Pennsylvania Pensions Will Get $15 Million Piece of S&P Settlement

Pennsylvania

On Tuesday, credit rating agency Standards & Poor’s entered a $1.375 billion settlement with 18 states over the alleged inflated ratings it gave mortgage-backed securities which eventually turned toxic.

Pennsylvania is receiving a $21.5 million chunk of the settlement. Of that money, $15 million will be distributed among state agencies, including pension systems.

Two of Pennsylvania’s pension systems – the Public School Employees Retirement System and the Pennsylvania Municipal Retirement System – will receive a slice of the $15 million.

More from PennLive:

Pennsylvania is to receive $21.5 million from a proposed $1.38 billion nationwide settlement over misconduct allegations against Standard & Poor’s Financial Services LLC, the country’s largest credit ratings agency, [Pennsylvania] Attorney General Kathleen Kane said Tuesday.

[…]

“We contend that Standard & Poor’s set aside its independence and objectivity in order to increase its profits, which led to disastrous results for consumers and the economy,” Kane said in a press release. “This historic settlement ends years of litigation against an industry giant and holds this company accountable for its role in the financial crisis. Attorneys General from across the country and the federal government joined together in a bipartisan fashion to show that no company is above the law.”

[…]

She said $15 million of the settlement is to be distributed to the state treasury, Public School Employees Retirement System, Pennsylvania Municipal Retirement System and the Turnpike Commission, agencies that purchased the S&P rated securities. The rest will pay litigation and investigation costs, Kane said.

The Justice Department statement on the settlement, which includes a list of the states receiving money, can be read here.

 

Photo credit: “Flag-map of Pennsylvania” by Niagara – Own work from File:Flag of Pennsylvania.svg and File:USA Pennsylvania location map.svgThis vector image was created with Inkscape. Licensed under CC BY-SA 3.0 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Flag-map_of_Pennsylvania.svg#mediaviewer/File:Flag-map_of_Pennsylvania.svg

CalPERS, CalSTRS Nab $300 Million From Settlement With S&P in Suit Over Mortgage Ratings

The CalSTRS Building
The CalSTRS Building

It was revealed today that credit rating agency Standards & Poor’s has entered a $1.375 billion settlement with 18 states over the alleged inflated ratings it gave mortgage-backed securities which eventually turned toxic.

CalPERS and CalSTRS are the biggest individual beneficiaries of the settlement; the entities will receive more than $300 million combined.

More from the Sacramento Bee:

CalPERS said it will receive $301 million from S&P. CalSTRS said it will get $23 million.

“This money belongs to our members and will be put back to work to ensure their long-term retirement security,” said CalPERS Chief Executive Anne Stausboll in a prepared statement.

[…]

“S&P played a central role in the crisis that devastated our economy by giving AAA ratings to mortgage-backed securities that turned out to be little better than junk,” said Stephanie Yonekura, acting U.S. attorney for Los Angeles, in a prepared statement. “This historic settlement makes clear the consequences of putting corporate profits over honesty in the financial markets.”

[…]

With the S&P settlement, CalPERS said it has now recovered approximately $900 million in settlements from bad investments made during the bubble. The big pension fund already settled with Fitch but is continuing to press its suit against Moody’s.

The Justice Department statement on the settlement, which includes a list of the states receiving money, can be read here.

 

Photo by Stephen Curtin

Pension Funds Find Farmland To Be Fertile Investment

cornfield

Institutional investors are donning their straw hats, opening their tool sheds and getting to work in the crop fields.

Investors are drawn to farmland by strong returns and its weak correlation with other assets.

From The Economist:

Institutional investors such as pension funds see farmland as fertile ground to plough, either doing their own deals or farming them out to specialist funds. Some act as landlords by buying land and leasing it out. Others buy plots of low-value land, such as pastures, and upgrade them to higher-yielding orchards. Investors who are keen on even bigger risks and rewards flock to places such as Brazil, Ukraine and Zambia, where farming techniques are often still underdeveloped and potential productivity gains immense.

