In a nearly four-decade career as an institutional investor, Christopher Ailman has experienced multiple economic cycles. As investors navigate one of the most difficult operating environments in history, Ailman, chief investment officer (CIO) of the California State Teachers’ Retirement Fund (CalSTRS), a US public pension fund with a portfolio valued at $331 billion,1 emphasizes the importance of getting the timing right: “Being right too early is indistinguishable from being wrong.”
Ailman, who is set to retire in June, ending his run as one of the longest-tenured CIOs in the world, spoke with McKinsey’s Elizabeth Skovira and Marcos Tarnowski about his investing mindset, CalSTRS’ approach to portfolio construction, and how organizational culture can create alpha. This interview was edited for length and clarity.
Elizabeth Skovira: The average tenure of a chief investment officer in the US is four years. You’ve been at CalSTRS for over two decades. What brought you to the role in the first place?
Christopher Ailman: I always said I’d come back to Sacramento for one of two jobs: California Public Employees’ Retirement System [CalPERS] or CalSTRS, because they are meaningful to me. My sister, sister-in-law, and now my daughter are all teachers, so I have an affinity for both organizations.
Elizabeth Skovira: 2023 was a tumultuous year, with failed banks, rising interest rates, and global unrest. What lessons are you drawing on from your experience in prior cycles?
Christopher Ailman: This is my first global pandemic, and I don’t have a lot of experience with how to restart an economy. In March or April 2000, the global economy was turned off like a light switch, and restarting it has happened in fits and starts. We provided over-stimulus to consumers so that they had enough money. We had high inflation and supply chain shocks.
It is amazing how important it is for the economy to be in a steady state, and we’re not there yet; 2024 looks to be a very challenging year to figure all this out. But we are back to the old rules: don’t fight the Fed [US Federal Reserve], pay attention to what the Fed is doing in the direction of interest rates, and then try to read the economy.
One lesson over the last 20 years has been that interest rates can go to zero. In the 1990s, you did not believe rates could reach zero, but now the Fed has done it twice. When I look back at my career, I am constantly amazed at the ever-changing markets. History rhymes, but it doesn’t repeat, and it’s different. You get some gauge and some structure with age, but it doesn’t map out the future.
History rhymes, but it doesn’t repeat, and it’s different. You get some gauge and some structure with age, but it doesn’t map out the future.
Portfolio allocation amid market volatility
Elizabeth Skovira: You began your career with an inverted yield curve, and here we are again. How are you shifting your portfolio in light of the volatility?
Christopher Ailman: Yes, but not nearly as inverted. I remember when short-term rates were up at 13 percent, thanks to the Volcker rule.2
This is a chance for people to continue to look at fixed income and private credit, which look very attractive. You can finally balance your portfolio, but the real challenge in private equity [PE] is the high cost of financing. Everything is priced for perfection. And in real estate, we still don’t know how to value an office property, especially between a downtown office property and maybe a class B property in a suburban or secondary market. Nobody’s trading and nothing’s moving. The people I talk to are super bullish about valuations, but they’re not doing a lot of transactions. They’re recycling and holding onto their companies. I think that should thaw, but it may take a recession for that to happen.
Elizabeth Skovira: What’s your view on how private markets will fare in 2024? What do you hope for from your managers in an environment like this?
Christopher Ailman: I hope for a balance of purchasing and selling companies, and a traditional market flow. If managers just draw the capital and start investing and buying companies, many of us will be way over our allocation.
I know of investors that are thinking about selling assets for liquidity reasons, and also to reemploy capital. People want some flexibility. If you’re an endowment right now, you were probably already overweight in PE or venture capital, and now it’s a huge amount of your portfolio. Unless you get some distributions, you’re going to have to tap into your liquid markets to commit to beneficiaries. So we’re muddling along. People are surviving, but liquidity continues to be constrained.
On the other side, you’ve got the sovereign-wealth fund of Norway talking about allocating money into PE for the first time,3 and GPIF [Government Pension Investment Fund] in Japan looking to increase its exposure to the asset class. Even at 1 to 2 percent, or as much as 5 percent allocation, you’re talking about $40 billion to $60 billion of new money flooding into PE. So that market is going to be viable, with more people coming in with new money and those with established portfolios looking for liquidity opportunities. Hopefully, we will see some nice spring thaw where it loosens up slowly, but not a dam break, where all of a sudden we get a lot of write-downs and acquisitions.
