With a low interest-rate environment expected to continue, the California Public Employees’ Retirement System (CalPERS) will keep the lower interim target of 2 percent for infrastructure in place for one more year, following a recent decision by its investment committee.
The body first approved the use of interim asset allocation targets last May, lowering the percentage that will be allocated to infrastructure to 2 percent while keeping intact its long-term target of 3 percent.
Inexpensive financing that led to high valuations for assets was one of the key reasons CalPERS made the adjustment last year, while market conditions that have remained mostly unchanged led to this year’s decision to maintain the interim target.
The decision does not apply only to infrastructure but also to real assets – the broader category under which infrastructure falls – as well as private equity, asset categories that are characterised by the same market conditions, according to CalPERS. As a result, the interim target for real assets and private equity is two percentage points lower than the approved policy target of 14 and 12 percent, respectively.
“Private equity continues to experience a slow pace for deployment of committed capital,” the investment committee wrote in documents presented at a recent meeting. “Similar deployment challenges are also in place in real assets as those assets continue to be richly valued. Given this market environment, staff’s review indicates that maintaining the interim targets for private equity and real assets would be appropriate until the next review in 2016.”
Pension Consulting Alliance (PCA) and Wilshire Associates, CalPERS’ investment consultants, agreed with the investment committee. However, in a letter addressed to investment committee chairman Henry Jones, PCA noted that “in the real assets space […] given that the current allocation levels to those assets remain below both interim and long-term targets, incremental commitments would still be required to achieve both interim and long-term allocation targets.” As of February 28, infrastructure and forestland, which CalPERS groups together, represented 1.4 percent of the fund’s total portfolio.
During the meeting, chief operating investment officer Wylie Tollette presented the committee with a cost-effectiveness report that showed CalPERS’ investment office has reduced costs by approximately $90 million for the five-year fiscal period from 2009-2014.
External management fees accounted for the majority of costs. Of the approximate $1.7 billion CalPERS spent in fiscal year 2013-14 to manage its portfolio, 92 percent was due to external management fees.
According to Tollette’s report, private assets are primarily externally managed and therefore represent 90 percent of external management fees. In the aforementioned period, management fees for the fund’s real assets portfolio totalled $467 million.
CalPERS said it would continue to monitor and manage costs through various means including increasing flexibility to manage the use of external versus internal resources.
Asked whether this continuing effort will affect how the pension fund manages its infrastructure portfolio – given that CalPERS has identified private assets and complex investment strategies as cost drivers – Tollette said that while CalPERS is examining new business and operating models for infrastructure investments that help reduce management fees, it will not do so at the expense of the pension fund’s primary focus of achieving the long-term investment objectives of the asset class.
“These new business models could involve new ownership and management structures and agreements that ensure clear alignment of interests between our partners and CalPERS,” he said in an e-mailed response.
Based in Sacramento, CalPERS administers health and retirement benefits on behalf of 3,089 public school, local agency and state employers. The institution counts more than 1.7 million members in its retirement system and more than 1.3 million in its health plans.
With assets under management valued at approximately $300 billion, CalPERS is the largest public pension fund in the US.