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Exclusive Q&A: Christopher Ailman, Chief Investment Officer At California State Teachers’ Retirement System

by trusted insight posted 5years ago 11098 views
Christopher Ailman is the chief investment officer of California State Teachers’ Retirement System (CalSTRS), where he oversees an investment portfolio valued at approximately $178.7 billion. Prior to joining CalSTRS, he was the CIO at Washington State Investment Board. Ailman has a B.A in business economics from the University of California, Santa Barbara. He also holds a certified financial planner designation from the University of Southern California.

Ailman was recently named to Trusted Insight’s ranked list of the Top 30 Pension Fund Chief Investment Officers. He graciously spoke to Trusted Insight on January 26, 2016. The following interview has been edited and condensed for clarity.

Trusted Insight: Your investment team is rather large team: 117 staff members. Tell me about the structure, the team dynamic and how your team might differ from peer institutions?

Christopher Ailman: I think, number one, we have an absolutely fantastic team. I'm incredibly proud of this team and it really is the big reason I have stayed here. I've had job offers to leave and go to other institutions but it's the people I work with that really keep me here because they are just, they're great.
The thing that I'm very intentional about is our culture. I think our culture is very different from other institutions. A lot of cultures can lead to positive alpha but when the culture changes, that's when the alpha disappears. If you think about it, think of any sports team and when they change head coaches and change culture, their record deteriorates generally. It's common sense. So we're very intentional about it and I think we're slated to grow to 140 here shortly. That's big for a public pension plan. I realize that. My peers in the states just adjoining to us are much smaller in size but that's because we're trying to run more assets in-house because we can do it at lower cost, but I think we're also creating a career path for young people in the investment industry. Our staff is wonderfully diverse. We are 50% female and that's not just administrative staff. That diversity is in the investment officer ranks. That is so unusual for Wall Street but I am really proud of how we've built up our staff and the talent that we have. I think it's led to better decision making.
We do believe in a consensus-driven, collegiate atmosphere and the key is, I would say, management lives it and walks the talk. We don't demand the core staff to follow our culture. We actually demand management to follow the culture and it flips it on its head but it really works here.

Trusted Insight: You touched on something that I wanted to bring up. There’s a trend of bringing investment functions in house, as opposed to relying on external managers. Can you talk about CalSTRS’ push toward that and put it in context to the broader pension fund industry?

Christopher Ailman: I think it's just a natural evolution of the process. When you look back most public pension plans shifted to what we call the prudent investor rule in about 1982 to 1984. There were no staffs to speak of before then. Before that, frankly, there were legal lists of investments from either the institution or the legislative bodies that controlled what you could own. So then we went to a prudent investor standard, which is much broader and opened up the world to diversification. The immediate reaction of most boards was to go out and hire a consultant to help them do that because they didn't have the expertise and they didn't have it in house.
What's happened over the past 35 years is that all that in-house talent has changed, grown and built up to where frankly a lot of staffs are as experienced, or more so, than even the consultants, so I just think it's a natural progression.
In CalSTRS' case, we were actually born 103 years ago. We’re a hundred and three years old but the investment office is only 30 years old. It was started in 1985. CalSTRS’ investments were originally managed by CalPERS and the legislature divided the management up, so the Teachers’ Retirement Board had to go hire a CIO for the first time and build up the staff. When they split it out of PERS, CalSTRS went 100% externally managed, so it all went to outside money managers. We've been in a slow process of building up our internal capabilities and moving some of those assets in house.
When we look at our peers of other large pension plans around the world, about 58%, just under 60% of their assets are internally managed and we think that's probably about the right sweet spot for us. We're about 40% internally managed now, so we'll be ramping that up in the next couple of years.
It's quite clear you've got to have the right business model and the right compensation structure to run certain types of assets in house. We are definitely a governmental entity. We are government employees so there are certain things we can do well internally and then certain other things I wouldn't even try and tackle.

Trusted Insight: Being a government entity, naturally you're not going to be able to offer the same type of compensation that anyone in the private sector might be able to, so how do you go about retaining and attracting talent?

