Friends with Benefits: Calpers Hedged or....Not?

Four months ago, we looked at the new Calpers chief investment officer Ben Meng's early moves to shore up the municipal and state workers' pension fund here.  We watch this because the City sends a sizeable chunk of pension money to Calpers to invest on its behalf.  We already know the coming year or two is going to be ugly for city finances.  The hotel tax ("TOT") has evaporated and it's certain the various sources of sales tax are going to be down substantially.  So sending cash off to Calpers in Sacramento has to be funded from somewhere and how Calpers manages it is important to all of us.  A piece in today's Wall Street Journal highlights Meng's call to exit several "tail risk" funds--meaning they hedge against rare events (the "long tail" in a probability distribution).

The California Public Employees’ Retirement System was well prepared to cash in on a stock market selloff. Until a few months ago.  After suffering big losses during the financial crisis, the $371 billion pension fund hedged against another dramatic downturn by investing in three funds designed to produce big payoffs when markets fall steeply. But the pension, also known as Calpers, decided to sell out of these hedges last year, giving up what could have been a payday of more than $1 billion.

Some members of the Calpers board were caught by surprise.  “He took away a risk strategy that the board had approved without telling the board,” Ms. Brown said in an interview.  Calpers began investing in both funds in August 2017 and developed a third internally managed fund with a similar strategy.  Calpers decided to unwind the positions in October, and by March it only had a residual stake left in one fund-- LongTail Alpha LLC , according to documents and people familiar with the changes.

Mr. Meng, who took over as the pension’s chief investment officer in January 2019, said he has no regrets about exiting Universa and the other funds. “Knowing what we know, we would make the exact same decision,” he said in an interview.

We shall see how the board and Meng address this.  Meng may have put in a viable substitute strategy--it's a story that is just starting, but one that highlights how expensive this lockdown will be for everyone regardless of whether they are working now or not and regardless of whether they are stock market investors or not.  Personally, I'm glad I live in a fairly well-run (financially speaking) city and that over the years we have chosen to limit our interdependence on other cities.

Comments

[Account Deleted]

Well, this is certainly interesting:

https://www.bloomberg.com/news/articles/2020-06-15/calpers-cio-eyes-more-private-equity-leverage-to-boost-returns

[Joe]

Yes, Ben Meng had an opinion piece in the WSJ on the 14th. Here is a bit of it:

Over the past year, we have reviewed our investment approaches. We improved our liquidity position and redeployed $64 billion to reduce active risks in public markets. These decisions, along with asset allocation changes over the past couple of years, helped Calpers reduce by about $11 billion the impacts of the market downturn caused by Covid-19. We also scaled back our use of external asset managers, saving $115 million in fees annually.

Yet even before the pandemic, we knew that our goal of achieving a risk-adjusted return of 7% would require addressing the market’s triple threat of low interest rates, high asset valuation and low economic growth. In late 2019 we mapped out an investment strategy to deliver sustainable results.

The solution is based on “better assets” and “more assets” and will capitalize on Calpers’s advantages: a long-term investment horizon and access to private asset classes.

Calpers must diversify and increase exposure to private assets, such as private equity and private credit. We refer to these as “better assets” because they have the potential for higher returns and lower expected volatility when compared with publicly traded assets.
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The Rolling Stones' Tumbling Dice is playing in my head. Thanks for the reminder to note this.

[Joe]

Here's the latest on public pension returns, funding and Mr. Meng:

Public pension funds set a 22-year performance record in the second quarter, recovering some but not all of their losses from the first quarter.

Double-digit stock gains pushed pension returns to a median 11.1% for the second quarter, according to Wilshire Trust Universe Comparison Service.

Even with the rebound, median annual returns for the public pensions whose fiscal years ended June 30 were 3.2%, far short of the funds’ long-term investment-return target of around 7%.

The California Public Employees’ Retirement System, the nation’s largest pension fund, returned 4.7% for its fiscal year ended June 30 while the California State Teachers’ Retirement System returned 3.9%.

With local governments hemorrhaging tax dollars as a result of the pandemic, pension managers have to worry about governments adjusting budgets midyear, said Keith Brainard, research director of the National Association of State Retirement Administrators.
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California Public Employees’ Retirement System Investment Chief Ben Meng has resigned after about a year and a half in the position at the nation’s largest pension fund, according to the fund.

The resignation was effective Wednesday (Aug 5). Dan Bienvenue, deputy chief investment officer, will serve as interim chief investment officer.

A prominent board member expressed disappointment Thursday morning over what she said was Mr. Meng’s failure to adhere to conflict-of-interest rules.

Calpers has on hand only about 71% of the assets needed to meet future pension promises for more than two million workers and retirees.

Calpers delivered a 4.7% return for the year ended June 30, Mr. Meng’s first full fiscal year at the helm. The median return for public pension funds was 3.2% after huge losses in the first quarter during the early days of the Covid-19 pandemic. The California fund has earned an annualized return of 8.5% over the past decade and 5.5% over the past 20 years.
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7.0-5.5= Ugh Oh.