CalPERS' Private Markets Pivot: Balancing Long-Term Gains with Near-Term Risks

In a bold move to bolster long-term returns, the California Public Employees' Retirement System (CalPERS) has announced a strategic reallocation of its portfolio, increasing private equity and private debt allocations to 17% and 8% of its total assets, respectively. This shift, part of a broader transition to private markets now representing 40% of its holdings, underscores a growing confidence in alternative assets to counterbalance the volatility of traditional public markets. But as CalPERS leans into this strategy, the question remains: Can the long-term benefits of diversification and higher returns outweigh the near-term risks of illiquidity and market uncertainty?

The Strategic Shift: A Move Toward Higher Returns and Diversification

CalPERS' decision to reduce public equity holdings from 42% to 37% and fixed income from 30% to 28% reflects its belief in the superior risk-adjusted returns of private markets. Over the past two decades, private equity has delivered an annualized return of 12.3%, far outpacing public equities and fixed income. By mid-2025, its private equity portfolio had a five-year return of 12.8%, exceeding its policy benchmark of 11.9%, while private debt achieved a one-year return of 13.3% as of 2023.

The strategy emphasizes diversification within private markets, shifting focus from large buyouts to growth, venture buyouts, and co-investments. By 2023–24, allocations to growth and venture segments rose to 43%, while traditional buyouts fell to 58% from 91%. This shift has already borne fruit: the venture program launched in 2022 delivered a 14.7% one-year return, outperforming other segments. Co-investments, now 40% of the $15.5 billion annual commitment target, promise to save $25 billion in fees over a decade, directly boosting net returns.

The Long-Term Case: Resilience Through Diversification

The long-term benefits of CalPERS' strategy are compelling. Private markets offer:
1. Lower correlation with public markets, reducing portfolio volatility during downturns.
2. Structural alpha opportunities, such as secondary market transactions and co-investments, which provide liquidity and fee savings.
3. Exposure to high-growth sectors, like technology and renewable energy, which are often underrepresented in public indices.

CalPERS' leadership, including Trustee David Miller, has cited the 20-year track record of private equity as justification for its expanded role. With a discount rate of 6.8%—critical for funding pensions—the system must prioritize assets that can sustainably meet its obligations. By reducing reliance on fixed income, which faces headwinds from rising interest rates, CalPERS is positioning itself for a higher return profile in a low-yield world.

Near-Term Risks: Liquidity, Volatility, and Execution Challenges

Despite its merits, the strategy carries significant risks:
- Illiquidity: Private markets require long holding periods, making it harder to exit positions during a crisis. CalPERS' $68.7 billion private equity portfolio and $12.3 billion private debt holdings are largely locked in for years.
- Cyclical Volatility: Private equity returns are tied to economic cycles. A prolonged downturn could delay realizations, compressing IRRs.
- Manager Selection: Success hinges on identifying top-tier managers, especially in venture and growth segments, where performance can vary widely.
- Regulatory and Labor Risks: CalPERS' adoption of stringent labor principles may limit flexibility in engaging with companies, potentially constraining returns.

Navigating the Balance: How CalPERS Mitigates Risk

CalPERS has built safeguards into its strategy:
- Allocation Ranges: A 5% buffer around target allocations (e.g., private equity's 12–22% range) allows flexibility to adjust to market conditions.
- Diversification: Vintage-year and fund-size diversification reduce exposure to any single economic cycle or sector.
- Liquidity Management: Secondary market activity and co-investments provide limited liquidity without forcing fire sales.

President Theresa Taylor's emphasis on responsible engagement also aims to align investments with societal goals, though this could come at a cost if labor standards limit profitability.

Investment Implications: A Playbook for Long-Term Investors

For institutional investors, CalPERS' model offers a template:
1. Increase private market exposure incrementally, prioritizing co-investments and sectors with proven alpha (e.g., venture capital).
2. Diversify within private markets, avoiding overconcentration in any sub-asset class.
3. Accept illiquidity, but ensure portfolio liquidity needs are met through public equity and short-term instruments.

Retail investors, however, should exercise caution. Direct access to private markets is typically limited, but listed vehicles like private equity ETFs or funds-of-funds can provide exposure—though with higher fees and less control.

Conclusion: A High-Reward, High-Conviction Play

CalPERS' pivot to private markets is a high-stakes bet on long-term resilience. While risks like illiquidity and cyclical downturns loom, the historical performance of private assets and strategic shifts toward fee-efficient co-investments and high-growth sectors make this a compelling strategy. For investors with a multi-decade horizon, the diversification and return potential justify the risks—if execution remains flawless.

As the next Asset Liability Management review approaches in 2025, CalPERS' ability to navigate these trade-offs will determine whether its bold move secures its legacy—or becomes a cautionary tale.