This article is from public number: Guotai Junan Securities Research (ID: gtjaresearch) , author: monarch asset allocation team title figure from: vision China
California Civil Service Retirement Fund (California Public Employee Retire System, CalPERS for short) was established in 1932, and it is the largest pay-as-you-go DB public pension in the United States.
As the world’s seventh largest pension fund, as of fiscal 2018, CalPERS ‘assets have reached US $ 354 billion.
The finale of the “Worldwide Top Institutional Asset Allocation Methodology Tour”, which was organized by the asset allocation team of Guotai Junan Research Institute and the Product Development Center, chose CalPERS as the most representative US public pension for analysis. There are three main reasons:
First, CalPERS was hit hard in the 2008 financial crisis. Not only have stock and real estate positions suffered, but total assets have shrunk to $ 100 billion, posing a serious threat to the long-term sustainability of the fund. We are not only concerned about the reasons behind it, the huge flaws that may exist in investment management, but also hope to help domestic institutional investors cope with possible future crises by summing up their lessons learned and subsequent reform measures.
Second, CalPERS has formed a complete set of asset allocation framework based on macro risks in recent years, and its investment methods and strategic characteristics are based on asset-liability management. This is highly complementary to the non-liability-constrained institutions we have studied, such as Norwegian sovereign funds and Singapore GIC, in terms of investment methodology, which helps us build a more complete institutional investor asset Configure the map.
Third, we also compared CalPERS with other pension funds we studied, including the Canadian pension fund CPPIB and the Taiwan Labor Retirement Fund. They have obvious similarities and differences in investment philosophy, investment model, and system and fund governance, so as to provide more levels of reference for China’s pension investment institutions.
In this push, we have selected some parts of the financial crisis case to share with you, to see the three lessons learned from this pension with heavy losses, and how it has taken five measures to repair the dead, Step by step out of the mud.
01 Mess in the ground after the crisis
The 2008 financial crisis caused huge losses to institutional investors worldwide, and CalPERS is almost the largest pension fund with the worst losses.
In June 2007, CalPERS had total assets of US $ 304 billion and a funding rate of 101%. By June 2009 two years later, CalPERS ‘total assets had shrunk to $ 212 billion, and the funding rate had fallen to 61%.
Among them, the stock position has shrunk from $ 100 billion to $ 38 billion, and in 2008-2010, real estate positions lost more than 70%.
Even though asset prices rebounded from 2009 to 2010, CalPERS ‘funding rate remained low at 65%.
As can be seen from the figure below, CalPERS’s liability side has been increasing, and has shown an accelerated rise after the discount rate has been reduced and life expectancy has been extended in recent years. However, the asset side has returned to its pre-crisis scale after 6 years after the financial crisis. Since 2014, investment performance has fallen short of expected returns, making it difficult to repair the funding rate.
As of June 2018, CalPERS ‘funding rate has reached only 70%, far from the 100% target, and far below many similar public pension funds, such as the New York State Common Retirement Fund NYCRF.
Historical changes in funding rate, Source: CalPERS, Guotai Junan Securities Research
02 Three Lessons from the Tragedy
We believe that CalPERS’s failure lessons in the crisis can be summarized as follows:
1, cyclical investment, lack of rebalancing policy
Before and after the crisis, CalPERS has obvious procyclical characteristics in both stock and real estate allocation.
In terms of stock investment, with the continuous rise of the US stock market from 2005 to 2006, CalPERS ‘domestic stock target allocation weight increased from 58% to 60%. When the stock price fell to the bottom in 2009, which is also the highest expected return in the future, the weight of the policy target fell to 56%, and the actual weight fell to 43%, which was far below the target weight and exceeded the range of change.
Because of this, because the stock position was sold in large quantities at the bottom of the market in 2009, CalPERS’s performance did not rise rapidly in the subsequent rise in stock prices.
CalPERS “chasing up and down” before and after the crisis does not meet the counter-cyclical investment philosophy of general long-term investors, and undoubtedly makes it suffer more serious losses.
In terms of real estate investment, before the financial crisis, CalPERS continuously increased real estate risk exposure and increased leverage.
In 2001, the loan-to-value ratio of CalPERS real estate investment was (LTV) , which increased to 41% by 2004, a rapid increase The leverage ratio has increased the risk exposure of real estate investment.
From 2006 to 2007, when real estate prices reached historical highs and the expected return on real estate investment was the lowest, the target weight of CalPERS ‘real estate investment rose from 8% to 10%. The actual weight reached a maximum of 9.2% in fiscal 2008 .
