Christopher Ailman, chief investment officer of the $224.9 billion California State Teachers’ Retirement System, manages the largest teacher-only plan in the world and the second largest public pension plan in the US. His goal: to deliver expected returns of 7 percent over a 30-year investment horizon to meet the retirement needs of more than 933,000 California educators and their beneficiaries.
CalSTRS had a good 2016-17 fiscal year after two years with single-digit returns. As of end-April, the fund posted 13.4 percent net of fees for the period. That’s higher than its peers, the $323 billion California Public Employees’ Retirement System and the $206.9 billion New York State Common Retirement Fund, which generated 11.2 percent and 11.4 percent respectively in FY2016-17.
However, Ailman, like many pension managers, constantly worries about the rapidly rising cost of retirement systems. He tells Private Equity International: “The bottom line is it’s a defined benefit plan. And the cost of that benefit should be whatever the taxpayers and the members can contribute and afford – that has been a big struggle in America. In our plan and for most teacher plans, we have been underfunded.”
Ailman points out it’s often not the investment results that have led to the underfunding, it’s either poor management of liabilities or a lack of contributions.
Asked whether this keeps him up at night, he says he sleeps like a baby – wakes up and screams every three hours. “We pay out half a billion dollars a month in benefit payments, more than we bring in. Instead of a net buyer I am a net seller of assets and that dominates our asset allocation discussions: what’s our cash position and what will happen in that negative cashflow. Where do we need to sell first?”
Ailman’s journey from private sector investment consultant to CIO at the Sacramento Employees Retirement System, the Washington State Investment Board and CalSTRS is an interesting one, but the impressive CV he has built during nearly two decades at the teachers’ pension gives us plenty to talk about.
The day we meet, Ailman is in Hong Kong for the CFA Institute’s annual conference where he speaks on an all-star asset owner panel including Hiro Mizuno, CIO of Japan’s $1.4 trillion Government Pension Investment Fund, and Alison Tarditi, CIO of the A$45 billion ($34 billion; €28 billion) Commonwealth Superannuation Corporation.
We talk first about AB-2833, the California law that took effect in January 2017 requiring state or local public pension plans to disclose additional information about fees and expenses. Ailman says: “I still question the value of that information. California passed the bill for additional disclosure which only has about two or three extra columns in addition to what we were already capturing from our partners. The difference is we were reporting it out in an aggregated asset class level instead of the granular level by partnership.”
By ‘value’, Ailman means pensions in the state have already been required to disclose detailed information for over 10 years, and none of it has been used by regulators.
“It’s really been about, ‘Oh there’s an area that’s not transparent, we are going to make it transparent. But now that they can see in, what will they do with the information?’” he asks.
Ailman says CalSTRS has lost about three partnership opportunities because of the law.
“While the GP wouldn’t name AB-2833 specifically, today’s highly competitive fundraising environment means there’s a lot of capital chasing transactions,” he adds. “When your capital comes with extra rules and extra issues attached to it, the GP will pick the easier investor.”
Well-intentioned initiatives can have unintended consequences, Ailman adds.
“We now have a situation in the state of California where CalPERS and CalSTRS have less invested in Silicon Valley than the Dutch, Asian and Middle Eastern sovereign wealth funds. Fundamentally, as a native Californian I think that’s just so wrong, but I can’t change people’s minds. It is what it is now.”
Planning a handover
“It is what it is” might be Ailman’s driving philosophy. It shapes how he feels about the challenges of pension management and the goals he has laid out for CalSTRS in the next year.
“When we queried our existing general partners we found inconsistent reporting and a lack of clarity in the information. So we are reaching out to those GPs and trying to get them to follow a common reporting template and consistent methodology,” Ailman says. “I am hopeful that next year and in the years to follow we will be able to get GPs to disclose more information along the industry template. The largest firms are quickly moving in that direction and listening to their LPs.”
One large Japanese institutional investor in the early years of its alternatives programme tells PEI the “inflexibility” of US pensions is one reason why it has looked to Singapore’s GIC and Canada Pension Plan Investment Board as role models instead. “I believe they have much more flexibility compared to US pensions, who are always under intense public scrutiny and have less flexibility in their compensation programmes,” the investor says.
The other two major concerns on Ailman’s mind are the succession planning at the big buyout shops and the tremendous amount of money chasing private companies. He hopes to see the kind of succession plans put in place this year at Blackstone and Carlyle at all institutions.
Ailman concludes that returns for 2016-18 vintages will not be that great, thanks to that abundance of capital.
“When you are paying up for some of these companies, GPs really have to grow the portfolio companies organically and that takes key solid management operational skills. We’ve always said for 10 years now – long gone is the day of financial leverage and just generating alpha. GPs have got to do it by organically growing these businesses and adding value to them. That will be a challenge.”
