Institutional Investors: Where in the World Will Returns Come From? (audio/video update)

Panelists and Fund Profiles:

• Joe Deere (CalPERS): CIO of California's public employees retirement system; manages $260 billion; target return of 7.5%; funded status improved from 60% to 73% post-crisis.
• Janet Cowell (NC Treasurer): Oversees $80 billion for 875,000 beneficiaries; currently 20% allocated to alternatives, proposing a 40% allocation via legislation.
• Michael Sabia (Caisse de Dépôt): CEO of Canadian fund with $176 billion AUM; target return of 6.7%; 87% of portfolio managed internally.
• Maurizio Wanderly (Funcef/Dalia): CIO of Brazilian pension fund with $8 billion AUM; historically 100% Brazil overweight, moving toward diversification; 20-year annualized return of ~20%.

Performance Recovery and Liability Context:

• CalPERS recovered from a $100 billion drawdown to pre-crisis levels, driven by maintaining high growth risk exposure and restructuring operations.
• North Carolina rebounded from a $20 billion loss in 2009, now exceeding $80 billion despite a conservative historical allocation (35% fixed income, 40%+ equities).
• CalPERS highlights a tension between the 7.5% target return and current low-yield environments, noting a 10-year average return of 8.1% despite the crisis.
• CalPERS warns that achieving 7.5% requires high growth risk, exposing funds to "tail events" that could create a deep hole difficult to grow out of without reducing target returns.

Strategic Shifts in Asset Selection and Risk Management:

• Focus on "Real Economy" Assets: Caisse de Dépôt prioritizes assets rooted in the real economy (goods, services) over traditional asset class categories, emphasizing quality and selectivity over broad market exposure.
• Move Away from Benchmarks: Caisse de Dépôt is shifting from relative returns to absolute returns, avoiding index-hugging strategies in favor of direct ownership of undervalued companies.
• Internalization of Management: Caisse de Dépôt manages 85–87% of its portfolio internally at a cost of $0.17 per $100 assets, citing efficiency and the ability to hold assets long-term (10–15 years) for infrastructure deals.
• Risk Hedging Limitations: Janet Cowell notes that hedging against long-term low-growth scenarios is too expensive; strategies are limited to specific sub-segments (e.g., currency) or trading strategies (e.g., rebalancing fees).
• Tail Risk Mitigation: CalPERS is evaluating tail hedging programs, minimum volatility strategies, and low-beta hedge fund exposures to moderate drawdowns while maintaining growth exposure.

Geographic Allocation and Emerging Markets:

• Brazilian Diversification: Funcef is moving from a 60% fixed-income (inflation-linked) portfolio to alternatives due to falling interest rates, targeting 8% private equity, 8% real estate, and 25% equity.
• Infrastructure Opportunities in Brazil: Key investments include private equity in middle-class consumption sectors, real estate (malls), and infrastructure (ports, oil drilling for Petrobras, railroads, and logistics).
• Emerging Market Selectivity: Michael Sabia emphasizes that success in "high-growth markets" (China, Brazil) requires substantial local partners to navigate transparency challenges; Caisse de Dépôt currently holds 8% direct exposure in these markets.
• Indirect Exposure Strategy: Caisse de Dépôt utilizes indirect exposure to emerging growth via Western multinationals (e.g., Canadian resource firms, Nestlé) influenced by Chinese and Brazilian demand.
• US as Emerging Market: Janet Cowell references North Dakota's energy boom as a significant "emerging market" opportunity within the US.

European Market Outlook:

• Distressed and Debt Opportunities: CalPERS sees opportunities in European distressed debt and loans (8–12% returns) rather than large-scale bank restructuring, driven by ECB liquidity preventing immediate balance sheet cleanups.
• Mid-Cap and Infrastructure Gap: ECB liquidity has reduced bank financing, creating gaps for mid-cap funding and infrastructure investment, particularly in assets suitable for long-term institutional holds.
• Political Caution: Caisse de Dépôt acknowledges Europe's "hesitation" in political leadership and the "quasi-political" risk of monetary policy but maintains a cautiously optimistic stance on long-term stability.
• Valuation Constraints: Entry prices in Europe remain elevated due to bank liquidity support; investors must wait for balance sheet cleaning to access high-quality assets at "decent prices."

Alternatives and Real Assets Strategy:

• Shift to Direct Investment: CalPERS aims to move from fund-of-funds to direct co-investments and internal management to save fees (estimated $18 million in fund fees) and gain control.
• Infrastructure Scarcity: A primary bottleneck for pension infrastructure investment is not capital but the lack of vehicles and tax laws that welcome long-term pension capital; CalPERS is creating structures to hold assets long-term.
• Inflation Hedging: Real assets (energy, infrastructure, real estate) are increasingly viewed as necessary to fill the "hole" left by declining fixed-income yields and to hedge against inflation.
• Fee Reduction as Return: Janet Cowell highlights that internal management and removing intermediary fees can effectively return 10%+ on investment through cost avoidance alone.

Forward-Looking Statements and 2013 Outlook:

• CalPERS: Adopts a "moderately offensive posture," anticipating a slow-growth (not no-growth) environment driven by US household formation and global demand (China, Brazil); remains committed to the 7.5% target via selective dislocation hunting.
• North Carolina: Planning to secure legislative approval for 40% alternative allocation to access credit, selective equity, and stressed real estate opportunities; expects the biggest challenge to be finding enough high-quality partners.
• Caisse de Dépôt: Maintains a "moderately offensive" capital deployment strategy, avoiding sitting on sidelines, while remaining vigilant regarding political and monetary policy risks in Europe.
• Funcef: Continues diversification globally and domestically (increasing equity/real estate/PE), looking for opportunities in international alternatives and maintaining a focus on long-term trends despite short-term interest rate fluctuations.