In uncertain times, the mission of California’s pension funds is vital

July 11, 2020

No one needs to be reminded that these are uncertain times.

The course of the COVID-19 pandemic and its long-term effect on the economy is unknown. Financial markets are unpredictable. No one knows when people will again be able to gather, travel, work and spend as freely as they had before.

In times like these, the mission of CalPERS is more vital than ever. It must provide for its 2 million workers and retirees the certainty of a secure retirement income.

CalPERS remains positioned to provide that certainty.

It has taken steps over the last couple of years to prepare for an economic downturn – one that we all knew inevitably would come.

Having learned a hard lesson from the 2008 financial crisis, CalPERS increased the fund’s liquidity to ensure that it can continue to pay benefits without having to sell assets in a depressed market. It increased the percentage of the fund managed by in-house investment professionals, saving about $115 million annually in fees. And it is in the process of restructuring its portfolio to take full advantage of its comparative advantages as an investor.

The new approach has already produced positive results, enabling CalPERS to reduce the effects of the market downturn caused by COVID-19 by about $11 billion. In addition, its increased liquidity is enabling it to access cash to take advantage of investment opportunities created by the downturn.

As the nation’s largest pension fund, with nearly $400 billion in assets, CalPERS has unique advantages. Because its obligation is to this and all future generations of workers, its investment horizon is infinite. It can set a smart course and stick to it, through all the up-and-down gyrations of uncertain markets. And because its investment fund is so large, it is able to fully diversify its holdings – not just in foreign and domestic stocks and bonds, but also in real estate, private equity and private credit.

The strategy mapped out last year is designed to enable CalPERS’ to achieve sustained returns that will meet its targeted annualized investment return of 7% over the long term – a critical target not just to provide retirement certainty for its members, but also to prevent burdening state and local governments at a time when they are facing their own challenges with economic uncertainty.

The strategy will allow CalPERS to increase its holdings in assets such as private equity and private credit that have the potential for higher returns than publicly traded assets such as stocks and bonds.

One element of this strategy is to take advantage of historically low interest rates to utilize leverage, or borrowing, and using that leverage to acquire more of those better-performing assets.

The strategy can be simply expressed: Generate more assets to invest in better assets. The prudent use of leverage will allow CalPERS to retain the appropriate level of risk-protected assets while also enabling it to pursue more aggressively higher returns in other segments of its portfolio.

This strategy cannot be implemented overnight. It takes time to fully assess market opportunities and to incorporate leveraged investments into the overall strategic asset allocation. The expectation is that a “more and better assets” portfolio can be built over the next three years.

Achieving the 7% average annual rate of return requires smart planning in these times of low interest rates, high valuation of stocks and low economic growth. In fact, experts last year predicted the existing portfolio would return about 6% over the next 10 years.

The new strategy puts the state’s largest public employee pension fund in a stronger position to weather these uncertain times than it was a year ago. It has increased the probability of the fund achieving its targeted 7% annual return over the next decade, and it has positioned CalPERS to continue to provide certainty for the workers and retirees who rely upon it.

Read more: