To mark its 50th anniversary this year, Pensions & Investments sought out Christopher Ailman, CIO of the $316.7 billion California State Teachers' Retirement System. In Part 2 of this Face to Face interview with Ailman, conducted in early October before the start of the Israel-Hamas war, we asked about his thoughts on AI, managing geopolitical risks and the future of defined benefit plans.
Questions and answers have been edited for style, conciseness and clarity.
A: Well, one of my daughters teased me and said, "dad, you should be an expert in AI. It's the first two initials in our last name." The reality is I'm not.
AI is going to be profound and I've got to look at the experts when all the experts went to Congress and said, "Hey, this could be really dangerous." I'm not quite sure I understand how that's going to be dangerous, but oh my gosh, they are really warning them when they're begging for regulation.
This is something that is truly profound and hopefully mankind can use it for good, not for evil.
Obviously the digitization of everything, including our own image, is a radical new concept. I've heard of actors and actresses who want to trademark their face. What a strange concept. I know real estate people who want to trademark their building because it's an iconic building and you can visit it digitally or you can visit it physically.
That's just a whole new concept, and again, another realm of a dimension that we have to expand our mind and think about, so likely to being big changes that I can't even foresee right now.
That massive power of information is huge and how that can be harnessed and used, but it obviously has to discern between fact and fiction, which is a huge critical issue. I'm sure it's going to impact investments, how we make investment decisions.
It makes things quicker, faster. But the thing I've said to my team is investments is still all about trying to anticipate or even predict the future. And I say that as a joke because you can't predict the future.
AI will help us, but I don't think it's going to be able to predict the future any better. You're still talking about human beings, who are irrational and very difficult to understand how they do things and how they react to markets and stimulus.So I think for investments, well, it's going to be a powerful tool. But it's going to stay a human business and a judgment business.
A: Well, I enjoy you bring up that point. There's a sailboat in the background and that's partly where I got that analogy.
My board asked me ... to look out on the horizon and tell them what risks I saw.
They called them inevitable risks, which sounds like an oxymoron, but when you think about it out here in California, the risk of a massive earthquake on the San Andreas, scientists will tell us it absolutely is going to happen. We just don't know when. So when it happens, it'll be a surprise, but it was inevitable.
So it's one thing to see a risk, it's a whole other order of magnitude to try and figure out how it interacts and how severe it's going to be.
But right now when I look out, I really do say No. 1 absolutely is climate change. To me it's existential. It's a long-term risk.
We have to wake up and pull our head out of the sand, and change is hard. I get it. People don't want to change, but we have to for survival. No. 2 on that list is actually viruses, both biological and digital. Think about how much we do. We rely on the internet in terms of so many different facets and ways and losing that capability would just cripple the global economy.
But now we're aware that biological viruses are massive and can spread; thank goodness we have the technology to fight them. Geopolitical risk is back up at an all-time high and is getting tighter and tenser —not easing.
It's very difficult to identify just one and say that's the only thing you have to pay attention to.
Always in life there are a number of risks ahead of us that can be navigated, mitigated, and that's what you have to decide as an investor. Do you want to accept a risk? Do you want to mitigate a risk? Do you want to avoid a risk?But risk is in front of us and that's how we make a return. We take a risk in order to make return.
A: I back up to an even bigger picture and look at democracy vs. other governmental systems because while China is the main focus and the No. 2 economy in the world, you still have Iran, you have North Korea, you have a number of problems.
First and foremost is Russia. So I think Russia really showed institutional investors that geopolitical risk doesn't revert to a mean. We think about markets, they could be overbought, oversold, but they tend to revert to a mean. Geopolitical risk is binary. It's either on or it's off. And like we learned with Russia that market's either open or it's closed and you got to get out.
So it's a different perspective and a different tool that you have to use with geopolitical risk. And I think we absolutely have to factor it in. It's one thing to be in the public markets, but it's a whole other thing to be in the private markets and this world is fraught with challenges and everybody's trying to get their heads around it.
There's no daily VaR (value at risk) on geopolitical risk. Maybe that's a way to think about it because the possibility of going to zero and having your assets frozen is real.
In the old days, we all believed in the emerging markets and expanding everywhere, but they're not just one thing. There are a whole series of regions and different countries and different markets that go through different political events and we need to factor that into those investments, into that diversification. Just like companies do. You know it, Tim Cook and Apple are debating this immensely.When you get dependent on one country as your main supply chain, you have to diversify and have to spread your risk. And so when corporate CEOs are thinking about it, then pension plan CIOs need to be thinking about it.
A: Well, if I could go back, I remember starting on Wall Street in 1981, the yield curve was inverted. Oil prices were extremely high and you could buy a long bond through 8%. So I've been through a lot of different markets. What amazes me is I try to look at the markets by decade, the '80s and the '90s, we were worried and nervous, but boy did we have the wind at our back and the sun in our face.
The '00s were a very difficult time period with '01, '02, and then obviously 2008, the 20 teens have been a pretty darn good period because of the federal stimulus.
It's always true: Don't fight the Fed, pay attention to what the Fed's doing. I recognized that in 1982, the long bond peaked and I had the wind at my back all the way until we hit zero in the short-term market and the long bond drop down, that is a huge positive trend that really helped equities and fixed income that produced amazing returns.
So it was difficult to not make a positive and a very sizable return over long periods. There certainly were years of recessions and difficulties.
The other thing is diversification, but maybe not too much diversification. I think we've always felt that you could diversify and the more diversification you do, the better. I think that's an open debate now about can you get too diversified and spread too thin.