On the other hand, the lack of rebalancing policies has exacerbated CalPERS’s procyclical investment behavior.
Before 2009, CalPERS believed that the weight of asset allocation in investment portfolios fluctuated within a certain range, and there was no need for a rebalancing policy.
From 2001 to 2007, the proportion of domestic stocks in the United States was in the range of 37.8% to 40.6%. However, during the financial crisis, due to falling prices and being forced to sell stocks, the allocation ratio fell to 20.8% in 2009, which is equivalent to the crisis The first half. The share of global equity assets fell from close to 60% to 43% before the crisis, far below the target weight of 56%.
Although CalPERS has a target weight and range, it does not rebalance against this target.The lack of rebalancing policy has significantly deviated the asset allocation from the strategic asset allocation, amplified the volatility of returns, and failed to obtain a rebalance premium for a long time.
2, lack of risk management system
The lack of a risk management system, especially liquidity risk management, is another major cause of CalPERS’s severe damage in the financial crisis.
The liquidity crisis that CalPERS faced during the financial crisis was related to leveraged investment.
On the one hand, CalPERS cooperates with private equity and real estate investment companies to invest part of the capital and promise to transfer part of the investment income. After the investment income shrinks during the crisis, it will require a lot of liquidity to fulfill the capital as promised. Far more than the amount of liquid assets in the portfolio.
CalPERS also provides securities lending to brokers and short sellers, and invests in high-risk credit products as collateral. It also suffered huge losses during the crisis.
Under multiple shocks, CalPERS was forced to sell a large number of stock positions in exchange for liquidity in a market downturn.
In addition, CalPERS did not set a tracking error requirement range before the financial crisis, which caused tracking error to significantly exceed the risk budget during the crisis.
The tracking error of global stock investment exceeded the upper limit during 2009 ~ 2012, Source: CalPERS, Guotai Junan Securities Research
3. Fund governance is not sound, lacking independence and professionalism
So why did CalPERS make such a series of serious investment strategy mistakes? We believe that this is not the same as fund governance and investmentDefects in capabilities are inseparable.
The lack of independence of CalPERS investment management is manifested in three aspects:
First, the board lacks independence. The trustee of CalPERS is the board of directors, who is responsible for appointing the CEO, CIO and chief actuary. However, six members of the board of directors are from the pension beneficiary group, three are appointed by the governor, and four are from the government authority. None of them have a background in the investment industry.
In addition, the board of directors of CalPERS is not independent, and is easily affected by political factors, which affects the efficiency of fund investment management and even corruption.
For example, real estate investment became more aggressive before 2008, driven primarily by board members. In 2003, CalPERS invested in a number of real estate projects and funds, whose managers were the governor and the main contributors to two government officials who are members of the CalPERS board.
The second is the lack of independence in investment decisions. From the perspective of governance, the board of directors assumes the function of trustee and is responsible for formulating investment policies. The selected professional investment management team assumes the role of manager and is responsible for specific investment decisions. The board of directors should not directly participate in investment decisions.
However, the board of directors of CalPERS is directly involved in investment decisions by voting, and has taken certain investment decisions regardless of the opposition of the investment team, resulting in investment proportions exceeding the target allocation weight of such assets. These investments violate the rules and often end up inefficient and failing.
The third is the lack of independence in formulating remuneration mechanisms. CalPERS is subordinate to the California government and follows the state government’s salary system for civil servants. The compensation mechanism, which is far below the market, is difficult to attract outstanding talents in the industry, and it is more difficult to maintain long-term positions of senior executives. From 1994 to 2009, CalPERS experienced five CEOs and four CIOs, with a higher turnover of executive positions than similar funds.
Especially during the 2008 financial crisis, the positions of CEO and CIO were vacant at the same time, and a temporary CIO agent with no investment experience was responsible for investment management, which was one of the reasons for failing to take effective measures in time to avoid huge losses.
03 Five-point reforms for recklessness
After the financial crisis, CalPERS began to re-examine its own problems,The current investment philosophy began, reforming existing governance and investment systems, asset allocation processes and management systems.
In terms of investment, it is important to ensure the financing rate, asset-liability management and cost control. In terms of governance, increase transparency, streamline processes, and improve assessment and incentive systems.
1. Develop a comprehensive investment philosophy
In 2014, the CalPERS board of directors formulated 10 investment ideas, sorted out and clarified various issues encountered in investment cognition and practice, with the purpose of establishing a broad consensus at the entire institution level to ensure the board and management’s philosophy Coordinating with behavior, providing judgment basis and standards for all decisions.
