CalPERS: A Risky Investment Strategy That May Burden Taxpayers

The California Public Employees’ Retirement System (CalPERS) currently faces $180 billion in unfunded liabilities. In an effort to address this financial challenge, CalPERS has recently approved a plan to significantly increase its investments in private markets. This decision marks a substantial commitment to a strategy that has yet to prove effective and presents considerable risks for taxpayers.

Investing in private markets involves managing non-publicly traded assets, including private loans, real estate, and private equity/venture capital. CalPERS aims to boost its private equity and private credit investments by 20%, leading to these assets comprising 40% of its overall portfolio.

This move comes at the expense of its public equity and fixed-income investments. Over the last 20 years, CalPERS has achieved an average annual return of 6.7%. In contrast, a corresponding passive investment in a 60/40 public stock and bond index would have yielded a 7.7% average annual return. Additionally, CalPERS has struggled to outperform the S&P 500, which reported a remarkable 9.7% return across the same timeframe, a trend that continues for the last 5, 10, and 15 years.

Private investments often tout higher potential returns and portfolio diversification. However, these promises frequently falter when considering the associated risks, fees, and market conditions. Though private equity has historically been touted as a high-performing asset class within pension portfolios, CalPERS has seen a 20-year annualized return of 12.3% on this class. This figure, however, stems from a period when competition for deals was low, making high returns more achievable. More recent private equity returns post-2008 have been disappointing, with many analyses indicating they don’t surpass public market returns on both a fee and risk-adjusted basis.

For the fiscal year 2023-2024, CalPERS has budgeted $790 million for administrative expenses and an additional $1.7 billion on third-party investment management fees. This results in total costs of $2.5 billion to manage the pension fund. Even with these substantial management expenditures, CalPERS has posted a 23-year average return of only 5.6%, falling short of its assumed 7.6% return for the same period.

CalPERS is not alone in its approach; many public pension plans are pursuing increased risk levels to offset chronic underperformance and rising unfunded liabilities.

When CalPERS underachieves its expected investment returns, it is Californians—state and local taxpayers—who shoulder the financial burden. This obligation is legally binding, meaning debts cannot be defaulted upon, so when CalPERS investments lag, the government is required to make up the difference, again coming from taxpayer funds.

As a result of continual underperformance, CalPERS recently updated its debt estimates, projecting the state’s unfunded pension debt to reach $90 billion in 2023. This estimate does not even cover local government liabilities, which are comparably significant. To counteract these liabilities, taxpayer contributions from government employers have surged, escalating from 19.5% of payroll in 2014 to 32.4% in 2023.

The increasing cost of pensions limits the available funds for critical public services such as education, infrastructure, and public safety. If these financial shortages persist, local governments may be forced into tough choices, including raising taxes, issuing bonds—adding to long-term debt—or cutting essential services.

Fortunately, there are alternative approaches. Since 2000, CalPERS' average return has been 5.6%. Conversely, the Public Employees’ Retirement System of Nevada, managing $58 billion, has achieved a 6.9% return during the same span, while assuming less risk than CalPERS. Nevada’s PERS obtains these returns with just three employees overseeing the fund, which helps keep costs low by primarily investing in publicly traded index funds.

CalPERS should shift its focus towards tested and efficient strategies that incur lower costs and reliably yield superior returns for taxpayers and public employees. Rather than continuing to invest heavily in high-risk and underperforming private market alternatives, CalPERS should consider adopting streamlined investment tactics, such as index funds, which have consistently outperformed its current strategies.

CalPERS, investments, taxpayer