Los Angeles County Employees Retirement Association significantly grew its private equity target Wednesday as part of a larger asset allocation reboot intended to provide better diversification to mitigate losses and enhance long-term returns.
The $70 billion pension system’s board of investments approved raising the target allocation from 10 percent to 17 percent, a sizable hike. But, the fund is considerably overweight in the asset class. As of March 31, 2021, private equity took up 13 percent of the fund’s assets.
The board considered several different asset mixes, all of which had more risk than the previous asset allocation. It ended up choosing the one recommended by staff. Once implemented, this allocation will place almost a third, or 32 percent, of the fund’s assets in illiquid investments.
Chief investment officer Jonathan Grabel said the greater risk was necessary to achieve the system’s actuarial return threshold of 7 percent.
“The higher risk is in terms of volatility, illiquidity, as well as operational complexity,” Grabel said. “With respect to these risks, I would not make a recommendation if we were not positioned to manage them.”
A staff memo said the increase in private equity assets would be funded by a reduction in global equities and investment grade bonds, due to the belief that private equity returns will be more attractive going forward. This would result in a considerable hike to the fund’s growth asset class allocation, which is made up of global equities, private equity and non-core private real estate.
“An increase to this category is designed to seek returns in a low-interest-rate environment,” the memo said.
LACERA’s consultant, Meketa Investment Group, played a key role in the asset allocation process. Last year, it published a working paper titled “Investing in a Low Rate Environment” which argued that because interest rates have remained so low for so long, and just went lower during the coronavirus pandemic, it may be necessary for investors to allocate more to riskier asset classes, including private equity, to meet return goals.
One of the areas of potential risk where the system may be more exposed is climate change, about which Meketa provided a short presentation.
“Portfolios that take on more investment risk will have a higher impact from climate change, because climate change tends to affect riskier assets,” said Meketa managing principal and co-CEO Stephen McCourt.
In fact, one of the assets most protected from climate change risk were investment-grade bonds, the very asset class from which capital was being redirected to private equity.
“As you move to asset allocations that have fewer of those assets and more assets that are at risk in businesses, those assets become more at risk due to climate change as well,” McCourt said.
The next step is for staff to transition to the updated asset allocation, a process McCourt said would likely take years.
Staff told Buyouts via email they were still working on that plan and would present a plan to the board at a future meeting.
Action Item: read the materials for the May 19 LACERA board of investments meeting here.