Farmland has been a great investment over the past 20 years, certainly in America, where annual returns of 12% caused some to dub it “gold with a coupon”. In America and Britain, where tax incentives have distorted the market, it outperformed most major asset classes over the past decade, and with low volatility to boot. Those going against the grain warn of a land-price bubble. Believers argue that increasing demand and shrinking supply—as well as urbanisation, poor soil management and pressure on water systems that are threats to farmland—mean the investment case is on solid ground.

It is not just the asset appreciation and yields that attract outside capital, says Bruce Sherrick of the University of Illinois at Urbana-Champaign: as important is the diversification to portfolios that farmland offers. It is uncorrelated with paper assets such as stocks and bonds, has proven relatively resistant to inflation, and is less sensitive to economic shocks (people continue to eat even during downturns) and to interest-rate hikes. Moreover, in the aftermath of the financial crisis investors are reassured by assets they can touch and sniff.

Read the full report from the Economist here.

Yves Smith on CalPERS’ Private Equity Review: Is It Enough?

magnifying glass on a twenty dollar bill

On Thursday, Pensions & Investments broke the story that CalPERS was putting its private equity benchmarks under review.

Beginning with the end of last fiscal year, the fund’s private equity portfolio has underperformed benchmarks over one year, three-year, five-year and ten-year periods [see the chart embedded in the post below].

CalPERS staff says the benchmarks are too aggressive – in their words, the current system “creates unintended active risk for the program”.

Yves Smith of Naked Capitalism has published a post that dives deeper into the pension fund’s decision – is the review justified? And is it enough?

__________________________________

By Yves Smith, originally published at Naked Capitalism

The giant California pension fund roiled the investment industry earlier this year with its decision to exit hedge funds entirely. That decision looked bold, until you look at CalPERS’s confession in 2006 that its hedge funds had underperformed for three years running. Its rationale for continuing to invest was that hedge funds delivered performance that was not strongly correlated with other investments. Why was that 2006 justification lame? Because even as of then, it was widely acknowledged in the investment community that hedge funds didn’t deliver alpha, or manager performance. Hedgies nevertheless sought to justify their existence through the value of that supposedly-not-strongly-correlated performance, or “synthetic beta”. The wee problem? You can deliver synthetic beta at a vastly lower cost than the prototypical 2% annual fee and 20% upside fee that hedge funds charge. Yet it took CalPERS eight more years to buck convention and ditch the strategy. Admittedly, CalPERS did keep its investments in hedge funds modest, at a mere 2% of its portfolio, so it was not an enthusiast.

By contrast, CalPERS is the largest public pension fund investor in private equity, and generally believed to be the biggest in the world. And in the face of flagging performance, CalPERS, like Harvard, appeared to be rethinking its commitment to private equity. In the first half of the year, it cut its allocation twice, from 14% to 10%.

But is it rethinking it enough? Astonishingly, Pensions & Investments reports that CalPERS is looking into lowering its private equity benchmarks to justify its continuing commitments to private equity. Remember, CalPERS is considered to be best of breed, more savvy than its peers, and able to negotiate better fees. But look at the results it has achieved:

Screen-shot-2014-12-12-at-6.26.23-AM

And the rationale for the change, aside from the perhaps too obvious one of making charts like that look prettier when they are redone? From the P&I article:

But the report says the benchmark — which is made up of the market returns of two-thirds of the FTSE U.S. Total Market index, one-third of the FTSE All World ex-U.S. Total Market index, plus 300 basis points — “creates unintended active risk for the program, as well as for the total fund.”

In effect, CalPERS is arguing that to meet the return targets, private equity managers are having to reach for more risk. Yet is there an iota of evidence that that is actually happening? If it were true, you’d see greater dispersion of returns and higher levels of bankruptcies. Yet bankruptcies are down, in part, as Eileen Appelbaum and Rosemary Batt describe in their important book Private Equity at Work, due to the general partners’ success in handling more troubled deals with “amend and extend” strategies, as in restructurings, rather than bankruptcies. So with portfolio company failures down even in a flagging economy, the claim that conventional targets are pushing managers to take too many chances doesn’t seem to be borne out by the data.

