2018 NextGen

“Carrie has been instrumental in developing a new asset class called Risk Mitigating Strategies (RMS). RMS now exceeds $20 billion and is a critical component of  CalSTRS portfolio.  Carrie is a solid and efficient rock star on our RMS team, led by Steve Tong. She is an example of CalSTRS future.” 

— Chris Ailman, CIO, CalSTRS

As the $222.5 billion CalSTRS buttresses its ‘newish’ risk mitigation strategy — which grew to become a $20 billion asset class in 18 months — Carrie Lo is the solid and inquisitive portfolio manager leading the charge. She helped to establish the hedge fund incubation program five years prior, and gained knowledge to adjust RMS to generate or protect returns during a downturn based on Trend Following, Long Duration (currently U.S. Treasuries), Global Macro and Systematic Risk Premia allocations. If the market drops 20% or more over several months, RMS is designed to create positive returns. This year, she’ll be fine tuning its methods of diversification and testing the way individual managers blend within the portfolio.

Before joining CalSTRS, the Haas School of Business undergrad and London Business School (MSc in Finance) grad started her career as a corporate finance analyst at Salomon Brothers, went on to become a CFO for Spunky Productions, a research analyst at Parnassus and a portfolio manager at Algert Coldiron. She says her desire to integrate mission within her earlier jobs was quenched by CalSTRS strong bent toward responsible investing.

CIO: What are the accomplishments you are most happy to have achieved recently, and why?

Lo: At the end of CalSTRS’ quadrennial 2015 asset allocation study, the Investment Committee approved the creation of and allocated nine percent to the Risk Mitigating Strategies (RMS) class. During this year-long study, the imperativeness of reducing drawdowns was impressed upon CalSTRS’ Investment Committee given the plan’s approximate 70 percent funding status (currently 63.9 percent), 7.5 percent return objective (reduced to 7.0 percent in July 2017), and negative cash flow. The timing of this study converged with our timeline to evaluate the next steps for the hedge fund incubation program. I had spearheaded this program in CalSTRS’ Innovation Portfolio five years prior. We operated a pilot program in Global Macro and Trend Following specifically to analyze their equity diversification properties.

Following a series of engaging discussions with the senior investment team and Investment Committee on the role of RMS and each strategy, performance drivers and expectations, and implementation considerations (such as manager selection and fee negotiations), the Investment Committee approved the allocation to RMS. The RMS allocation was established with four strategies: Trend Following, Long Duration (currently U.S. Treasuries), Global Macro and Systematic Risk Premia at 45, 40, 10 and five percent, respectively. Even with conservative capital market assumptions, RMS demonstrated a benefit to the plan’s long-term projected funding status.

Since inception through March 31, 2018, RMS has closely matched the performance of its benchmark primarily due to the outperformance of its Global Macro allocation. This performance result was achieved despite the time needed to establish a diversified portfolio, the performance challenges of Trend Following or specific managers during certain periods, and the various geopolitical, fiscal and monetary concerns that emerged. The discussions that began during the asset allocation study continue, and the Investment Committee’s confidence in and understanding of RMS continues to grow.

To fund RMS required tremendous coordination. In just one and a half years, the combined efforts of CalSTRS’ Risk Action Committee, Global Equities, Fixed Income, Investment Operations, and Legal teams, along with, the newly formed RMS team and its advisor, Lyxor Asset Management, established an approximately $20 billion asset class.

What would you be most excited to accomplish in the year ahead, and why?

We have achieved the original nine percent allocation to RMS. Now we can revisit how each strategy within the class is implemented and potentially introduce additional diversifying strategies. The initial research in these areas has started. I’m excited to be at the forefront of identifying areas of innovation in the year ahead. Plus, I’ll have the opportunity to contribute to the discussion on the strategic weight of RMS in the 2019 asset allocation study.

As part of the RMS team, I want to be able to demonstrate value to the total plan by improving its risk/return profile. While we do not welcome an extended market downturn—greater than negative 20 percent over several months—one indicator of RMS success will be a positive return. It is important to note that we do not have expectations of how RMS will perform during short-term or minor corrections (for example, a negative five percent or negative 10 percent return over a few days).

In the past two and a half years, the RMS team has grown to include five other individuals. I am dedicated to building a cohesive team that is well-versed in RMS and portfolio analysis.

What’s the most rewarding aspect of being an asset owner?

Prior to joining CalSTRS I worked in the private sector. There, I often sought ways to achieve some social benefit through my work or alongside it. At CalSTRS, the organization’s success and our members’ success are clearly intertwined. It is a privilege to help provide nearly one million of California’s valuable public school teachers with a secure retirement.

CalSTRS seeks to form true partnerships for idea exchanges that will enhance our investment approach. The opportunity to learn from and work with investment experts across multiple asset classes outside and within CalSTRS is extremely satisfying. Because RMS strategies span the spectrum of investment classes and instruments, my team is in a unique position to contribute a broad perspective to portfolio decisions and additional perspectives to our other asset classes. For example, the value of external managers is not just from favorable risk-adjusted performance but also from market intelligence. Engaging with asset managers and allocators to develop investment solutions for our teachers’ benefit, such as mitigating risk, is immensely gratifying.

