CalPERS Pioneers Total Portfolio Approach as US Pension Funds Question New Acronym
The California Public Employees’ Retirement System (CalPERS) has become the first US pension fund to adopt a total portfolio approach (TPA) to investment management, a move that is prompting debate among peers about the necessity of yet another industry label.
CalPERS’ shift, approved after extensive internal discussion, marks a significant step under the leadership of Chief Investment Officer Stephen Gilmore, who previously spearheaded similar strategies at NZ Super, Canada’s CPP Investments, and Australia’s Future Fund. However, some US public pension funds are skeptical that TPA represents a genuinely new approach, suggesting it simply formalizes common-sense investment principles.
“It’s interesting that we need a new acronym to help us focus on what should be common sense,” stated a senior investment officer at the $80 billion Pennsylvania Public School Employees Retirement System (PSERS), one of the oldest pension funds in the US, founded in 1917.
The official, Ben Cotton, who joined PSERS in 2023 after a career in the motor industry focused on retirement benefits, emphasized the importance of holistic investment decision-making. He explained that many investment firms have historically operated in “siloed and segmented” ways, prioritizing individual allocations over the overall portfolio’s performance. “I have tried to approach investments more holistically my whole career, and adding an acronym doesn’t make it a new strategy,” he said.
Cotton views TPA as a natural extension of sound investment practice – allocating capital based on prevailing opportunities while maintaining flexibility. PSERS already incorporates leeway into its allocation targets, allowing for strategic overweighting or underweighting of assets. Furthermore, the fund’s board routinely delegates rebalancing and asset allocation adjustments to the investment team within the framework of its strategic asset allocation.
“We always ask ourselves if we are making decisions that complement the whole portfolio or if we are making decisions that just maximise a silo in isolation. The former is the better way to go,” Cotton affirmed.
Currently, PSERS is nearing its target asset allocation, with a slight overweight in cash and an underweight position in long-duration fixed income. The fund’s leadership acknowledges that deviating from the long-term strategic plan requires strong conviction, a quality they believe is currently lacking in the market. As a result, they have maintained a closer adherence to target allocations.
Recent decisions illustrate this approach. PSERS eliminated its remaining 5% allocation to leverage, citing evolving market conditions. “When cash is close to zero and the cost of leverage is zero, over the long run the risk premium you pick up with a modest amount of leverage is additive. But once you hit the point where the cost of leverage is as high as the risk premium you pick up, it starts to introduce undue uncertainty, not only in return expectations, but also liquidity needs,” Cotton explained.
The fund’s decision to discontinue a long-standing foreign exchange (FX) hedging strategy, in place for 14 years, also exemplifies its holistic approach. Previously, PSERS hedged approximately 70% of its FX exposure to developed markets, a strategy that had reduced portfolio volatility and enhanced returns. However, the shift towards reshoring policies under the Trump administration altered the calculus. A weaker dollar, the fund reasoned, would make US-based manufacturing more competitive.
“On balance, we decided we’d rather not have that currency hedge,” Cotton reflected, adding that the move has not increased volatility in the equity portfolio and is being considered by other public pension funds.
Liquidity concerns, stemming from the fund’s 64% funded status, were central to both decisions. Paying out on hedges and settling derivative positions requires cash and incurs transaction costs. “In a period when we are concerned about our liquidity profile, we want to keep surprises at bay,” Cotton stated.
The fund’s funded ratio also influences its risk tolerance. A lower funded ratio compels pension funds to accept a minimum level of risk, as de-risking strategies could exacerbate inflationary pressures while simultaneously meeting cash outflow obligations. “Our funded ratio limits our options and opportunity to de-risk in light of uncertainty because de-risking exposes us to inflation at the same time as we are paying out cash to meet our liabilities,” he explained.
PSERS is also carefully managing its allocation to private markets, currently capped at 30%. Cotton noted that historical pacing models would have resulted in a significant overallocation. By moderating pacing, adopting a more selective manager approach, and selling off older assets, the fund has maintained its target allocation. “If we had blindly followed our pacing model in private markets based on historical experience, we would be significantly overallocated,” he said. The team benefited from favorable conditions when selling private assets in the secondary market, allowing them to reinvest proceeds during a market drawdown in April.
Despite the growing prominence of private markets, Cotton remains cautious due to higher capital costs and slower distribution cycles. “The cost of capital is much higher, so to make it work, investors want to buy private assets at a lower price. We are seeing things improve, but distributions are still challenged, and activity is a lot slower than historically.” He also highlighted the fund’s focus on minimizing fees, with a private markets fee load closer to 1:11, compared to the industry standard of 2:20.
A key priority for Cotton since joining PSERS has been rebuilding trust and strengthening communication between the investment staff and the board of trustees. This has involved increasing transparency, particularly regarding investment management fees, and providing the board with more contextualized information. “It’s about providing the information that helps answer [their] questions,” he said.
This improved communication has led to increased delegation of decision-making authority to the investment team, enhancing efficiency. “Up until recently, we had to bring approval for every GP commitment to the board, even when we were re-committing to long-term relationships. Now our policy provides for delegation approval for mandating certain existing relationships to the investment team, and it has started helping us be more efficient on investment decisions,” Cotton concluded.