Christopher Ailman: That is a big challenge. I've been very well aware that I operate a money manager. We are an external money manager but we're wrapped inside the business model of a governmental entity and it doesn't take a Harvard grad to figure out that's not the right business model. I'm not sure the government business model works for most investment functions, but it certainly doesn't work for money managers. I've spent my career really focusing in on, okay, we have a flawed model but how can we get the best out of it? I definitely learned in Washington that it's the culture of the organization. It's a work/life balance compared to Wall Street that will attract and retain talent. 

So it's offering people lifestyles that they can choose from that differ from Wall Street. Our community is a good-sized city but not a super-sized city. It's not New York.
If you go into the investment business and you're goal is to build wealth and to make money then you need to be in New York, or maybe San Francisco or Boston or London. If you're goal is to go into the finance business and have a family and have a balanced life, then places like us are an attractive alternative. You have the fun and the challenge of the investment business, but I always like to point out that you can also coach your son's Little League team or your daughter's soccer team. You can attend their sixth grade graduation. You can see their high school sport games. You don't have to miss all the milestones in life.
To me, when we talk about recruiting people we talk about our diversity. Again, the fact that we have such gender parity and ethnic diversity, that's very rare on Wall Street and attractive to many people. The fact that you can have somewhat of a work/life balance is huge to people, especially Generation X, Generation Y and the millennials. I think they recognize, okay, if I want to make a lot of money I've got to go one direction. If I want a balanced life, and obviously we pay very well, then I go to a place like CalSTRS. We get a lot of attention in the government, but that's where that issue of what can you manage internally with this business model and what is too difficult, comes into play. 

I applaud what the Canadians have done with their direct investment programs and operating more truly like a money manager, but I know from talking from Mark Wiseman, from Ron Mock, they feel those tensions of the fact that they are still a quasi-governmental entity and compensation is, at times, applauded but then other times, a source of tension, and that's a real challenge to their business environment.

Trusted Insight: To what degree are you concerned about or reacting to near-term market volatility? Or asked a different way, how are you positioning or how have you positioned the portfolio to achieve your required annual return while still maintaining your long-term perspective?

Christopher Ailman: First to your question, how are we dealing with it? The answer is a lot more Tagamet, Alka-Seltzer and Tums. That's part of the challenge of this job. When you have a 30-year investment horizon you can't worry about storms that blow through but you're a human being and so, you do. I just said to my deputy CIO yesterday, "I'm sick and tired of losing money, of seeing the assets so volatile and drop so much." To get the return, we need to be exposed to growth assets and that means you have to be exposed to volatility. 

Again, I was joking with somebody in the elevator, "When you take this job, life is a roller coaster. Unfortunately, I happen to be somebody who likes merry-go-rounds." That is a constant challenge of this job, dealing with that volatility. I think it's also why a lot of plans are looking at all the different range of, I would call it, exotic types of assets.
I've told our board for a long time: "We need to find a way to diversify away from daily priced assets." If we have a 30-year investment horizon we don't need liquidity, we don't need daily priced assets. Unfortunately the accountants keep trying to push everything to be priced more frequently, which just enhances our volatility. We're all looking for longer-term assets that are a bit more stable, cash-flow oriented. That's part of our interest in infrastructure; that market hasn't grown that much. Part of our interest in looking at what we call risk mitigating strategies, RMS strategies, different things that will help smooth out the portfolio a bit—not a ton but a bit—because we still need to be exposed to growth assets.
How are we positioning ourselves in this environment? We've been taking profits out of the U.S. market, not a ton, haircuts here and there over the last year and a half. We felt this for a while, I've said in TV interviews for the last year that the equity market was going to be running out of steam. A five-year bull market is enough, and it was long in the tooth when it was at five years—then it hit six years. Now, as we're seeing, if you look at a longer-term graph of the U.S. market, it's plateaued, and not that it's rolling over but it certainly has flattened out as you would expect. Earnings momentum has dropped. We're taking haircuts away from the U.S., not as much in hindsight as I would have liked, but we did. We've started to feather a little bit into emerging markets, a little bit into Europe, and we had already been long overweight Japan. But obviously, those markets are going to take their time and be very slow to move. Like a lot of plans, we have a solid real estate portfolio. We've taken some profits here or there.
I was interested to read a couple of weeks ago that quite a few plans had huge cash positions. I think the world of Matt Clark, who's up at South Dakota, and Matt's is a much more actively-managed portfolio. He's smaller, so he's much more nimble. I think Matt had over 20% in his cash portfolio, so he would have fared much better in this environment than we have. Our cash position got up to 2%, which is huge for us, and so that will help a bit. Overall I've been pleased by how the portfolio has handled the last two weeks.
You know, last fiscal year was single digit, barely positive. As I told the board at the start of this fiscal year, I'm worried that we'll barely see a positive return but I told them, at best, it's going to be a low single-digit year. There's still five months to go so maybe we can pull it out, but this is going to be a rough year. But again, you've got to back up and let's look at the decade of the 2000s and teens, the decade of the teens so far you have a double-digit return in stocks, so you can have a negative return this year and you could have a flat return for the next four years until 2020 and this decade would still be about average.
It's partly the fact that we have to live life day-to-day but we have to constantly back up. It's not an issue of staring at the waves but looking at the horizon and that's part of the challenge.

