CalPERS to examine leverage policies

The California Public Employees’ Retirement System may rethink how it uses leverage and is considering establishing a measurement that can determine its exposure on a total fund level, according to documents to be presented at an upcoming Board of Administration offsite meeting.

The Sacramento-based retirement plan’s leverage governance policies are currently established at the investment program level. Those statutes may be elevated to the fund’s trust level, providing a more macro picture of the total fund rather than individual investment programs.

By shifting its policy, CalPERS could give itself a “holistic and comprehensive understanding” of the leverage the $323.55 billion fund is taking on along with “actively controlling” how it applies leverage and consolidating its funding and liquidity management.

The meeting is informational; CalPERS staff and consultants are presenting ideas to the board, who will give their feedback, a spokeswoman for the western US retirement plan said

The presentation shows CalPERS may emphasise balancing portfolio priorities while making decisions on the timing and circumstances of leverage application.

The priorities could include guarding the pension plan’s funded ratio to reduce chances of a “severe” drawdown; balancing employer contribution rates to control volatility; and meeting its long-term required rate of return, which the documents note would be essential over a lengthier timeframe rather than at every point in an economic cycle.

Three external speakers – Allan Emkin from advisory firm Pension Consulting Alliance; Lionel Martellini, a professor at France’s EDHEC Business School; and Patrick Lighaam of consulting firm Wilshire Associates – are set to give presentations on the topic.

Double-edged sword

The materials acknowledged leverage had real benefits but also voiced caution as well; Emkin referred to it as a “double-edged sword”. While it can amp up returns, it can also magnify losses. He also recommended monitoring leverage at both the asset class level and the total fund level.

Martellini and Emkin were not available for comment. Wilshire declined to comment on Lighaam’s behalf.

The complexities of leverage were also noted; pension funds like CalPERS, corporations, private equity firms, hedge funds and banks all use leverage in several different forms including both recourse and non-recourse debt, subscription financing and credit accommodation.

It also notes leverage has evolved from something utilised in individual investment funds, namely private assets or hedge funds to becoming a means to hedge liabilities in liability-driven investing – in which pension funds make investment decisions based on their obligations to their beneficiaries rather than the assets on their books – and manage risk as well.

One example of liability-driven investing the presentation gives is the Healthcare of Ontario Pension Plan, which has net assets of about $70 billion and a gross asset exposure of $164 billion giving the Canadian investor a 2.34x leverage ratio in that circumstance.

CalPERS’ examination of its leverage policies follows scrutiny of subscription lines. A former CalPERS board member, Michael Flaherman, told pfm’s sister publication Private Equity International he had concerns that the pension fund was not doing enough to assess its exposure to those subscription credit lines.

“It’s striking that you have Howard Marks, who works for a private fund manager, discussing the risks that these credit lines can present to LPs, and you have an LP here who can conduct a similar analysis but doesn’t outline these risks,” he said.

CalPERS currently has 8.9 percent of its portfolio dedicated to private equity, which is also where private debt commitments are, against a strategic allocation target of 8 percent. It also lists a 9.3 percent allocation to real estate and 0.7 percent dedicated to forestland. The portfolio makeup targets for those are 9 percent and 1 percent, respectively. CalPERS has 0.9 percent of its fund in infrastructure, compared to a 1 percent target.