By Wes Venteicher
September 21, 2022 5:25 AM - The Sacramento Bee
The California Public Employees’ Retirement System performed worse on average than other large U.S. public pension systems over the last decade, missing out on billions of dollars in potential earnings, Chief Investment Officer Nicole Musicco told the system’s Board of Administration this week.
CalPERS, the country’s largest public pension system, earned an average of 7.7% per year on its investments over the last 10 years. That’s 1.2% less than a hypothetical peer should have expected to earn in the same time period, according to information Musicco shared at Monday’s board meeting.
A CalPERS consultant developed the hypothetical peer for comparison’s sake using data from other pension systems worth $10 billion or more. Musicco, who started work at CalPERS six months ago, told the board it was consistent with her own assessment.
The system’s biggest misstep, Musicco said, was in failing to commit more money to private equity from 2009 to 2018. In that time period, dubbed the “lost decade” in a presentation, the system likely missed out on $11 billion to $18 billion in private equity gains, she said.
CalPERS, recently valued at $440 billion, focused on avoiding big losses as it came out of the Great Recession, a strategy that resulted in missed opportunities even in the most recent years, Musicco said.
“We were constructing a portfolio to limit downside, and with that we missed out on a big chunk of growth,” she said.
The strategy leading to the missed gains was supposed to also minimize losses when the eventual downturn arrived, but the system’s performance in the most recent fiscal year - it reported a -6.1% return - cast that assurance into doubt.
“In the test of a down market, we continue to underperform our peers,” Terry Brennand, an SEIU California lobbyist, said at the meeting. “That’s a huge disappointment for those of us who believed this was a strategy that was going to work out.”
Among 31 other public pension systems with portfolios of at least $10 billion, 18 performed better than CalPERS through June, according to an analysis by The Sacramento Bee of annual returns collected online by the publication Pensions and Investments.
The systems that performed best had much larger portions of their portfolios invested in private assets than CalPERS, which had 8% of its assets in private equity as recently as fall 2021.
For example, private equity makes up about 24% of the Oregon Public Employee Retirement System’s portfolio, and the system reported a 6.3% gain for the year ending June 30. Maine, with 20% invested in private assets, reported a 3.3% gain, according to the Pensions and Investments figures.
But the results for all the systems come with a big caveat: Private equity and real estate returns are reported three months later than they are for public equities. That means annual return figures are likely to get worse when the systems update their numbers.
Over the years, several proposals to expand private equity have hit snags, including a 2018 proposal to create a new variety of investments with general partners.
The board over the years has wrestled with proposals to bring private equity investing in-house or to continue partnering with outside firms. Retiree groups and others have raised concerns about the lack of transparency that comes with private equity investments, and the aggressive tactics private equity firms sometimes use to turn a profit.
CalPERS last year directed its Investment Office to expand private equity to 13%. The retirement system has boosted its holdings in private equity firms to 12%.
The system pays for the pensions of about 2.1 million retired public employees.It has about 72% of the assets it would need to cover all its long-term debts, and aims to earn an average of 6.8% per year under a plan to reach 100% funding in the 2040s.
Most broadly, CalPERS erred over the last decade by improperly managing risk, Musicco said, acting overly cautious in some areas while failing to properly price the risks it did take.
She’s pitching the 13-member board on a strategy moving forward that would incorporate more risk in pursuit of bigger gains.
“It’s a cultural shift, frankly,” Musicco said. “We have to create an environment where people don’t fear taking risk.”
At the same time, she said, the next decade won’t look like the last one. She told the board the system needs to be more agile, and requested more discretion and larger spending caps for investors as part of a detailed proposal.
“We’re going to have to write larger checks; we’re going to have to look at our delegated authority levels,” she said.
The board will consider the proposal in the months ahead.