CalSTRS Grows Diversity for PE Funds

The California State Teachers Retirement System (CalSTRS) is expanding efforts to add diverse managers to its approximate $17 billion private equity lineup, committing $500 million to two fund of funds in 2017, according to the system’s diversity report.

The yearly report, released on February 7, details the $225.3 billion retirement system’s diversity efforts in hiring minority and women-owned external money managers last year.

The report was required by state lawmakers in 2011 as part of a push to give more minority-owned and woman money managers an opportunity to work with the largest teachers’ retirement system in the world.

CalSTRS Chief Investment Officer Chris Ailman has been a big supporter of expanding hiring efforts beyond the traditional white male-owned investment firms.

“We are committed to diversity,” he told CIO.

But advocacy can only go so far. California state law prohibits any state entity from hiring firms specifically based on race or gender.

This contrasts to Illinois, which requires public pension plans to set aside spots for minority- and woman-owned money managers. Other pension systems, including the New York City pension plans, the New York State Common pension plan, and plans in Pennsylvania and Maryland, encourage directly the hiring of woman- and minority-owned firms.

CalSTRS instead, along with The California Employees’ pension plan, must use broader guidelines in hiring. For example, its private equity emerging manager program gives eligibility to general partners investing their first, second and third funds, meaning white male-owned firms can also apply. The funds cannot be more than $1 billion in size.

CalSTRS said the first new diverse private equity commitment was made in early 2017, when it invested $250 million in a private equity fund of funds run by money manager INVESCO for newer and smaller private equity firms. INVESCO anticipates that several of the private equity managers it hires “will represent the diversity of the state of California,” the report notes.

CalSTRS also invested $250 million in December 2017 in another private equity fund of funds, HarbourVest Horizon Fund VI, notes the report. The fund of funds will be comprised of private equity general partners who invest in inner cities or other underserved (rural) markets.

CalSTRS has invested in at least three other HarbourVest Horizon funds since 2003, all of which have completed their investment cycle and have been liquidated.

The approximate $124 billion CalSTRS global equity asset class has the largest number of diverse managers in 2017, the diversity report shows.

Four manager of managers are hired by CalSTRS, who, in turn, hire developing money managers who are new or are smaller firms asset-wise to run US small cap equity mandates and non-US developed market strategies, the report said.  It noted the manager of manager program was restructured beginning in mid-2016, moving away from domestic equity strategies.

The report says that under the auspice of the four manager of managers are 24 asset managers, of which seven are minority-owned and five are woman-owned.

Investment performance has sometimes been challenged under CalSTRS’ emerging programs, which include its diversity offerings.

For example, the overall performance among the developing equity managers has constantly lagged CalSTRS’ custom equity benchmark. An January 2017 analysis by CalSTRS found that for the one-year period ending August 31, the developed managers had a combined rate of return of 5.9% compared to CalSTRS’ custom equity benchmark of 11.22%.

For the three-year period ending August 31, the developed managers together had an investment return of 8.05% compared to the benchmark’s 11.62.%. And for the same five-year period, the developing managers had a rate of return of 11.95% compared to the benchmark’s 14.40%.

The CalSTRS statistics do not specifically break apart the returns for the woman- and minority-owned firms.

Ailman said active equity managers had been challenged in general to beat their benchmarks during the equity bull market. He said it is hoped in the future that the developing managers will have more of an opportunity to beat their benchmarks in more specialized investment mandates.

CalSTRS has placed prior private equity fund of funds made up of emerging and diverse managers in what it calls its Proactive Portfolio. A January 17, 2017, analysis found that portfolio has lowered the overall performance of the Private Equity portfolio.

The report said that a disaggregation of the two components of the program, Underserved Urban & Rural and the New & Next Generation (managers) showed over a one-year period ending June 30, 2016, “that the New & Next Generation has provided a positive impact to the portfolio and in some periods actually outperformed the benchmark.”

“All the program’s underperformance drag can be attributed to the Underserved Urban & Rural portion,” the staff analysis said. “The returns from that portion have been about half of the overall private equity portfolio return over the past three and five years.”

“We have been disappointed,” Ailman said of the investment returns of the underserved urban and rural private equity program, but he said the CalSTRS board “still believes things can be turned around.”

He said one key change from prior funds by the Horizon HarborVest investment team is that that investment opportunities have been expanded beyond the borders of California.

In real estate, the report showed that CalSTRS did not hire any new diverse managers in 2017. The report said that CalSTRS has been investing with emerging real estate managers since 2001 and that approximately 35% of the current US-only Real Estate Portfolio is invested with 26 emerging managers, and six are diverse-owned.

CalSTRS’ other major asset class, fixed income, has no diverse managers, the report showed.

It also said that in some developing asset classes, like CalSTRS $2.1 billion infrastructure asset program, there are only a small number of minority or woman-owned firms. “Although the infrastructure program has committed to managers of diverse nationalities, it often has difficulty identifying funds owned or operated by women and ethnic minorities that meet the program’s requirements,” the report said.