CalSTRS Ponders Distressed Debt –

The California State Teachers’ Retirement System (CalSTRS), a public pension fund with $100.8 billion under management, may commit a sum north of $300 million to distressed debt investments before March, said alternative investments manager Real Desrochers in a presentation to the fund’s investment committee early this month. The committee agreed to the plan and moved to debate the target allocation for distressed debt within the fund’s alternative investments portfolio at the committee’s March meeting.

Currently, the Sacramento, Calif.-based pension fund holds $172 million in debt-related securities (including unfunded commitments), an asset class that includes distressed debt, accounting for 3.9% of the total market value of its $4.4 billion alternative investments portfolio. According to its most recent asset allocation targets, CalSTRS may invest up to 5% of its alternative investment portfolio in debt-related securities.

The team’s focus on distressed debt began in late August, just as state controller and CalSTRS investment committee member Kathleen Connell warned that a California state budget shortfall would not allow the state’s general fund to cover CalSTRS’ unfunded liabilities. Although CalSTRS is currently fully funded, falling returns in its public and private equity portfolio make distressed debt an attractive option. Elite distressed debt managers, says Connell, have achieved consistent returns of 25%.

“We’re not going to be in a position to write those checks from the general fund in the future,” Connell said at the investment committee meeting. “It’s counter-cyclical to go into distressed debt. I would not have recommended it two years ago, but it is a great asset class to be in now. Given the state of the public equity markets, it is an asset class we need to consider.”

Connell drafted an open letter on Feb. 1 to the fund’s investment team recommending the move into distressed debt. CalSTRS’ cross-town rival, CalPERS, the nation’s largest public pension fund with $144 billion under management, also has made moves into distressed debt in recent months.

Christopher Ailman, CalSTRS’s chief investment officer, agreed with the state controller and reported to the committee that his team was actively considering distressed debt managers, and was ready to complete due diligence, legal and financial negotiations within 30 days. When the committee questioned the timing of the potential investments and whether the increased investment would stretch the asset allocation target, others on Ailman’s staff reiterated the need to move quickly and close immediately on certain opportunities.

Behind the scenes, however, the alternative investment portfolio’s management team was frustrated by the board’s involvement in what it considers its own decision-making territory. Following the presentation to the committee, a plan consultant warned the team that there could be nothing worse than allowing the committee to dictate where the private equity markets are and how they should be approached. He also advised them to shift their strategy in presenting to the committee and not allow matters that should be considered routine business to come before the board and threaten the group’s timing and leverage in deal-making with investment managers.

Even if the fund does commit $300 million more to distressed debt, it will still be well within its asset allocation targets. CalSTRS’ alternative investments portfolio also includes private equity, venture capital, preferred equity and buyouts investments.

Although CalSTRS’ investment committee agreed not to interfere with the portfolio managers, it will review the plan’s allocation to distressed debt at its next meeting in March.

Carolina Braunschweig can be contacted at: