CalSTRS’ CIO Christopher Ailman recently spoke with Amanda Janis about some of the clouds hanging over the private equity asset class as well as controversy surrounding the ILPA principles.

The California State Teachers’ Retirement System’s shiny new headquarters – a 409,000 square foot building completed last summer – rises 15 stories above the banks of the Sacramento River. Located in West Sacramento, just across the river from California’s capitol, the LEED-certified building is part of an ongoing revitalisation effort along the city’s riverfront.

Ailman: Private equity is not yet out of the woods

Revitalisation is taking place inside the building, too, though of a slightly different kind. The $133 billion pension’s private equity portfolio – a little more than 70 percent of which is invested in buyout funds – recently reported a 9.4 percent decline for the 12-month period ended 30 September 2009 – a major improvement from the 30.7 percent drop it recorded for the 12-month period ending just six months earlier.

“Private equity still isn’t out of the woods,” Christopher Ailman, CalSTRS’ chief investment officer, cautions from behind his L-shaped desk. Many fund valuations remain at lower levels than the pension would like, and while there are indications that things are turning around for some private equity funds, Ailman says it’s impossible to know exactly what will happen. “A lot of debt still is going to come due that has to be recycled and just like we’re seeing in commercial real estate: the banks at first play hard ball, the debt markets are closed and nobody wants to refinance, but nobody wants to take a step back.”

The best way to characterise the pension’s private equity portfolio at present? “Surviving,” Ailman sighs. “The distressed debt people will tell you the world’s still going to come to an end, but the private equity people will tell you [they’re facing] tough negotiations but it’s all going to work out.”

There are still a lot of question marks for LPs surrounding the performance of funds raised in recent years. “You know that the ‘07 and ‘08 vintage years aren’t going to be too hot, but you don’t know how bad,” Ailman explains. Many large institutional investors like CalSTRS have a great deal of exposure to ‘07 and ‘08 vintages and may seek to be more time diversified in the future.

“What you’re trying to do now is figure out a plan on how to go forward,” explains Ailman. “Not a lot of people are raising funds; what kind of funds do you want to [commit to]?”

Making matters more difficult is that no one is quite sure if the global economy is headed for a sustained recovery or not. “It’s not like ‘03 or ‘04 where you were coming out of a recession and it was obvious the wind was at your back,” he recalls. “Now you still almost feel like …”, he pauses to hold up the cover of the PEI Annual Review 2009, featuring the satellite photo of a hurricane storm system. “You’re not in the eye of the storm, but has the storm cleared or not?”


CalSTRS saw $42.6 billion in value wiped from its investment portfolio in the 12 months ended 30 June 2009, with real estate and equities leading the heavy losses. While markets rebounded somewhat as 2009 went on and the pension’s assets increased, CalSTRS took some measures in response to the unprecedented volatility.

It created a programme in early 2009, dubbed “equity return”, temporarily shifting 5 percent of its global equities allocation to buy “quality” assets from distressed sellers across real estate, private equity and fixed income. It also permanently moved 5 percent of the portfolio from global equities to “absolute return”, its bucket for inflation-linked assets including infrastructure (see chart opposite).

CalSTRS also adopted a new asset allocation mix last year, which it does every three years following an allocation study. The pension bumped up its private equity allocation target to 12 percent from 11 percent and its allocation to real estate to 15 percent from 13 percent. As part of the changes, CalSTRS reduced its exposure to global equities and fixed income.

The pension decided that “private equity, and to a certain extent real estate, are just about the right size in our portfolio”, and thus didn’t dramatically increase exposure. As of 30 September 2009, the market value of CalSTRS’ private equity portfolio was $16.5 billion.

“We want to be steady state investors in the market,” Ailman explains. “The biggest change we’ve made from our experience in ‘08 and ‘09 is [to] be more consistent capital allocators and pay attention to the EBIDTA multiples and potentially dial up or down an allocation rather than looking at an asset allocation target and trying to invest to that.”

He’s instructed CalSTRS’ private equity investment team, led by Margot Wirth, not to worry about what percentage of the overall portfolio their investments comprise, but rather to invest when they see good opportunities and slow down when they don’t. “GPs hate that,” Ailman deadpans, “they always want more money.”


CalSTRS doesn’t have leadership roles on the board of the Institutional Limited Partners Association, but it is involved with the organisation and hopes GPs will become 100 percent compliant with the ILPA Principles. The guidelines, a set of best practice terms and conditions, call on GPs to adopt a number of practices including a European-style waterfall for profit distribution, reducing management fees and offsetting them with transaction fees. They also call for limited partners to be given stronger rights to suspend, terminate or dissolve a fund.

“We think they’re pretty straightforward, they’re good governance,” says Ailman, who adds that governance in private equity has been evolving since the early ‘80s. “The governance kind of ebbs and flows depending on if the markets are really hot – then the GPs start demanding everything.” He adds that, in his experience, it’s lawyers for the GPs that are pushing on terms because they’re able to tell prospective clients they were successful in negotiating certain types of legal coverage. “But when I call up a GP and say ‘Do you really want that legal protection? Is it really that important to you?’ [Their response] is usually, ‘Gosh no, it wasn’t huge, it’s a long-term relationship.’”

Making LP advisory boards more independent is one of the key ILPA principles Ailman flags as important and overlooked. “You’ve never seen an advisory board meet without the GP in the room and I think that’s something we’re asking for that’s pretty darn powerful,” he says. “LPs don’t want to become GPs, we’re not going to ask to run the company, but the LPs need to be allowed to speak to each other and talk as limited partners, figure out how everybody feels.”

Most LPs have lived through a handful of limited partnerships that have blown up when partners leave or other problems develop. Often, it’s not until that crisis point that LPs talk to one another for the first time, a fact that Ailman says ought to change. “That’s one of the things that’s going to be healthier for the industry because it creates better dialogue.”

Asked what he makes of allegations that the big push behind the ILPA Principles amounts to collusion and violates anti-trust rules, Ailman acknowledges that it is “a concern, because we are LPs and we are all aware of the rules and regulations”, and that such allegations would never be taken lightly. But, he continues, the perception that a group of LPs are now controlling the market is wrong. “It’s a pretty big world and capital comes from all over the place. You can’t get all the investors in one room,” he says, listing off a number of large pensions and sovereign funds around the world he says he’s never met but would like to if given the opportunity.

“Many LPs don’t even know each other, so to think that we can work a market –” he trails off before continuing, “It’s always in Wall Street’s interest to fragment the market because then you’ve got multiple people competing for the same thing and it drives up prices. We’d rather invest alongside of people, with people, and I think GPs ultimately want that, too – they want their LPs to be a good solid group they can count on.”