Wednesday, July 25, 2018

CalSTRS Gains 9% in Fiscal 2017-18

Randy Diamond of Chief Investment Officer reports, CalSTRS Returns 9% for Fiscal Year:
The California State Teachers’ Retirement System (CalSTRS) saw a 9% net return in the fiscal year ending June 30, exceeding its assumed expected return of 7% by two percentage points, Chris Ailman, the system’s CIO, told the CalSTRS investment committee Friday.

The 9% return also beat the system’s custom benchmark of 8.6%.

The overall returns for the $223 billion retirement system, the second-largest in the US by assets under management, beat the nation’s largest retirement system, CalPERS, which announced last week fiscal year returns of 8.6% for the June 30 fiscal year.

“We will rank high compared to similar funds, but it is only one year,” Ailman said. “We need to repeat that performance year in and out, on average, over the next 30 years.”

Private equity was the best-producing asset class with returns of 13.8%, slightly under its custom benchmark of 14.7%.

This was followed by global public equities, which produced returns of 11.7% against a custom benchmark of 11.8%.

The third-best results among large assets classes was real estate, which saw results of 10.4%, above the custom benchmark of 7.1%.

Fixed income saw returns of 0.3%, above the returns of the custom benchmark of -0.2%.

CalSTRS’s new risk mitigation asset class saw returns of 1.8%, beating its custom benchmark of 1.7%. The pension system has put $20 billion into the new asset class designed to mitigate the risk of a market downturn.

Among smaller strategies, Innovative Strategies had the biggest results of 11.4% above the custom benchmark of 6.5%.

CalPERS’s Inflation Sensitive Strategy saw results of 8.5%, above the custom benchmark of 4.5%.

Over the three-year period ending June 30, CalSTRS saw returns of 7.8%, over the five-year returns of 9.1% and 10-year returns of 6.3%.

Ailman said the 10-year results were more challenged. Those results include the great financial crisis when CalSTRS lost around 25% of its portfolio.
CalSTRS's press release on FY 17-18 results is available here and below:
The California State Teachers’ Retirement System announced that the fund posted a 9.0 percent return (net of fees) for the 2017-18 fiscal year, exceeding the investment assumption of 7.0 percent for the second consecutive year and helping advance the fund towards full funding in the decades ahead. As of June 30, 2018, the total fund value was $223.8 billion.

“This year’s positive investment performance is yet another testament to the long-term sustainability of a well-run pension fund guided by a committed board of trustees and a staff of diverse and talented investment experts,” said Chief Executive Officer Jack Ehnes. “The fiscal year returns are only one part of CalSTRS’ pursuit of long-term value creation. The CalSTRS Funding Plan, passed into law in July 2014, is the overarching model of shared responsibility, working in tandem with the positive return performance generated by the investment portfolio.”

CalSTRS’ returns reflect the following longer-term performance (click on image):


“This year we beat the 7.0 percent goal and exceeded our benchmark,” said Chief Investment Officer Christopher J. Ailman. “We will rank high compared to similar funds, but it is only one year. We need to repeat that performance year in and year out, on average, over the next 30 years. No small feat, but our award-winning staff and our complex portfolio are designed to do just that. This is a marathon, not a sprint to the finish line. And, as a large, mature pension system, we must continue to explore, innovate and collaborate to build an efficient, successful portfolio for the long term.”

The fiscal year saw strong double-digit returns in both the public and private equity markets with the S&P 500 returning over 14 percent. CalSTRS was positioned well to take advantage of this growth while maintaining a diversified portfolio to provide risk protection through the full allocation to the Risk Mitigating Strategies asset class which was fully implemented during the last 12 months. Given the focus on long-term funding to protect the funds’ value, these strategies are important to avoid losses experienced during market downturns such as the historic 2008 global financial crisis.


As of June 30, 2018, the CalSTRS investment portfolio holdings were 53.7 percent in U.S. and non-U.S. stocks, or Global Equity; 12.8 percent in Real Estate; 12.3 percent in Fixed Income; 8.9 percent in Risk Mitigating Strategies; 8.2 percent in Private Equity; 1.9 percent in Inflation Sensitive; 0.8 percent in Innovative Strategies and Strategic Overlay; and 1.4 percent in Cash.