Managing climate and diversification risk in the portfolio
Marcos Tarnowski: The breadth of risks and the level of complexity that CIOs face today is striking. How do you balance the need to diversify your portfolio in order to capitalize on opportunities arising from megatrends while also safeguarding your members’ retirement capital?
Christopher Ailman: It is a good point, and I think diversification can go a bit too far. When I look at our emerging-market exposure, we are exposed to 42 countries. I can tell you that countries numbered 40, 41, and 42 are not going to move the needle for us.
Take the energy transition issue, for example, which is a massive shift over the next ten to 20 years that we can all take advantage of. But we can’t get too far ahead of it. Just because you transition your portfolio doesn’t mean you’re going to get the timing right. Trying to measure where the world’s at, and where your portfolio is at on carbon, is really difficult right now.
At CalSTRS, we are trying to create a carbon tracker to figure out where the broad society and the broad market is on carbon. We want to be ahead of it, but we don’t want to be so far ahead that it creates tracking errors and underperformance.
I’ve said it a million times: being right too early is indistinguishable from being wrong. If I know something’s going to happen in the market, but I’m five years too early, that’s the same thing as being wrong. It is about timing and size. And that’s what makes an investment market really challenging.
I’ve said it a million times: being right too early is indistinguishable from being wrong.
Marcos Tarnowski: At many pension funds, there is a tension among the stakeholders between doing what’s good for the plan and what’s good for the planet. How do you balance these goals?
Christopher Ailman: It is a tension between taking care of your fiduciary duty, but not just today—for the future and future generations as well. We want to make money today and also 30 years from now, because we’re so long-term-oriented. We have to consider the impact of our investments, and that requires predicting the future, which is near impossible. It is really hard to make an investment today and say it won’t harm the world in the future. Look at all the debate about rare earth minerals in cell phones and batteries.
For us, first and foremost, it still has to be about the returns. But if the world decides to ignore the build-up of carbon in the atmosphere and not change our lifestyle, we’re going to destroy the investment environment. If that happens, we can’t make money and then we can’t meet promises even as early as 15 years from now.
I have told my staff that energy transition is the most significant trend in their career, and they have to pay attention to it and take action to shift how energy is used. If we don’t, we’re all going to be looking at very low returns because of all the risk and the mitigation of extreme weather events.
Collaborative approach to investing
Elizabeth Skovira: CalSTRS recently announced $1.6 billion in savings due to the collaboration model and a shift to internal management.4 How should public and private managers interpret this model?
Christopher Ailman: I did a ten-year financial plan for my board, where we looked at the growing cost of asset management, particularly the cost of partnerships at 2 and 20 [percent].5 We felt it was not sustainable, and we were giving away way too much money and profit potential. Credit goes to a Stanford professor who came and gave us a lecture, where one of the words he used was collaborative. It was kind of an epiphany. We felt it was the right word: broad and covered any kind of structure, whether it’s internal management or just partnerships.
A lot of that [model] came from spending time with the Canadian pension plans as they were growing. We are a state entity, so I knew we couldn’t be a Canadian plan, but it doesn’t mean we can’t join them. So, we decided to partner with them. We’ll look at any model and structure, whether we launch a product with a general partner [GP], own the GP, and in many cases find ways to participate so that we’re just not paying 2 and 20 percent on everything.
For us, it has been a very successful effort to change our cost structure, focusing not on pinching pennies but on trying to partner with people instead of bidding against one another. Moreover, the creativity of different ideas has been wonderful across every asset class. We’ve created opportunities that have better economics for us longer term. That’s what it’s all about: doing business differently with a long-term eye on the bottom line, and being a good, solid, consistent business partner.
Elizabeth Skovira: What does it mean to be a good partner to your GPs?
Christopher Ailman: It changes for different markets and asset classes. In PE, it’s the speed of a decision. They always say the best decision is yes, but the next best decision is a quick no. I’ve always said I want to be demanding, but I also want to be a fair business partner and somebody you respect.
