A news release said the approach incorporates new ideas on investment risk, including the concept of overlaying risk across the asset classes, rather than replacing asset classes with risk categories. Another innovation is the development of six broad risk factors, including governance regulation, such as accounting rules and tax laws.
The study culminates research that was listed on the fiscal year 2009-10 Investment Committee Work Plan. Peer funds who contributed analysis on risk include ATP-Denmark, Alaska PFD and CalPERS. Money managers were PIMCO, Bridgewater and GMO.
The announcement explained that modern portfolio theory identifies diversification as the key to reducing risk. By using investments that are less correlated, the overall portfolio will have a reduced volatility and overall risk. The study, however, concluded that the global market declines in 2001 and 2008 showed diversification failed and the theory did not hold up when needed most.
The approved CalSTRS approach calls for the evaluation of risk across the entire portfolio; not dividing the portfolio by exposure, but rather overlaying risk factors across the entire portfolio.
The resolution includes six core risk measures:
- Global Economic Growth Risk,
- Interest Rate Risk,
- Inflation Risk,
- Liquidity – Fluid Markets,
- Leverage/Financing, and
- Governance Risk.
Staff and consultants will now develop measures for each risk and integrate the risks into future Investment Committee reports.The California State Teachers’ Retirement System, with a portfolio valued at $146.4 billion, is the second largest public pension fund in the United States. It administers retirement, disability and survivor benefits for California’s 852,000 public school educators and their families from the state’s 1,600 school districts, county offices of education and community college districts.