About CalSTRS

The California State Teachers’ Retirement System, with a portfolio valued at $223.8 billion as of June 30, 2018, is the largest educator-only pension fund in the world. CalSTRS serves California’s more than 933,000 public school educators and their families from the state’s 1,700 school districts, county offices of education and community college districts. A hybrid retirement system, CalSTRS administers a combined traditional defined benefit, cash balance and voluntary defined contribution plan. CalSTRS also provides disability and survivor benefits. CalSTRS members retire on average after more than 25 years of service, with a median retirement age of 62.9, and a monthly pension of approximately $4,475, which is not eligible for Social Security participation. For more data, download the CalSTRS Fast Facts 2017 brochure.

See how CalSTRS demonstrates its strong commitment to long-term corporate sustainability principles in its annual Global Reporting Initiative sustainability report: Global Stewardship at Work.
Before I begin my comment, it's crucial you read and understand the details of the CalSTRS Funding Plan which explains in detail the rise in employee and employer contribution rates and other provisions to reduce the plan's deficit (click on image):


CalSTRS had a good fiscal year mostly owing to strong gains in private equity, domestic and global equities, real estate and inflation-sensitive assets.

CalSTRS's new risk mitigation asset class is described in detail here and here. It's a sizable $20 billion portfolio which invests in two absolute return strategies, global macros and commodity trading advisors (CTAs).

Why only these two hedge fund strategies? Because when markets turn south, these two strategies have historically offered investors "tail-risk protection". And more importantly, these two are the most liquid and scalable hedge fund strategies investors can invest in so it didn't take CalSTRS a long time to ramp up this portfolio.

Who are the managers in this portfolio? I don't have details, but my money is on brand name funds like Bridgewater and Winton Capital, basically top macro and CTA funds where CalSTRS can write a big check to gain access to these strategies quickly and efficiently.

[Note: My advice to CalSTRS is to use the same managed account platform Ontario Teachers', CPPIB, the Caisse, and other large pensions use to onboard and monitor all risks with their liquid hedge fund strategies, Inncocap, based here in Montreal and owned by the Caisse, BNP Paribas and management. The fees are very low, it's basically a service provider, not an advisor, which offers numerous advantages to its clients.]

What do I think of risk mitigation strategies? Well, given my outlook based on a flattening yield curve, I've already stated it's time to take a closer look at hedge funds.

And I mean ALL hedge funds, not just large global macros and CTAs which have had mixed results until this year where they seem to be staging a comeback (although I read CTAs are getting slammed this year).

My best advice to all large asset allocators is to roll up your sleeves, do your homework, and find the best long-only and absolute return managers all over the world and invest with them.

Easier said than done, I know, I worked with Mario Therrien at the Caisse back in 2002-2003 and was in charge of the directional hedge fund portfolio investing in top global macro, L/S Equity and CTA funds.

It was fun, I met some of the industry's best managers but I realized picking managers is a lot tougher than people think. Sure, you can use consultants but most of them are totally useless and will recommend the well-known brand names. At the end of the day, you really need to kick the tires, grill these managers who have huge egos, and make a decision as to whether or not they are worth an allocation and if so, how much.

Still, despite all that, I think it's very important to allocate to top absolute return managers and prepare for the eventual downturn. Don't focus on fees, focus on people, process, performance and persistence. That is my best advice.

If I were to recommend a hedge fund portfolio, I'd do exactly what we were doing at the Caisse back then, 50% multi-strategy and arbitrage strategies and 50% directional hedge funds (global macros, CTAs, L/S Equity and short-sellers).

Under Michael Sabia, the Caisse has tremendously cut its hedge fund allocations. It still invests in the space but Michael's focus is on infrastructure, real estate, private equity and private debt.

Nothing wrong with that, Michael thinks like a businessman and his focus is on the long run, but he has never experienced a nasty bear market while at the helm of the Caisse and my best advice to him is to start rethinking and repositioning the Caisse's external absolute return strategies portfolio and prepare for a protracted downturn.

Anyway, back to CalSTRS, it too is revamping its private equity portfolio. Arleen Jacobius of Pensions & Investments reports, CalSTRS posts 9% fiscal-year gain, working toward private equity portfolio changes:
CalSTRS posted a net return of 9% for the fiscal year ended June 30, outperforming its benchmark return of 8.6%, said Christopher Ailman, chief investment officer, at the pension plan's investment committee meeting on July 20.

The $223.8 billion pension plan outperformed its benchmark for the three-, five- and 10-year periods, earning a 7.8% annualized return for the three years, 9.1% for five years, 6.3% for 10 years and 6.5% for the 20 years ended June 30. By comparison, the benchmark returns were 7.7% for the three years, 9.3% for the five years, 7.15% for 10 years and 6.5% for the 20 years. CalSTRS earned a 13.4% net return for fiscal year 2017.