Moreover, it looks like CalPERS may also be trying to cover for being too loyal to the wrong managers. Not only did its performance lag its equity portfolio performance for its fiscal year ended June 30, which meant the gap versus its benchmarks was even greater. A Cambridge Associates report also shows that CalPERS underperformed its benchmarks by a meaningful margin. CalPERS’ PE return for the year ended June 30 was 20%. By contrast, the Cambridge US private equity benchmark for the same period was 22.4%. But the Cambridge comparisons also show that private equity fell short of major stock market indexes last year, let alone the expected stock market returns plus a PE illiquidity premium.

The astonishing part of this attempt to move the goalposts is that the 300 basis point premium versus the stock market (as defined, there is debate over how to set the stock market benchmark) is not simply widely accepted by academics as a reasonable premium for the illiquidity of private equity. Indeed, some experts and academics call for even higher premiums. Harvard, another industry leader, thinks 400 basis points is more fitting; Ludovic Philappou of Oxford pegs the needed extra compensation at 330 basis points

So if there is no analytical justification for this change, where did CalPERS get this self-serving idea? It appears to be running Blackstone’s new talking points. As we wrote earlier this month in Private Equity Titan Blackstone Admits New Normal of Lousy Returns, Proposes Changes to Preserve Its Profits:

Private equity stalwarts try to argue that recent years of underwhelming returns are a feature, not a bug, that private equity should be expected to underperform when stocks are doing well. To put that politely, that’s novel.

The reality is uglier. The private equity industry did a tsunami of deals in 2006 and 2007. Although the press has since focused on the subprime funding craze, the Financial Times in particular at the time reported extensively on the pre-crisis merger frenzy, which was in large measure driven by private equity.

The Fed, through ZIRP and QE didn’t just bail out the banks, it also bailed out the private equity industry. Experts like Josh Kosman expected a crisis of private equity portfolio company defaults in 2012 through 2014 as heavily-levered private equity companies would have trouble refinancing. Desperation for yield took care of that problem. But even so, the crisis led to bankruptcies among private equity companies, as well as restructurings. And the ones that weren’t plagued with actual distress still suffered from the generally weak economic environment and showed less than sparkling performance.

Thus, even with all that central help, it’s hard to solve for doing lots of deals at a cyclical peak. The Fed and Treasury’s success in goosing the stock market was enough to prevent a train wreck but not enough to allow private equity firms to exit their investments well. The best deals for general partners and their investors are ones where they can turn a quick, large profit. Really good deals can typically be sold by years four or five, and private equity firm have also taken to controversial strategies like leveraged dividend recapitalizations to provide high returns to investors in even shorter periods.

Since the crisis, private equity companies have therefore exited investments more slowly than in better times. The extended timetables alone depress returns. On top of that, many of the sales have been to other private equity companies, an approach called a secondary buyout. From the perspective of large investors that have decent-sized private equity portfolios, all this asset-shuffling does is result in fees being paid to the private equity firms and their various helpers….

As the Financial Times reports today, the response of industry leader Blackstone is to restructure their arrangements so as to lower return targets and lock up investor funds longer. Pray tell, why should investors relish the prospect of giving private equity funds their monies even longer when Blackstone is simultaneously telling them returns will be lower? Here is the gist of Blackstone’s cheeky proposal:

Blackstone has become the second large buyout group to consider establishing a separate private equity fund with a longer life, fewer investments and lower returns than its existing funds, echoing an initiative of London-based CVC.

The planned funds from Blackstone and CVC also promise their prime investors lower fees, said people close to Blackstone.

Traditional private equity funds give investors 8 per cent before Blackstone itself makes money on any profitable deal – a so-called hurdle rate.

Some private equity executives believe that in a zero or low interest rate world, investors get too sweet a deal because the private equity groups do not receive profits on deals until the hurdle rate is cleared.