Trusted Insight:  You have a 30-year time horizon with the pension plans. If you could go back 30 years and offer yourself investing advice, then what would you say?

Christopher Ailman: When I started, my title wasn't chief investment officer because nobody was using that. But I started in ‘84. I've been a public fund CIO for 32 years, which is pretty mind-boggling to me, and I've been in the business since '81. It's interesting, I started in the business when the Dow hit a 1,000 and in my first 18 months, it dropped to about 780. I cut my teeth at the start of a bear market. But yes, I've been with the business 35 years, overall.
If I could go back I would say get long U.S. equities, a little mix of non-U.S., and I would say real estate is an industry not an asset class—time it. And private equity is for real because I think a lot of us were very slow to get into private equity. Washington and Oregon were very early adopters in private equity and that has paid off handsomely for them. That would be the investment advice. 

I think career advice I'd tell people is they've got to find out what suits them. I enjoy the leadership side of this job and the planning side of this job. Find out what you enjoy, but most of all, find out what you stand for. What's the most important thing in your life? Are you a finance person first or a family person first. So this is my philosophical point: I learned very early in my career, as somebody said, “what do you stand for?” Everybody in the audience was quiet, and he said, "Okay, what did Superman stand for?" Everybody said, "oh, truth, justice and the American way." His point was okay, you should be just as clear that you have three or four things you stand for. For me, I'm a Christian, I'm a husband, a father and then I'm a chief investment officer. I try and make my decisions in life in that order. It's hard. Work is very consuming, and I tend to put that first, but I've got to remind myself all the time to back up and put them back in the right order. I would tell myself stick with that and focus in that order and don't lose track.

Trusted Insight: In your time at public pensions, what trends have you identified that have built up over time and are particularly important right now?

Christopher Ailman: Contribution rates really matter. I remember after the ‘80s and the ‘90s, which were huge double-digit equity return decades that most pension plans increased benefits or gave away that surplus instead of stockpiling it for the future. The laws of mean reversion are very powerful and really do come back.
The things that you've seen over time are just the ever-increasing creativity of Wall Street to create products that have high fees for them—make money for them—and generally don't make money for clients. So be leery of all the creativity and all the newfangled ideas. 

We are seeing these portfolios grow so complex. Most pension plans in the USA operate under a business model that was designed in the 1970s with a volunteer board that is trying to run now mega-million- or billion-dollar complex portfolios. That business model has never changed and is desperately in need of improvement. The Canadians and some of the sovereign wealth funds are trying different models and maybe time will tell. A good example would be the endowments in the U.S., run under a different model. Corporations run under a different model but not the public pension plans.
Increased complexity, massive dispersion of how portfolios are built now. In the old days, the questions were, are you 70/30 or are you 80/20? Do you have non-U.S. or not? Do you have real estate or not? The plans were not that different. Now everybody is incredibly diverse and there is a wide dispersion of portfolio construction ideas.
The last thing would be just the talent and dedication. I remember when I started in the business the average tenure of a public-fund CIO was four years. It hasn't improved a lot but you've had—and I'm sure on your top-30 list you have some public funds in the USA—Matt Clark, Rick Dahl who's just retiring, Bob Maynard, Ron Schmitz, Howard Bicker. You've had some amazing folks leave who have served in their jobs for almost 20-to-25 years. I think that's a real nod to the fact that now it's an industry. These are careers that people can have for their lifetime. You've had some really awesome, dedicated public servants.

