At $130 billion in assets, the California State Teachers'
Retirement System is the third largest pension in the United
States. But in terms of its approach to investing in hedge
funds, the pension lags far behind its peers.
The $199.4 billion California Public Employees' Retirement
System first started investing in hedge funds in 2002 and now
has $6 billion invested with the funds, while the $132 billion
New York State Common Retirement Fund made its first hedge fund
investment in 2005 and now allocates $3.8 billion to various
managers. By contrast, Calstrs has invested only 1% of its
assets in what it calls alternative strategies-and that money
is mostly invested in distressed strategies and Treasury
Inflation Protected Securities.
"Because we're one of the largest funds that hasn't embraced
hedge funds and drank the Kool Aid, we get made fun of on the
school block," Calstrs' chief investment officer Christopher
But that is about to change. In a world where markets are more
correlated than ever, diversification has become critical, and
Ailman's believes hedge funds are the way to achieve it.
Calstrs is searching for a consultant to help it select hedge
funds and is evaluating a variety of strategies. Ailman is
particularly optimistic about global macro, commodities, and
funds invested in infrastructure.
In the near term, Calstrs will allocate $250 million in up to
five global macro funds, but the pension's goal is to increase
its hedge fund allocations to 5% of total assets, or $6.5
billion. Ailman is confident that if the hedge fund investments
generate consistent returns, that allocation will only
increase. "This is a marathon, not a sprint," he said. "In a
marathon you don't win in the first mile or even in the
Ailman joined Calstrs in 2000. In addition to managing the
pension, he oversees seven directors and 96 investment
professionals. AR Staff Writer Suzy Waite caught up with
Ailman to discuss the market outlook, the search for the
perfect manager and why the third largest pension in the U.S.
is investing in hedge funds for the first time.
AR: Calstrs is entering hedge funds for the first time.
We do have investments in distressed debt funds, of which some
could be categorized as hedge funds. We also have investments
in corporate governance activist funds.
With that as a backdrop, our interest in traditional hedge
funds is really coming from a broad review of different
strategies that we think could add value and diversification.
We think global macro looks particularly interesting. We're not
going to invest in a mess of hedge funds. We're specifically
looking at global macro, both systematic and pure active, and
this will be our first allocation to global macro.
Why have you waited so long to seriously invest in
Calstrs is a very education-focused fund. We obviously
represent school teachers in California, so the board is
comprised of people interested in education. We tend to study
things before we run out and invest in them. Our fund has a
history dating back 20 years of not wanting to start out with
newest idea out of Wall Street. We like to see how it performs
and see some track records.
I applaud some of the universities, particularly endowments,
that were early in global macro and did well. We're a large
public fund with a different liability scheme and a different
We've also, for a period of time, avoided things we view as too
high cost. That's partly why we've been slow at looking at
hedge funds. We view them as business structures that are a
high cost and put the investor in a position of weakness or
disadvantage to the general partner.
If you think hedge funds are expensive, what are you
planning to do about fees?
Calstrs will negotiate the best fee structure we feel is both
fair for our partners and which maximizes long-term value for
How do plan to get started?
We'll invest $250 million over the next nine months in three to
five managers. We recognize that that's a small allocation for
us, but obviously people are willing to talk with us because of
our sheer size and in the hopes that the allocation will grow.
It's an opportunity to see how global macro performs for us. If
it adds value and reduces risk for the fund, we'll expand the
program over time.
Why global macro? What opportunities do you hope to
Clearly the lesson of the decade-not just 2008, but the entire
decade-was that there is more correlation amongst equity
markets, credit markets, stocks and bonds around the world.
Institutional investors are looking for more diversification
and a different return pattern.
We think global macro is a good strategy simply because it
should be able to not just add returns, but reduce risk by
What are some other strategies that you're
We like the idea of inflation sensitivity, so our board
approved an investment in commodities. We're looking at all
different types, not just managed futures. We're also doing
research into micro finance and will be allocating to
I've always liked convertible arbitrage and M&A arbitrage,
but the spread has contracted as people entered into those
markets. Still, I think we're coming into an era where M&A
arbitrage might be an interesting place. We're coming into a
cycle with private equity where we'll see more acquisitions and
strategic mergers between companies and subsidiaries.
What is in the portfolio right now?
Fifty-four percent is in global equity (long only), 21% in
fixed income, 13% in private equity, 10% in real estate and 1%
each in absolute return and cash.
Our absolute return bucket is a bit of a misnomer. It's
basically a bucket in which we put lots of different types of
assets. Most of that 1% is an inflation sensitive portfolio,
which is TIPS. Our allocation into global macro and any hedge
fund would land in the absolute return portfolio.
You've said you would like to eventually get to a 5%
allocation in hedge funds. How long will that take?
That's where our sheer size comes into play. Moving this
portfolio around is like steering a huge cruise ship. You don't
want to throw the wheel to one side or another because you'll
disrupt everything. You'll also create a wake-e.g., transaction
costs-which just is a drag on the portfolio. It's a challenge
for a portfolio this large to be nimble. That's something we
aspire to be, though.
