CalPERS CEO on ESG: Our position 'really has not changed' despite political pushback

The California Public Employees' Retirement System, also known as CalPERS, is the largest public pension fund in the U.S. CalPERS CEO Marcie Frost spoke to Yahoo Finance Live as part of its "Retirement Readiness" series. Frost says the asset classes that worked well for them over the last 12 months were public equity and private debt, while private equity and real estate underperformed.

There has recently been a lot of pushback, particularly from Republicans, against environmental, social, and governance, or ESG investing. Frost, though, says CalPERS is long-term investors and they are sticking with a strategy that gives them ESG exposure. "Our position and our posture on ESG really has not changed, regardless of the political headwinds that are starting to pick up," Frost says. However, Frost also notes CalPERS remains "completely invested in the oil and gas industry on the public equity side."

Video Transcript

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AKIKO FUJITA: A recent BlackRock survey finds a record number of Americans are increasingly feeling off-track when it comes to retirement savings. Market volatility and inflation are only adding to the anxiety. The country's largest pension fund, California Public Employees Retirement System, or CalPERS, still managed to post a gain of near 6% on the year despite that. I spoke to CEO Marcie Frost about the challenges of investing in this environment and why she continues to doubledown on ESG.

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MARCIE FROST: You're correct. We have a return target of 6.8. And the 5.8 certainly didn't hit that target. So what we're really looking at is we run a very diversified portfolio, where we saw the asset classes perform very well. We're in public equity and in private debt, private credit. And the asset classes that did not perform as well would be the private equity private equity and real estate.

But you know, where we're looking is, where can we take more active positions, whether that's public equity or private equity? Where can we take the active position where we actually have conviction around a specific strategy or about a trend? And under our new chief investment officer, or newer, I should say, Nicole Musicco, adding in those active strategies across the portfolio, that's one of the places where we think we can generate additional alpha.

AKIKO FUJITA: You mentioned private equity. This was the first full fiscal year where you really ramped up investments in that space. And we did see a bit of a pullback on that, slipped about 2%. Are you rethinking that investment in terms of how prominently it is in the portfolio?

MARCIE FROST: We will-- we always look at the way that the assets are allocated across the various markets. We have an agenda item coming up in November, what we call our mid asset class review, our mid asset liability review. So we're always looking to see if the policy target still makes sense under long-term conditions.

Remember, we're a very long-term investor. We don't really make shifts, dramatic shifts shorter term. But private equity, for us, we were a little bit later too to the game there. We had a very strong outing, I would say, you know, as private equity was starting to emerge as an asset class back in the '80s. And then we really stalled out over a period of time. We did a 15-year lookback at that stall period and really what that cost the portfolio in terms of returns.

So I think the secret for us is to stay committed. Stay into our policy target that move from 8% to 13%. And then just making sure that we do that consistent deployment of capital across all of the vintage years. And again, that 15-year lookback gave us a bit of insight into areas where we didn't perform as well. And a lot of that can be attributed to the fact that we were not a consistent allocator. So consistency at a time where valuations are coming down, putting capital in while the valuations are lower, is still a good strategy.

Increasing the allocation to co-investments, starting to look more at venture capital. I know that we have a newer head of our private equity team. And he believes that we've got, you know, the team in place, the utility in place to really take the 10% private equity allocation and move that into venture, 10% of that 13%.

AKIKO FUJITA: What about bonds? I mean, we have seen-- you are the largest public pension fund. But we have seen some of your other counterparts talk about increasing exposure when you're getting yields of 5% to 4%. And we have seen so much choppiness at least in the equity space. Is that something that you're looking to lean in on further?

MARCIE FROST: I think the diversification of the portfolio, the ratio between, you know, our equity exposure and the bond exposure, I don't see that changing dramatically. It's been-- fixed income was a flat performer for us this last fiscal year. We still have some drawdown risk protection in the portfolio and that did impact our fixed income returns due to some of the duration decisions that were made. We also have a factor weighted sleeve that underperformed our cap weighted sleeve in public markets.