Trusted Insight: What's the biggest investing challenge that is unique to pensions?

Christopher Ailman: The larger political environment is really tough. As a public pension or even a defined benefit plan, not just pensions but defined benefit plans, you feel like you have a target on your back. Everybody is trying throw rocks at public pension plans. 

The other is the investment environment. The world is much more complex, much more inter-correlated. I have to worry about how Shanghai opens up as well as worrying about the price of oil or what's going on in the USA. That's made these jobs immeasurably more difficult and complex than they were in the past.
For the big funds like us, it is the distractions. All the political pressures on social issues, governance issues, environmental issues. When I look toward the future, I really do believe one of the biggest challenges to us will be that the economies of the world have to adjust for climate change. It's not a surprise that our East Coast just had the biggest snowstorm on record. We're going to have stronger storms, weather is going to disrupt our economy more in the future around the world and the things that drive the economy are going to transition for the first time in our lifetimes. We've got to be able to adjust and adapt these portfolios to that. That is going to be a heck of a challenge.

Trusted Insight: Pension funds manage a pool of average Americans wages who are probably not particularly wealthy. You run the second largest pension in the U.S. and the largest teachers' pension fund. Is that a burden to bear or the same as managing any other large AUM that needs to be deployed strategically?

Christopher Ailman: It does matter. Instead of just trying to make money and get rich there is a sense of public purpose. I would have to say, having run some broad defined benefit plans, for instance the state of Washington, you're running everything, from local governments, state governments, firefighters, municipal, police officers to state workers. I find it very satisfying to be running money just for teachers. Obviously teachers have a profound impact in almost everybody's life. I went to public school in California, and so I think there is a sense of higher purpose and I think keeping that in mind adds to our work environment. These are hard, stressful jobs in the first place and almost everybody on my staff lives near a teacher, knows a teacher well.
In my life, my sister was a 30-year career teacher here in California. I have two sisters-in-law that are teachers. My daughter just graduated with her Master’s in education, and so she's about to enter the teaching field. If it's someone near and dear to your heart you realize that what's really cool is most of them have gone into this because it is a life commitment. It is their passion and finance isn't necessarily their strong suit. They want somebody to take care of the money for them and I think my staff and I get a lot of satisfaction with that. We enjoy having the teacher members, and the retirees especially, come and visit the trading desk because most of them haven't seen a trading desk. We're in Sacramento, we're not in a financial capital.
So this is cutesy; you may write about it but I think it's cute. We brought in a group of retirees from the middle of the state and we were showing them the trade desk and one of these older ladies walked over to one of our fixed income traders and put her arms on his shoulders and he kind of froze for a minute and she just said, "thank you," and he turned to her and he said, "what?" She said: "No, thank you. You're taking care of my retirement. That really means a lot to me." I mean he was walking on clouds for a couple of weeks and it just was like, wow! Everybody around him realized, "Man, this is real. This isn't just trading on Wall Street. This isn't just making money."
You're right. The retirement for a teacher in California is fairly modest. Even though there's a lot of dislike for defined-benefit plans and public defined-benefit plans, in almost every part of our state and, in every state, in general, people’s heart goes out to teachers and they realize that okay, the principals may be at high incomes but the average teacher in the classroom—very modest pension.
One thing you can add somewhere in the article that's interesting is California teachers, once they reach age 60, if they live that long, they have the longest projected lifespan of any other occupation in the United States. That always blows people away but a lot of it has to do with the fact that 72% of our teachers are female, they live in California, which means they generally have healthier lifestyles. They're almost all non-smokers. They're all college educated and so they're attentive to their health. An amazing group. You would not believe the number of 100-year birthday cards we have to write on a regular basis.

Trusted Insight: Let’s talk about your career history leading up to CalSTRS. You were at Washington State Investment Board and then Sacramento County Employees' Retirement System before that. What attracted you to the realm of pension investing, and what's kept you around? 

