Christopher Ailman is the CIO of CalSTRS, at $120 billion, second-largest DB fund in the nation and the manager of my wife’s pension (she is a school teacher in San Diego where we live). His presentation is entitled Allocating Risk Capital in a Low Interest Rate Environment.
My session notes follow. As always, these are at-the-time notes. I make no guaranty as to their accuracy or completeness.
- He’s a big fan of Jimmy Buffett — a committed Parrothead.
- Teaching is more of a lifestyle than a job.
- Teachers live longer than any other profession and they represent 70% women — the demographics are tough for the plan.
- Fed announcement 1/23 — low rates on tap for at least a while (321 months and counting).
- Chart — 20-year decline of UST 10-year notes (and huge bond returns).
- Lost decade? Even during secular bear markets, significant cyclical bull markets (up to 25+% — cf., Japan).
- During secular bear markets — how to trade to take advantage of the cyclical bull markets?
- “‘Buy and hold’ doesn’t work in this environment. We need to be nimble” (even though — as a “cruise ship” it’s tough to be nimble).
- Being nimble, tactical and active is akin to market-timing, but that isn’t likely to work; thus — what to do?
- DB plans are under attack — expect it to continue.
- Lack of DB plans in the private sector has led to “pension envy” toward the public sector.
- Debate over pension funding and management should be done by CFAs, not politicians.
- The cost of retirement has gone up and is going up (20% savings rate probably required all-in).
- DB plan provides better risk-return envelop than DC (economies of scale and asset allocation).
- There is a value to funding retirement despite the cost.
- The true replacement rate likely to be closer to 90% than the traditional 75% (Georgia State Replacement Ratio Study).
- Problem with Gen X/Y who may be spooked away from investing in stocks.
- Portfolio construction tougher than ever; fat tails are 4% of outcomes; a crisis every 5-7 years (we want a more stable worth but aren’t likely to get it).
- Cf. PIMCO study of typical endowment return — 4% fat tails.
- As rates fall, FI portfolio duration tends to be extended to get yield — rising rates will have a very serious impact.
- What does it mean for a portfolio if bonds have a zero expected return, perhaps for a decade or more?
- Strategies: dividends and high-yielding ETFs; MLPs; sell equity vol and skew; corporate credit w/strong balance sheets; provide monetizing consistent, mature drug royalty streams; incremental income from existing asset allocation (from Morgan Stanley pension/endowment/foundation report).
- Strategies from Ailman’s staff: covered calls and index calls; infrastructure (brown field/high cash flow); leasing (RE/aircraft/equipment); senior secured loans (Europe and U.S.); long-tail revenue streams (royalties); distressed debt.
- As always, it’s all about price.
- Approach: stay nimble; non-traditional asset classes; complex and illiquid investments, perhaps with a limited window.
- Note that correlations are non-stationary (diversification not enough) and that investors need more risk management tools.
- Huge political risk post-election: capital gain increase?
- Risk isn’t discreet — it blurs across the portfolio.
- Risk factors for Ailman (that blur): investment governance — regulation and taxation; leverage; liquidity; inflation; interest rates; global economic growth.
- So what? building portfolios more complex than ever; “low return” depends upon time horizon; income rules; costs of retirement going up for all’ black swans and fat tails happen.
- Re discounting liabilities: for Ailman, set by Board; Ailman argues that there is no one simple answer; multiple answers — can’t know costs until we “get there”; consistent contributions necessary.
- We can’t keep kicking the can down the road; political issues are tough.
- Active/passive — Ailman has lots of passive in his portfolio (market cap — even though it forces him to buy high and sell low to a point, but we need a measurement tool); looking at tilting via indexes and equal weighted indexes.
- Re fundamental indexes — Ailman likes the idea (DFA).
- Markets are highly efficient, but he still sees value in active management despite periods of underperformance.
- Looking to hedge (dynamically) more and more, especially due to the speed of information and globalization (correlation harder to achieve).
- Public fund and individuals not as able to maintain illiquid investments to the extent that endowments can.
- Ailman has been underweight most of this year but are now neutral (low P/E and decent earnings but lots of “overhang” — such as Europe and deficits); portfolio has home-country bias; market more differentiated and fragmented than normal by a lot.
- Be nimble (emphasized yet again).
I note that CalSTRS incorporates an annualized return of 7.50% in its calculations (reduced from 7.75%). Relative to other PFs, these are semi-realistic projections.
If 40% of its portfolio were in fixed income, and hedge funds have been shown to return close to zero after fees (or perhaps less than zero if you account for survivor bias), pension funds need to consistently earn a ridiculous return on their equity, real estate, AI and cash allocation to hit that 7.50% — perhaps greater than 11% on equities. This would put them in the realm of Superinvestors. As it is, CalSTRS has an astonishing 81.5% of assets in investments other than fixed income and cash (equities, PE, RE, hedge funds). Maybe that is what it takes to achieve the return needed to meet promised payout obligations. It will be interesting to see how the profile changes as the demographics and work/retirementment status of plan participants changes. I would hate to be a PF manager.
“DB plan provides better risk-return envelope than DC (economies of scale and asset allocation)”: this may be true, but I wonder how the increasing popularity of target-date funds changes that dynamic.