Sacramento officials are cheering a decision by the California Public Employees’ Retirement System to build what would be the tallest tower in its hometown. But some inside Calpers’ boardroom are concerned the 550-foot project represents too much risk.

During a private meeting earlier this summer three Calpers directors voted against a new $550 million commitment to the proposed office-condominium-retail complex, according to people familiar with the situation. Calpers abandoned a previous development plan for the same site in 2007.

The dissent came after board members reviewed a memo from an outside consultant that raised some concerns about the project’s return projections, these people said. The specific votes and memo haven't been previously reported. A majority of other members of the 13-person board agreed to support the project as long as it yielded a 5.8% return and 40% of the office space was pre-leased.

“Should this project go forward with development, we believe it will be a successful investment for the fund and an iconic building,” Calpers said in a statement.

Competing pressures of local politics and investment often collide at the nation’s largest public retirement systems, which are responsible for benefit obligations to firefighters, police officers, teachers and other public workers.

These funds across the U.S. are under increasing pressure to hit aggressive return targets as a way of closing widening funding gaps. They are also heavily dependent on local political support, relying on government contributions to supplement investment income. Their boards are typically staffed by political appointees, union officials and local business leaders.

In California Calpers hasn’t always made decisions that were popular locally. It has resisted some calls from activists and state officials to divest from politically controversial investments. Cities in California have also complained about how much it costs them to participate in the Calpers system. When the fund elected to lower its investment return assumptions in 2016, it chose to phase in the change gradually to soften the impact of higher yearly pension costs on local governments.

But in the state’s capital of Sacramento, Calpers’ support for a new tower is winning lots of local praise. The site, 301 Capitol Mall, is one of the most prominent in the city, planted along the road that runs between the California State Capitol building and the city’s iconic Tower Bridge.

“The development of 301 Capitol Mall would be transformative for our capital region,” said Sacramento Metropolitan Chamber of Commerce CEO and President Amanda Blackwood. She said she looks forward to watching the tower go up from her window.

The office of Sacramento Mayor Darrell Steinberg is equally enthusiastic. “We’re pleased to see Calpers moving forward with an ambitious project on this prominent piece of land at Sacramento’s front door,” said the mayor’s spokeswoman. “We look forward to working with them to make it happen.”

Sacramento Mayor Darrell Steinberg, shown in March 2017, is enthusiastic about the project. Photo: Stephen Lam/Reuters

This isn’t the first time Calpers has considered a fix for the empty, block-long parcel. During the last real-estate boom Calpers planned to build twin 53-story condominium towers in partnership with a local developer, pledging $100 million for the project. That plan fell apart in 2007, and Calpers then asked the real-estate firm CIM Group to manage the project.

The following year the market cratered, and the fund’s real estate holdings plummeted, costing the pension fund billions in losses. Calpers reorganized its real estate portfolio and focused on fully-leased buildings in big markets.

The investment in 301 Capitol Mall remained a part of its portfolio over the last decade even as the value of the site dropped, according to local records and documents from Calpers.

The assessed value of the downtown Sacramento property has dropped by 24% since 2007, according to the Sacramento County Assessor’s Office. Investment returns for 301 Capitol Mall L.P. have been negative in six of the past seven years, according to Calpers’ records.

The value of Calpers’ investment in 301 Capitol Mall L.P. is $17 million, as of Dec. 31. That is a fraction of its total real estate portfolio, which is worth more than $30 billion. Calpers manages total assets of more than $361 billion.

The headquarters of the California State Teachers' Retirement System, shown at right, on the Sacramento River in West Sacramento, Calif., on Sunday. Photo: Max Whittaker for The Wall Street Journal

Talk of a new tower at 301 Capitol Mall began in 2016 when CIM presented its plans amid a surge of interest in the Sacramento real-estate market. A sports arena for the Sacramento Kings had opened nearby that year, and another public pension fund, the California State Teachers’ Retirement System, considered a new office tower alongside its West Sacramento headquarters. That fund, known as Calstrs, even allocated $8 million for design and estimating costs.

The plan that went before Calpers’ board earlier this summer featured offices, condos, retail stores and an elevated public park, according to a person familiar with the situation. A real estate advisory firm, RCLCO, prepared a memo for board members saying that the 5.8% return target was an aggressive projection for the local market, according to people familiar with the matter. The memo stated that those returns were nonetheless too low to make up for the risk involved in the project, but nonfinancial factors could justify the investment, these people said.

The directors opposed to the idea had varying concerns, said people familiar with the matter, including worries that moving ahead after receiving mixed guidance from an outside consultant would open the board to scrutiny and that starting a big development project at this point in the economic cycle would expose Calpers to market volatility. Moreover, the directors were concerned that the pension fund would likely be able to find less risky and more attractive investments elsewhere, these people said.

Local real estate observers say risk can’t be avoided on a development of this magnitude.

“There’s no way to do a project of this size that wouldn’t be speculative because we’re talking at least 30 months before construction is complete,” said Daniel Collins, president of Sacramento real estate adviser Collins Commercial. “That’s why real-estate development isn’t for the timid.”

Write to Heather Gillers at heather.gillers@wsj.com and Dawn Lim at dawn.lim@wsj.com