In May 2022, CalSTRS added a 2% private credit allocation, specifically direct lending, to its fixed-income portfolio, which now has a 14% target allocation, and boosted its private equity and inflation-sensitive allocations by 1 percentage point each to 14% and 7%, respectively. Both increases were at the expense of public equity, which the board cut by 4 percentage points to a 38% target allocation.
"We're not going to be building our own internal … Blackstone," said Scott Chan, CalSTRS' deputy chief investment officer, in an interview.
Instead, CalSTRS officials are looking to leverage the fund's partnerships to extend the benefits of internal management. Through investment structures such as co-investments, joint ventures, separately managed accounts and revenue sharing, CalSTRS officials expect to lower costs and lessen risks, Chan said.
CalSTRS' collaborative model strategy has saved the fund $1.6 billion over five years, according to a report for the board's Nov. 1 investment committee meeting. While the amount of savings CalSTRS expects to reap from the collaborative model has leveled off, fund officials still think they can wring more savings by applying that model to private assets portfolios, a move that effectively would be "bending the cost curve," Chan said.
"The low-hanging fruit in the collaborative model has been picked," said Stephen McCourt, managing principal and co-CEO at CalSTRS general investment consultant Meketa Investment Group, during the meeting.
Not every structure — such as revenue sharing — will fit each private market asset class. In private equity, CalSTRS officials plan to increase the share of its private equity portfolio that is in co-investments and other lower-fee strategies to 35% from 20%.
Co-investments provided the largest savings from the collaborative model, with co-investments across the private asset classes cutting $246.3 million in costs in 2022. Internally managed public assets saved CalSTRS $88.2 million in 2022.
But private equity may not be as amenable to control-revenue sharing types of strategies as real estate, Chan said. Now, 80% of CalSTRS' real estate portfolio is in structures that give pension fund officials control, he said.
In joint ventures, CalSTRS capital is invested alongside manager capital with the pension fund sharing control. CalSTRS also owns a number of real estate operating companies, giving the pension fund nearly total control and a share of the firms' revenues over those investments, Chan said.
The benefits of the collaborative model go beyond cost savings, he said. In these structures, CalSTRS can control the risk and control the liquidity, Chan explained.
"We know from a ground up, asset level what risk we own," Chan said. So, in a develop-to-core real estate strategy in which real estate is built or is remodeled into a stabilized, income-generating asset, for example, CalSTRS can help decide what properties to sell off to the market and when, he said.
"We're on the ground floor of sourcing opportunities as well," helping to make CalSTRS a partner of choice, Chan said.
The teams running the different private market asset classes are developing their own expertise and determining which managers in which areas of the market are more or less interested in having CalSTRS take ownership, Chan said.
CalSTRS officials have decided to employ the collaborative model in private equity mainly through co-investments, which represent about 2.5% of the portfolios' net asset value, he said.
In other areas like private credit, CalSTRS officials think they can extend into joint ventures and ownership structures "where the market might be more amenable to these structures," Chan said.
In one instance, CalSTRS committed $500 million to a private credit fund, committed another $500 million for co-investments and also owns a portion of the profits through a revenue-sharing arrangement, said Chan, who declined to identify the manager.
Revenue-sharing arrangements are not solely with emerging managers, Chan said. CalSTRS has these arrangements with larger firms as well, he said.
"The manager has to want to partner with CalSTRS in this way," Chan said. "It benefits both sides."
For the manager, it gets CalSTRS as an anchor of one of its funds, he said.
"We view it more as how we can partner more together," Chan said.
"Our mantra is trying to be a partner of choice … we try to be very responsible, very nimble," he said. "Ultimately we can be a trusted expert for them. It's really a two-way street."
This is all part of the evolution of the collaborative model, Chan said.
"We are moving to try to source deals and have economics through ownership" and revenue-sharing arrangements."
These structures will help CalSTRS control risk … those are areas where we still have room to grow."
CalSTRS officials are not only looking for more revenue-sharing arrangements but they are starting to "connect the dots" across the organization, Chan said.
Connecting the dots can include investments that can flow across asset classes in what CalSTRS executives call a "one platform, one organization" model. Such a control-revenue-sharing-oriented strategy can start, for example, with CalSTRS issuing private commercial real estate debt, which eventually gets securitized, bundled into commercial mortgage-backed securities, which the fixed-income team could invest in, he said. CalSTRS could launch an in-house unit or back a manager to do these investments, he said. The work could be done either by an internal team or by a manager that CalSTRS would fund.
These in-house type structures are more efficient and would help CalSTRS officials better understand the risks, Chan said. CalSTRS officials would better understand what risks to keep, which to securitize and which of these securities CalSTRS should own in its fixed-income portfolio, he said.