Among them, the investment philosophy that debt affects the asset structure is the core, so CalPERS has established an asset-liability management framework.
10 investment ideas, source: CalPERS, Guotai Junan Securities Research
2. Establishing a more risk-conscious asset-liability framework
In order to achieve the long-term goal of 100% financing rate, the debt end should be fully considered in the asset allocation decision. To this end, CalPERS establishes a strategic asset allocation plan based on asset-liability management, and adjusts the allocation structure based on changes in liability actuarial assumptions.
According to CalPERS’s own situation, the Investment Office has established three portfolio priority goals: first, to maintain and protect the existing funding rate; second, to keep the employer’s contribution rate basically stable; and third, to achieve long-term revenue goals. Therefore, it is necessary to calculate and control the possibility and magnitude of the substantial retracement, and control the volatility of the portfolio income.
Finally, combining these three objectives, the board of directors selects the best solution among the candidate policy combinations.
CalPERS has established a risk budget. The tracking error of strategic allocation portfolios and policy benchmarks is limited to 0.75%. At the total fund level, including active investment, the tracking error is limited to 1.5%.
Since 2011, CalPERS has begun to shift to a macro risk-based asset allocation framework, which is described in more detail in subsequent sections of the report.
3. Strengthen overall portfolio management
CalPERS’s past investment management was based on the investment departments of each asset class, lacking overall coordination at the overall portfolio level.
In 2017, CalPERS established trust-level portfolio management (Trust Level Portfolio Management, TLPM) , a department responsible for strategic asset and liability management (ALM) and dynamic asset allocation (DAA) , and The function of portfolio strategy research.
TLPM is built on the basis of various investment units, manages and monitors the risk and performance of the investment portfolio from the trust fund level, and is responsible for the overall portfolio strategy.
In terms of ALM, TLPM and ALMAC each have a division of labor. ALMAC is responsible for coordinating the review and adjustment of the ALM cycle every four years by the board of directors. TLPM is authorized by the Investment Committee to implement SAA, set target return rates and select asset allocation portfolios.
TLPM’s dynamic asset allocation DAA functions include the use of overlay portfolios to manage liquidity, leverage, strategic and active risk exposures, and implement a systematic rebalancing policy.
In addition, the DAA also includes a variety of multi-asset strategies, such as a tail risk buffer strategy. (Control downside risks and protect funding rates) , Volatility target strategy (Manage total portfolio volatility) ,And establish partners to implement outsourced dynamic asset allocation strategies.
This overlay strategy occupies less capital and accounts for less than 1% of the total portfolio, but it has played a significant role in reducing the tracking error of the total fund.
Management structure and functions of TLPM, Source: CalPERS, Guotai Junan Securities Research
4, reduce management costs
Before the financial crisis, the outsourcing management cost of CalPERS was significantly higher than that of its peers. High management costs and huge losses during the crisis caused some pressure on CalPERS. And after deducting fees, the performance of some outsourced active investments is comparable to that of self-operated passive investments, and high management costs have not brought benefits to CalPERS.
After the crisis, CalPERS began a series of measures to strengthen cost effectiveness, including continuing to promote outsourcing investment to proprietary investment, reducing external cooperative investment partners, reducing external investment manager fees, and reducing external investment consultants.
From 2011 to 2018, CalPERS ‘outsourced management expenses and operating expenses were reduced from US $ 262 million to US $ 23 million, a significant reduction of 91%. Measured by the CEM benchmark, the management cost of CalPERS is already lower than the average value of similar funds.
After this transformation, CalPERS’s passive and proprietary investment ratios have increased significantly, with proprietary investment accounting for 80% of the portfolio.
5, Improve fund governance
CalPERS improves fund governance in two ways.
First, strengthen information disclosure, increase transparency, and strengthen accountability mechanisms. CalPERS recognizes the need to strengthen public oversight by improving transparency and reducing complexity to reduce internal corruption, inefficiency, and unclear power and responsibility. For example, CalPERS discloses annual financial benefits to members of the board of directors and senior management to strengthen compliance risk management.
The second is to improve the performance evaluation and incentive system. In 2018, the CalPERS board of directors approved the CIO compensation structure adjustment proposal to increase basic wages, add performance-based compensation mechanisms and long-term incentives, raise the compensation of investment managers to the median level in the industry, and provide long-term incentive The mechanism is linked to the performance of the five-year fund, to achieve consistency in long-term interests, and to ensure that managers do not damage the interests of fund owners because of short-sighted investments.
This article is from the public number: Guotai Junan Securities Research (ID: gtjaresearch) , author: monarch asset allocation team