Will you invest in startups or more established
managers, such as those running $5 billion or
If you look at our other asset categories, we very much believe
in a blend of long-term, established firms as well as new
That said, normally we talk to startups. We're very interested
in them. Now we're kind of on a clinical trial, and we're
looking for a small handful of funds with an existing track
record that we can really sink our teeth into.
We tend to find that with new firms, the people are very
hungry, very focused on alpha. Their name is on the door, they
have a lot at stake.
You've discussed the advantages to investing with new
firms. What are the disadvantages?
It's challenging for a firm our size. I've had that experience
of being the majority of someone's assets under management. And
if things aren't going well and you want to pull out, you're
pretty much going to put them out of business.
What are the disadvantages to investing with an
A lot of times, a large chunk of the portfolio is their own
money and often, they want to invest your money on different
terms and conditions. Suddenly you're secondary, and that's
pretty clear, especially if it's a different pool of assets and
not commingled. You get a little worried about where the
loyalty lies, how they'll allocate it, where will the best idea
go, and when they run to the exit, where will it go.
What we also find with bigger firms, and I call it the "CFO
syndrome," is when you get to be pretty big and you hire your
CFO, sometimes they talk with the traders, and the discussion
moves away from investment ideas and comes around revenue flow,
income levels, fee levels, and everyone becomes more benchmark
aware. We find that as a negative.
Some managers will come in and tout that they're benchmark
aware. To me, that's a big red flag. That means they're risk
adverse and are just trying to get a more stable revenue
stream. I can get market returns for almost free. What I am
looking for is skill that is repeatable over time.
You see these firms ebb and flow over culture, structure, and
sometimes the skill just leaves the building, even if there's
no change of personnel. It becomes an interesting challenge.
Everybody talks about the people, process and philosophy, but
what we really focus on is the culture. It's the subtle changes
in culture that are very difficult to measure, but it's the
culture of the office and the people that's a leading
What would cause you to redeem?
The simple and obvious signals are key departures and mergers
in the money management business.
But we look for the subtle changes within the dynamics. You can
only get that from being in the office. You can't get that from
having the senior people visit you. And you can't get that from
a one hour meeting in their corner glass conference room. When
I go to meet managers, I'll wander off and around the office. I
encourage my staff to do the same, and to sit in the office for
several hours working at one of their desks. In the first hour
everyone is on guard, but after that, you see how people deal
Are you planning on investing direct or going the funds
of funds route?
We'll be going direct; we're not doing funds of funds. I view
that as fees on fees.
I think one of the things we are skillful at is performing
extensive due diligence. We have a lot of good analytical tools
and we have the people to analyze firms and investment
processes to help us try and cull between people with luck and
people with skill.
What we're looking for is sustainable performance. Not a short
term run or even a good cycle. We want reputable, sustainable
What are the disadvantages of funds of funds?
I know I'm a bit critical of them, but you have to recognize
the position we're coming from as a very large investor with a
lot of resources. For a smaller shop or fund, I could certainly
understand going that direction and getting that institutional
help. You're also getting access to some of the best and
But it also gets back to our philosophy on hedge funds; which
is they are not just a bucket asset class. They are a bunch of
different investment strategies that fall under our existing
asset class structure. You're either fixed income, equity or
asset allocation strategies, and so a fund of funds in
deploying all six broad categories doesn't fit that philosophy.
We would rather take our equity team and look at market neutral
and long/short, or take our fixed income group and look at
convertible arbitrage and fixed income arbitrage.
Traditional funds of funds don't fit our philosophy. We've been
investing in private equity for over 20 years and investing in
real estate for almost two decades. We've shown that we have
some level of skill in discerning between shops that have a
solid investment philosophy and have the right people and
structure to succeed.
What strategies are you avoiding?
I wouldn't say we're avoiding anything specific. We generally
tried to avoid areas where everyone else is rushing into.
Sometimes the herd mentality is wrong. We like investing in
things that other people are tending to move out of.
For example, lots of our peers have been reducing or
eliminating their currency active management strategy. We've
been adding to our currency overlay.
What are some areas that everyone else is rushing into
It's interesting now. I see people in a holding pattern. I
wouldn't describe it as shell shocked or frozen, I think
they're in a holding pattern. It's so uncertain where these
markets globally will head.
There are real, deep systematic issues plaguing Europe and the
U.S. and difficulties with the Japan market still. It's really
tough to figure out. We all know the BRIC story. It's tough to
figure out how the global GDP will turn it out. Right now,
sovereign debt is at historic highs. That's an area that's
worrisome. Meanwhile, U.S. interest rates are at absolute
In the past year, high yield is still at historic ranges, but
they've made great returns recently. I don't know if that means
you should put more money there. It's a very challenging market
and very tough for investors.