Make no mistake about it, this makes private equity all in vastly less attractive to investors. First, even if Blackstone and CVC really do lower management fees, which are the fees charged on an annual basis, the “prime investors” caveat suggests that this concession won’t be widespread. And even if management fees are lowered, recall how private equity firms handle rebates for all the other fees they charge to portfolio companies, such as monitoring fees and transaction fees. Investors get those fees rebated against the management fee, typically 80%. So if the management fees are lower, that just limits how much of those theoretically rebated fees actually are rebated. Any amounts that exceed the now-lower management fee are retained by the general partners.

The complaint about an 8% hurdle rate being high is simply priceless. Remember that for US funds, the norm is for the 8% to be calculated on a deal by deal basis and paid out on a deal by deal basis. In theory, there’s a mechanism called a clawback that requires the general partners at the end of a fund’s life to settle up with the limited partners in case the upside fees they did on their good deals was more than offset by the dogs. As we wrote at some length, those clawbacks are never paid out in practice. But the private equity mafia nevertheless feels compelled to preserve their profits even when they are underdelivering on returns.

And the longer fund life is an astonishing demand. Recall that the investors assign a 300 to 400 basis point premium for illiquidity. That clearly need to be increased if the funds plan slower returns of capital. And recall that we’ve argued that even this 300 to 400 basis points premium is probably too low. What investors have really done is give private equity firms a very long-dated option as to when they get their money back. Long dated options are very expensive, and longer-dated ones, even more so.

The Financial Times points out the elephant in the room, the admission that private equity is admitting it does not expect to outperform much, if at all:

The trend toward funds with less lucrative deals also represents a further step in the convergence between traditional asset managers with their lower return and much lower fees and the biggest alternative investment companies such as Blackstone.

So if approaches and returns are converging, fees structures should too. Private equity firms should be lowering their fees across the board, not trying to claim they are when they are again working to extract as much of the shrinking total returns from their strategy for themselves.

Back to the present post. While the Financial Times article suggested that some investors weren’t buying this cheeky set of demands, CalPERS’ move to lower its benchmarks looks like it is capitulating in part and perhaps in toto. For an institution to accept lower returns for the same risk and not insist on a restructuing of the deal with managers in light of their inability to deliver their long-promised level of performance is appalling. But private equity industry limited partners have been remarkably passive even as the SEC has told them about widespread embezzlement and widespread compliance failure. Apparently limited partners, even the supposedly powerful CalPERS, find it easier to rationalize the one-sided deal that general partners have cut with them rather than do anything about it.

 

Photo by TaxRebate.org.uk

General Partners Gain Upper Hand Over Pension Funds As Raising Capital Becomes Easier

balancePensions & Investments released an interesting report yesterday outlining the balance of power in the private equity world between general partners and pension funds.

In the last few years, the balance of power has shifted dramatically towards GP’s, according to the report.

From Pensions & Investments:

Until the 2008 financial crisis, general partners pretty much set the rules, leaving most limited partners little say on terms, including on fees and expenses, when they committed to funds. Then fundraising got harder, and even the most popular private equity managers had to accept investors’ demands for lower fees and expenses and a greater degree of transparency.

Now, the highest-returning general partners are regaining the upper hand.

“Certainly, the pendulum has swung more toward the GP compared to 2009,” said Kevin Campbell, managing director and portfolio manager in the private markets group at fund-of-funds manager DuPont Capital Management, Wilmington, Del. The firm was spun out from the pension management division of DuPont’s pension plan in 1993.

[…]

Said DuPont’s Mr. Campbell: “I’ve seen the pendulum of power change positions several different times during the last 15 years,” where private equity fund terms are determined by the GP and sometimes they are more influenced by the LP.

Strong-performing managers that retain the same team and the same investment strategy used when they earned their strong returns have the most influence over fund terms, Mr. Campbell said. These managers also are raising a fund that is similar in size to their last fund and they have a “good investor base,” meaning investors who routinely commit to their funds, he said.

[…]

Some are increasing their negotiating clout by getting large capital commitments from sovereign wealth funds before the first close, enabling them to give other interested institutional investors a take-it-or-leave-it deal, said Stephen L. Nesbitt, chief executive officer of Marina del Rey, Calif.-based alternative investment consulting firm Cliffwater LLC.

