In the face of wide market swings and continued uncertainty this year, CalSTRS CIO Scott Chan said pension fund officials expect to lean into offense and defense: offense such as private market investments in energy transition and “pockets of private credit”, and defense by bringing back to target allocation diversifying assets like fixed income.
“The market will be volatile” with a possibility of a markets dropping 10% or 20%, Chan said.
One theme that could impact performance is artificial intelligence and its potential to drive markets, Chan said.
“Has it gotten ahead of itself?” Chan queried.
CalSTRS officials expect to see a large amount of spending by companies on AI technology and its use cases and is uncertain how this will impact earnings, which Chan said “is a great risk.”
Recently the CalSTRS investment committee built in liquidity and rebalancing tools — including leverage and wider bands around asset class targets — that pension officials have yet to use, Chan said at the Jan 8 investment committee meeting of the $346.5 billion California State Teachers' Retirement System, West Sacramento.
“This could be the year that we use them,” Chan said.
Offense and defense
Asset prices could fall in volatile markets and CalSTRS could use added liquidity to take advantage of that, he said.
There is much uncertainty in the market for 2025 with other themes including interest rates, artificial intelligence and policy changes such as tariffs, Chan said.
President-elect Donald Trump’s campaign rhetoric around tariffs could be inflationary and adds uncertainty to the markets. Inflationary pressure from Trump tariffs could work its way into interest rates, the economy and private market prices, Chan said.
“This is why it is important keep our dry powder, keep a diversified portfolio and be ready to take advantage of opportunities,” he said.
CalSTRS officials see investment opportunities particularly in private markets, which could “produce some alpha or exceed our benchmarks,” Chan said.
Some potential offensive plays include investing in energy transition, private credit sectors that are structurally growing and, after a few years of decline, possibly real estate.
“We are underweight that (real estate)...there could be a looming inflexion point, although we’re not calling one,” he said.
CalSTRS officials are also seeing more private equity deal flow as well, Chan said.
At the same time, CalSTRS officials plan to continue playing defense by bringing diversifying assets such as fixed income back to target due to the risks, Chan said.
In 2024, CalSTRS adopted a new asset allocation increasing its fixed income target by 1 percentage point to a new 13% target allocation, to fund its private credit direct lending strategy.
Indeed, one of the longer-term mega themes Chan and his team identified is the continued shift of credit from banks to the private sector, he said.
“This is a good thing because in every crisis we see banks going out of business,” because as in the case of Silicon Valley Bank, their assets do not match their liabilities, he said. The movement of debt off of bank balance sheets is a “generational” investment opportunity to invest in the select number of private credit segments where there are opportunities. Chan said.
However, in the short term, Chan said he expects there will be a default cycle whether in the private or public credit markets.
That could be an opportunity because there are some sectors where investors get paid more in a default cycle, he said. There won’t be a big change in defaults if there is a quick decline in the market with a rebound in 2025. Even such a “rough patch” could impact prices, he added. However, a recession will produce a default cycle, Chan said.
