The second-largest US retirement plan, the California State Teachers’ Retirement System (CalSTRS), saw dismal investment returns of -3.2% in calendar year 2018, but there is still a chance of recovery, because the period that officially counts is its fiscal year, which has five more months to go.
In fact, improved stock market performance in January 2019 bought the overall investment returns for the 2018-2019 fiscal year so far to around “break even,” Chris Ailman, the pension system’s chief investment officer, told investment committee members on Jan. 30.
CalSTRS is far from alone in struggling to meet its investment return projections, which the West Sacramento pension system sets at 7% a year. All institutional investors have been dealing with market volatility over the last year.
The S&P 500 stock index returned -4.38% in calendar year 2018 and many retirement plans, like CalSTRS, have around 50% or more of their asset allocation devoted to equities. This has spurred concerns for most pension plans of negative returns, or only slightly positive returns, if the stock market cooperates for the remainder of the 2018-2019 fiscal year.
CalSTRS’s neighbor in Sacramento, the California Public Employees’ Retirement System (CalPERS), did even worse than CalSTRS, reporting investment returns of -3.9% in calendar year 2018. CalPERS is the largest US retirement system with more than $345 billion in assets under management.
Ailman did not predict what investment results the $221 billion CalSTRS expects in the fiscal year, which ends June 30. He did acknowledge to the investment committee that it needed to meet in closed session to discuss whether a stock market recovery would occur in coming months and whether CalSTRS would want to increase its equity allocation.
CalSTRS, as of Dec. 31, had a $105.5 billion global equity portfolio, which makes up 49.13% of overall plan assets. However, the pension plan’s target global equity allocation is almost 5% larger.
CalSTRS is only 62.6% funded with an unfunded liability of $107.3 billion.
Ailman did reveal at the investment committee meeting his top risks for CalSTRS in 2019: stock market volatility, a surprise from the Federal Reserve, President Donald Trump’s tweets, the Mueller report, Brexit, and a trade war with China.
“A Fed surprise from [Fed Chairman Jerome Powell] or a comment at a press conference or a speech the Federal Reserve gives is definitely going to be something that could shock this market,” Ailman said, “Obviously the presidential tweets currently, clearly the Mueller report is coming out, that may or may not impact the market.”
Ailman said what he would really focus on is Brexit. He noted that the UK has the third-largest stock market in the world and that the whole process of withdrawal by the UK from the European Union (EU) is turning out to be “ugly.”
“I think the most likely forecast is [the UK] will try and kick the can down the road,” he said. “The EU will try and hold its ground and kick them out.” The deadline for the UK to leave the European Union is March 29.
Ailman relayed to the investment committee that CalSTRS staffers have talked to unspecified persons in
France about the disastrous effects the UK leaving the EU could bring.
“Their comment was that if there was a hard Brexit, you would see at least a three- to a five-hour wait line for trucks to go through the channel to bring goods and services, just an absolute slowdown of delivery,” he said. “ I’ve always said that the UK will suddenly remind themselves that they actually are an island.”
If those risks weren’t bad enough, Ailman also had a second list of potential problems for CalSTRS and the economy, called “inevitable surprises.”
“These are surprises that we know are going to happen in our lifetime, but when they happen, there’ll be a surprise,” he said.
Ailman said these included stronger storms/extreme weather, climate change, earthquakes, social unrest/income inequality, internet disruption, lone wolf terrorism, North Korea, pandemic, and the 2020 election.
“I hate to knock on wood and bring up California earthquakes, but lord, we’re overdue,” he said.
He also discussed the demonstrations occurring in France.
“I think the social unrest we’ve seen with the yellow jackets in Paris and France, I think we are going to see that in other parts of the world,” he said.
On the 2020 presidential elections, Ailman mentioned potential independent presidential candidate Howard Schultz, founder of Starbucks.
“I don’t know if that’ll surprise the market, but, Howard Schultz, I mean, who knows what’s going to happen there,” he said, “That’s going to be something that we’ll watch.”
Ailman recounted the stock market volatility of 2018 to the investment committee. He told them that he remembered telling a teachers’ retirement organization in January 2018 that the stock market couldn’t keep on going up.
“And sure enough, about four days later, it cracked and it went back down,” he said.
Months of volatility followed, he recalled.
“I have to say in June….we started to get much more defensive and take profits out of the US equity market and that’s part of the nature of our job. And you do that and then find out by August you’re wrong, that was a stupid move. The market actually traded higher, only by 3%.”
Ailman went on to say that by September, equity markets “broke down again,” and the decision to sell in June then seemed like a “smart idea.”
“The end of that graph is what’s so painful,” he said of the last month of 2018. “It was the worst December on record, as in ever. The Christmas Eve selloff of 600 points still baffles me.”
Ailman said the mood on Christmas Eve is usually optimistic in the half-day of trading before the early stock market close. He compared the selloff, accelerated by computerized trading, to a dagger striking.
He said CalSTRS started to buy again when the markets reopened after Christmas Day and benefited from the recovery that day. It also set the pension plan up to benefit from January’s up market.
The S&P 500 posted a 7.9% return in January, its best monthly results since 1987.