Harvard Case - California PERS (A)
"California PERS (A)" Harvard business case study is written by Jay O. Light, Jay W. Lorsch, James E. Sailer. It deals with the challenges in the field of Finance. The case study is 18 page(s) long and it was first published on : Jul 10, 1991
At Fern Fort University, we recommend that the California Public Employees' Retirement System (CalPERS) adopt a more diversified investment strategy, with a greater focus on alternative asset classes like private equity, real estate, and infrastructure. This shift should be accompanied by a comprehensive risk management framework and a robust due diligence process for all investments.
2. Background
The case study focuses on CalPERS, the largest public pension fund in the United States, facing challenges in achieving its investment objectives due to a changing economic environment and increasing pressure to meet its obligations to its beneficiaries. CalPERS's traditional investment portfolio heavily relies on fixed income securities and equities, leaving it vulnerable to market volatility and potentially inadequate returns.
The main protagonists are the CalPERS Board of Administration and the investment staff, who are responsible for managing the fund's assets and ensuring the long-term financial security of its beneficiaries. The case study highlights the internal debate regarding the optimal investment strategy, balancing risk and return while navigating a complex regulatory environment.
3. Analysis of the Case Study
This case study can be analyzed through the lens of several frameworks:
- Financial Analysis: CalPERS faces a significant funding gap, requiring a shift from a passive to an active investment strategy. This necessitates a thorough financial analysis of its existing portfolio, including balance sheet analysis, income statement, and ratio analysis to identify areas for improvement.
- Risk Management: CalPERS needs to develop a robust risk management framework to mitigate the impact of market volatility and other unforeseen events. This framework should incorporate hedging strategies, stress testing, and scenario planning to assess potential risks and develop appropriate mitigation measures.
- Investment Management: CalPERS should consider a more diversified investment strategy, including allocating a greater portion of its portfolio to alternative asset classes like private equity, real estate, and infrastructure. This requires a deep understanding of these markets, including valuation methods, due diligence processes, and investment management expertise.
- Corporate Governance: CalPERS needs to ensure strong corporate governance practices, including transparency, accountability, and alignment with its mission. This involves establishing clear investment objectives, implementing robust governance structures, and ensuring compliance with relevant regulations.
4. Recommendations
- Diversify Investment Portfolio: CalPERS should diversify its portfolio by increasing its allocation to alternative asset classes, including private equity, real estate, and infrastructure. This diversification will help mitigate risk and potentially generate higher returns.
- Strengthen Risk Management: Implement a comprehensive risk management framework that includes:
- Risk identification and assessment: Proactively identify and assess potential risks across all asset classes.
- Risk mitigation strategies: Develop and implement appropriate risk mitigation strategies, including hedging, diversification, and stress testing.
- Risk monitoring and reporting: Continuously monitor and report on risk exposures and the effectiveness of mitigation strategies.
- Enhance Due Diligence: Implement a robust due diligence process for all investments, including:
- Thorough research and analysis: Conduct in-depth research and analysis of potential investments, including financial statements, management teams, and market conditions.
- Independent evaluation: Engage independent experts to evaluate investment opportunities and provide objective assessments.
- Ongoing monitoring: Continuously monitor investments and adjust strategies as needed.
- Develop a Long-Term Investment Strategy: CalPERS should develop a long-term investment strategy that aligns with its mission and considers its long-term financial obligations. This strategy should be reviewed and updated regularly to reflect changing market conditions and economic forecasts.
- Improve Transparency and Communication: Enhance transparency and communication with stakeholders, including beneficiaries, policymakers, and the public. This includes providing regular updates on investment performance, risk management practices, and investment strategies.
5. Basis of Recommendations
These recommendations are based on several key considerations:
- Core Competencies and Consistency with Mission: Diversifying the portfolio and strengthening risk management align with CalPERS's mission of ensuring the long-term financial security of its beneficiaries.
- External Customers and Internal Clients: The recommendations address the needs of both beneficiaries and the CalPERS Board of Administration by seeking to maximize returns while mitigating risk.
- Competitors: CalPERS needs to stay competitive with other large pension funds by adopting innovative investment strategies and adopting best practices in risk management.
- Attractiveness: The proposed investment strategy has the potential to generate higher returns and mitigate risk, ultimately improving the long-term financial health of CalPERS.
6. Conclusion
CalPERS needs to adopt a more diversified investment strategy, focusing on alternative asset classes and implementing a comprehensive risk management framework. This approach will help CalPERS achieve its investment objectives, mitigate risk, and ensure the long-term financial security of its beneficiaries.
7. Discussion
Other alternatives not selected include:
- Maintaining the current investment strategy: This approach would be risky and could lead to inadequate returns, potentially jeopardizing CalPERS's ability to meet its obligations.
- Investing solely in fixed income securities: This strategy would be too conservative and likely generate low returns, failing to meet the needs of CalPERS's beneficiaries.
Key assumptions of the recommendations include:
- Market conditions will remain favorable for alternative asset classes: This assumption is based on historical trends and current market conditions, but future market performance is uncertain.
- CalPERS has the necessary expertise to manage alternative assets: This assumption requires CalPERS to develop or acquire the necessary expertise to effectively manage these investments.
8. Next Steps
- Develop a detailed investment strategy: This should include specific asset allocation targets for alternative asset classes, risk management policies, and due diligence procedures.
- Recruit and train investment staff: CalPERS needs to ensure it has the necessary expertise to manage alternative assets effectively.
- Implement a robust risk management framework: This should include a comprehensive risk assessment, mitigation strategies, and monitoring procedures.
- Communicate the new investment strategy to stakeholders: This will ensure transparency and build trust with beneficiaries and policymakers.
By taking these steps, CalPERS can effectively manage its assets, achieve its investment objectives, and ensure the long-term financial security of its beneficiaries.
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Case Description
Examines California Public Employees Retirement System (CalPERS), the world's fourth largest pension fund. Dale Hanson, CEO of CalPERS, has a problem; how does he use CalPERS' influence as the holder of a small percentage of 1,300 American companies to put pressure on corporate America to achieve better returns for shareholders? The case discusses the constraints which confront CalPERS as a quasi-state agency and describes their efforts to improve corporate governance to date.
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