CalSTRS Investment Staff Wants Stock Reductions

The investment staff of the California State Teachers Retirement System (CalSTRS) is recommending that the pension system reduce its target allocation to stocks to 42% of the portfolio from 47%, investment documents show.

The recommendation is designed to reduce equity risk for the second largest U.S. retirement plan with $241.3 billion in assets. It comes as the CalSTRS Investment Committee is considering what the retirement plan’s asset allocation for the four-year period starting in July of 2020 should be, according to CalSTRS’s investment documents reviewed by CIO.

The investment committee is considered likely to give initial approval to the plan in November since it usually follows the recommendations of Chief Investment Officer Chris Ailman and his investment staff. Tomorrow, (Thursday, Sept. 4), the investment committee is scheduled to publicly discuss the staff recommendation for the first time.

Other recommendations in the target allocation plan include increasing the CalSTRS real estate allocation to 15% from 13% of the total portfolio, increasing the risk mitigating asset class to 10% from the current 9% allocation and increasing the inflation sensitive portfolios target to 6% from the current 4%.

The risk mitigating asset class, which was first introduced in 2015, consists of long duration U.S. treasury and alternative investments, such as trends following instruments and global micro hedge funds. It was part of a plan to reduce CalSTRS’s equity risk to a major stock market drawdown. CalSTRS’s exposure to the stock market was as high as 55% of the system’s total portfolio before the asset class was assembled.

The other area that would get a larger allocation, the inflation sensitive portfolio, which is part of CalSTRS’s real assets asset class, consists of infrastructure investments and inflation sensitive bonds.

The asset allocation plan keeps CalSTRS’s current 13% share of the portfolio to private equity. However, CalSTRS has been unable to get as large a share of private equity investments as it wants.

Private equity makes up only around 9% of CalSTRS total portfolio as the pension plan faces increased competition from other institutional investors for places as limited partners in PE funds.

CalSTRS investment staff is exploring a collaborative model in which it hopes to join with investment managers and other institutional investors in more direct style private market investments.

This could increase the private equity investments to 13% over time if the model was successful, but the 13% is very much an aspirational goal for the foreseeable future.

The recommended asset allocation also maintains CalSTRS current expected annual investment return calculation at 7%.

In the documents, CalSTRS investment staff says the proposed asset allocation changes are “not far off” from the current portfolio.

“This is fine tuning focused on improving diversification, enhancing portfolio down-side protection, and taking advantage of the risk-return profile of the private assets as outlined in the Collaborative Model initiative,” the investment documents said.

The pension plan lost 25% of its assets during the great financial crisis back in 2008-2009. The effects of that drawdown put CalSTRS on a trajectory to run out of money by the mid-2040s.

Former California governor Jerry Brown promoted a plan in 2014, which was approved by the California legislature, increasing contributions by school districts and the state to the pension plan.

The educators’ pension fund has an appropriate 65% funding level. Brown’s plan aims to restore full funding for the pension plan by 2046, but CalSTRS must meet or exceed its 7% expected return on average over the next 26 years for full funding to become a reality.

A CalPERS report last year put the fund’s chances of meeting that goal at 70%. It also emphasized the importance of protecting the pension plan from a major equity drawdown.

The new investment documents reviewed by CIO also revisit the subject of a major drawdown and what CalSTRS is doing to prevent it.

“As the markets and CalSTRS staff evolved, the portfolio has gotten more sophisticated offering greater diversification and investment opportunities,” the CalSTRS memo says. “Since the Great Financial Crisis of 2008, more focus has been on protecting the portfolio from large stock market declines as evidenced by the addition of RMS (risk mitigating asset class.)”

The investment staff was evaluating six different investment portfolios as part of its asset allocation plan for the future.

In addition to the portfolio it selected, CalSTRS investment staff also analyzed a lower risk in portfolio, following the direction of the investment committee in July.

The asset plan would have lowered CalSTRS equity portfolio to 34% of the overall portfolio—down by 13 percentage points from the current target.

The problem with the portfolio is it had an lower assumed annual investment return of 6.75, meaning it would have increased CalSTRS unfunded liability and have resulted in additional contribution increases by school districts and the state.

Investment staff rejected the proposal saying that it would require higher contribution while, “offering minimum reduction in the risk of low funded status.”