Page 643 – Top1000funds.com

CalSTRS will explore the potential of risk-oriented strategic allocation management and wider asset class ranges, as it sets out its investment business plan for 2010-11, which also includes collaborating with UC Regents and CIC about improvements to Barra One – its risk management system – and potentially further insourcing.

Each fiscal year CalSTRS sets out an investment business plan, with this year’s theme of “continuous improvement” on the back of last year’s “back to basics, alpha, beta, costs”.

“Pension Consulting Alliance will lead us through a discussion of how we might attempt to be more nimble in the financial markets and more actively manage risk at the extreme inflection points in the market,” said a paper to be presented at the meeting states.

The paper also says that later in the financial year, the fund will explore different levels of internal versus external asset management.

Risk measurement and management will also be a key area of continuous improvement, and all the private asset classes will be integrated into Barra One, the fund’s risk measurement system.

It has also said it will work with staff at UC Regents and the China Investment Company to improve the system and enhance reporting.

Climate change and diversity will be a key focus, which includes continuing to expand climate change investment in real estate, private equity and global equity.

The fund endeavours to consider global sustainability issues across its entire portfolio, but this year the innovation and risk unit will also be incorporating environmental factors into a quantitative screen to identify potential new strategies for incubation.

According to the business plan, to be presented at the July 9 investment committee meeting, two core objectives for the investment team this year are adding 60 basis points of value over the policy benchmark, and achieving an absolute return above the actuary assumed rate, which is currently 8 per cent.

In real dollar terms this is $10 billion in profits from the financial markets, and an extra $1 billion of return above the market.

The fund also aims to prudently diversify the portfolio and strive for lower costs.

“The big challenge before us is whether to shift our asset allocation process to make it more nimble to accommodate market dynamics,” the paper said.

In the past, themes for the business plan have included “the year of alph” and “squeezing 8 per cent out of a 5 per cent market”.

The $130 billion Californian fund, CalSTRS, will hire a deputy chief investment officer who will oversee the new absolute-return asset class, investment operations and a majority of the day-to-day investment branch management.

This brand new position will allow the chief investment officer, Chris Ailman, to focus more on portfolio management and asset allocation.

All existing heads of departments – innovation and risk, global equities, fixed income, real estate, private equity and corporate governance – will continue to report to Ailman, as will the new deputy.

In addition to overseeing investment operations, which has about 18 staff and includes cash management, portfolio controls, reporting and performance, and administration and management, the new deputy will manage the new absolute-return asset class.

An allocation of up to 5 per cent of the fund has been approved by the board for the absolute return asset class which is made up of Treasury inflation-protected securities (TIPS) and infrastructure, although no investments have been made in infrastructure yet.

A portfolio manager was appointed this spring and will develop internal processes, portfolio construction planning and hire a general infrastructure consultant.

The three-year plan is for five staff in this business unit, reporting to the deputy CIO.

Alternative beta is catching on, with Russell Investments the latest market index builder to embrace the non-cap-weighted index trend by inking a deal with Rob Arnott’s Research Affiliates company.

Russell will launch a series of “fundamental” indices, in association with Research Affiliates, during the third quarter of this year.

Fundamental indices rank stocks according to a range of factors which the strength of the underlying businesses rather than the price multiple of all their shares (capitalisation value). Critics have suggested that it is a form of value-biased index but Research Affiliates say that more factors are assessed than price:earnings figures.

Arnott, the founder and chair of Research Affiliates, said that about US$50 billion in assets were being managed using fundamental indices around the world.

Russell’s Ron Bundy, the managing director for indices, said the firm would continue to believe that cap-weighted indices represented the best description of the market’s opportunity set and therefore the most appropriate benchmarks for investors.

However he noted the increasing demand from index investors for a “more active” approach using alternative beta.

The big quant index houses, State Street Global Advisors and Barclays Global Investors (now BlackRock), have provided various bespoke and packaged indices in recent years.

SSgA, for instance, has a “diversified” index strategy which combines low-volatility with value and size tilts.

Russell, which is best known for its multi-manager funds and asset consulting, pioneered the development of growth and value indices in the US in the 1980s. The first index in the new series is likely to be a global equities index.

Research Affiliates, based in Newport, California, also provides a range of investment services from direct asset management and sub-advisory services to licensing agreements.

Through their momentum properties, cap-weighted indices favour the emergence of speculative bubbles, according to research by EDHEC-Risk Institute, which concludes cap-weighted stock market indices offer no particular advantage.

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With less institutional flows forecast in the next few years, asset managers will need to implement a convincing “fiduciary overlay” to win business from large investors.

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The effects of adding TIPS and alternatives to the existing asset mix are being explored in an asset liability analysis conducted for the $53 billion Oregon Public Employees Retirement System by Strategic Investment Solutions.

A presentation from SIS, which looked at five new asset allocation scenarios adding a 5 per cent alternatives allocation, and between a 0.1 per cent and 11.4 per cent allocation to TIPS, showed all except the most conservative mix achieved the actuarial return without accounting for alpha.

Further, reducing the total equities allocation by nearly 10 per cent, achieved through halving public equities and slightly increasing private equities, together with a 5 per cent and 4 per cent allocation to alternatives and TIPS, would yield the same expected return.

A risk/reward analysis was used to point toward an appropriate level of risk/return with the consultant finding generally the Sharpe ratio, or risk/return efficiency was higher for lower return mixes.

With liquidity analysis, and scenario analysis in inflation, deflation, recession and low-return environments, the conclusion was that the ultimate net cost does not suggest taking less risk.

A July presentation to the investment committee will include defining the ALM analyses, refining a potential asset allocation policy (including new asset classes such as the opportunity portfolio, alternatives and TIPS) and adopting a new asset allocation policy.

Asset allocation

Asset class	target	Mix4-1	Mix4-2	Mix4-3	Mix4-4	Mix4-5	current mix
Public equity	46%	19.8%	21.9%	24.2%	31.4%	39.2%	42.9%
Private equity	16%	18.8%	20.7%	22.9%	24.0%	25.0%	19.8%
Fixed income	27%	36.9%	36.9%	31.5%	28.5%	20.7%	25.7%
Real estate	11%	8.2%	10.1%	12.1%	11.0%	10.0%	9.4%
TIPS	0%	11.4%	5.5%	4.3%	0.1%	0.1%	0%
Alts Port	0%	5.0%	4.8%	5.0%	5.0%	5.0%	2.2%
Equity	73%	51.7%	57.6%	64.2%	71.4%	79.2%	74.3%
Expected return	8.61%	7.75%	8.08%	8.42%	8.76%	9.09%	8.61%
Std deviation	12.8%	10%	10.9%	11.9%	12.9%	14%	12.8%
Sharpe ratio	0.44	0.47	0.47	0.46	0.45	0.44	0.44