We cover one million public school teachers who go into a classroom every day to teach future generations. We try to show that we’re committed for the long term—we’re going to be a good partner and not change our personality every six months or couple of years. The tremendous turnover among CIOs is really a detriment to the teams.
Think of any sport, art, or business: if you have a turnover of management that quickly, it’s very hard to get things up and going, because everybody is readjusting every couple of years to some new goalpost and objectives. But if you have a consistent playbook and it attracts talent, your people can really focus on what they need to do. Point them in the right direction, give them the right tools, and then get out of their way. That was my father’s advice to me years ago.
Point them in the right direction, give them the right tools, and then get out of their way. That was my father’s advice to me years ago.
Changing culture and governance to enhance performance
Marcos Tarnowski: At CalSTRS, how do you think about portfolio construction as a real tool to differentiate your returns versus having a steady, North Star type of approach?
Christopher Ailman: Historically, we have always been policy- and big-picture-driven with our asset allocation. The board pays attention to tracking errors. We have a budget: we’re allowed to stay within that and make tilts. Since we’re so long-term-focused, we recognize that it’s very difficult to make tactical shifts and try and bet the farm. And our funding plan is locked in: the [California] legislature already passed a plan to fund us over the next 20 years, so we have to stick to that glide path.
I think our secret sauce at CalSTRS is the culture we’ve built. It was there before I got there in 2000. I just tried to cement it in and make it intentional with the team. We’re not perfect, but we really talk about teamwork, input, inclusion, and getting everybody’s ideas on the table, because that’s going to help us make a better decision.
I’ve looked at a lot of money managers over the last 40 years, and the thing that most often explains the alpha is the culture inside the shop. It’s the people, process, and philosophy. Culture can be a star system or a teamwork structure, but when it changes, the alpha disappears. And if you want an early indicator of underperformance, it is understanding what the talk is in the office. That’s harder now that everybody’s working remotely.
To me, it’s really hard when you’re interviewing a manager. They’ve given you a flip book, and you’re in their conference room, but that doesn’t tell you anything. You have to get out and walk around on the floor, look at the team, and try to get a sense of what the culture is. I’ve often told my staff that the best thing to do is to sit there for a half an hour, waiting for your next meeting. People go back to their normal behavior after a few minutes. Then you’ll get an idea of the office environment, whether it is a real star system, where everybody just cowers under one person, or actual teamwork.
Elizabeth Skovira: If you could make one change in the US public pension governance landscape, what would it be?
Christopher Ailman: If you look at the governance structure that public pensions use, it was mostly written in the 1970s.
If you look back, you can say that the 1970s model wasn’t bad, because people are salt of the earth and did a darn good job, but governance needs to move into the 21st century. These are funds that cover—and are funded from—huge numbers of people across multiple generations. So there’s a value to making them a trust fund and amortizing the mortality table and the life and putting all the investments together.
I think, sadly, that’s part of what has to do with the turnover in the CIO ranks. You’ve got to have really good governance, and you have to have the right personality to stay in this job. Most of the CIOs work for five or 12 people and they turn over constantly. In most other occupations, you work for one or two people, maybe, and you know who you report to, you know your boss, and you know what it takes to make them happy.
Marcos Tarnowski: As you look back on your long and storied career, are there any key things that you would do either the same or differently if you were at the beginning of your career today? What advice would you give to newcomers in the industry?
Christopher Ailman: My first advice would be to not forget to buy low and sell high. Too many times, we bought high and sold low, and we learned a hard lesson.
My second advice would be to not shy away from learning and trying to grow more. As much as you think things are going to stay the same, Lord knows they’re going to change. In the early 2000s, for example, my board had asked me to put together a list of inevitable surprises that we should be thinking about. One of the things I mentioned was a global pandemic. I was thinking something like SARS or Ebola might happen, but we ended up having an even worse global pandemic. And yet, what amazes me the most is that during the pandemic, we also ended up having a great economic environment, particularly for the stock markets.
I think this is a good example of how you just have to be on your toes. You can plan for the future, but you cannot predict the future. And you’re going to be humbled. That’s my final piece of advice. Stay humble. Just because you say it’s so doesn’t mean it’s right.