Probably the biggest advice is just that risk and return matter. Do your due diligence and don't fight the Fed and think and act long term. Do not think short term and try and time these markets. I'm constantly amazed at how difficult it is and yet how much time and attention every day gets spent on fast money and quick money and trading ideas.I always like to say we're long-term patient money. We're an investor, not a trader. Think long term, act long term. It is terribly hard when you live life day to day, but it's absolutely critical when you're running pension money.
A: I've tried to be a really loud, outspoken person when it comes to defined benefit plans. And my point is to an employer, they're an employee benefit, literally just like dental, vision, health care — they're an employee benefit. If you want employees with longevity with institutional memory, then reward them with a defined benefit plan. If you want and you don't mind employee turnover and employee mobility, then offer them a defined contribution plan.
I think we really need to focus in on it like that.
Obviously, I run a teachers fund and I'm passionate that with teachers, absolutely longevity matters and experience matters in that field.
You want to reward that long career and you want to reward it with a defined benefit plan. And I think we're going to look at corporate America and realize there's some jobs at a corporation, you want to reward longevity and you're better off having a defined benefit plan.
We're going to have a giant defined contribution crisis in America as people retire. No. 1, not having to put enough money away for retirement. No. 2, probably not taking enough risk in their portfolio, and No. 3, bearing a higher fee cost each year to manage that retirement account.
Then they're going to end up where they retire with a lump sum and if they don't put it in an annuity, they have a real big risk of outliving their money. That's a huge social crisis that America's going to have to face.
I don't view this as a political discussion.
I really view this as an employee benefit discussion and it's a financial decision. Defined benefit plans blend the longevity risk. They are a lower-cost structure. They blend the investment risk and put it in the hands of institutional experts instead of retail investors. And so to me, it's a superior way to save and to go for retirement.
Is it going to be under attack? Yes, because right now most defined benefit plans are only for public employees and obviously public employees are not popular with the average citizen.
And since most people are going to be in a defined contribution plan, they're going to realize they have less in retirement and a bigger retirement risk.
I wish we would get away from that kind of a fight and just have more of an honest discussion about what's the right way for society to save for the future; look at our Social Security plan and compare it to Canada or other social security plans, where they've started to put money away and invest into the future. We're still going to be pay as you go and we're going to be broke in no time.I think the power of compounding, the power of investing and thinking long term is good for our country. It's good for the employees and it's good for the employer.
A: When I look at defined benefit plans today in today's market, there are two things that really strike me. One, we need to stop calling them pension plans and start referring to them as they are, as trust funds.
It's a trust fund of money from an employer and an employee saved for the future for the employee or their beneficiaries. The money doesn't belong to the employer. It actually doesn't even belong to the employee, yet it belongs to that future employee 20 or 30 years down the road or that beneficiary. It's a trust fund and it needs to be preserved as a trust fund.
We don't need political interference in it. We don't need outsiders telling us how to invest it. Hold the fiduciaries to a fiduciary duty as sitting over a trust.
The second thing that I really is struck by is governance.
Frankly in the USA, most of our governance models were designed in the 1970s, and while I love the 1970s — I like music from the '70s — there's not much else we've kept from the '70s.
I think it's time to modernize our governance structures to look at other countries, the Canadian model, the Australian model, and recognize people that have designed pension plans post the 1970s have opted for different governance structures. And it's time that we refresh those and look at those. There are very few states, cities or counties or districts that have revised or refreshed and taken a hard look at the governance that leads the trustees and how these trustees are selected.These are no longer a little $10 million or $100 million funds. These are hundreds of billions of dollars. They are important to the U.S. economy, to the world economy, and they need to modernize the governance.
A: I'm smiling because I've heard the argument about rates of return and the assumed rates of return for 40 years. Not as quite as old as P&I, but for a heck of a long time, and it was interesting in the first 20 years of my career,it was that our rate was far too low. Now in these last 20 years, it's that it's too high and we should be assuming a lower rate of return.
Maybe that means that over a very long term, it is right about the right rate. Look, the assumed rate of return is part of a formula. Yes, it's a forecast, but realistically it's — I have a benefit I have to pay in the future. How much do I want that benefit to cost today? And you end up just going through math and the actuarial sciences and you have to come out with a contribution rate and an assumed investment rate.
So it's a huge input, but you can't make that benefit so expensive so that nobody wants it. You've got to price it right, and you've got to balance with what's realistic looking forward. So I take a multigeneration, literally not just a decade, but a multidecade view of where the assumed rate should be, and I think it's probably pretty accurate.
Is it accurate for next year? No, that's not what it's intended for. It's intended to be over the next 20 and 30 years. What can we think we can assume as a rate of return? And if I look at P&I and I look backwards, yeah, that's about right.
I think that in terms of investment opportunity, we can still have a reasonable assumption rate. Should it be 6%, 6.5%, 7%, 7.5%, 8%?
You can have an interesting debate, but it should be around that number and it really should again come back to what the benefit costs, you have to contribute to pay that benefit.
When you look at most pension plans that are unfunded today across the country, their investment results are not radically different.
The difference is the contribution pattern. You see employer holidays, you see employees get discounts for periods of time. You see benefits grow without corresponding increase in cost. It's frankly the benefits side and the liability side that's created a lot of pressure on the funded status of pensions.The returns in and out have stayed within a pretty decent range. So there's a long-winded answer. I'm good at those, but I really got to tell you, I think it is about the right level.
A: Hey, what a huge pleasure. I am a giant fan of P&I and I still have P&Is from all the way back when I first started in the business. I remember the first time my name showed up. I was very, very excited.
I love the fact that you're still published in print. That's important to me. But obviously you're online, and to us, you're the backbone of our industry. You're the one publication we all go to and look at and get information and source of truth. So congratulations to P&I and on 50 years. Let's hope you're there another 50 years.
