CalPERS: A Call for Safer Investment Strategies

The California Public Employees’ Retirement System, known as CalPERS, manages a substantial amount of money, but it currently faces a troubling situation. As reported, the pension system has $180 billion in unfunded liabilities. In an effort to address this growing debt, CalPERS has recently decided to increase its investments in private markets, a choice that raises alarms regarding its potential risks for taxpayers.

Investing in private markets means that CalPERS will be putting money into assets that are not publicly traded. This includes things like private loans, real estate, and both private equity and venture capital investments. Specifically, CalPERS is set to raise its investment in private equity and private credit by 20%, which would mean these categories will make up 40% of its entire portfolio.

This change comes with a significant trade-off. To make room for these increased private investments, CalPERS has decided to decrease its holdings in public equity and fixed-income investments. Historically, the performance of CalPERS' portfolio has averaged a 6.7% return over the last 20 years. In contrast, had fund managers chosen to invest in a straightforward 60/40 public stock and bond index portfolio, they could have seen an average return of 7.7%. Furthermore, CalPERS has struggled to keep pace with the S&P 500, which yielded an impressive 9.7% return during the same period. This pattern of underperformance can also be seen through different time frames, including the past 5, 10, and 15 years.

One of the reasons private investments are touted is their potential for higher returns compared to public markets, along with promises of better diversification. However, these claims often do not materialize when the costs, risks, and market conditions are factored in. While private equity has historically appeared to be the strongest asset class for CalPERS—reporting a 20-year average return of 12.3%—this figure is influenced by the earlier phase of private equity investing when competition for deals was low and returns were easier to secure. In more recent years, particularly post-2008, private equity returns have not outperformed public markets, especially when considering fees and risks.

CalPERS's operational costs are quite substantial. For the fiscal year 2023-2024, it has set aside $790 million for administrative expenses and another $1.7 billion for third-party investment management fees. This results in a hefty total of $2.5 billion allocated for managing the pension fund. Alarmingly, despite these high management costs, CalPERS's average return over the last 23 years is only 5.6%, which is significantly lower than its anticipated rate of return of 7.6% during the same time frame.

CalPERS is not an outlier in this trend; many public pension funds are increasingly taking on more risk in hopes of recovering from chronic underperformance and addressing unfunded liabilities.

The consequence of CalPERS not achieving its investment return goals falls directly on California's state and local governments, ultimately impacting taxpayers. Public pension liabilities are legally mandated and cannot be neglected, meaning that when CalPERS investments underperform, it is the taxpayers who must make up for the shortfall.

Due to these continuous failures to meet expectations, CalPERS has had to revise its debt estimates. As of 2023, California's unfunded pension debt has climbed to $90 billion—this figure pertains solely to state liabilities, while local governments also hold nearly the same amount of unfunded debts. As a direct result, government contributions made by taxpayers have surged from 19.5% of payroll in 2014 to 32.4% in 2023.

These escalating pension costs have significant consequences for California's local governments, including cities, counties, and school districts. They will have less available funding for essential public services, such as education, infrastructure, and public safety. If these funding deficits persist, governments might be faced with difficult decisions, such as raising taxes, taking on more debt through bonds, or reducing services.

However, there is a more effective approach to consider. Since the year 2000, CalPERS has produced an average 23-year return of just 5.6%. By contrast, the Public Employees’ Retirement System in Nevada, valued at $58 billion, managed to achieve a 6.9% return. Significantly, Nevada PERS accomplished this with a much lower level of risk, employing only three staff members to manage the fund and dedicating efforts to investing predominantly in publicly traded index funds.

Going forward, CalPERS should shift its focus to proven, effective investment strategies that offer lower costs and consistently better returns for taxpayers and public employees alike. Rather than doubling down on high-cost, high-risk private investments that have underperformed, CalPERS should consider more efficient, lower-cost practices, such as integrating index funds into its strategy—a practice that has demonstrated superior performance in a variety of comparisons.

Mariana Trujillo, a policy analyst, argues for a rethinking of CalPERS's strategies to better serve public employees and protect taxpayers).

CalPERS, Investments, Taxpayers