Part of the reason GPs have power over LPs has to do with fundraising. GPs are having an easy time raising capital, which means they don’t have any incentive to negotiate terms with LPs. From P&I:

It’s easier to raise capital now; funds are raised more quickly and general partners have more influence on terms, he added.

Indeed, some private equity funds are closing very quickly, with access to much more capital than they need. Instead of holding several fund closings — giving general partners the ability to invest the capital commitments before the final close — a number of firms are having “one-and-done” closings. Because there are asset owners willing to invest on those terms, the GPs have little reason to give in to limited partners demanding changes to fund terms.

For example, Veritas Fund Management in August held a first and final close at $1.875 billion for its latest middle-market private equity fund, after just three months of fundraising. And private equity real estate manager Iron Point Partners LLC in November closed the Iron Point Real Estate Partners III LP at $750 million, well above its $450 million target.

And KPS Capital Partners LP held a first and final closing last year of its $3.5 billion KPS Special Situations Fund IV, above its $3 billion target. It was KPS’ third oversubscribed institutional private equity fund, according to a statement from the firm at the time.

Read the full report here.

Pension Funds Look to Place Bets on Shipping Recovery

shipping boat on the water

Some pension funds are thinking of buying a boat.

More specifically, they are weighing investments in the shipping industry, which some observers say is due for a recovery. If the industry does rebound, pension funds want to be among the beneficiaries.

But they are treading these waters carefully.

Reported by Reuters:

Pension funds, squeezed by low interest rates, are exploring investments in shipping in their hunt for higher returns, hoping to benefit once this industry starts to recover from one of its worst ever downturns.

There are signs of a gradual pick-up in world trade and ship values for the first time since the financial crisis. Ship financier NordLB has said the market could see a broad recovery but not before 2016.

The industry’s revival could deliver double-digit returns for pension funds that decide to add shipping to their so-called alternative assets such as infrastructure, which can make up about 15 percent of a fund.

But they need to do their homework.

Some hedge funds and private equity firms have been burned by diving into shipping too early and have found the recovery they were betting on has taken longer to materialise.

So far only a few pension funds have taken the plunge, also partly because of the need for specialised knowledge on shipping, such as how to price vessels accurately.

One pension fund leading the way is Ilmarinen in Finland, which had 34 billion euros ($41.8 billion) in assets at end-September. Earlier this year, Ilmarinen acquired five oil tankers and three supply ships from Finland’s state owned refiner, Neste Oil.

Esko Torsti, head of non-listed investments at Ilmarinen, said the investment was for tens of millions of euros through a new joint-venture firm owned by the pension fund and Finland.

“Investing in ships is not the easiest area, it requires extreme carefulness and special expertise,” Torsti said.

Another potential driver for investment is the shipping industry’s growing funding gap that has opened up as banks scale back lending due to capital constraints.

The combined value of ships on the water is estimated at $1.25 trillion with a further $380 billion in ships on order.

Among the pension funds that have taken the dive: Canada’s OMERS, Britain’s Merseyside Pension Fund and Finland’s Ilmarinen.

 

Photo by  Louis Vest via Flickr CC License

Hedge Funds Willing to Reduce Fees In Exchange For Longer Commitments

hedge funds lockup

Hedge funds are looking to lock up investor funds for longer periods of time — 66 percent of hedge funds aimed to lock up funds for one year or more in 2013, according to a survey by eVestment.

In exchange, funds are willing to revise their fee structures downward.

From the Wall Street Journal:

Managers say tying up investor money for a year or more enables them to buy less easily tradable but potentially more profitable assets. It also reduces the pressure from monthly or quarterly redemption requests when performance wanes.

Extending the term also allows managers to distinguish themselves from the growing cadre of “liquid alternative” mutual funds that try to replicate hedge-fund-style trading but must allow daily redemptions.

[…]

Two-thirds of new hedge funds demanded a lockup of one year or more in 2013, a 30% increase from the previous year, according to the most recent data available from research firm eVestment. The average fund has a lockup of 377 days, eVestment said. Those pushing for longer terms include funds managed by industry stalwarts like Fir Tree Inc., GoldenTree Asset Management LLC, Trian Fund Management LP and Viking Global Investors LP, said people with knowledge of the funds.