But the board will have an opportunity to look at that again in November 1, determine whether that drawdown risk protection is still working the way that we intended it to work, but also look at the allocations to the various asset classes and make sure that they, you know, will be consistent over the new capital market assumptions that we're starting to see come in.

AKIKO FUJITA: Let's talk specifically about ESG investments, which is something that you have really been a big proponent of before, increasingly political. We have seen Republicans recently holding a hearing about the value of ESG investing. You recently doubled down on that saying that you still believe in exposure, at least on the ESG side. What's driving that? And are you still getting the same returns?

MARCIE FROST: So we're very long-term investors. And the way that we have looked at the E, the S, or the G is really the risk mitigation. So are we being compensated appropriately for every unit of risk that we're taking, whether that's related to climate, whether that's related to human capital, whether that workers are being treated in companies, as an example, or governance? Do we have independent board directors on the companies where we're investing?

So our position and our posture on ESG really has not changed regardless of the political headwinds that are, you know, starting to pick up as we all have noticed. But we are finding great investments on the alternative or the cleaner energy side and the private part of our portfolio. But we still remain completely invested in the oil and gas industry on the public equity side.

AKIKO FUJITA: So let's talk about that, because the state of California, the Senate at least, recently passed a bill that essentially calls for public pension funds, such as yourself, to divest from fossil fuel companies. You know, you spoke out against that, saying that that's not necessarily something that CalPERS should be thinking about, especially because your core mission is to maximize returns.

MARCIE FROST: It is--

AKIKO FUJITA: Is there a bit of a hypocrisy between doubling down on ESG investments but also still saying that you don't believe in divesting from fossil fuels? Help me understand that divide.

MARCIE FROST: Yeah. We don't see it as hypocrisy by any means. What we see it as, as I mentioned, finding those opportunities where we think we can hit that 6.8 return target that we have in order to pay the benefits to the 2 million members who are expecting to receive them. But also, really understanding as a part of the energy transition itself, how are the current oil and gas companies planning to transition their business models into those cleaner energy technologies?

And we have to have a seat at the table. We think that our voice really matters in this. We get the callback when we make a call out to one of the oil and gas CEOs. I get a callback if I need one. But we think that staying in at this point and really understanding the transition, because this is about reducing emissions in the total economy, not just about reducing emissions in a specific sector or specific industry.

The moment we start kind of hammering out a particular part of the portfolio, we do have this opportunity where we may have missed some returns that we would have otherwise gotten. So we have to be very careful there, very cautious. We have a fiduciary duty, a fiduciary responsibility. So we think staying in for now makes sense, you know, really looking at the energy transition, helping to fund the energy transition, which will take over $1 trillion of capital to do that appropriately and really not leave anyone behind.

And then also finding those great investment deals on the private side of the portfolio, of which we found a number of those. You know, I can't remember the number right now, but I think 30% of the real assets portfolio is already invested in cleaner energy technologies.

AKIKO FUJITA: If it is about maximizing returns, though, I mean, help me understand, how big of a hit you would take if you were forced to divest from fossil fuels completely?

MARCIE FROST: The numbers that we've been communicating to a variety of stakeholders is that even with a 4.4 potential BPS loss in performance, that is about $385 million a year. And over a 20-year period of time, you're talking over $1 billion, of which those costs get completely transferred to the public employers who are paying into the system.

So the unfunded liability is what happens when we expect an investment to return. Remember, we're a universal owner. We own the market, including oil and gas. When we create tracking error by divesting from a particular sector or a particular company, that is tracked on an annual basis by the board's external consultant. And in this case, our assumptions based on economic scenarios is there could be a 4.4 BPS loss in return over a 20-year period of time.

AKIKO FUJITA: And that was CalPERS CEO Marcie Frost.