"We are going to grow that slowly" given rates are likely to come down, Ailman said in an interview on Dec. 20. "It lessens the interest in private debt going into 2024."
Private debt has a place in the CalSTRS portfolio and the system isn't planning to reduce its allocation. But the Federal Reserve's signal that it's essentially done with its rate-hiking campaign changes the outlook for the pension fund's private credit growth, Ailman said. Since private debt leans on variable rates, returns can go down with them, he added.
"That's why I think we have pivoted in our appetite on private debt," Ailman said. "We'll keep investing but it's not our number one thing in 2024."
Private debt has grown into a $1.6 trillion market globally as regulators tightened rules on risky lending by deposit-taking institutions since the 2008 financial crisis and in response banks have pulled back.
State and local retirement plans' funding had tumbled from 92% of total long-term liabilities in 2007 to 62% in 2009 as equity markets plunged during the Great Recession, according to Equable, a bipartisan pension researcher founded by former public finance officials.
They've turned to alternatives such as private equity to boost returns. U.S. public pension funds broadly have increased allocations of alternative assets, with private debt emerging as the biggest new part of their portfolios and many others are still expanding or just now entering the market. CalSTRS posted a 6.3% net return for its 2022–23 fiscal year. Its funding ratio stands at about 74%, which means it holds enough assets to cover about three-fourths of all promised benefits.
CalSTRS is also set to increase its fixed-income target allocation to 12% from 10.5%, according to its website.
After aggressive rate hikes by the Fed spurred uncharacteristic volatility in bond markets, traditional fixed-income returns have come roaring back since the beginning of November as yields tumbled. That's led investors such as CalSTRS to take a fresh look at the usually staid market.
In the last few decades, rates had largely moved down until the Fed began its aggressive hikes in March 2022. Rates may fluctuate going forward and CalSTRS is trying to pay attention to the direction of change, Ailman said. Over the next six months, Ailman expects CalSTRS to slowly increase its exposure to fixed income.
"We are underweight fixed income," Ailman said. "Now, it's gotten a little more attractive."
--Bloomberg
