The California Public Employees’ Retirement System, which has a history of making poor choices, plans to become a lending institution. A healthy pension fund wouldn’t be making such a risky decision.
Still hurting from $100 billion in losses from the Great Recession, CalPERS was bruised again by the coronavirus pandemic. Now, funded at only 71%, it’s scrambling to recover.
“We need every arrow in the quiver we can get, and private debt is one of the critical ones,” explains Dan Bienvenue, CalPERS’ deputy chief investment officer. “There isn’t a no-risk choice.”
The plan, approved last month by the board, allows “CalPERS to put up to 5% of its total value into ‘opportunistic’ investments, which includes private debt. That works out to about $20 billion,” CalMatters reports. The Financial Times says leverage could reach “as high as 20% of the value of the fund, or nearly $80 billion based on current assets.”
State Treasurer Fiona Ma, also an ex-officio member of the pension fund’s board, believes that “allocating more of CalPERS’ nearly $400 billion portfolio into private equity and private debt, thereby investing in ‘better assets,’ is a reasonable” plan.
“This approach is specifically designed to overcome the challenges of low interest rates, high asset valuations and low economic growth that are pervasive in the investment markets today,” Ma wrote in Pensions & Investments.
Only a single board member dissented. Margaret Brown said she didn’t “agree with leveraging the fund up to $80 billion.”
“It is way too risky,” she told the Financial Times.
“It reminds me what CalPERS did back in 2008 when we used leverage and lost close to $100 billion,” Brown said.
“Red flags about the growing riskiness of CalPERS’ portfolio” were visible but nonetheless ignored, even as the fund was making “ever riskier bets,” and struggling with risk management, Reuters reported in 2009.
According to David Crane, a longtime and level-headed CalPERS critic, the assumed return of 7% from the direct loans will not close the gap – the “unfunded liability” – between the assets managed by CalPERS and the “pension liabilities owed by the employers for whom CalPERS administers pension obligations.”
“In fact,” the Stanford lecturer and president of Govern For California notes in Medium post, “CalPERS has to earn much more than 7% for the unfunded liability not to grow.”
CalPERS management has to know this. And in fact does. Chief Investment Officer Ben Meng has acknowledged that the 7% threshold is not enough. That being the case, the pension fund will have little choice but to make riskier, and therefore more volatile, loans. While doing so will increase the fund’s potential to meet its return targets, it also sets it up for a “greater chance of catastrophe,” says Don Boyd, a researcher at the Rockefeller College for Public Affairs and Policy at the University of Albany.
Taking injudicious risk is by no means a break with the past for CalPERS. It has a history of making lousy choices. Along with CalSTRS, the California State Teachers’ Retirement System, CalPERS has adopted an investment strategy based not on returns but politics, and when that is a greater concern than fiduciary duty, the outcome is usually substandard. Investments made in companies judged by the left to be “responsible” or “woke” simply cannot match the returns that a broad-based index fund produces.
Last year, an American Council for Capital Formation paper reported that CalPERS prioritized politically driven investments at the expense of returns. Particularly egregious were the investments made in green energy ventures. Even as Suntech, a Chinese solar panel maker in China, was going through a Chapter 15 bankruptcy in the U.S., CalPERS increased its position in the company by 40.4%. It also sunk retirement dollars into other “clean energy” losers simply because the companies’ operations were consistent with a political agenda.
CalPERS has a history, as well, of steering “billions of dollars into politically connected firms,” City Journal’s Steven Malanga wrote some years ago. Will it follow that precedent and loan to companies favored by board members or even lawmakers in Sacramento? The latter is by no means unimaginable. A former director once complained lawmakers “wanted us to invest in government buildings.” Will there be safeguards to prevent an elected official from pressuring the fund to make a dicey loan to a business owned by his or her brother-in-law, or maybe a campaign donor?
If not, CalPERS might want to redefine itself as a credit union for political cronies.