Where CalSTRS’ Scott Chan Sees Opportunities
Scott Chan
Scott Chan has taken the helm of the California State Teachers’ Retirement System’s investments, succeeding the outgoing Chris Ailman, who had served as the fund’s investment chief for 20 years.
In an interview with CIO, Chan discussed the fund’s fiscal year returns, artificial intelligence and what opportunities Chan is looking for. Chan had been deputy CIO of CalSTRS since 2018.
In July, CalSTRS announced an 8.4% net return in fiscal year 2024, which ended June 30. The pension fund’s assets rose to $341.4 billion at the end of the period. Despite strong returns which outperformed the fund’s benchmark, Chan is focused on the big picture.
“One year to me is like just one mile in a marathon, because our goal is really, really long term,” Chan says. “Our mission is to secure the time and future of California’s teachers. How do we achieve that mission? It’s a long-term approach.”
His preferred benchmark for success: the five-year annualized return rate.
“It was a solid year, 8.4%: To me that’s great,” Chan says. “We added about $26.6 billion of value to the trust, and we beat our benchmark by a little over 100 basis points. The biggest driver of returns, no surprise, was global equities: That was up 19.3%. Every broad asset class that we have outperformed the benchmark.”
On Tech and AI
Chan says CalSTRS is looking at ways to utilize AI at the fund. “CalSTRS is looking at these types of technology innovations and how we could use it with our research process, with our ability to add insights into our investment process.”
“I think that AI really does appear to be a technology that could change our future in very dramatic ways,” says Chan. “But these go through cycles, where everybody is really ebullient about it and driving valuations of stocks higher, and then as people recognize that the pace of that acceleration may not be as vertical as people think.”
“Then as people will be selling stocks, and they’ll overcorrect on the downside” says Chan, following this month’s retraction in equities due to fallout from the carry-trade unwinding, which occurred shortly before the interview.
“We see this time and time again through the cycles, but over the long term, I think what does seem to be the case is that this technology could transform businesses as we know it,” says Chan. “I think [AI] is a long-term trend and theme that is going to be transformative, but we’ve got to expect the cycles through it.”
“We’ve been going through quite a significant ebullient cycle, right? Which I think is cause for people to step back and say, ‘Well, OK, is this really going to go as vertical as people think it is in terms of the pace of that acceleration of change? Or maybe it won’t?’ I think there is evidence to suggest that it’s going to be rapid, but maybe not as vertical as the valuation of stocks appear to be suggesting.”
Opportunities in Real Estate
Chan also sees opportunities in real estate, telling CIO that he thinks a lot of the declines of the last two years are not likely to recur.
“In the past, real estate has been a driver of returns when we’ve outperformed our benchmarks across the 1-3-5-[year] period, but this year it was the biggest detractor, down 9.8%. CalSTRS is not alone,” Chan says. “This was an industry-wide phenomenon. We did better than the industry—we beat the benchmark—but it’s been a couple years in a row where real estate’s been down.”
Chan says investors are not out of the woods yet. “Do I think that the Odyssey, the [NCREIF Fund Index – Open End Diversified Core Equity] index is going to go down maybe for the next few quarters? I do. If I look across our experts, they think the same,” says Chan. “But the worst, I think, is behind us, and I think it it’s a time to start to think about the inflection point of real estate, getting back in rebalancing the portfolio back into those assets. We are seeing opportunities in capital structure because of the very large rise in interest rates.”
“You’re seeing that there’s some distress in the capital structure, but not in the underlying asset, the real estate itself,” continues Chan. “So CalSTRS can come in with our partners and essentially solve that distressed capital structure, mainly on the debt side of it.”
Data Centers
As data center construction continues to grow due to demands from AI, Chan sees opportunities across the whole development chain. “Number one, they have to build out power, so we’re seeing some of the hyperscalers and others want to build renewable power and try to connect that to the grid and transport it, and then the real estate that needs to happen to help the digital infrastructure,” says Chan. “So we’re seeing [a lot] in terms of pipelines of opportunities. … That spending is huge, the predictions are huge, and there is evidence of that happening—we’re seeing it in the pipelines—but I think the question is: How fast and how large, right? I think that question is the one that’s going to cause these cycles of ebullience and overcorrections to the downside as people analyze: ‘Well, is it as fast as we are thinking? Or is it slowing down?’ I think we’re kind of in the ebullient stage.”
Fixed Income and Private Credit
With higher interest rates, CalSTRS increased its allocations to fixed income and to private credit—an asset class it recently added to its portfolio.
“We have been, over the last 18 to 24 months, allocating back into fixed income and beginning to overweight that,” says Chan. “If you look at the past decade, we were moving out of fixed income; we were projecting less than 2% returns per year. Now we’re projecting a lot higher because the yield curve shifted up dramatically since a few years ago. … We’ve [also] been allocating more to private credit, another area where we think it’s a good opportunity, because there’s a large premium in terms of the credit that you can have.”
“So it’s very attractive, but I wouldn’t say it’s a phenomenal, great time, and the reason is: I do think we will have a default cycle,” continues Chan. “I think there is that risk out there, but the premiums today, I would argue, account for the fact that there could be a default cycle coming up at some point. I think it would actually be healthy at some point [to] have a default cycle, a normal default cycle.”
CalSTRS’ Collaborative Strategies
One of the asset classes in CalSTRS’ portfolio with the highest returns for the year was the fund’s collaborative strategies portfolio. With a 14.4% return, it was second only to equities, but it had the smallest allocation among CalSTRS asset classes, with a 1.6% allocation.
The collaborative model is an investment strategy spearheaded by Chan that seeks to reduce costs and increase returns through internal management and leveraging external partnerships. Between 2017 and 2022, according to the fund, the model saved CalSTRS $1.64 billion.
The collaborative strategies portfolio houses opportunities that do not fit into CalSTRS’ other portfolios. According to CalSTRS, the portfolio is for opportunities that may extend beyond the frameworks or capacities of existing asset classes and those that exist between or across asset classes, even traversing both public and private markets.
“It’s a portfolio that we can flex from 0% of our allocation to up to 5%, and we can be a lot more dynamic in that portfolio,” says the CIO. “What’s behind the 14.4% return? We have a lot of private credit that is asset backed, and that’s an area where there’s going to continue to be a shift, a movement of these types of assets … off the balance sheet of banks and onto the balance sheets of pension funds and other long-term investors.”
The shift offers “a very large opportunity for a pension fund like CalSTRS, because there is so much of the supply coming to the market, it’s coming at a premium, and we can access that premium, and I think it’s a very good time, because the premiums are pretty significant.”
CalSTRS can also use the collaborative portfolio to scale into positions.
“If I look at CalSTRS’ total portfolio, we have a lot of ability to invest for greater scale,” says Chan. “When we do, we can execute things like the collaborative model and save on fees, do more joint ventures or revenue shares, all for the benefit of the teachers.”
Related Stories:
Scott Chan Named CalSTRS’ New CIO