For nearly nine years straight, U.S. stock prices have been on the rise. By many measures, valuations are high. No one knows where the current bull run will end — but the aging market cycle is enough to make investors nervous.
Attempts to time the market, however, can have mixed results: Sell too soon, and miss out on gains from the continuing market rally. Fail to de-risk in time, and suffer during the crash. And when the portfolio being invested is beholden to government officials and future retirees, not to mention a board, rebalancing is often easier said than done.
“The scrutiny for public pension funds has never been more intense than it is right now,” says Daniel Cummings, a managing director at executive recruiting firm EFL Associates.
While he says it’s rare for pension CIOs to be terminated for cause, investment chiefs face mounting job pressures in the wake of prolonged low interest rates and low returns. Worsening the situation is that most public pension plans remain underfunded in the aftermath of the 2008 financial crisis: The 100 largest U.S. pensions had an aggregate solvency ratio of 70.7 percent in mid-2017, according to a Milliman study.
“What’s a CIO to do in light of the knowledge that a correction could happen?” Cummings asks. “If they de-risk, they could possibly leave return on the table. So do they get out of equities, do they change the position?”
The California Public Employees’ Retirement System, led by CIO Ted Eliopoulos, is among the allocators now attempting to answer that question. At a board workshop in mid-November, CalPERS managing investment director Eric Baggesen presented four possible portfolio changes to adopt beginning in 2018. One option, including a 50 percent allocation to global equities and a 28 percent fixed-income target, closely resembled CalPERS’ existing portfolio at the end of September, adhering to the 7 percent expected return the board adopted in December 2016.
But two other options entailed a cutback on equity exposure, with the most drastic reducing the portfolio’s global equity target to just 34 percent and adopting a 44 percent fixed-income allocation. This portfolio, Baggesen said, would decrease the fund’s expected volatility to 9.1 percent from 11.5 percent — but it would also bring the fund’s expected return down to 6.5 percent, increasing the need for employer contributions.
“We consider any of these portfolio mixes to be implementable and potentially prudent portfolios, although they are not necessarily all equally advisable,” Baggesen said. Neither he nor the board expressed a preference for any of the four portfolio candidates, though he pointed to “fairly stretched” U.S. equity valuations as a concern. While a CalPERS spokesman reached two weeks after the workshop declined to comment on which portfolio the fund was leaning toward, California government officials have made their views clear on the matter.
More than 30 mayors, city council members, and other representatives from around the state attended the workshop to voice their concerns about raising contributions from strained city budgets. Among them was Kathryn Downs, director of finance for Carson, California, who said lowering the pension’s expected return would be “very problematic” for her city.
CalPERS’ Eliopoulos has remained quiet. At the pension’s most recent investment committee meeting, his comments merely drew from the fund’s stated investment beliefs: “We should ensure the ability to pay promised benefits by maintaining an adequate funding status.” Easier said than done.