CalSTRS could bring its emerging markets equity portfolio in house and use an active risk budget approach to allow staff to move equity investments between passive and active management to allow greater flexibility, June Kim, the pension plan's global equity director, said Thursday at an investment committee meeting.
CalSTRS is currently evaluating whether to adopt an active risk budget as part of its fiscal year 2020 work plan. In November, staff is expected to bring the first draft of a new global equity policy that will for the first time include proposed ranges showing how far each investment strategy can stray from its benchmark. They will also lead a discussion on the implementation and oversight of a global equity active risk budget. CalSTRS is considering using an active risk budget, which is a new governance approach to help plan officials manage the pension fund's risk and performance as well as to implement CalSTRS' strategic asset allocation. CalSTRS is also expected to consider adopting a new asset allocation in November.
A risk budget would make it easier for the board to delegate more of the investment decisions to staff by giving it a framework, Deputy CIO Scott Chan said.
Separately, CIO Christopher Ailman noted during CalSTRS semiannual review of its $33.2 billion real estate portfolio that real estate has always been a challenging asset class over CalSTRS' history, starting in the 1980s and 1990s when the pension plan's portfolio was so concentrated that much of its properties were in West Los Angeles. In 2008, the real estate portfolio suffered, in part, with high leverage. Since the financial crisis, most of CalSTRS' real estate return has come from lease income and not capital gains.
Currently, CalSTRS officials has been selling more properties than it has been buying, Mr. Ailman said.
"In this kind of a market, we are a net seller," he said. "I think we have the right real estate portfolio."
Currently, 70% of CalSTRS' portfolio is in core real estate with less value-added and opportunistic properties than before the global financial crisis, Mr. Ailman said. CalSTRS' real estate portfolio leverage is at 36% down from 44% in the last real estate cycle ending in 2008.
What's more, 80% of CalSTRS' portfolio is currently under staff's control in the form of open-end funds, separately managed accounts, joint ventures and investments operating companies, noted Taylor Mammen, senior managing director and director of institutional advisory services at CalSTRS' real estate consultant, RCLCO Real Estate Advisors. By comparison, much of CalSTRS' legacy investments, those invested in before the last economic downturn, are in funds. In 2010, 46% of the portfolio was controlled by staff. The shift to staff control has resulted in significantly lower fees.
During a semiannual review of CalSTRS' private equity portfolio, Steven Hartt, principal at CalSTRS' private equity consultant, Meketa Investment Group, said that CalSTRS currently pays management fees of less than 1.5% in a portfolio dominated by very large private equity managers.
Most large managers have recognized that they do not need to charge a 2% management fee, he told the investment committee.
In response to investment committee member questions, he said that due to its size, it is difficult for CalSTRS to invest in many strategies other than large buyouts — such as small buyouts or venture capital.
Separately, in his report to the board, Mr. Ailman said that the bull market looks like it is running out of steam.
"It's hard to have confidence in it and so we have shifted slightly to defensive in our all over asset allocation," Mr. Ailman said.
But he added that staff has its "leg out to shift to a very defensive strategy" should economic indicators worsen such as the U.S.-China trade war intensify or Brexit negotiations fail.
CalSTRS officials plan to have its risk mitigating strategies and fixed-income allocations fully funded should either event occur, he said.
In response to investment committee questions, Mr. Ailman said that the inverted yield has been accurate in predicting a recession but that the market, historically, hasn't gone down right away. The market still continues to rise for about 18-to-20 months before the recession hits.
"I don't know what the cause of the recession will be," he said.
