The California Public Employees’ Retirement System recently announced good news—it is lowering their investment assumption from 7% to 6.8%. Oh, and the nation’s largest pension fund also returned a strong 21.3% on investments for their most recent fiscal year.
The reduction in investment assumption was actually triggered by the investment returns. CalPERS in 2015 enacted a policy that stated its assumed rate of return would reduce by a certain amount each year, but only if its investment returns reached a certain amount annually. Ultimately, the pension fund hopes to get to a 6.5% assumed rate of return.
There is no doubt this year’s CalPERS return is a positive for the pension fund. Financial markets around the world were really strong between July of 2020 and June 2021, and CalPERS took advantage of that. But the more important piece of news from last week is about how CalPERS is using this return as leverage to continue adopting more reasonable long-term assumptions.
One year of good returns should not be treated as evidence CalPERS fixed its problems. Even their board members have said this.
At the same time, one year of bad returns — like last year’s 4.7% — doesn’t mean the sky is falling. CalPERS, as a long-term investor, cares about its average return relative to assumptions. And what matters the most is making sure that the pension fund has the right expectations about the future.
Over the past few years, CalPERS has gradually been reducing its investment assumptions because there is a consensus that investment returns in the future will not be as good as the past. Over the past 30 years CalPERS has averaged around 8%; but going forward its investment advisors have estimated average returns will be closer to a 6% return.
So the step from a 7% assumption about future returns to a 6.8% return is just that, a step. It is a positive step, but also doesn’t mean CalPERS work on adapting to the 21st century is done.