Calpers Confronts Cuts to Return Rate
Trimming 7.75% Could Add to California's Woes; BlackRock to Board—'You'll Be Lucky to Get 6%'
By GINA CHON
Wall Street Journal, March 1, 2010
Calpers is considering reducing the projected rate of return used by the giant pension fund to make investment decisions. A cut could force cash-strapped governments in California to pay millions more each year to cover their employee pension obligations.
Since 2003, the California Public Employees' Retirement System has assumed that the value of its stocks, bonds and other holdings would increase by 7.75% a year. But the likelihood of an extended period of modest economic growth world-wide is fueling doubts inside Calpers that the pension fund can continue aiming so high.Pressure to lower the target has been building for months. "You'll be lucky to get 6% on your portfolios, maybe 5%," BlackRock Inc. Chairman and Chief Executive Laurence Fink told Calpers board members last July.
Calpers is a client of the New York company. Mr. Fink declined to comment Friday. No specific alternate targets have been discussed by Calpers officials, but the board has been encouraged to shrink its projected rate of return to as low as 6%.
"It's bruising...but it has to be done," said David Crane, a pension adviser to California Gov. Arnold Schwarzenegger. Facing a projected budget deficit of nearly $20 billion, the Republican favors a lower target at Calpers, according to Mr. Crane. Calpers manages about $200 billion, making it the U.S.'s largest public pension fund.
The percentage is an important factor in calculations by Calpers officials of future contributions needed from employees and local governments to cover payouts promised to retirees and other beneficiaries. If the return assumption declines, contributors likely would have to make up the difference.
Paying more into Calpers could deepen the financial misery facing many California governments. Some likely would increase taxes or cut services.
For the pension fund, lower investment-return expectations could reduce the temptation to seek outsize profits through real-estate, private-equity and other nontraditional investments that wound up burning Calpers with big losses.
In its fiscal year ended June 30, Calpers was down 23%, or $58 billion, the worst performance in the pension fund's 78-year history. It was up 12% for the year ended Dec. 31. Calpers's annualized return over the past 20 fiscal years is slightly higher than the 7.75% target.
At a meeting of the pension fund's investment committee last month, some Calpers board members pressed to review whether the current 7.75% projected rate of return still is realistic.
"We intend to open that question," responded Joseph Dear, the pension fund's chief investment officer, according to a transcript of the meeting. "Should we be considering other possible outcomes?"
Patricia Macht, a Calpers spokeswoman, said Mr. Dear still feels comfortable that 7.75% "could be the right number, but he's not making that prediction." The pension fund wants to hear varying opinions so that it has the information it needs to make a decision, she added.
The decision isn't expected until early 2011. Calpers officials also are examining the pension fund's asset allocation, risk management and other areas as part of a routine review done every three years.
Calpers last reduced its rate-of-return assumption in 2003 amid economic turbulence. The previous target was 8.25%.
The most common projected rate of return among public pensions in the U.S. is 8%, according to Pew Center on the States, a research unit of Pew Charitable Trusts. But that figure looks daunting following double-digit percentage losses at many pension funds amid the financial crisis.
Even though many pension funds topped their assumed returns over the long term, "whether or not that should be the rate going forward is another question," says Kil Huh, Pew research director.
William Atwood, executive director of the Illinois State Board of Investment, says he is comfortable with the pension fund's assumed 8.5%-a-year return, noting that Illinois has earned about 8.6% a year since 1970.
Still, public pension systems are watching Calpers closely because "they are the big kid on the block," Mr. Atwood says. The Illinois investment board manages three pension funds with $8.7 billion in assets.
At Calpers, about 75% of payouts come from the pension fund's investments, with the remaining 25% tied to contributions from California governments and employees. According to Pew, a hypothetical $100 billion pension fund that achieved a 7.75% return rate for 10 years would have about $211 billion. With a 6% rate, the same fund would grow to $179 billion—a difference of $32 billion.
Mr. Schwarzenegger has proposed as part of the budget being debated in Sacramento that state employees contribute an additional 5% for their retirement costs. While forcing outsiders to pump more into Calpers would be painful, there is no alternative given the huge liabilities facing the pension fund, said Mr. Crane, the governor's pension adviser.
Mr. Schwarzenegger had proposed that the state's contribution to Calpers increase to at least $4.5 billion in the next fiscal year. The pension fund, which can change the employer-contribution rate without legislative approval, agreed to a $3.5 billion payment. That would defer some of the cash payments needed to make up for investment losses and reduce the impact on local governments.
Another potential loser if Calpers decides to ratchet back its ambitions: private-equity firms. The pension fund was a private-equity pioneer, starting with a $1 billion allocation in 1990 that has since grown to about $25 billion.
A lower assumed rate of return could cause Calpers to reduce its exposure to private equity and other aggressive holdings. The pension fund already is looking to prune the number of private-equity firms with which it invests and reduce its fees by making direct investments in deals.
-- Peter Lattman
contributed to this article.
Link to original Wall Street Journal story
Submitted by Jim Wagner
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