Podcast Summary: E142 - How to Generate Alpha on $350 Billion with CIO of CalSTRS Scott Chan
Podcast Information:
- Title: How I Invest with David Weisburd
- Host: David Weisburd
- Episode: E142: How to Generate Alpha on $350 Billion with CIO of CalSTRS Scott Chan
- Release Date: March 4, 2025
I. Introduction
In Episode 142 of "How I Invest with David Weisburd," host David Weisburd engages in an insightful conversation with Scott Chan, Chief Investment Officer (CIO) of the California State Teachers' Retirement System (CalSTRS). Managing a colossal $350 billion, Chan delves into the strategies, philosophies, and structural nuances that underpin CalSTRS' investment approach, aiming to generate sustainable alpha while serving over one million teachers.
II. Investment Philosophy and Strategy
Scott Chan begins by addressing the dual nature of managing such a vast capital base. He emphasizes CalSTRS' long-term investment horizon as a cornerstone of their strategy. This perspective enables them to adopt a contrarian stance, focusing on enduring trends rather than transient market noises.
Scott Chan [00:11]: "Thinking long term gives you the capability to be contrarian because most of what you're seeing in the short term is noise."
Chan further elaborates on their bottom-up, transaction-by-transaction approach, fostering expertise across various markets. This meticulous, scientific method allows CalSTRS to build a team of experts capable of making informed, high-probability investment decisions.
III. Public vs. Private Market Allocation
A significant portion of CalSTRS' assets, approximately 80-85%, is allocated to public markets, including global equities and fixed income. These assets are managed internally, a strategy that has consistently outperformed market benchmarks. In contrast, the remaining 15-20% is invested in private markets, where CalSTRS leverages its scale to partner with leading General Partners (GPs), aiming to harness higher alpha potentials.
Scott Chan [02:39]: "We're trying to become the global partner of choice... If we do, then we're going to be successful in accessing the best transactions globally."
IV. Collaborative Model and Becoming the Global Partner of Choice
CalSTRS adopts a collaborative model as its primary investment strategy. This involves bringing more assets in-house to lower costs and manage risks better, while also forming strategic partnerships in the private markets to achieve similar benefits. Being the global partner of choice allows CalSTRS to access premier investment opportunities by positioning itself as a top contender for limited partnership (LP) allocations.
V. Criteria for Partnering with GPs
When selecting GPs for joint ventures or partnerships, CalSTRS prioritizes three key attributes:
- Competitive Advantage: Managers with unique strengths or market positions.
- Desire for Collaborative Value Creation: GPs eager to build synergistic value with CalSTRS.
- Shared Long-Term Investing Principles: Alignment in investment philosophies and team-building strategies.
Scott Chan [09:38]: "We look for managers that have a competitive advantage... a desire to create more value together... shared principles around a whole host of how we think about investing for the long term."
VI. Contrarian Investing and Asset Allocation Shifts
As a contrarian investor, Chan identifies and capitalizes on asset allocation shifts that diverge from prevailing market sentiments. In 2025, he highlights three primary shifts CalSTRS is pursuing:
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Reducing Exposure to Global Equities: Anticipating below-average returns in the next 5-10 years, CalSTRS is cautiously decreasing its allocation to global equities.
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Increasing Allocation to Infrastructure and Energy Transition: Focusing on sectors with higher alpha potential and lower risk profiles, such as infrastructure debt and energy transition projects.
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Enhancing Liquidity Positions: Prioritizing liquidity over traditional safe havens like gold, to better navigate market uncertainties and capitalize on downturn opportunities.
Scott Chan [11:50]: "The probability that the stock market is going to generate below average returns over the next five to 10 years, it's becoming more probable... we're shifting a few percentage points away from global equities."
VII. Managing Liquidity and Crisis Preparation
CalSTRS places significant emphasis on maintaining liquidity to exploit market dislocations and downturns. This involves:
- Adjusting Asset Allocations: Balancing fixed income, hedge funds, and cash to ensure readiness for crisis investment.
- Developing Liquidity Tools: Preparing mechanisms to deploy capital swiftly during market sell-offs.
- Strategic Leverage: Utilizing leverage cautiously to enhance investment capacity during market downturns.
Scott Chan [17:15]: "We're bringing what we call our diversifying assets back to target... ensuring that we have the firepower and liquidity to invest in a crisis or a market downturn."