The fact that investors have been receptive to longer lockups could indicate higher confidence:

That investors are agreeing to the extended terms, or lockups, demonstrates a significant shift in confidence since the financial crisis, when trust was shaken by rapid market losses and some fund managers prevented investors from withdrawing their money. That was quickly followed in late 2008 by Bernard Madoff ’s admission he had been running a Ponzi scheme, causing billions of dollars in losses for his investors.

“As we move further and further from 2008, people are getting more comfortable,” said Spiros Maliagros, president of $3 billion hedge-fund firm TIG Advisors LLC.

But some investors are skeptical of longer commitments:

Some observers warn that investors should be careful about allowing a manager to keep their money for so long, pointing back to the crisis when some hedge funds—particularly those holding less-liquid assets— halted withdrawals. Some investors still haven’t been paid back.

“People have forgotten a lot of the lessons from the crisis,” said Andrew Beer, chief executive of Beachhead Capital Management, which invests in hedge funds.

Several investors said they were skeptical that many hedge funds, particularly those that invest in markets that are easily traded such as stocks, need the extra leeway. Some pointed to the recent underperformance of these equity-focused funds relative to their benchmark markets as a risk of extended lockups.

View the graphic at the top of this page to see how hedge funds are changing their fee structures for longer commitments.

Pennsylvania Teachers’ Pension Puts $2 Billion of Private Equity Stakes Up For Sale

SALE signs

The Pennsylvania Public School Employees’ Retirement System (PSERS) is attempting to sell a significant portion of its stakes in various private equity funds.

The pension fund is looking to sell off $2 billion of such investments, a total that amounts to about 22 percent of its private equity holdings.

PSERS is putting the stakes up for sale to cash in on high prices.

From Bloomberg:

Pennsylvania Public School Employees’ Retirement System is offering about $2 billion of private-equity fund stakes for sale after prices for such investments reached the highest levels since the 2008 financial crisis

The $53.3 billion system, known as Psers, hired Dallas-based investment bank Cogent Partners to manage the sale process, said three people with knowledge of the matter, who asked not to be identified because the information is private. The amount for sale is less than a quarter of the plan’s $8.7 billion private-equity holdings as of June 30.

“We are considering a secondary sale since we are overweight in our long-term allocation to private equity and have been since coming out of the financial crisis,” said Evelyn Tatkovski Williams, a spokeswoman at the plan.

The pension system’s level of private-market investments was near its 21 percent target as of June 30, according to data on the Psers website. Private markets includes private equity, private debt and venture capital.

Bill Murphy, a managing director at Cogent in New York, declined to comment on the sale process.

The pension plan reported a net investment return of 3.3 percent for private markets during the quarter ended June 30 and 14 percent for the latest fiscal year.

PSERS manages $53.3 billion in assets and is 63.8 percent funded.

 

Photo by  Simon Greig via Flickr CC License

The Dutch Pension System’s “Hidden Risk”

EU Netherlands

The Dutch pension system has been getting lots of press in recent days – a recent New York Times report and a PBS documentary from last year have espoused the virtues of the system, which covers 90 percent of workers while remaining well-funded.

But the system carries a “hidden risk” for participants. Allison Schrager explains in BusinessWeek:

Compared with defined-benefit plans in the U.S.—rare, underfunded, and governed by accounting standards derided by almost every economist—the Dutch pension system looks even better. It does have a weakness, though, one that’s often overlooked, even though it may be the only aspect of the Dutch system that’s likely to be adopted here: In the Netherlands, annual cost-of-living increases depend on the health of the pension’s balance sheet. If returns fall, benefits don’t increase. If the fund performs badly enough, pensioners may even suffer benefit cuts.

