CalPERS is considering doing away with traditional asset class classifications in favour of classifying assets according to fundamental characteristics in a bid to provide a better understanding of portfolio risks and performance drivers and so move to a more effective portfolio construction and risk management framework. In response to analysis of the CalPERS portfolio, which found that the big Californian public sector fund did not have a meaningful-enough exposure to assets that could have been a hedge in times of financial crisis and provide adequate liquidity to the fund, the staff and the board’s consultants – Wilshire and PCA – have developed an alternative classification of assets based on underlying fundamental characteristics.

CalPERS now uses five broad asset classes in its strategic asset allocation – public equity, private equity, fixed income, real estate, inflation-linked and cash – but the new classification system would expand this to six different categories based on return drivers and fundamental characteristics. In a letter to the investment committee, PCA describes the new asset classifications as a “necessary evolution towards a more effective portfolio construction and risk management framework”. The proposed new categorisations are: government bonds, income; growth, inflationlinked, market neutral and liquidity. Under those broad categories, assets or “building blocks” are allocated according to their objectives and risk drivers.

Within government bonds sits government nominal bonds and government inflation-linked bonds, which have the objective of diversifying growth assets, hedging liabilities, and providing liquidity. In the income classification sits investment-grade spread sector, securities lending and credit enhancement, which are driven by yield and have the aim of diversification and liability hedging. In growth sits public equities, private equity, real estate and highyield bonds which aim to achieve high returns from economic growth subject to prudent risk. Inflation-linked consists of infrastructure, forestland and commodities which aim to hedge inflation risk and risk of commodity price spikes and are driven by changes in inflation. Market neutral includes absolute return, hedge funds and all strategies with low asset class beta, which aim to materially outperform cash and generate stable returns and are driven by manager decisions.

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