“The sharp decline in markets caused the global equity allocation to fall below the minimum of the policy range. Additionally, cash was raised by selling equities to meet part of the liquidity needs of the fund,” according to a memo that will be presented and discussed at a December 15 investment committee meeting. The alternative allocation is also well above the admissable policy range.

Given today’s environment, there is limited flexibility for pension funds to manage their asset allocation relative to existing policy ranges. The profound dislocations have moved Calpers to review its strategic asset allocation adopted in December 2007. Those guidelines stipulate a 56% weighting in global equity, a 9.5% allocation to alternatives and zero to cash. The combination of sharply lower stock valuations and actual selling of equities lowered the fund’s equity allocation to 41.9% or 9% below its +/-5% range. The fund’s alternative allocation has risen to 13.8%, 4.3% above its +/-3% policy range and cash is now at 8.6%. Global fixed income (21.7%) remains very close the policy target.

‘No other option’

“Calpers and other institutional investors face unexpectedly rapid asset allocation changes due to the unanticipated extreme stock market volatility and illiquidity in the fixed-income environment. We are of the opinion that the most prudent approach during the current market environment is to temporarily widen the asset class ranges until such time as the investment committee adopts a new asset allocation policy,” wrote the Pension Consulting Alliance.

“If the stock market had increased 40% in value over the past year, no one would be requesting a new study,” Wilshire Consulting wrote in a letter to Anne Stausboll, Calpers’ interim CIO. “We do note, however, that the illiquidity in the fixed-income portfolio was unanticipated in the last study.” The potential drain on cash liquidity that could be caused by commitments by alternative investments and real estate to new funds was also unanticipated, according to the letter. The over-allocation to alternative investments, the inability to sell fixed-income securities and the potential to maintain an on-going cash balance are all new elements of asset allocation that were not incorporated in the 2007 evaluation and augur for a new study.

“No other option, including buying stock options to hedge further market declines, selling fixed-income at current prices, or re-investing the 9% cash position in equity futures appeared to be a better use of Calpers’ capital than waiting for action by the Federal Reserve and the US Treasury to free up the currently illiquid fixed-income markets.”

Historically, Calpers’ Alternative Investment Management (AIM) had difficulty reaching its target allocation. This was largely due to strong public market performance and favourable private equity market conditions that led to substantial distributions. Commitments in the alternative sector averaged about $12bn per year in the 2006-2008 period. Today, distributions have slowed considerably. The situation is not unique to Calpers. Many public pension funds are experiencing what is known as the denominator effect with respect to their private equity holdings and are in the process of re-evaluating targets or ranges for a number of asset classes.

VB