[…]

But to call it risk-sharing makes it sound more benign than it really is, particularly because retirees can’t tolerate as much risk as working people can. Post-retirement, most people live on a fixed income. In general, it’s too late to save more or get another job. Many state employees don’t have other sources of inflation-linked income like Social Security. If “fairness” means everyone has to bear risk equally, then the Dutch system makes sense. But if it’s more “fair” to treat people differently according to their means, then it would be better to share the risk with current workers instead.

Inflation risk may not seem like a big deal now. But the future is uncertain, which is why the guarantees are so valuable. Until the financial crisis, Dutch pensioners took it for granted they’d get their cost-of-living adjustment each year. Gambling on future inflation may be preferable to an underfunded pension—or no pension at all—but it’s no free lunch.

As Schrager points out, variations of the “risk-sharing” model have made their way to the United States:

This kind of risk-sharing has been catching on in America. Public pension benefits are often secured by state constitutions, but it’s not clear whether those guarantees extend to inflation-linked adjustments. Eager to contain costs, some states have eliminated cost-of-living increases entirely. The state of Wisconsin adopted a variant of the Dutch model in which retirees in the Wisconsin Retirement System get a cost-of-living adjustment only when pension assets return at least 5 percent. Previous inflation adjustments can be clawed back; monthly checks were 10 percent smaller in 2013 as a result of the financial crisis. Although, unlike in the Dutch plans, retirement income can never fall below its nominal level at retirement.

Stanford’s Josh Rauh and University of Rochester’s Robert Novy-Marx have projected that unfunded liabilities in the U.S. would fall by 25 percent if every state adopted Wisconsin’s pension model.

CalPERS Dials Up Real Estate; Will Increase Allocation By 27 Percent

man in suit holding small model house in his hands

CalPERS has beefed up its real estate portfolio this summer, but the fund is far from finished: by 2016, it plans to increase its real estate holdings by 27 percent.

The pension fund says real estate will largely fill the void left in the wake of its hedge fund exit.

From Bloomberg:

The California Public Employees’ Retirement System, the biggest U.S. fund, is increasing investments in real estate by about $6 billion within a year as it begins to exit hedge funds.

The $295 billion fund had 8.7 percent in real estate as of July 31. Since then, the allocation has risen to 9.9 percent, and the fund has set a target of 11 percent in fiscal 2016, according to documents posted on its website.

Calpers began restructuring its real estate portfolio after suffering a 37 percent loss in 2010, when it wrote off speculative residential investments as property values slumped. As part of the overhaul, the fund has focused on core income investments such as rental apartments, industrial parks, offices and retail space.

The shift will mean an increase in commercial real-estate investments by 27 percent, the Wall Street Journal reported.

More details on the strategy from the Wall Street Journal:

[CalPERS] is focusing on investments such as fully leased office towers and apartments in big cities, which it argues are safer because there is established demand for these properties. In another shift, the giant pension fund has been investing almost exclusively through real-estate funds that manage separate accounts created for Calpers, which offers more control over how that money is invested.

Some of Calpers’ real-estate consultants are warning that moving too much money into pricey properties could backfire. Pension Consulting Alliance Inc. cautioned in a July report to Calpers not to expect “these increases in value to be sustained when interest rates and new construction starts return to more normalized levels.”

Ted Eliopoulos, Calpers’ recently appointed chief investment officer, changed the fund’s real-estate approach in 2011, when he led that group. Since then, the fund has delivered average annual returns of 14% in its real-estate portfolio. But Mr. Eliopoulos acknowledges the recent high returns are unsustainable.

The fund’s goals now are to diversify its portfolio risk and generate steady, modest gains, rather than striving for outsize returns with more speculative bets, he said. Likewise, Calpers on Sept. 15 said it would shed its $4 billion investment in hedge funds as part of an effort to simplify its assets and reduce costs.

“Our strategy is to focus on high-quality real estate,” Mr. Eliopoulos said. “We’re still on track.”

CalPERS was a large real estate investor in the years before the financial crisis and frequently saw returns of 30 percent or more within the asset class. But the economic downturn led to losses of $10 billion, or 50 percent.

CalPERS’ CIO, Ted Eliopoulos, maintains that the fund learned from those losses and staff plan to make less speculative investments this time around.