“The world is awash with capital,” Ailman often says in interviews. But most of it, he asserts, is not in the US. According to advisor Willis Towers Watson, pension assets worldwide totalled $45 trillion in 2017 and are expected to grow 6.2 percent on a 20-year compound growth rate.
CalSTRS had $224.9 billion in assets at the end of May, according to its website, of which about $18 billion is invested in private equity across more than 130 active manager relationships, co-investments and secondaries transactions. It is a global portfolio with approximately 80 percent in US-based funds.
The nextgen club deal
Ailman envisages a time when global pension funds syndicate deals together.
“Our investment committee spent the last year studying different options and brought in a panel with Ashby Monk from Stanford’s Global Projects Center, Mark Wiseman who was previously at Canada Pension Plan Investment Board and now at BlackRock, and Jonathan Hausman from Ontario Teachers’ Pension Plan to talk about what they were seeing in transactions. Looking at the Dutch pension model, the endowment model in the US, the Canadian pension model and the sovereign wealth fund model, we concluded that the best option for us was a collaborative model in both private and public markets.”
What that means is CalSTRS could collaborate with its peers as well as asset managers and non-government organisations, particularly in infrastructure development.
“We’re trying to open up and it means very different legal structures. It will branch from partnerships, and obviously the natural move is separate accounts, co-investments, direct investments. But I have long said, particularly in infrastructure where cost matters tremendously, that it made more sense for us larger institutions to syndicate together. As you’ve seen in venture capital when the risks are high, people syndicate the deal, spread the risk gladly and share.
“Instead of bidding against each other we are all realising it makes a lot more sense to work together in a more efficient business model instead of paying Wall Street agent fees to use our capital. We’d rather operate more as a principal and work together with people.”
Ailman recalls when he first started at CalSTRS in 2000, the pension was third in the US and seventh in the world in terms of total assets. CalSTRS is now second in the US and barely in the top 25 list of asset owners, and yet the pension has doubled its portfolio.
“And it’s not that they are bigger than us by $100 billion or $200 billion, they are five and seven times our size,” he points out.
One LP Ailman is keen to work with closely is the world’s largest pension fund, Japan’s Government Pension Investment Fund. When Mizuno and Ailman are onstage together at conferences there is a visible camaraderie, and Ailman wants to collaborate.
“I’ve gone to him and said, ‘Look we’ve been at this for 25 years and you are starting from scratch, maybe there are ways to work together, so they can learn from what we have already been through and find new opportunities together’,” Ailman says.
“Having new money come in and compete means they will set the price or they will accept the price. And I don’t want them to just accept the price. I want them to push back on it and work together with us.
“Yes, we are big capital, well-known in the industry. But rather than compete with this new money coming in, we’d rather collaborate with it, join and invest.”
Long-term, long horizon
Core private equity, or longer-term funds, are another important component of the fund’s private equity future.
“It’s the idea that even a partnership with a seven to 14-year life fund is actually fairly short-term for me – because once it’s done I’ve got to do it again and again for four to five years.
“GPs want to liquidate and monetise their investment, but in many cases, we’ve looked at that and said, ‘We’d actually rather own that company and not sell it. We’d like to buy it, deleverage it and hold it for the long-term’,” he explains.
This expanded sub-asset class will have lower returns than traditional private equity, but also lower costs, lower risk and less volatility. Ailman predicts this will be a growing segment of the market.
“We’ve already added it in as a sub-asset class structure, it’s a small slice, under 5 percent, but I wouldn’t be surprised if we see that grow tremendously as an opportunity over the next five years.”
GPs PEI spoke to often comment that one thing they appreciate about CalSTRS’ team is its stability. Ailman, the longest serving CIO in the fund’s history, is also seen by the asset management industry as “open-minded, unbureaucratic and not too operational”, a Hong Kong-based placement agent tells us.
Ailman says it boils down to culture, attracting and retaining the right people. He manages a team of more than 150 investment staff, which has an annual average staff turnover of about 4 percent.
“It’s really about growing and building staff up from within, an area we are focused on. Our staff is still very lean, so we will continue to expand it in the future.”
CalSTRS is also seeing a transition from the baby boomers to Generation X to millennials in its staff. To address this, it set up a student intern programme and an investment mentor programme, designed to support both proteges and mentors in achieving their career goals.
“We are in Sacramento, obviously not a big finance community. We are trying to build into people that there are finance jobs, opportunities and internships. However, a big challenge that we are seeing is that our industry still suffers from an image problem. Hollywood does not portray it at all as positive, so we are trying to get that message out and create opportunities for millennials.”
Ailman adds: “If a young person is driven to build wealth, he needs to go to the GP side. But somebody that’s looking for more work-life balance, a bit more stability will be attracted to what we offer.”