The asset class with the highest return for the fiscal year was private equity, earning 13.8%, although it underperformed its 14.7% benchmark return. The next highest returning asset class was global equities at 11.7%, slightly underperforming its 11.8% benchmark.

Innovative strategies earned 11.4%, outperforming its 6.5% benchmark; real estate returned 10.4%, vs. its 7.1% benchmark; inflation sensitive produced 8.5%, compared to its 4.5% benchmark; risk-mitigating strategies earned a 1.8% return vs. its 1.7% benchmark; and fixed income returned 0.3%, outperforming its -0.2% benchmark.

The risk-mitigating asset class was established in 2016 to protect against equity market downturns and includes long-duration U.S. Treasuries, trend following, global macro and systematic risk premiums.

CalSTRS' actual asset allocation as of April 30, the most recent data available, was 53.7% global equities, 12.3% real estate, 12.2% fixed income, 8.9% risk-mitigating strategies, 8% private equity, 2.9% cash and 1.9% inflation-sensitive.

Mr. Ailman also discussed the 10-year business plan, which he called a "road map" for the pension plan that could approach $400 billion in assets in 10 years. The business plan expects lower returns because assets are expensive these days, but also lower costs in the future, in part, as a result on CalSTRS' becoming less reliant on external managers, he said.

The California State Teachers' Retirement System, West Sacramento, is in the midst of studying how it can use a collaborative approach to investing including making direct investments either alone or together with other asset owners in each of its asset classes. Projected lower costs is consistent with the collaborative model, Mr. Ailman said.

Staff expects to return to the investment committee in September with a recommendation regarding the collaborative model and how pension officials can implement the approach.

Among the challenges reflected in the road map is hiring talent, Mr. Ailman noted. Hiring investment executives, motivating them and retaining them as they move up the ladder is part of what Mr. Ailman said he considers CalSTRS' succession planning. The 10-year plan across asset classes includes training junior staff for relationship transfer and succession planning.

Still, Mr. Ailman noted that "it is more and more a challenge to recruit."

In private equity, for example, CalSTRS has been looking to hire investment professionals with more transaction experience, said Margot Wirth, director of private equity, at the July 20 investment committee meeting. The private equity team has been "drifting toward" hiring more deal-focused professionals but that should accelerate as CalSTRS moves toward the collaborative model, she said.

Currently, 93% of CalSTRS' $18.2 billion private equity portfolio as of March 31 was invested with external managers, with the remaining 7% internally managed, Ms. Wirth said.

She said that it would "not be overly ambitious" to expect that 20% of the portfolio could be internally managed in co-investments in three years.

As part of its fiscal year 2019 business plan, CalSTRS' private equity team expects to work to establish joint ventures with other like-minded and complementary investors as well as to consider investing in money managers "when strategic for the program."

Also at the meeting, the investment committee got a first look at a revised private equity investment policy statement in which it would establish a subasset interim target allocation of 2% and a long-term target of 4% of the private equity portfolio for what it is now calling a multistrategy subasset class. (Interim targets are allocations expect to be achieved in 12 months to 36 months.) Last fiscal year, CalSTRS transferred the strategy it had then called tactical opportunities to the private equity portfolio from its innovations portfolio, where the strategy had been incubated. The new subasset class currently consists of 1.2% of the private equity portfolio but staff believes that some existing investments might logically reside in this subasset class, according to a staff report to the investment committee.

In addition to adding the new allocation, CalSTRS would increase its interim target to buyouts by 3 percentage points to 69% within the private equity portfolio, while retaining a 69% long-term target to buyouts, and trim the interim allocation to debt-related strategies by 5 percentage points to 10%. CalSTRS' long-term target allocation to debt-related strategies is dropping to 11% from 15%. The interim and long-term targets will not change for venture capital (10% and 7%, respectively,) longer-term strategies (2% and 5%) and special situations (7% and 4%).

The new private equity investment policy would reorganize its two main categories — traditional and opportunistic — by moving longer-term strategies (formerly "core private equity") and special mandates to opportunistic from traditional. The traditional category would then consist of buyouts, venture capital and debt-related investments. Opportunistic would consist of longer-term strategies, special mandates and the new multistrategy subasset class. The revised private equity investment policy would also allow staff to make co-investments alongside all of CalSTRS' general partners across asset classes, not only private equity general partners.

