CalSTRS Board Approves Plan to Increase Portfolio Leverage up to 10%

The CalSTRS board on Thursday adopted two changes to the pension fund’s Investment Policy Statement that would permit a broader use of leverage and widening of asset allocation bands, intended to build a more resilient portfolio.

The vote came during a California State Teachers’ Retirement System investment committee meeting in which CIO Chris Ailman announced his plans to retire at the end of June.

With Ailman retiring in the summer, this will mean that both CalSTRS and the California Public Employees Retirement System will be searching for a new CIO. CalPERS expects to announce the results of its search sometime early 2024, following the resignation of CIO Nicole Musicco in September.

The pension fund’s board approved a plan to increase the fund’s maximum usable leverage limit to 10%, allowing CalSTRS to temporarily borrow up to 10% of the fund’s assets for total fund portfolio positioning and liquidity management. This would allow the fund, which holds $317.8 billion in assets, to borrow up to $30 billion as leverage.

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“After independently evaluating the proposed policy, Meketa Investment Group concurs with Staff’s recommendation to adopt a modified IPS incorporating new target asset allocation bands and defining the leverage maximum allowance at 10%,” Meketa, CalSTRS’ investment consultant, stated in its review of CalSTRS plan.

According to the review, both CalSTRS staff and Meketa concluded that up to 10% leverage would pose minimal risk to the pension fund’s funded status, although it was noted in a report that there would still be other risks, such as counterparty risk, reputational risk, execution risk and maturity risk.

CalSTRS staff noted that it would not plan to immediately use the leverage, but it would have the option to use it in times of market downturns. The 10% limit would not necessarily mean the fund plans to borrow up to the limit.

In addition to the tools the fund already uses, the fund under this new policy will consider using commercial paper borrowing and unsecured term debt. CalSTRS currently uses derivatives, reverse repurchase agreements, and bank credit lines.

The fund has used leverage in the past to navigate such downturns. In 2020, the fund used derivative tools to mitigate weak equity markets and outperformed its target that year. Without the use of derivatives, the fund would not have been able to do so.

“Leverage is not new to CalSTRS, nor is it not new to large asset owners like [CalSTRS],” said Meketa co-CEO Stephen McCourt in Thursday’s meeting.

CalSTRS currently holds $12.306 billion, 4% of the fund’s assets, as gross leverage. Net leverage—gross leverage minus fund cash—stands at $4.747 billion, 1.6% of the portfolio.

Expanding strategic asset allocation ranges, combined with the 10% maximum leverage for total fund management, could lead to optimal portfolio implementation and risk management, according to CalSTRS’ recommendation cited in the meeting.

“Think of the analogy, we all use credit cards for short-term purchases and then pay them off just to smooth out our cash flow and this is the kind of thing we’re trying to do here, is take advantage of opportunities when we think they appear, and we are being very judicious and monitoring the heck out of it,” Ailman said of the policy change.