In the three months since new CalSTRS CIO Scott Chan took the wheel of the $346.5 billion pension plan, he has largely stuck to the same route plotted out over the last few years while preparing for a possible default cycle and volatility.
Chan has been at the California State Teachers' Retirement System, West Sacramento, for six years, serving as deputy chief investment officer before he assumed the CIO post on July 1, following the retirement of long-standing CIO Christopher Ailman.
“It’s an exciting adventure,” said Chan in an interview. “I couldn’t be more excited and energized.”
Chan's team and the board will spend this fiscal year crafting a shared vision on creating more value alongside its existing collaborative model, net-zero plans and diversity programs.
CalSTRS is facing a less accommodative investment environment with political and war risk among the challenges. But Chan said CalSTRS' liquidity and rebalancing tools — including leverage and wider bands around asset class targets — makes the pension fund more resilient.
If there is a default cycle, which Chan expects, CalSTRS’ portfolio “will be able to make a decent return,” Chan said.
“We’ve seen Fed (Federal Reserve) and the government come and save the too big to fail ... rather than have a normal cycle where people that made that investment pay for those bad investments and wipe the slate clean,” Chan said. “It’s only natural to have a default cycle.”
Ongoing risks
Some of the risks CalSTRS' portfolio will encounter include political risk with a presidential election on the horizon and the risk of war with a number of hot spots across the globe, said Stephen P. McCourt, managing principal and co-CEO of Meketa Investment Group, CalSTRS' general investment consultant, at the Sept. 25 investment committee meeting.
CalSTRS' board built in flexibility in the portfolio with leverage and liquidity tools to allow the pension fund to nimbly invest through in a crisis, Chan said at the same meeting.
There was a significant drawdown in 2022 equity markets during which CalSTRS was able to move capital into equity derivatives, a form of leverage, to rebalance its equity portfolios and capture excess value until the market snapped back. CalSTRS has the ability to add 10% leverage the total portfolio.
“As we know the market really came back very, very quickly,” Chan said. “Things can happen more quickly than they had in the past and we have tools to create a more resilient portfolio.”
CalSTRS' starting point is its mission of securing financial futures and sustaining the trust of California’s teachers, including his spouse, Chan said.
“How do we achieve our mission? One, we take a very long-term approach. That’s how we will succeed,” he said
CalSTRS officials are also developing a very diversified portfolio across geographies, asset classes, sectors, risk factors, “you name it,” Chan said.
And CalSTRS is developing “an expert investment staff” to serve as “trusted stewards” who are positioning the portfolio based on dynamic market conditions, he said.
Next generation
On his first day as CIO, Chan established a new division called total fund management to make the pension fund more resilient, flexible and dynamic, and promoted June Kim, formerly director of global equity, to the head the division as senior investment director.
Kim was the first promotion in a leadership transition CalSTRS has been undergoing since Chan moved up to the top investment job.
In September, Chan named David Murphy director, taking over for Kim as head of CalSTRS’ $144.9 billion global equity portfolio, and Rosie Lucchesini-Jack as director of the $41.2 billion fixed-income portfolios, replacing Glenn Hosokawa, another long-tenured investment official who had retired after 25 years at CalSTRS.
Charles Fitzpatrick was named interim director of inflation sensitive, taking over from 31-year veteran Paul Shantic, who retired at the end of September, and Sally Stocks was promoted to senior portfolio manager in real estate, a new role. Some leadership changes did occur before Chan was named CIO. In September 2023, for example, Julie Donegan had been promoted to real estate investment director from interim real estate director, becoming the first female executive to take on the role. She took over from Mike DiRe, who was appointed senior investment director of private markets in January.
“I am very excited for the next generation here,” Chan said at the same investment committee meeting after describing what he called the leadership transition.
“I’m in the middle of the generation that is retiring and the new generation,” Chan said at the meeting. “For me passing the baton, passing the torch ... doesn’t happen overnight.”
Chan noted that many of the new generation were mentored and coached by those who have since retired as well as current top executives.
CalSTRS is focused on creating the opportunity for advancement, said Mindy Tirapelle, CalSTRS spokeswoman, in an emailed response to questions. “We have developed mentorship and succession planning programs to provide coaching and career opportunities to employees.”
Diversification pays off
Chan was also at the helm of the second-largest public pension fund in the nation in July when CalSTRS announced its fiscal-year returns in which the pension fund outperformed its benchmarks in all time periods. CalSTRS earned a 8.4% net return for the year, 8.5% for the five years, 7.7% for the 10 years, 7.6% for the 20 years and 8.1% for the 30 years ended June 30.
“Our strategic asset allocation explains 90% of our return and we, as a staff, try to add value and create more return than our benchmark,” he said in the interview.
Chan said he prefers to look at a longer time period, like five years, rather than the one year when analyzing performance.
“I look at the one-year as one mile in a marathon,” he said.
According to public pension fund returns tracked by Pensions & Investments, CalSTRS ranks below the 9.8% median for the one year but was 13th for the five-year period and ninth for 10 years.
Another significant reason for CalSTRS' 8.5% net return in the five-year period is the plan’s focus on moving about $50 billion in assets into private markets and alternative assets during last five or six years, he said at the meeting.
CalSTRS has been increasing its private markets allocations over that period including in 2021 adding a 5% private credit allocation. After its last asset-liability management review in 2023, CalSTRS lowered its public equity allocation by 4 percentage points to 38% to increase its allocations to private assets, including a 2-percentage-point increase to 14% to fund its private credit direct lending strategy, a 1-percentage-point increase to its private equity allocation to 14% and a 1-percentage-point increase to its inflation-sensitive allocation to 7%.
Over the past five years, diversification really paid off.
“There were surprises and bumps,” including the pandemic in fiscal year 2021, he said. “That was a defining year where diversification really paid off,” Chan said.
During the five-year period, the board took steps to give staff more flexibility including approving in January entire portfolio leverage of up to 10% to smooth out cash flows and wider ranges around its asset class target allocations.
The portfolio’s outperformance means that the team was able to add value above the benchmark and part of this is the collaborative model, Chan said in the interview.
Chan is also looking to bring more assets in-house.
In the private markets, CalSTRS is "unlikely to build an internal Blackstone,” but its collaborative model has a wide array of strategies that give CalSTRS more control, such as co-investments, joint ventures and minority or majority ownership interests or revenue-sharing with money managers, Chan said.
Since 2017, the collaborative model as well as the contribution of its expert staff has saved CalSTRS $1.6 billion in fees and created more than $10 billion in value added to the fund, he said.
“It was part the collaborative model ... but part our expert staff selecting better managers and beating the benchmark,” Chan said.