What’s the most challenging?

With $222.5 billion in assets at March 31, 2018, CalSTRS size affords it access to many industry thought-leaders, the ability to invest through managed accounts and other custom structures, and negotiating power with managers. Our size can also pose challenges. For example, we may be less nimble in making tactical investment decisions, there may be more considerations when investing with smaller managers, we may be more vulnerable to market impact, and we may be subject to peer comparisons.

One approach to mitigate some of these challenges is to internalize more of our investment processes. This can provide additional capacity, more flexibility and a scalable base of investment skills to invest in a larger set of opportunities.

Additionally, rather than succumbing to the pressures of peer comparisons, we must remember that we are long-term investors with unique objectives and comparative advantages. Particularly in the face of performance comparisons, it is important to be cognizant of behavioral biases that may result in sub-optimal investment decisions. These include loss aversion that may cause us to abandon a long-term investment at the wrong time, recency bias that causes us to chase returns that may not be sustainable, or ambiguity aversion bias that causes us to avoid a diversifying investment with uncertain returns (such as Trend Following) in exchange for a less diversifying investment with more certainty.

What are you most hopeful about in the future of the industry?

CalSTRS’ culture places great value on peer engagement. Several themes with respect to common areas of interest continue to be discussed, including:

• Improving diversity and incorporating ESG factors.
• Protecting capital in a downturn through adoption of RMS-like strategies.
• Developing internal management and co-investment capabilities.
• Using factor analysis to better understand total portfolio risks and exposures.
• Focusing on absolute rather than relative returns to offer more flexibility to access alpha opportunities.
• Aligning asset managers’ interests with ours.

The meaningful dialogue we have with like-minded institutions around these topics gives me hope that we will continue to move towards more efficient solutions and innovations. Being able to collaborate by investing together, sharing resources and contributing ideas increases the likelihood that we will continue to move in the right direction.

What are you most cautious about?

When building portfolios—and in particular selecting external managers— one is often more confident in those managers that appear attractive on a stand-alone basis but may not be additive to the total portfolio. Conversely, one may need to add a strategy or manager that does not appear attractive on a stand-alone basis to complement the total portfolio. Thus it is important to understand each manager’s investment process and exposures, and which of these may overlap or complement existing investments. Establishing true investment partnerships that include in-depth, transparent conversations to gain these insights is critical to achieve the desired portfolio construction. This is an evolutionary process and may require more customized solutions to ensure the total plan has the exposures it desires.

As a leader, what are the most important aspects of the industry you hope to change over your career?

The 2008 financial crisis heightened efforts to improve alignment of interests between asset owners and asset managers. While some strides have been made, there is still room for improvement. Fees and terms should be designed so that allocators retain a high percentage of profits over a market cycle.

Additionally, I serve as a mentor to several full-time staff and summer interns. It is my goal to inspire and help prepare women and other under-represented groups to build careers in finance and at public pensions. Diversity on a number of fronts, including but not limited to gender, ethnicity, sexual orientation, socio-economic status and academic background, is not only desirable but necessary for improved outcomes.

If you had one piece of advice for your peers, what would it be?

Despite being a large mature pension plan, CalSTRS seeks to continuously innovate and incorporate the best investment ideas possible. This may require deviations from the way things have been done historically, gaining comfort with investments that don’t have a long or successful track record, or failing but learning and trying again. When accessing a new investment strategy, it is important to clearly state upfront how you measure success, understand when and why a certain strategy may not perform, and how a strategy or manager complements your existing portfolio. This requires understanding the role and reason for the strategy and regularly reassessing this hypothesis.  For example, when we evaluated hedge funds, we did not view them as an asset class. Rather we evaluated each strategy’s risk and return characteristics and identified which strategies were most desirable to achieve our objective of downside protection. This led us to invest in only Global Macro and Trend Following rather than the full range of hedge fund strategies.

Furthermore, we do not expect RMS to perform as well during an equity bull market and understand that it may exhibit negative performance. This is especially challenging when fees to access RMS managers are generally higher than fees for beta. Despite this, we take a long-term perspective and understand the value of RMS—low correlation and positive net returns. By reducing drawdowns and protecting capital, RMS can improve the total plan’s compounded return and preserve capital to deploy during market dislocations. This will ultimately improve the long-term funding ratio. In short, a dollar saved is more valuable than a dollar earned.

What are the biggest current trends you are seeing that have surprised you?​

The jury is still out on the effectiveness of machine learning in finance. The hurdles to develop these strategies are formidable. Machine learning requires a vast amount of data and data cleaning, tremendous computing power and advanced programming skills. Yet a couple of pension funds are utilizing machine learning for investment signals. They were able to develop the expertise, obtain resources and convince their boards to implement machine learning programs.