Overnight one of the biggest #pension schemes in the world set out plans to borrow up to $30bn, to avoid firesales of assets, in times of market stress.

Calstrs, the $317bn California-based #pension fund, is a big investor in illiquid assets. It wants to add 10% leverage.

— Josephine Cumbo (@JosephineCumbo) January 5, 2024

What’s all this then?

Has Calstrs, the largest pension fund in the world got itself in a bit of trouble? Is it borrowing liquidity because it has to – or because it wants to invest in patient capital?

It turns out to be the latter. The story was broken in the United States by Bloomberg and  it goes like this

The California State Teachers’ Retirement System, the country’s second-largest pension fund, may borrow more than $30 billion to help it maintain liquidity without having to sell assets at fire-sale prices, according to a new policy its investment committee will consider this month.

If approved, the policy will allow staff to borrow as much as 10% of the roughly $318 billion portfolio. The proposal calls for leverage to be used “on a temporary basis to fulfill cash flow needs in circumstances when it is disadvantageous to sell assets,” a Calstrs policy document said.

The California Public Employees’ Retirement System board approved adding 5% leverage in 2021, adopting an investment strategy that could enhance returns but potentially increases the risk of losses during market downturns.

Meketa Investment Group, a Calstrs consultant, said increased leverage poses minimal risk to the fund. Calstrs already leverages 4% of its portfolio, and the new policy would not create a new asset allocation policy. Instead leverage would be used to smooth cash flow and as an “intermittent tool” to manage the portfolio,

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Why is this important?

If you are a farmer, you may be sitting on  £100m worth of land but it you can’t find the money in your bank account to pay to get your milk to market, you are going bust. You need money in the bank or at least an overdraft facility to draw on when cash dries up (and your cows don’t).

The business of pension schemes is not to get milk to market but to get pension payments into people’s bank accounts on time and in full. That’s the missioin.

To get that done, there needs either to be an Exchequer – like the Treasury that pays our state and unfunded public pensions, or a fund – that can be drawn on when money is needed.

If you run a payroll that runs to billions of dollars a month – as Calstrs does – you need a great deal of cash every month – you need liquidity. Everyone who has ever run a business knows that sometimes liquidity dries up.

Which is why businesses run an overdraft facility which allows them to borrow money rather than having to sell land, plant or even lose the business.

So why not just keep the money in cash?

The answer is all about “conviction “, conviction in the positive sense of the word. Calprs are convinced that by investing for the long-term in real assets which are non-fungible, it can achieve its mission at the least cost to its sponsors.

This is a very different view than that which we have taken in the UK this century. Here we believe that should a pension scheme be called upon to wind up tomorrow, it should be able to do so. So we ask pension schemes to be funded “marked to market” and be ready for buy-out. This has resulted in cash demands from sponsoring employers from Trustees , egged on by the Pension Regulator. Pension Schemes were targeted to be funded for self-sufficiency or buy-out with “reasonable recovery times”. The result was disinvestment from real assets that provided productive finance in the UK to a point where only 4% of our DB scheme assets are even invested in the UK , let alone in the areas of the economy that need long-term patient capital.

The “conviction” of the Calprs fiduciaries is such that they would rather pay for a revolving liquidity system (an overdraft to you and me) than risk having to sell investments at times of financial stress.

Though this may be thought of by many as a “bad thing”, I think it is a good thing. I wish that a lot more UK pension funds would seek capital backing and set about investing for the future as Calprs has. I see no problem in schemes running an overdraft facility so that they can pay pensions and death claims and lump-sums on request, while being fully invested.

Is borrowing always bad?

Self-evidently no it isn’t. Almost every business is required to get short-term liquidity and pay a price for it , in order that it can carry out its mission and achieve its long-term goals.

People who don’t understand this, have not run businesses.

Having an overdraft the size that Calprs is considering makes for a blistering headline but in reality, having $310bn in assets is also a blistering headline! You don’t get to that position by putting your money on deposit.

Borrowing for short-term contingencies is not bad, borrowing as a long-term strategy – as happened with leveraged LDI is another matter.

If we are to switch from a pension system intent on its own wind-up , to one that wishes to pay pensions on an indefinite basis, we are going to need to invest funds to maximum effect. Calprs and their advisers have worked out that it is better to run an overdraft and stay invested than keep a liquid buffer in the fund and miss out on the investment opportunity. Most businesses would recognise that as good business. So why doesn’t more of that happen with our pensions?

Pensions need not  be  a corporate debt, they can be a business asset. When Bim Afolami asks his regulators to write him reports, the first section has to be about the impact of regulation on promoting growth. Calprs has given our regulators a template.