Two deals executed by California State Teachers’ Retirement System in mid-May are signs of things to come as the pension takes more investment in-house.
First, CalSTRS secured a majority ownership of Fairfield Residential, a California-based multifamily operating company. Then it received a second $200 million commitment from Korea’s Public Officials Benefit Association for their joint venture targeting US real estate debt.
The transactions are in line with the pension’s collaborative model, which it has been implementing since May 2018 to maximize internal portfolio management. During the investment committee meeting on May 8, deputy chief investment officer Scott Chan outlined what the pension would need to execute its plan, which should be finalized by September. He identified the addition of 27 more investment professionals this fiscal year, along with a special consultant, a bigger travel budget and more money for legal, technical, financial and communication services among the measures necessary.
Chan said the pension hopes to increase its investment team from 180 professionals to more than 300 in the next five years. This growth is important, he explained, if CalSTRS hopes to compete for assets with other top global pension and sovereign funds, many of which have more resources and are subject to less stringent investment protocols.
“Given the competition, given the regulatory constraints, given our measurable track record of success, now is the time for us to bring more resources to bear,” he said. “In order for it to be meaningful, for us to continue our track record, it needs to be a unified effort across our organization.”
The collaborative model takes a three-pronged view of ‘internal management.’ It calls for a focus on partnerships with other investors and managers – in the form of JVs, separate accounts or other arrangements. It also encourages the acquisition of operating companies to increase dealflow. The final component is a robust team of in-house professionals.
“We’re seeing the competition, not just generally, but on the assets we’re going after, which makes us have to partner with folks that can move fast.” – Mike DiRe, head of real estate, CalSTRS
CalSTRS has favored some of these methods in its core real estate portfolio for decades so the asset class has a head-start on other parts of its portfolio. Its first real estate separate account investment, for instance, was in 1987. Now, 80 percent of its real estate allocation is owned directly and, in the coming year, it plans to focus on adding more operating companies and JVs.
Parts of CalSTRS’ roughly $230 billion general portfolio are already handled internally, such as its global public equity and fixed income allocations. The collaborative model aims to increase these structures across the board to increase returns, better control risks and save on fees and expenses. It also calls for sharing resources across asset classes. Mike DiRe, CalSTRS’ head of real estate investment, said during the meeting that his department worked with the global equity team to launch a REIT strategy this year.
Cost and competition
Partnerships are especially important in the real estate space now CalSTRS faces increased competition from global investors, DiRe said.
“We’re seeing the competition, not just generally but on the assets we’re going after, which makes us have to partner with folks that can move fast.”
In 2017, 56 percent of CalSTRS’s overall portfolio was managed externally at a cost of $1.8 billion, a significant expense compared with the other 44 percent which cost $30 million to manage internally. Chan said savings could be realized by managing more assets internally, estimating every $1 paid to its investment staff results in $10 of savings.
Over the past 30 years, the pension plan’s general strategy has achieved a total return of 8.6 percent. Chan said roughly 0.3 percent of that was attributable to its direct investments, accounting for $600 million per year, adjusted for inflation.
“We’re seeing the competition, not just generally, but on the assets we’re going after, which makes us have to partner with folks that can move fast ”