CalSTRS is the world’s largest educator-only pension fund, and the world’s second largest state PPF, only behind its stablemate CalPERS. For the fiscal year 2020-21 the educator-only fund scored an impressive 27.2% return, which will improve its funding ratio by 300 bp. In the past few years, it has built a successful collaborative model and become a frequent partner of other SOIs. We had the immense pleasure of talking with Scott Chan, its Deputy CIO, about the challenges and opportunities ahead.
[GSWF] California is the largest US state in terms of pension capital, with over 3.7 million members and US$ 1.2 trillion in AuM. Can you please describe the importance of CalSTRS?
[CalSTRS] We are the largest educator-only pension fund with US$ 320 billion AuM (Jan 31) and almost a million members and beneficiaries. We pay US$ 16.7 billion in annual benefits to our retired members and create 160,000 jobs and US$ 21.6 billion in labor income across the state of California.
[GSWF] CalSTRS’ liabilities have outgrown its assets and the funding is at 67%. When do you expect to reach full funding?
[CalSTRS] We haven’t published our 2021 actuarial valuation yet but we expect the funded ratio to increase given the 27.2% return, and we expect to reach full funding in 2046. We do not expect to change our discount rate assumption, which is 7%.
[GSWF] How do you look at the global portfolio and asset allocation? Are you considering a total portfolio approach?
[CalSTRS] We manage in-house 70% of our stocks and 85% of our fixed income but cannot aspire to do the same with private markets. So, we seek co-investments and partnerships, to generate higher returns and keep fees low, and this saved us US$ 390 mn last year and US$ 780 mn in costs over the past four years. The next frontier for CalSTRS is to shape our “Collaborative Model 2.0,” which includes:
Leveraging our existing relationships and becoming their global partner of choice.
Exploiting our “one-fund advantage” across all asset classes.
Capitalizing on scale to capture more across the value chain.
We’d like to become a very strategic investor; pursuing returns is important but so is how we get there and preserving our shared values.
[GSWF] Where do you think your growth will come from in the next few years? What themes are you most bullish on?
[CalSTRS] We have identified certain areas for growth: infrastructure and real estate, including health care-related properties. CalSTRS is the fifth largest owner of real estate life science lab space in the US, and we will continue to focus on that area. We believe the approx. 140 mn sqft of lab space will double over the next decade due to the population aging and growing healthcare needs. We need to be careful in Private Credit as we move toward the end of the cycle, but we have a 1.7% allocation now and would love to double that in the next few years. We are particularly interested in increasing our exposure to direct lending in the U.S. and Europe over other areas of private credit, which may not fare as well in an environment that may include more inflation and an eventual default cycle. The third area of interest is creating alpha in our US$ 8 billion annual allocation to private equity and increasing our share of co-investments from 20% to 25% to 35%. As an organization, we need to expand our footprint in Asia and we will continue to seek partnerships there.
[GSWF] Could you quickly walk us through your Race to Zero campaign and any other ESG initiatives you may be pursuing?
[CalSTRS] Our framework is about finding the opportunities to invest while also influencing our portfolio companies and partners. CalSTRS’ Board pledged to a goal of Net Zero by 2050 or sooner in Sept 2021 and the first step is to look across our portfolio and decide how to measure the footprint. After that, we will start setting targets likely first in global equities and then it becomes a question of risk. We seek to increase our investments in climate solutions that absolutely align with our risk and return goals. I’d like to build a strong track record during the transition and be very thorough in our due diligence, avoiding partners with no specific experience.
[GSWF] How do you manage to keep a slim organization, and is the plan to increase your investment teams?
[CalSTRS] Strategically we decided to build internal teams in public markets and to leverage our external partners in private markets. We are expecting to move from 178 to 285 staff in our investment team in the next five years, and we may consider to open an office in California outside of Sacramento, e.g., in San Francisco or Los Angeles in order to recruit more talent and establish an area of expertise.
[GSWF] What summary do you make of the past 3.5 years? What are your goals for the next five years?
[CalSTRS] One of the reasons I joined CalSTRS was to work with Christopher Ailman, who is one of the best CIOs in the country. Having invested on a direct basis as a partner and portfolio manager of a hedge fund and as the CIO of other smaller pension plans, I have learned a lot during the past few years at CalSTRS because of the scale, the complexity, and the size of the staff. I feel lucky I have a great team I can rely on—and that will become even more amazing leaders in the future. My goal for the investment division in the next few years is to become the global partner of choice and to become a nimbler organization - offering our partners speed, certainty, scale and a long-term investment horizon.