The California State Teachers’ Retirement System, the nation’s second-largest public pension system, is considering a new strategy that would shift up to 12% of its $191-billion portfolio into safer investments, such as long-term Treasury bonds.
The strategy is one of the most aggressive actions by a major public pension fund to lower its risk of losses, especially from stock markets.
The potential moves, discussed in a meeting of the fund’s investment committee Wednesday, are part of a proposal broached by the fund’s staff and consultants for creating a complex, highly managed portfolio to mitigate risk.
Under the plan, CalSTRS would move up to $20 billion in ways that would enable it to maintain its target of earning returns of 7.5% a year on its investments.
The strategy offers “significant diversification benefits” to offset the risk of more volatile asset classes, such as stocks, real estate, private equity and fixed income, according to a CalSTRS study posted on its website.
The questions of whether to adopt the strategy and how much to allocate to the program are “the most significant potential change to the current portfolio” currently under consideration, the study said.
No decision was made on the strategy, and officials said in the meeting that there was no need to rush into a decision.
The discussion about dialing back investment risk, which has taken place over months, comes amid a wild period of volatility in the stock market that has seen major U.S. stocks plunge more than 7% in the last month.
The roiling domestic and worldwide markets are reflecting growing concerns over the health of the Chinese economy and fears of a global economic slowdown.
A strategy such as CalSTRS is considering raises the question of whether such a move would hamper the fund’s ability to meet its investment target of 7.5%, which is in line with other pension plans but is what analysts consider aggressive nonetheless.
Michael Rosen, principal of Angeles Investment Advisors, a Los Angeles pension consultant, said that to contemplate such a move, investors need to understand their goal and then execute the strategy in a “systematic and disciplined” way.
“If it’s to stay out of the next 5% drop in the market, OK. But the question might be, why do you care about such a move?” he said.
At Wednesday’s meeting, Steven Tong, a CalSTRS investment executive, said the goal of the program was to reduce risk “without degrading overall investment returns.”
Alan Emkin, managing director of Pension Consulting Alliance, one of the main consultants to the fund, acknowledged that the risk-mitigation strategy, which would involve active portfolio management, would be more expensive than conventional investments, such as stocks and bonds.
“These are more expensive,” he said. “We think they can work.”
Paul Rosenstiel, a committee member, asked why other public pension funds weren’t using such a program if it could truly mitigate risk while maintaining targeted returns.
“You guys are really smart, but why should we have confidence that you’re smarter than everybody else?” he said. “This sounds too good to be true. We have figured out a way to mitigate downside risk without compromising returns.”
Staffers and consultants said other pension funds and endowments, particularly larger ones, have begun using the strategy.
“This is not you by yourself,” Emkin said.
The California Public Employees’ Retirement System also is discussing a plan to move more of its investments to bonds and other more conservative investments. Under the plan, the change would be made slowly and gradually over the coming decades. CalSTRS indicated its plan also would develop over a period of time.
CalPERS staff has estimated that the fund’s investment returns would gradually be reduced if more money is put into bonds. Lower returns would require the state, cities and other local governments to contribute more taxpayer money to cover workers’ pensions.
Starkman reported from New York and Petersen from Los Angeles.