Investing Billions - E142: How to Generate Alpha on $350 Billion w/CIO of CalSTRS Scott Chan

Episode Date: March 4, 2025

In this episode of How I Invest, I have a conversation with Scott Chan, Chief Investment Officer of CalSTRS, to explore how he oversees a staggering $350 billion in assets. Scott shares insights on CalSTRS’ collaborative investment model, their approach to private and public markets, and why they aim to be the "global partner of choice." We also discuss the importance of structural alpha, liquidity management, and identifying long-term supply-demand imbalances.

You manage $350 billion or over a third of a trillion dollars, kind of a crazy number. In what way is your capital base an advantage? In what way is it a disadvantage? That's a great question. It's two sides of the same coin here. One thing that we've talked about is we just have a very long-term horizon. You're labeling me as contrarian. I think thinking long-term gives you the capability to be contrarian

because most of what you're seeing in the short term is noise. So that's number one. Number two, the way you make money with a high degree of probability is bottom-up transaction by transaction, deal by deal. And so our science gives us the capability to build an expertise, expert team across markets. Which is not typical for organizations from our side, is create a nimble and dynamic decision-making structure

at the division level. That's something that's unique. The second thing is scale economics. Some of the transactions we can negotiate from a collaborative model perspective is the scale. If we're going to be a significant size, it just aids us being able to negotiate better win-wins with our partners. Scott, I've been excited to chat. Welcome to the podcast.

Thank you. No, thanks for having me. This is really exciting and you've done a great job with your podcast. I'm so excited to be here, David. Thank you, Scott. So how does One go about investing $350 billion? Thank you, Scott. So how does one go about investing $350 billion? Let me just talk about the CalSTRS CloudRib model, which is our primary way of how we implement our investment strategy. So if I were just to step back and define,

what is the CloudRib model for your audience, for CalSTRS, that's an investment strategy to bring more of our assets in-house, to lower costs, increase alpha, or control our risks better, or to leverage our partners in the private markets to achieve similar benefits. If you think about public markets versus private markets here at CalSTRS, in the public markets, for example, in global equities and fixed income, we have roughly 80 to 85 percent of our assets managed by our own internal team from, you know,

trading to portfolio management and anything in between. And these areas have consistently beat the markets. We take a little bit of active risk, you know, sort of enhanced active, is what we call it. When some fixed income, you know, call it 30 basis points a year, we generate an alpha. In global equity, that's become more significant. It's around 50 basis points a year or so. But in the private markets, we don't think we have the capacity to build our own internal, for example, Blackstone or Apollo or Carlyle, fill in the blank. And so what we try to do is become

the global partner of choice. Why is it important for you to be the global partner of choice for the GPs that you work with? So that's a defining characteristic of our cloud model is trying to be the global partner of choice for the GPs that you work with? So that's a defining characteristic of our Cloud model is trying to become the global partner of choice. You might ask yourself, well, why is that important? Because we strive, David, to be one of the top three calls

for any of our partners. If we do, then we're going to be successful in accessing the best transactions globally. So you can think about it. It'd be easy for us at 350 billion or so in assets on our management to be a one way street where all these asset managers, they come to us on the private market side

or the alternative side, and we say yes or no to invest in any of their funds as an LP. But because we have 350 billion in capital invest, I wanna transform that traditional dynamic. And so it's important for us to do this because, number one, the best investors in the world, they can also select their partners, right? They have a certain amount of capacity.

And particularly when it comes to the subset of their best transactions, how can we access that? Number two, it's by putting the best of CalSTRS ideas with the best of our partners ideas and leveraging that, we find that we can create a lot more value for our over 1 million teachers. And so that's kind of one element of it is becoming the global partner of choice. I think that would be the second kind of main point for the cloud model. If you think about the essence, the core things we're trying to achieve is we're trying to provide a value proposition for our partners too. So, you know, number one, I wanna be known,

I want CalSTRS to be known as having the trusted relationships and expertise that all our partners need. So we can help you and together we can solve the complex financing needs of the world. So my staff needs to be the forefront of the minds of our partners. We need to sort of mirror them in our expertise too. And I think we've been able to show

that or demonstrate that. Number two, we need to be nimble and dynamic in the marketplace as well. So we, you know, if a decision needs to be made, and this doesn't happen often, but if it needs to be made same day, we have to match that capability. And we do that by delegating a lot of authority to the divisions and giving them the opportunity to have their own investment committees. So we're nimble and dynamic. And the third element is for us to be flexible. So we don't have this one size fits all model, but we can structure anything depending on what makes sense for the particular transaction or what makes sense for the partner and us together. So we could be in the limited partnership. We could have a separately managed account

that's more bespoke. We can co-invest, we can do a joint venture, we can share revenues all the way to owning a minority or majority interest in the asset managers. So those things I think are at the core of how we execute the cloud model. So you divide it into public and private parts of the market and then implicit understanding there is that

