CalPERS, CalSTRS need fresh skills to take on new risks, Betty Yee says

Asset owners need a different set of tools to navigate their portfolios through the uncharted waters they find themselves in today, said Betty T. Yee, outgoing California state controller and member of the boards of CalPERS and CalSTRS.

To get there, boards need more education related to these issues and risks including geopolitical and climate change, and to hire staff with different skill sets to augment the deep investment expertise plans already require.

"How do we best fulfill our fiduciary duty in a world where there is more geopolitical risk, in a world where the climate is changing?" said Ms. Yee, who on Jan. 2 will end her eight years as controller, which gave her seats on the boards of the two largest public pension plans in the nation: the $444.1 billion California Public Employees' Retirement System, Sacramento, and the $297.6 billion California State Teachers' Retirement System, West Sacramento.

After a 38-year career that included two terms as California state controller, during which time she also chaired the California Franchise Tax Board and the California Lands Commission, Ms. Yee said she plans to take a break. However, Ms. Yee's vision of taking a rest includes maintaining her seat on the board of Ceres, a non-profit organization that works to make the financial business case for sustainability to capital market leaders.

As she leaves her position on the boards of CalPERS and CalSTRS, having served two terms for each plan, she said that running the pension funds the way they have always been run will no longer work in light of the new hazards of climate change, the war in Ukraine and the impact of an ascending China on the world stage.

"It's getting harder and harder to be a fiduciary when there are these new risks," Ms. Yee said.

In light of this, both funds are doing the best they can to assess their risk tolerances and translate those into what they believe as investors, she said. "CalSTRS is doing a good job and is pretty disciplined in looking at all this," Ms. Yee said.

Part of this is the risk budgeting approach CalSTRS has been taking and "CalPERS is following suit," she said. CalSTRS has been incorporating a risk budget since 2020 when the board. Between 2020 and 2021, CalSTRS adopted risk budgets for its public market strategies — global equities, fixed income, and sustainable investment and stewardship strategies — to allow staff flexibility to invest among asset categories within public market asset classes.

But, she suggested that the CalPERS board "does have to be more involved in setting strategy, short-term and long-term," and not only through the important process of selecting a strategic asset allocation. "The (CalPERS) board has to dig in and become more in tune with all the externalities that could impact the fund," Ms. Yee said. "We need more frequent investment committee meetings, (and) board education looking at geopolitical risk."

CalPERS has scheduled four investment committee meetings for 2023. CalSTRS schedules its meetings on a fiscal year basis and has six investment committee meetings scheduled for fiscal year 2023. These schedules do not include one board off-site meeting each pension fund has scheduled for next year and fiscal year, respectively, nor does it include a board education day CalPERS has scheduled for Jan. 17.

"The (CalPERS) board needs to be more plugged in, more knowledgeable about what may come at us," Ms. Yee said. "I'd like to see the investment committee carve out time for board education related to some of these issues and some of these risks."

And the CalPERS board should be working more in partnership with other institutional investors to try to share best practices as all asset owners face risks and possible investment opportunities that they have not seen before — particularly with one another.

Both CalPERS and CalSTRS are approaching the task of investing in a challenging environment differently and officials at each plan should be more attuned to what the other plan is doing, she said. For example, to the extent both pension funds are placing an emphasis on investing in private asset classes, more attention should be paid on the differing approaches each is taking, Ms. Yee said.

It's also time to "shift gears on the type of talent we hire," Ms. Yee said. "Are we at the point where we should be recruiting around skill sets such as data analytics?"

Deep investment experience is still crucial but is no longer enough, she said. Asset owners now also need people with technology skills as well as expertise in emerging markets and where the global climate transition is headed to help identify investment opportunities, Ms. Yee said.

CalPERS has, however, now added a permanent CIO after almost two years of searching. Plan officials on Feb. 22 announced the hiring of CIO Nicole Musicco, who was a partner at New York-based private equity shop RedBird Capital Partners LLC. Before that she spent a year as senior managing director, head of private markets at the C$79 billion ($59 billion) Investment Management Corp. of Ontario and spent 16 years with the C$242.5 billion Ontario Teachers' Pension Plan.

CalPERS has had trouble attracting and retaining talent over the years. For example, CalSTRS' CIO Christopher J. Ailman has held that post since 2000. CalPERS has had seven chief investment officers during the same time period. Other than Joseph Dear, who died in 2014, they all left to take other positions.

"I think CalPERS is, in some ways unfairly so, is always, always under the microscope," Ms. Yee said. "If you're a professional investor your attention gets taken away from the job at hand."

And it is not getting any easier.

Ms. Yee said that the politicization of asset owners' use of ESG factors in investing is "unfortunate."

Some politicians and asset owners have been pushing back against ESG considerations, resulting in many states enacting anti-ESG policies, several terminating mandates from BlackRock Inc., and other asset owners pulling back from incorporating ESG factors into their investment processes.

"It puts boards in positions where there's another element coming in that is keeping us from staying focused on doing our fiduciary duty," Ms. Yee said. "And it's from both ends of the political spectrum."

There will continue to be ongoing pressures for the funds to divest from fossil fuels, whether through legislation or increased activism, Ms. Yee said.

"What I would say about that, and I say this respectfully, I understand the calls for divestment," she said. "Our planet is in a dire condition, and I understand the impact of those industries on the health of our planet." CalPERS and CalSTRS have taken the approach of both making sustainable investments but also declining to divest from fossil fuels. Instead, officials at both pension plans have said they prefer to push for change as an investor in fossil fuel companies.

However, she pushed back on accusations from anti-fossil fuel activists and others that CalPERS and CalSTRS are "hiding behind our fidiciary duty" and not divesting from fossil fuel investments.

"If anything, we're leaning into our fiduciary duty by incorporating sustainability into investment decisions," Ms. Yee said.

"Those calling for divestment should sit on boards that represent a total of about 3 million beneficiaries …and experience what that duty is and how you fulfill that. Talk of divestment doesn't help us in trying to fulfill that duty."

Instead of divesting, the plans should continue to use their clout to push for change at fossil fuel companies, she said.

"We should be very focused on addressing the effect of climate change, especially in private asset classes," she said. "The opportunity discussion has been lacking for pension funds."

One thing that Ms. Yee is proud of is CalSTRS' board decision in August to reduce its greenhouse gas carbon emissions by 50% by 2030.

Both CalPERS and CalSTRS have pledged to move to net-zero by 2050, but the pace at which each fund is moving toward that net-zero goal has been different.

CalSTRS' 2030 goal "is a big deal," and is an example of pension officials walking their own talk, she said.

If investors ask companies to really set science-based net-zero targets on the way to 2050, they have to be willing to do the same, Ms. Yee said.

It will be hard for CalSTRS, she said. How CalSTRS will get there is "murky" but it's an important development, she said.