CalSTRS' Shift to Internal Management?

Dawn Lim of the Wall Street Journal reports, Calstrs’ Investment Office Restructuring Paves Way for More Internal Management:

The California State Teachers’ Retirement System said it restructured how its investment office is organized and is emphasizing stronger internal controls to pave the way for a shift toward more internal management.

Calstrs, the nation’s second-largest public pension fund, said in a release that it plans to increase the amount of assets its investment team manages internally to 60% of its portfolio, from the current 45%.

The closely watched $186.4 billion pension fund has previously said in investment policy documents that by managing assets internally, it can have more control over corporate governance issues and the flexibility to tailor strategies to its needs.

Calstrs will focus initially on publicly traded assets as it looks to raise the amount of assets its staff will oversee, Spokesman Ricardo Duran said.

In a signal that fixed income could be emphasized for more in-house management, Glenn Hosokawa was named director of fixed income, while Paul Shantic was named director of inflation-sensitive assets. They were previously acting co-directors of fixed income.

Fixed income made up 15.8% of Calstrs’s portfolio, as of Sept. 30, short of an allocation target of 17%. Inflation-sensitive assets made up 0.7% of pension fund assets; the target allocation for the asset class is 1%.

A new organizational structure “allows us to bring more assets in-house,” said Calstrs’ Chief Investment Officer Christopher Ailman in the release.

In addition, Debra Smith was named chief operating investment officer, a new role at the pension fund. She was previously director of investment operations.

Ms. Smith leads a new unit that will tackle issues such as compliance, ethics and internal controls. She will report to the investment committee twice a year, giving her a direct line to board members.

The position builds more separation between investment management and operations at the pension fund, allowing the chief operating investment officer more “structural autonomy,” said Mr. Duran.

Dale Kasler of the Sacramento Bee also reports, CalSTRS restructures investment staff, hires operating officer:

CalSTRS has named its first-ever chief operating investment officer as part of a restructuring of the office that oversees the pension fund’s $186 billion portfolio.

The California State Teachers’ Retirement System said Debra Smith, who had been director of investment operations, is the pension fund’s chief operating investment officer.

CalSTRS also named two asset class directors. Glenn Hosokawa was named director of the $22 billion fixed-income portfolio, and Paul Shantic was named director of CalSTRS’ $1.4 billion inflation-sensitive portfolio. Both had been with CalSTRS in other investment-related roles.

Pension fund officials said the restructuring gives CalSTRS greater control over its portfolio.

“These three appointments, coupled with our 2010 creation of a deputy chief investment officer, completes a new organizational structure that allows us to bring more assets in house,” said Chief Investment Officer Christopher Ailman in a prepared statement. “This structure matches what you find in most large investment money managers. This also fits our plans to internally manage more of our assets – currently at 45 percent in house – to a projected 60 percent internally managed.”

The Sovereign Wealth Fund Institute also commented on CalSTRS' shift to manage more assets internally stating it's "taking the playbook from sapient Canadian public pensions" saving on fees and looking to take a more activist role:

Besides saving on investment fees and cost, CalSTRS desires to have more control over corporate governance issues. By owning the shares or underlying securities directly, CalSTRS can push forward with activist-based strategies. 

I'm not sure how much of an "activist" role CalSTRS is looking to take or how successful they will be if they do take on such a role, but the shift toward internal management is a smart move and I like the way they restructured their senior staff to implement this shift.

According to Reuters, Debra Smith, the new chief operating investment officer, will oversee the fund's Investment Operations, Branch Administration, and a new unit comprised of Compliance, Internal Controls, Ethics and Business Continuity. And as stated in the WSJ article above, Smith will report to the investment committee twice a year, giving her a direct line to board members.

Pay attention here folks because this is a great move from a pension governance perspective. I've always argued that the head of risk and head of operations at public and private pension funds should report directly to the board of directors, not the CEO or CIO. If there is a disagreement on operational or investment risks being taken, the board can listen to the arguments and decide if the risks are worth taking.

I've also long argued that whistleblowers need to be protected and whistleblower policies need to be beefed up at all public pension funds so that employees who witness shady activity can safely report it without worrying about being fired. If some senior manager is accepting bribes from an external fund manager or from a big vendor peddling the latest most expensive software, there should be a way to detect and report this fraud.

Finally, go back to read my comment on why U.S. pension funds are going Canadian. The reason is simple. It makes sense to manage assets internally, saving on fees and having more control over your investments. CalSTRS isn't the first big state pension fund to do this (Wisconsin is) and it won't be the last.

Of course, to really go Canadian, U.S. public pensions have to pay their senior investment staff big bucks and they have to separate politics from their entire governance process. When I read articles on how John Buck Co., a real-estate investment firm whose executives contributed substantially to the campaign of Chicago Mayor Rahm Emanuel, has earned more than $1 million in fees for managing city pension money, I shake my head in disbelief. This is Chicago-style politics at its worst. No wonder Illinois is a pension hell hole!

Below, Christopher Ailman, CalSTRS CIO, says stay invested and discusses why he would hedge the yen back to dollars and thinks the Japanese market has some potential. I'm bearish on the yen and euro and only bullish on U.S. equities, for now. Choose your stocks and sectors carefully and enjoy the liquidity party while it lasts. Once deflation hits America, the hangover will last for decades.