In a Wall Street Journal editorial, Ben Meng, the Chief Investment Officer of the California Public Employees’ Retirement System, announced their goal of achieving a risk-adjusted return of 7% would require a strategic change based on investing in “better assets” and “more assets”.

Calpers is the largest defined-benefit public pension fund in the U.S., so changes in their strategy can be an important bellwether.

According to Mr. Meng:

Calpers must diversify and increase exposure to private assets, such as private equity and private credit. We refer to these as “better assets” because they have the potential for higher returns and lower expected volatility when compared with publicly traded assets.

“More assets” refers to a plan to use leverage, or borrowing, to increase the base of the assets generating returns in the portfolio. Leverage allows Calpers to take advantage of low interest rates by borrowing and using those funds to acquire assets with potentially higher returns.

Using leverage to buy illiquid assets does not sound like a good idea to me.  Banks and pension funds
used a similar strategy prior to the Global Financial Crisis, investing in illiquid mortgage backed securities (MBSs) and collateralized debt obligations (CDOs), and that didn’t turn out well.

Opinion | Calpers Prepares for the Long HaulBy investing in private equity and credit, we expect to be able to achieve 7% returns.www.wsj.com

Scary. Meng is betting private equity has an 8.3% annual return, versus stocks at 6.8%, but with higher volatility and risk. Seems like volatility and risk are jarring words for a pension fund for 2 million public employees.

Margaret Brown seems to be the only board member (out of 12) that thinks it’s too risky. She points to the loss of $100 billion, a quarter of the fund’s value, during the 2008 collapse of the market, but a spokesman for the fund says that was equity — not the same.

The Financial Times did a story about her concerns.

Calpers board member objects to $80bn leverage gambleUS public pension scheme's push into private equity and private debt is 'too risky', according to Margaret Brownwww.ft.com

The FDIC is now permitting banks to invest in illiquid venture capital funds. Apparently banks don't need that extra liquidity since the Federal Reserve will ensure those pesky bank runs are a thing of the past. That's so 2008!

The FDIC’s decision to ease the Volcker Rule could prove to be a boon for some startups, freeing up banks to invest tens of billions of dollars in high-risk venture capital funds that specialize in fast-growing fledgling companies.

Bank stocks surged on the news, which will free financial institutions (FIs) to pump as much as $40 billion into venture capital funds, a move that supporters say will boost growth among small businesses and startups and create badly needed jobs.

Volcker Rule Revision Inspires Hope For Startups | PYMNTS.comThe FDIC's decision to ease the Volcker Rule could be a boon for some startups, freeing up banks to invest tens of billions of dollars in high-risk VC funds.www.pymnts.com

Interesting possible result of this development. Banks may end up making emergency loans to the VC firms’s startups to keep the startups afloat, the VC firms afloat, and ultimately the banks afloat.

No cascading effects of disaster to worry about.

I wonder if they will want to invest in Softbank’s $100 billion Vision fund:

“It also runs Vision Fund, the world's largest technology-focused venture capital fund, with over $100 billion in capital.“

Further Reading

The Vision Fund And Its Impact On The Venture Capital Market

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What, me worry?