CalPERS Risky Investment Strategies Could Burden Taxpayers

The California Public Employees’ Retirement System (CalPERS) is facing significant financial challenges, with reports indicating $180 billion in unfunded liabilities. In an effort to address this growing debt, CalPERS has adopted a plan that increases investment in private markets, a move that raises alarms due to its associated risks for taxpayers.

Private market investments entail ownership of assets that are not publicly traded. This includes private loans, real estate, and private equity as well as venture capital. The current plan indicates CalPERS aims to boost its commitments to private equity and private credit by 20%, which means these types of investments will make up 40% of its total portfolio.

However, this adjustment necessitates a cut in holdings of public equities and bonds. CalPERS has reported an average annual return of 6.7% over the past two decades. In contrast, a simple investment in a passive portfolio—comprised of 60% public stocks and 40% bonds—would have yielded an average annual return of 7.7%. Additionally, CalPERS has been unable to match the performance of the S&P 500, which delivered a 9.7% return over the same timeframe. This trend of underperformance is consistent across the past 5, 10, and 15-year periods.

While private investments are frequently marketed as opportunities for higher returns and portfolio diversification, the reality often tells a different story. When risks, fees, and actual market conditions are taken into account, these lofty promises often fall short. On paper, private equity has appeared to be CalPERS’ best-performing investment category with a 12.3% annualized return over the last 20 years. However, this figure originates from an earlier time when fewer investors were chasing after deals, which made higher returns more feasible. Many experts suggest that post-2008 private investment returns have been less favorable, often lagging behind public markets when adjusted for risks and fees.

For the fiscal year 2023-2024, CalPERS forecasts its budget to allocate a staggering $790 million for administrative costs, along with an additional $1.7 billion in fees for third-party investment management, resulting in total management costs of $2.5 billion. Unfortunately, even with these high expenditures, the fund's 23-year average return has only reached 5.6%, which is considerably below the assumed return rate of 7.6% for the same timeframe.

CalPERS is not an isolated case; the trend of increasing private investment reflects a broader pattern among public pension plans that are undertaking greater risks in hopes of remedying persistent underperformance and escalating unfunded liabilities.

When CalPERS fails to meet its forecasted investment returns, responsibility falls squarely on California’s state and local governments, thereby impacting taxpayers. Public pension liabilities are legally mandated, which means there is no prerogative to default on these obligations. Consequently, when the investment performance of the pension system falters, government employers are compelled to cover any deficits, further straining taxpayer resources.

CalPERS has had to revise its debt estimations after consistently underwhelming investment returns, leading to California’s unfunded pension debt reaching an alarming $90 billion in 2023. Notably, this figure reflects only the state’s debt, while local governments grapple with an almost equivalent amount of unfunded liabilities. Subsequently, the contributions from government employers, funded by taxpayers, have escalated from 19.5% of payroll in 2014 to 32.4% in 2023.

This rise in pension-related expenses is squeezing California’s cities, counties, and school districts, leaving them with less funding for essential services such as education, public safety, and infrastructure. If funding deficits persist, governments face tough decisions to either hike taxes, issue bonds—which leads to more long-term debt—or reduce public services.

Nonetheless, a more effective approach may be evident. Since 2000, CalPERS has experienced a 23-year average return of merely 5.6%. In sharp contrast, the Public Employees’ Retirement System of Nevada, which manages a fund of $58 billion, achieved a 6.9% return during the same period while taking on significantly less risk. Nevada PERS accomplished such results with only three employees who managed the fund, thereby minimizing costs and enhancing long-term returns through a near-total investment in publicly traded index funds.

Thus, rather than continuing to pursue high-cost, high-risk—and ultimately underperforming—private investment strategies, CalPERS ought to focus on proven, cost-effective methods that yield superior returns for both taxpayers and public employees. Switching to low-cost investment strategies like index funds, which have consistently outperformed CalPERS' current model, should be given serious consideration.

CalPERS, Pension, Investment