Staff is expected to bring the private equity investment policy statement back to the investment committee for adoption in September.

Mr. Ailman noted that longer-term strategies, which include investing in longer-dated funds that can last 20 years, is at the early stages with a lot of managers "stepping in" to the strategy. He added that private equity is undergoing "big changes." He mentioned that CalPERS is considering creating a separate entity to make direct private equity investments.

"I don't think you would … replicate that but good luck to them," Mr. Ailman said. "That's my pension plan."

Separately, Mr. Ailman said that he was starting a study of whether to keep investments in private prisons because they are posing an increased risk to CalSTRS' portfolio. The new risk factors are in respect to violations of human rights by private prisons that are now being used to house immigrants and children of immigrants who have separated from their parents. CalSTRS staff have already been speaking to company executives but this process increases resources to staff. CalSTRS has $120 million invested in three private prison companies: CoreCivic Inc., General Dynamics Corp. and GEO Group Inc.

Mr. Ailman noted the University of California Regents has already divested from private prison investments. The UC's investment office oversees the Berkeley-based university system's $66.7 billion pension fund and $11.9 billion endowment.

A spokeswoman for UC said that university sold some $25 million worth of indirect holdings in private prison companies in 2015. "As part of a comprehensive evaluation process for investments, UC assessed that these holdings were not a good long-term investment," she said in an email.

During public comment, a large number of CalSTRS' members asked the investment committee to divest from its private prison investments. Douglas Orr, a retired professor of economics and social sciences at City College of San Francisco, speaking on behalf of the American Federation of Teachers, suggested that CalSTRS collaborate with other asset owners to pressure private prison companies to discontinue its contracts to house immigrants and immigrant children with the federal government. California Federation of Teachers is also pressing the idea with CalSTRS and the $357.3 billion California Public Employees Retirement System, Sacramento, said Tristan Brown, legislative representative in the union's Sacramento office.

In other actions, CalSTRS' board on July 19 approved a compensation committee recommended setting the incentive criteria for a new position of director of investment strategy and risk. The new director would implement and monitor the overall investment portfolio's strategy and risk profile. During the board meeting, Mr. Ailman also noted as CalSTRS develops its collaborative model, the new director would make connections with other asset owners.
Anyone see CNN's recent documentary, American Jail? If you watch it, you'll understand how America's prison industrial complex works. It's all about profits, it's big business fraught with human rights abuses (the only place where forced slavery still exists in the US and it's legal). America loves its prisons but its prison system is a disaster on so many levels.

Anyway, CalSTRS is moving toward more long-term private equity and more direct investments in the form of co-investments following Canada's large pensions like Ontario Teachers', CPPIB, the Caisse and PSP Investments.

The benefit of this approach is you can maintain large allocations to private equity, lower overall fees and focus more on long-term investing.

The problem is in order to ramp up a co-investment program, CalSTRS needs to hire qualified people and pay them properly. This is the same problem CalPERS has as it gears up its direct program to co-invest and bring more assets internally.

How will CalSTRS go about this? Will it use BlackRock or someone else to ramp up co-investments? That all remains to be seen.

Lastly, I read a very silly comment on the naked capitalism blog on how CalSTRS is outperforming CalPERS. Please take these silly comments with a shaker of salt as CalSTRS takes more global equity risk than CalPERS, has a more concentrated PE portfolio, and you are not comparing two identical plans here with the same liabilities.

Also, both CalSTRS and CalPERS are underfunded, and funded status is the true measure of success, so who cares if one is outperforming the other? And while they both earned more than 8% last fiscal year, that's unlikely to go on for much longer.

The next 30 years will be a lot more challenging than the last 30 years. How do I know? Look at the starting point: historic low bond yields, all assets are way overvalued, demographic pressures will add more pressure on pensions, and America's public pension crisis will get worse.

Below, Part 1 and 2 of the CalSTRS's July Investment Committee meeting. All four parts and other meetings are available online here. Take the time to listen to CalSTRS's CIO Chris Ailman, he goes over a lot here.

Lastly, Ted Eliopoulos, CalPERS Chief Investment Officer, comments on the positive fiscal year returns and what it means as a long-term investor. For more information on CalPERS's fiscal 2017-18 results, click here and you will see a lot of similarities with CalSTRS's fiscal year results but there are important differences too as the two plans have a different asset allocation and different liabilities.



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