Winner: CalPERS

The largest public pension plan in the US – the US$495bn California Public Employee’s Retirement System (CalPERS) – has long been a CLO investor and has been involved with middle market CLOs since 2018. However, what caught our attention was market participants’ reports of the fund’s increased buying activity at the top of the MM CLO stack from the beginning of 2022 and its public announcement of a new asset allocation strategy at the end of 2021. That, combined with the reassurance of the US$495bn behemoth’s strong and long-term presence in a market dealing with difficult times, makes CalPERS a clear choice for SCI’s MM CLO Investor of the Year.

“Middle market CLOs is actually part of our broader CLO strategy,” explains Justina Wang, investment manager at CalPERS. “We constantly evaluate opportunities that align with CalPERS Core Values across different asset classes, and middle market is a part of that.”

CalPERS has established itself in the market as a chiefly relationship-centric investor, prioritising collaboration and longevity in deals. “Why so many managers like to work with us is because we view our investment as a partnership,” says Wang. “We work together with the managers through all aspects of the deal – from the assets, right through to the document negotiations.”

CalPERS appreciates the impact that the expected recession may have on the middle market space, but also considers it an opportunity to see greater manager differentiation as they weather the wider macroeconomic difficulties. Indeed, prior to investment, CalPERS dedicates a lot of time to understanding the value of managers.

“One of the key components of our MM CLO strategy is that we really view our work with managers as long-term partnerships,” Wang says. “Given our selected manager’s track record and expertise – as well as the resilience of CLOs seen in the past through different credit cycles, and the structural protections embedded in the CLO structure – I believe our portfolio should fare through this economic downturn okay.”

CalPERS has strengthened its MM CLO business triumphantly in the last 12 months as it has refocused its wider CLO strategy. Nevertheless, CalPERS’ steadfast commitment to establishing relationships with managers has continued through this refocus.

Wang explains: “We keep a dialogue open with the managers – even after the CLO transaction has closed – which means we can continue to talk and, if the right opportunity presents itself, then we are not afraid of moving forward with it. We’ve learned a lot over the past year – both deal-wise, market dynamic-wise and industry-wise. We really have an appreciation for the managers and how they are willing to help us understand the credit selection process.”

On 15 November 2021, the CalPERS Board of Administration announced that it had selected a new asset allocation mix that will guide the fund’s investment portfolio for the next four years, while at the same time retaining the current 6.8% target it assumes those investments will earn over the long term. The board also approved adding 5% leverage to increase diversification.

The decision concluded a nearly year-long comprehensive review of the pension system’s investment portfolio and actuarial liabilities. Known as the Asset Liability Management (ALM) process, the board conducts the evaluation every four years.

As part of the ALM process, led by CalPERS’ investment, actuarial and financial offices, the board examined different investment portfolios and their potential impact to the CalPERS fund. Each portfolio presented a different mix of assets and corresponding rate of expected return and risk volatility.

Ultimately, the board selected the portfolio with expected volatility of 12.1% and a return of 6.8%. The discount rate has been at 6.8% since July, when a strong double-digit fiscal year investment return automatically triggered a reduction under the Funding Risk Mitigation Policy.

The new asset allocation incorporated a shift towards alternative assets, which would include CLOs. It included a projected increase in private debt investment from 0% to 5% – representing approximately US$25bn. The new asset allocation took effect from 1 July 2022.

For the full list of winners in this year’s SCI Middle Market CLO Awards click here.