CalPERS and the Risky Investment Gamble: Why a Safer Approach is Needed

The California Public Employees’ Retirement System (CalPERS) is facing serious financial challenges, with $180 billion in unfunded liabilities according to its latest report. Efforts to lower this debt have led CalPERS to adopt a plan that significantly increases its investment in private markets. This move raises concerns about unnecessary risks that could ultimately burden taxpayers.

Private market investments include non-publicly traded assets such as private loans, real estate, and private equity ventures. CalPERS aims to boost its investments in private equity and private credit by 20%, making these investments account for 40% of its total portfolio. However, this shift means reducing its investments in public equities and fixed income assets.

Over the past 20 years, CalPERS has achieved an average annual return of 6.7%. In comparison, a passive investment strategy that involved a 60% allocation to public stocks and 40% to bonds would have yielded a 7.7% return. Even more striking is CalPERS’ difficulty in keeping pace with the S&P 500, which provided a return of 9.7% during the same timeframe. This pattern of underperformance has persisted over 5-, 10-, and 15-year periods.

Private investments are often promoted as a means to attain higher returns and diversify portfolios. However, when accounting for risks, management fees, and actual market performance, these investments frequently disappoint. On paper, private equity has been CalPERS’ top-performing asset class, boasting a 20-year annualized return of 12.3%. Yet, this figure stems from a time when competition for private equity deals was limited, making high returns easier to secure. More recent estimates suggest that private equity returns following the 2008 financial crisis have not outperformed public market returns when adjusted for fees and risk.

For the fiscal year 2023-2024, CalPERS has earmarked $790 million for administrative costs, along with another $1.7 billion for third-party investment management fees, totaling $2.5 billion annually in fund management costs. Even with these substantial expenses, CalPERS has recorded a dismal 23-year average return of only 5.6%, significantly trailing behind its assumed return target of 7.6% over the same duration.

This trend is not unique to CalPERS; many public pension plans are opting for riskier private investments in their quest to offset chronic underperformance and escalating unfunded liabilities. When CalPERS fails to meet its investment return goals, it is the taxpayers in California's state and local communities who shoulder the burden of the resulting financial shortfall. Public pension obligations are legally binding, meaning there is no option to default on them. Therefore, when the investments within the pension fund underperform, government employers must find a way to cover the losses, leading to increased costs for taxpayers.

CalPERS has had to revise its debt estimates upwards because its investment performance fell short, resulting in California's unfunded pension debt now reaching an estimated $90 billion in 2023. This figure does not even take into account the unfunded liabilities of local governments, which approximate a similar amount. To address these growing liabilities, taxpayer contributions for government employers have skyrocketed from 19.5% of payroll in 2014 to 32.4% in 2023.

These escalating pension costs can negatively impact California's cities, counties, and school districts, leaving them with diminished funding for critical public services such as education, infrastructure, and public safety. As pension shortfalls become more pronounced, governments may have to consider difficult options like raising taxes, issuing bonds that increase long-term debt, or making cuts to essential services.

There is, however, a more prudent method that could be followed. Since the year 2000, CalPERS has realized an average return of only 5.6% over a 23-year span. In contrast, Nevada's Public Employees’ Retirement System (Nevada PERS), which manages a fund of $58 billion, achieved a return of 6.9% over the same period, all while taking on less risk than CalPERS. Remarkably, Nevada PERS accomplished this with just three staff members overseeing the fund, keeping costs low by investing predominantly in publicly traded index funds.

CalPERS should reorient its strategy to focus on tested and effective investment approaches that lower costs and consistently yield better returns for both taxpayers and public employees. Rather than doubling down on costly, high-risk private investment strategies, CalPERS would be better served adopting efficient, low-cost investment strategies, such as using index funds, which have consistently surpassed its returns.

CalPERS, Investments, Taxpayers