CalPERS reveals challenges in raising core allocation

The $260 billion pension system has approved a two-year extension of its interim real estate portfolio limits to give itself more time to increase its core exposure.

The California Public Employees’ Retirement System (CalPERS) plans to extend its interim real estate policy limits by two years to allow more time for the rebalancing of its property portfolio to be more heavily weighted toward core strategies.

The primary area where CalPERS’ real estate portfolio is out of compliance is in its allocation to core investments. Currently, the pension plan has set an interim range for the risk category at 20 percent to 100 percent of its total real estate portfolio through June 30 and at 50 percent to 100 percent through June 30, 2015. 

However, given a core allocation of 43.4 percent as of September 30, “current market conditions combined with delayed timing for certain key portfolio transactions means the real estate portfolio is unlikely to meet these shorter-term targets,” Pension Consulting Alliance (PCA) wrote in a memorandum to CalPERS. Extending the interim limits would allow the pension’s staff “adequate time to prudently address the remaining out-of-policy issues.”

CalPERS staff has strived to rebalance the portfolio more heavily toward core through the acquisition of more core properties and through the liquidation of opportunistic investments. However, two primary factors have challenged the pension plan’s ability to make new core acquisitions. First, executing new operating agreements has taken longer than expected, an issue that staff intends to address through the hire of additional managers in fiscal year 2014. Also, the level of pricing of core assets in target markets has made it difficult for CalPERS’ managers to make investments that would generate desired returns.

“As a result, it has been challenging to significantly increase CalPERS’ exposure to core through acquisitions,” PCA noted in its memo. “It is anticipated that larger portfolio-level transactions may come to market over the next two years, and it is possible that CalPERS will be able to meet the current long-term strategic limits by 2015 by acquiring larger portfolios of assets.”

Alternatively, CalPERS could rebalance its real estate portfolio partially by selling its legacy opportunistic investments at a more aggressive pace, although that strategy could have the adverse impact of reducing the overall percentage allocation to real estate in the short term. That said, PCA advocated such a liquidation strategy because those investments are inconsistent with CalPERS’ real estate objectives given their risk characteristics, namely leverage, alignment, control/governance issues and fees. In addition, “the management of these investments is highly specialized and time consuming,” PCA added. 

CalPERS has a long-term strategic limit of 75 percent to 100 percent for core and 0 to 25 percent for both value-added and opportunistic investments. Under the newly approved policy limits extension, the target date for achieving that limit will be July 1, 2017. As of September 30, the pension plan’s allocation to real estate was nine percent of its overall portfolio, within a long-term strategic range of 7 percent to 13 percent.