VIII. Governance Structure and Decision Making
CalSTRS boasts a flexible and dynamic governance structure that empowers divisional autonomy while maintaining overarching strategic coherence. Key features include:
- Innovative Board Oversight: A forward-thinking board that delegates authority effectively.
- Division-Level Decision Making: Investment decisions are made at the division level by mature investment committees, allowing for swift and informed responses to market changes.
- Expertise Across Asset Classes: Building specialized teams to manage different segments ensures expertise-driven investment processes.
Scott Chan [24:20]: "Great governance starts with our board... we have a nimble and dynamic decision-making structure at the division level."
IX. Structural Alpha and Cost Efficiency
CalSTRS pioneers the concept of structural alpha, which involves embedding value within the structure of investment deals without incurring additional market risk. This is achieved by:
- Operational Risk Mitigation: Utilizing expert staff to structure deals that minimize operational risks.
- Fee Optimization: Engaging in collaborative deals that reduce fees and enhance returns through revenue-sharing arrangements.
- Cost Savings: Streamlining operations to achieve significant cost reductions, directly benefiting the pensioners.
Scott Chan [26:35]: "Structural alpha is embedded in the structure of the deal or the transaction... operational risks are mitigated through resources and expert staff."
X. Capital Base: Advantages and Challenges
Managing a large capital base of $350 billion presents both opportunities and challenges for CalSTRS:
Advantages:
- Negotiating Power: Ability to negotiate better terms and win-win partnerships due to scale.
- Ecosystem Growth: Facilitates the creation of interconnected investment opportunities across various divisions.
Challenges:
- Coordination Complexity: Synchronizing investment strategies across multiple divisions can be difficult.
- Market Scalability: Ensuring investments are scalable enough to justify large capital deployments.
Scott Chan [31:30]: "The largest challenge is coordinating our approach across divisions. It's very hard to do dynamically at scale."
XI. Identifying Supply-Demand Imbalances
CalSTRS identifies investment opportunities by analyzing supply-demand imbalances in the market. The firm focuses on:
- Crisis-Induced Gaps: Leveraging supply-demand gaps that arise during financial crises.
- Emerging Sectors: Investing in new and technologically advanced areas experiencing significant demand.
- Complex Markets: Capitalizing on sectors where complexity creates premium opportunities due to specialized knowledge requirements.
Scott Chan [35:58]: "We have to look for sizable imbalances that we think are going to last a long period of time so that CalSTRS can benefit."
XII. Personal Insights and Alignment with CalSTRS Mission
Scott Chan's personal connection to the mission of CalSTRS is profound. Being married to a teacher for over 30 years fosters a deep alignment of interest, ensuring that CalSTRS' investment success directly benefits California's educators.
Scott Chan [40:38]: "If CalSTRS doesn't do well, I might be sleeping on the couch because Heather is a teacher... I've got tremendous alignment of interest around the mission here at CalSTRS."
XIII. Team and Culture as Competitive Advantage
Chan attributes much of CalSTRS' success to its exceptional team and supportive culture. Leading through people, he highlights the importance of a collaborative and skilled senior leadership team, which he considers the ultimate competitive advantage.
Scott Chan [43:07]: "I'd like to highlight the team and culture of CalSTRS, which I think is the ultimate competitive advantage... it's a team sport and thankfully I have an amazing team."
Conclusion
Scott Chan’s discourse offers a comprehensive look into how CalSTRS adeptly manages a substantial $350 billion portfolio through a combination of long-term vision, strategic partnerships, and structural innovations. By maintaining a keen focus on diversification, operational excellence, and adaptive governance, CalSTRS not only strives to generate alpha but also ensures the financial well-being of California's teachers for generations to come.
Notable Quotes:
- Scott Chan [00:11]: "Thinking long term gives you the capability to be contrarian because most of what you're seeing in the short term is noise."
- Scott Chan [02:39]: "We're trying to become the global partner of choice... If we do, then we're going to be successful in accessing the best transactions globally."
- Scott Chan [11:50]: "The probability that the stock market is going to generate below average returns over the next five to 10 years, it's becoming more probable... we're shifting a few percentage points away from global equities."
- Scott Chan [26:35]: "Structural alpha is embedded in the structure of the deal or the transaction... operational risks are mitigated through resources and expert staff."
- Scott Chan [40:38]: "If CalSTRS doesn't do well, I might be sleeping on the couch because Heather is a teacher... I've got tremendous alignment of interest around the mission here at CalSTRS."