Christopher Ailman: Let me answer it two ways. One, I often say—because we host a lot of college kids and try and give them guidance—that when I went to school, these jobs didn't even exist. CalSTRS, in fact, didn't even have an investment office when I went to school. This was not a long-term career plan initially for me. I knew I wanted to be in finance, and as I got into the business I started with several Wall Street firms. I found I really enjoyed the planning side of it and more long term rather than sort of short term and trading strategies. 

I left the private sector and went to work for the County of Sacramento and I talked to my wife and said: "You know, I think I'll just stay in government for maybe five years, kind of get our feet under us," and I found I actually liked it. It fit with my lifestyle because to me work/life balance is very important. I wanted to be very involved (with family). Family is more important to me than my job. I found that this was, frankly, a better structure that allowed me more flexibility to control my calendar and, I decided to stay.
At the County of Sacramento I had a lot of fun because it's a smaller fund and a smaller organization. I was both the Chief Investment Officer for the County and for the Employees' Retirement System, so I was the CIO for the treasurer of the county. I got to issue a lot of municipal bonds, run the DC program, which was a 457 program there, fixed income portfolio, a lot of bond proceeds portfolios and then at the same time also work for the Retirement Board as their Chief Investment Officer, which back then, was probably $600 million. I haven't looked lately but I think it's up in the $3 or $4 billion range.
I found the long-term planning side of the defined benefit plan really fit my personality. I enjoyed the strategy, the development, asset allocation. Working with boards is always a challenge and some people find they can't handle that because you don't work for one boss. You work for 10 or 11 bosses and so that's tough.

Trusted Insight: What’s the number one rule that you've learned in your career?

Christopher Ailman: That's a challenge, number-one rule. I really think it's cool what Britt Harris does down at Texas A&M with his Titans of Finance class. I have been saying this for two years, so I'm finally going to do it. I'm going to teach a class on how to be a CIO, first to my staff, then open it up to PERS and to Sacramento County and just be open to anybody who wants it. I think it is time for us to pass on our knowledge and our experience.
Also, study the liabilities. Whether you're running a pension plan, a money management firm, or an insurance trust: understand you liabilities. In our case that is to understand the design in an asset portfolio. To be a good fit for a client, you first have to understand what their liability is. That could be as simple as ours which is a real dedicated pattern, but it could be as complex as somebody's life goals. What do they really want to do with this pool of money? What's the purpose of it? Too often I see asset liability mismatches. People design portfolios that have too much risk or too much volatility for what the underlying liabilities are. I don't think we as an industry spend enough time talking about the purpose of the money. That may be a better way to say it than liability.
So if you're a money manager, instead of just thinking of well I'm a small-cap manager. That's what I do, and I've got to beat the Russell 2000. Why do you have your client's money? What is their purpose in you having their money? What is their goal? What are they trying to achieve with your portfolio?
I had a benefit of working at a small shop where I got to do lots of different things. But now a lot of places you are in a big firm and only do one small thing. Take the time to learn the big picture of why you run that money to that benchmark? What are your clients trying to achieve? What are their goals and objectives? Pay attention to the purpose of the capital because it will change and to do a good job, you really need to understand that.

Trusted Insight: What have I failed to ask that I should either know about you, about CalSTRS or about pension fund investing in general?

Christopher Ailman: What you failed to ask me? What's the thing that keeps you up at night? Everybody always loves that question. My answer would be that I sleep like a baby. I wake up every two hours and scream. I used to sleep well, but now that I'm older I wake up every two hours. Like you said, we're the second largest in the USA. The external pressure is incredible to do other things with this pool of money, to provide economic benefit for a community or impact investing, the divestment pressure to bring about social change. That stuff is really frustrating, hard and frankly isn't part of our core mission. I've told our board, there's lots of good things we could do, and we could succeed at those, but if we don't make 7.5%, then we have failed. Bottom line: we have failed. Far too often at the big-fund level we should have an absolutely singular focus on one thing, and we get way too distracted—pushed and pulled in different directions.

To learn more about the the Top 30 Pension Fund Chief Investment Officers, click here.