CalSTRS facing the 'cauliflower' effect

It’s no surprise that the investment chief of the US’ largest teachers scheme looks at new investment ideas in the same way a PhD student dissects his thesis. Christopher Ailman’s team of researchers dig through data and speak to experts to put together an expert white paper on topics of choice. 

Currently on the research agenda for the US$138bn pension plan are commodities, microfinance, LDI and others. But Ailman has to walk a fine line between overloading trustees with information, and taking what he called the “cauliflower” route including myriad investments, or keeping things simple. 

Last month, Ailman met with global-macro hedge fund managers in London to gather information on what will be a maiden investment for CalSTRS. 

Raquel Pichardo-Allison: How are you looking to incorporate global macro into the portfolio?

Christopher Ailman:  We haven’t done hedge funds. We are not creating a special asset class for it. We have always felt they are part of the existing asset classes, they belong somewhere. We’ve done what some people classify as hedge funds in corporate governance, we’ve done distressed debt. So I’m always kind of reticent to label what is or isn’t hedge funds. 

We wanted to go out and meet with the managers directly face to face. Some of the best funds are in London. And we’ve also issued an RFP for a consultant, or a fiduciary. We’re not interested in doing a fund of funds. 

Originally we went to the board with a recommendation of US$250m... but they approved $200m. 

Raquel Pichardo-Allison: You’ve also been looking at micro-finance. 

Christopher Ailman: The board asked us to do a research paper. The board asked us for three studies last year: commodities, a white paper on microfinance and a little more detail on liability driven investments. We’ve also had a request for a white paper on life settlements. 

We tend to publish white papers out there for the industry as well. I think that comes from our education trust background. 

Raquel Pichardo-Allison: Do you think there’s room for it within the portfolio? It would be a small sliver of your large portfolio. Is it worth it?

Christopher Ailman: Well, it’s sourcing and it’s fees. That’s going to be part of the interesting challenge going forward. I’ve talked to a lot of (chief investment officers) and there’s going to be a wave coming. As we get bigger, it’s like a cauliflower effect, we bloom into a zillion different places. We become incredibly complex. 

That means a couple of things. That means generally higher costs. You’re doing it theoretically in the name of diversification, but that’s somewhat unproven when you have a crisis. And it also just means more complexity that the board has to try to understand. Are you getting to the point where you overwhelm them? 

But when we look at the funds that are bigger than us, that’s exactly what they’re doing. There is just a proliferation of ideas. 

We’ve had that open debate internally. The theory now in finance is that the 80s and 90s were all about capturing beta. In 2000, you didn’t want beta, you wanted the right return. So what’s it going to be going forward? Are you going to go back to capturing beta, which we’re all very good at; or is it going to shift to capturing the right beta and not owning the wrong beta, which is very hard to do; or have this proliferation of ideas. 

To me it looked like there were three future models all with distinct costs and distinct management challenges in terms of the amount of people you need to have. The question is, what is our future? I’m not sure. 

So back to your question about whether there’s room for something like that, in a portfolio this big, unfortunately you can do a million things. It doesn’t mean you should. 

Raquel Pichardo-Allison: You’ve recently presented a recommendation to continue your research on commodities. 

Christopher Ailman: We’ve had nothing but interest and curiosity from the board. 

The criticism I’ve had about commodities is it adds more daily volatility, and I don’t need more daily volatility. I need more long-term, stable cash flows. We’re really hunting for things that are inflation sensitive. 

One of the things we’ve talked about is direct investments. Is there a way to get at the underlying commodity exposure? We’ve been chatting to one company that owns a mine. I’m not sure that I’d want to own a mine in the US with all the environmental issues associated with it, but does that make sense? 

Raquel Pichardo-Allison: It seems from what the board is asking you to do that you are going more of the cauliflower route. 

Christopher Ailman: Compared to our past, I can see that, because I didn’t have the ability to do this kind of research. I go back to the fact that we are an education-based fund. I think we’re constantly going to study lots of stuff. But a lot of it may not turn out to become investments. Where a lot of our peers say, ‘We’re going to put $1bn,’ and then they study it, we’re going to study it first. 

But that will lend us into the discussion of how much complexity we should absorb.