CalSTRS is nearing the end of a three-year process of investing 9% of its portfolio into a risk mitigation strategy aimed at protecting the plan in the event of another sustained stock market decline.
But pension fund officials won't know whether their bet will pay off until there is a long bear market. In the meantime, the pension plan is staying the course during a time when equities have handily outperformed components of the plan: U.S. Treasury bonds and trend-following strategies.
Investing about $20 billion of its $219.2 billion portfolio in the strategy hasn't won the West Sacramento-based California State Teachers' Retirement System any popularity contests, said Chief Investment Officer Christopher J. Ailman.
"Peers criticize it," Mr. Ailman said. "They don't think it will work."
The idea came out of the global financial crisis, he said.
"In 2008, almost everything moved together. Fixed income, U.S. Treasuries and cash were the only things with positive returns," Mr. Ailman said. "So the innovations team dived into what could diversify the plan. The seeds gave us the risk mitigation strategies that complement the diversity of the plan."
Beginning in 2010, CalSTRS' innovations team began studying various strategies to mitigate risk in the event of a deep recession.
"Everyone has been and remain worried about interest rates going up. That's not a positive for long Treasuries," explained Neil Rue, Portland-based managing director of general consultant Pension Consulting Alliance LLC, one of CalSTRS' general investment consultants who helped develop the concept.
What's more, U.S. Treasuries can experience short-term unrealized losses in a growing economy, especially when there are investor fears of rising inflation, he said.
"That has put general pressure on the implementation of risk mitigation strategies that utilize long Treasuries," he said. "Longer-term Treasuries can fluctuate dramatically while investors are waiting for `flight to quality' to happen."
CalSTRS' risk mitigating strategy earned 0.19% net return for the five years ended June 30, compared to its benchmark of -0.94%. It earned -2.92% for the three year-period and 1.78% for the one year period, compared to benchmarks of -2.54% and 1.73%, respectively.