Christopher Ailman, chief investment officer at the California State Teachers' Retirement System, Sacramento, is an old-fashioned guy. He still knows how to use a bulky Monroe Business Trader and he recalls the days when commercial paper data was pulled on a Telerate.
But he can lean on his nearly 30 years of asset management experience to smoothly maneuver the country's second-largest public pension plan through the modern market, one of the most volatile financial environments in history. “I've been in the business through 1981, 1987, 1991 and 2001 and the real difference I note now vs. then is the extreme volatility and speed of these markets,” said Mr. Ailman.
Mr. Ailman joined the now $158.6 billion pension fund in 2000, when it had $116 billion in assets. In July, CalSTRS adopted a new global allocation, joining the ranks of sophisticated investors looking to abandon their home-country bias and Mr. Ailman has called for 21st century ideas to tackling risk. Prior to joining CalSTRS, he was CIO at the $78 billion Washington State Investment Board, Olympia; before that, investment chief at the $6.1 billion Sacramento County (Calif.) Employees Retirement System.
What have your days been like this past month and a half? My days have been days and nights. People often ask me if I sleep like a baby and my answer is: “Yes. I'm up every two hours screaming.” The volatility has just been remarkable. It's pretty remarkable that the data point we have to use to give us perspective is either 1987 or 1933.
The credit crisis has lasted 14 months already. Do you see an end in sight? The subprime crisis that started 14 months ago really morphed into a full-on credit crisis with Bear Stearns in February, and then it really morphed into a solvency crisis with Merrill Lynch and Lehman. In the last three weeks, it's been a crisis of confidence. I think we need to unwind in that same way. We'll get a little more confident about the solvency from all of the government intervention, both in the U.S. and internationally. We'll get some confidence and solvency in the banking system ... that'll help us gain confidence about credit. And how long this will take, I'm not sure. But the two statistics we're absolutely focused on ... is watching jobs (and) any information about mortgages and foreclosures. ... Getting out of this, it started with home prices, it will end with home prices.
Will we hit a prolonged, global recession? There's no question we'll hit a recession. The question is whether it's prolonged. A lot of that is whether it'll be a V-shaped pattern, or a U-shaped pattern. The statistics that will tell us if we're climbing out is going to be the jobs. Layoffs beget more foreclosures, which would beget more layoffs and then you end up in a very prolonged, deep recession. (But) I think there's more stability, there's more diversification in our economy than we had seen in the '80s or even the '50s and certainly the 1930s.
Globally, we still have little engines of economic growth within India, within China, within Brazil. They continue to foster growth internally. There's probably a 10% chance of a catastrophic economic downturn, but that's lessening every time the government steps in. There's probably more of a 40% likelihood that there's more of a sharp V-shaped turnaround and a 50% likelihood that it's a prolonged global recession.
What's your view on the bailout package and the infusion of capital governments are looking at? Right now we have two very broad concepts. You'll know a lot more once it's implemented. There's no question that the free market operates, but there are times when it gets to extremes — extremes of optimism, extremes of pessimism. And that's when you need circuit breakers to slow it down.
You do need the social structure to come in and be a buffer in extreme tail events. And we're clearly in an extreme tail event. So you need to government to come in ... aggressively. I like the fact that it's coming in with more of an investment concept. I'm still very bothered by the term bailout.
What opportunities does this market present to CalSTRS? We learned from 1982 and '87 that it presents a tremendous buying opportunity. We also learned from the (Resolution Trust Corp.) bail-out that distressed debt assets can present a very good opportunity. The difference now is that I am seeing so many institutions trying to raise a fund already to deal with these distressed assets. I joked the other day with my staff, I guess it's kind of like in the '60s where everybody claimed they were at Woodstock. Now every manager I talk to claims they managed money during the RTC bailout, and the reality is there weren't that many involved in it.
Even though there's going to be a lot of money raised in that, there are going to be some winners, some losers. But we do know that people (who) do invest in that can potentially generate over 20% rates of returns. We also know historically, that when the stock markets get down to these p/e ratios, it's a bargain. So it's a matter of trying to stick to your asset allocation, trying to have the discipline to tippy-toe into the market and take advantage.
CalSTRS recently approved an allocation to global equity. We're going to continue to look at it. ... This (current market) absolutely reinforces the idea of how correlated the markets are at extreme points. What this shows us is that during severe downturns, right when you want diversification, the correlations are all going to one. I think it helped all of us realize that we need more sophisticated asset models than the industry has been able to use. We need models that can deal with non-stationary correlations. We need models that can recognize the tails are a lot fatter. A lot of people are going to hear about kurtosis and they're going to have to scramble to their statistics books.
About a year ago, CalSTRS was looking for a portfoliowide risk management system, and more recently, looked at developing a separate risk unit. Has that helped? We are still in the process of implementing our risk system. The biggest challenge with any of the risk systems today is that they have to proxy private equity and real estate. I need a risk system for the 20% of my portfolio that's private and doesn't move every day. That's still a failing of those systems. These systems are designed to tell you the risk portfolio in a normal market period. Well, thank you very much. I actually need them in periods of significant distress. We're seeing an evolution in our industry. We're going to need 21st century tools to get through this. A lot of that isn't available off the shelf. That's why we so quickly turn to history to get some perspective.
Looking ahead, 10, 20, 30 years, where do you see CalSTRS? I think we're going to be a major player in the global marketplace. I know we will have a global presence. I think we will continue to play a role as one of the largest and strongest advocates for fair and open markets. We're institutional money managers. ... If you look at our peers in Canada, Britain, Norway ... and even sovereign wealth funds, they have all become quasi-public/private money management companies.
I don't know what the catalyst of change will be, but I am absolutely convinced 20 years from now, all of the major pension plans will be investment management companies.
