CalSTRS Votes on Portfolio Risk Factors | Chief Investment Officer

(June 6, 2103) — The investment committee of the $164 billion California State Teachers Retirement System (CalSTRS) is to vote today on the risk factors that will determine the direction of the pension fund’s portfolio.

In October last year, Chris Ailman the fund’s CIO, announced CalSTRS would consider this method of assessing its needs, and the most efficient way of finding investment returns to meet them.

At a monthly meeting in Sacramento today, each member of the committee will be given a free vote on how to weight a choice of four factors, which were chosen at a previous meeting.

The move is part of a shift by large institutional investors to base their investment decisions on risk factors, rather than arbitrary-and often inefficient-portfolio diversification models.

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CalSTRS’ pre-determined decision factors are:

Return-oriented: Seek relative improvement to the projected funded status path over next 30 years
Return-oriented: Seek to maximize the 20-year geometric real return
Protection-oriented: Avoid significant asset drawdowns within next 10 years
Protection-oriented: Minimize likelihood of PAYGO status beyond 10 years

After deciding on these factors, the committee had requested to see a series of potential policy portfolios and their behaviour under two separate state-level funding scenarios: keeping the status quo or increasing contribution levels by 3%.

Today, committee members will be given a series of likely outcomes to consider before making their decision, which will be done anonymously.

The purpose of the exercise is to “develop a consensus risk philosophy/risk tolerance through deliberation and prioritizing major plan risk issues,” according to an agenda pack published ahead of the meeting. The meeting agenda warns: “Emphasizing one or more of the decision factors versus others can alter policy significantly.”

The panel will be given the option to discuss the weighting decisions and reconsider their initial view after all the votes have been cast. By the end of the 90 minute meeting, the committee should have a clear risk philosophy, the agenda says.

“In light of the final risk philosophy, the investment committee will then discuss the merits of the resulting policy portfolio; Investment committee and staff may choose to modify the policy portfolio based on qualitative and implementation considerations,” the document states.

By the end of the day, CalSTRS could have an entirely new investment direction.

To read the agenda document with full detail on scenarios and asset class assessments, click here.

For an in-depth look at the evolution of risk-factor investing, don’t miss the next edition of aiCIO, published later this month.

Trust between investors and asset managers has been destroyed by the transactional nature of the investment industry, according to John Kay, visiting Professor of Economics at the LSE.

Speaking at the Russell Investments Annual Pensions Conference, Kay said: “Relationships are personal and formed on the basis of trust, whereas transactions and trading exist in an environment of seeking advantage and suspicion. Participants know more about what other traders are doing than about companies these days.”

Kay was also critical of reams of new regulation being forced on the markets, calling the recent regulatory pushes “wrong-headed” and “flawed”.

“All our experience of regulation of other industries tells us that behavioural regulation just diminishes trust and proliferates complexity.”

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Why should we care about a lack of trust? Because the results of maintaining the status quo will be worse and more frequent crises, according to Kay.

“The view that systemic crises, such as Tulip Mania, the South Sea Bubble, the Great Depression and the high-tech boom and bust, are inevitable misses the point that crises are becoming more frequent and larger in amplitude.

“I fear that we will move from crisis to crisis, driven by the disfunctionality of financial services,” he said.

To solve the problem, financial services must become more stream-lined, with fewer intermediary chains for transactions, or as Kay put it “a world in which there are one or at most two intermediaries between savers and borrowers”.

If that all sounds a bit gloomy, that’s because it is. But fear not, UK asset managers, for the Investment Management Association (IMA) has got your back.

On June 5, the IMA’s annual Mansion House dinner sought to reassure fund managers that at least in London, asset managers were starting to regain any trust lost during the financial crisis.

Douglas Ferrans, chairman of the IMA, said the first step was to reconnect with investors and understand what they need and how best to serve those needs.

“The second is to demonstrate why we deserve their trust and confidence,” he continued.

“We need to ensure that when we spend our clients’ money, we do so with real skill and diligence. We must ensure that when we face issues that give rise to potential conflicts of interest, we are able to think independently and put our clients’ interests first.”

Talking about how the industry tackles the challenge of effective engagement with companies in which it invests, Ferrans said: “There is a very mixed approach in this area among investment management firms. The challenges in effective engagement are well-known and I have in the past defended the right of our firms and clients to decide how far down this path they individually go.

“However, as an industry, this is an area that cannot and should not be ignored.”

So, become more streamlined or become touchy-feely and listen to your clients? Ultimately, aiCIO suspects how asset managers go about regaining trust will boil down to how much they have to spend.