand it to more than $45 billion.
The problem is the expansion plan is still a work in progress and even if it is implemented in the near-term, it could take years for the new private equity funds to start returning dividends.
Another expected discussion today is how CalPERS will deal with another great financial crisis, like in 2008 and 2009, when the system saw its investment portfolio decline by more than 25%.
Meng, shows the video stream of the June meeting, has suggested that CalPERS could leverage up its entire portfolio—so it would have cash on hand to buy stocks and other securities at low prices if a drawdown occurred.
CalPERS investment staff rejected such a move in 2017, saying the cost of using leverage would be too expensive, but never released data explaining how much it could cost the retirement system.
Meng, who took office in January, ordered the new ongoing review, shows the June video steam. He says leveraging the portfolio would enable CalPERS to have cash on hand to buy securities cheaply if the drawdown occurs.
CalPERS is only around 70% funded and the state and local towns and school districts have all been facing rising rates to pay for the shortfall.
CalPERS Investment Committee Approves Private Equity Plan at Urging of the CIO