the public side of the market, there's not much alpha there. So you don't wanna be spending a lot on management fees, but on the private side, there is a lot of alpha. So you wanna partner with managers there. In our public markets, because we have so much capital, we end up being the market. And it's very difficult to deploy the amount of capital we have in a way that we can generate alpha on a consistent basis. And so if you looked at our global equity portfolio as an example, I would say 80% of that is passively managed, and maybe 20% of that is

actively managed. And then if you looked at the fixed income side, again, we're sort of enhanced active. So you're right in the sense that we've taken what we think is appropriate risks, but those risks tend to be narrow. And we've shifted a lot more of our risk budget, so to speak, as an organization into the private markets where we think the probability of generating alpha, the greater value add, is a lot higher. And over the years, if you looked at the trends of the last couple decades, we've shifted roughly 44% of our asset allocation into the private markets and the alternative

assets. That's not only diversified the portfolio, but what you're alluding to, an alpha generator for CalSTRS. And you mentioned you want to be the global partner of choice, and there's different ways to do that, whether through JV, through anchor checks. What is CalSTRS ideal way to work with a private manager? And talk to me about the life cycle of partnering with a private manager. I don't think there is an ideal way that we collaborate with our partners. And that's why I think the key word, and if I were to just summarize it in one word, it's collaboration, right?

We want to sit down with our partners and do what makes sense. And that, that differs, right? It differs by the type of transaction, the type of market, as well as the, the, um, the capabilities of our partners, because our partners are all organized differently as well in terms of their governance structure. For us to do well, it's really by being flexible. Now, I can give you an example, but again, we can traverse from just an LP interest

all the way to ownership, and Fairfield Residential, for example, is an example of a cloud remodel transaction where CalSTRS has majority ownership. And so if you think about the current real estate cycle, I know that it's been depressed for a few years, but long-term, if you think about residential housing in the U.S., which is essentially what Fairfield Residential folks is on, we think that that's going to be undersupplied for the foreseeable future.

So if we looked out five or 10 years, even after the great boom and bust in 08, 09, we just never saw the supply come back the way it should have to meet the type of demand demographics that we have here in the US. For us, it's very strategic to have ownership in Fairfield, which is, for us then can act as an extension of staff. We have 250 investment professionals, for example, here at CalSTRS,

but Fairfield does call it 1,400. They're in every sub market, they're in 30 plus sub markets in the United States. They're in almost every one that matters. They're a top 10 producer of residential real estate. So that really puts us on the ground floor to capitalize on opportunities and sourcing. And as an example, we were then early with them on developing affordable housing. And as prices continue to go up,

the definition of affordable housing in the United States keeps growing because we had majority ownership. We also anchored a number of those strategies and we benefited from those investments in affordable housing, but we also benefit from the growth of Fairfield as well, because we own the general partnership. We own the asset manager, so to speak. New areas are complex. They may not have like a 5-year track record behind that. But if we have the expertise and we can build the expertise with our staff to mirror that of our partners, we can also invest in that complexity

for the benefit of CalSTRS. What does CalSTRS look for in a GP before deciding to do a joint venture? One of the number one things that we look for, or sort of one, two, and three, is we look for managers that have a competitive advantage. Number two, we're looking for a desire to create more value together, right?

Things like what we do with cloud model transactions. The third is we want some, in the major category, shared principles around a whole host of how we think about investing for the longterm. How are you building your teams? How are you getting diverse ideas? around a whole host of how we think about investing for the long term. How are you building your teams? How are you getting diverse ideas? So those are some of the characteristics that we are really looking for.

But if I were to, and each one of those probably could, we could go into a 30 minute conversation. But if I were just to stick on the competitive advantage piece of it, in Fairfield's case, they're one of the top 10 producers of real estate in the country. And we felt that they were going to be able to grow in a number of adjacencies. They felt that too. What are the benefits to the manager of partnering with CalSTRS? We look like an attractive partner because if you think about another asset manager acquiring Fairfield residential, for example, in this case, they would also have a lot of those adjacencies already covered by other acquisitions

they did with other asset managers, right? And so what we provide is the capability of growing together with them. And that's a very powerful incentive for any asset manager to want to partner with us is this idea that over the long term, we're very committed to, for example, building residential housing in the United States. If I look forward a decade, I think this is going to continue to be a major part of what CalSTRS does. And so that long-term investing

and the ability to help them grow into adjacencies in this case, I think was very, very compelling for them. And if you looked at their alternative being acquired by another asset manager, well, the other asset manager chances are they've got a number of these adjacencies already covered through other parts of the business. And so, a fair field would be stymied in potentially growing in certain trajectories. And you're somebody that I would consider contrarian thinker. How do you go about incorporating consider contrarian thinker. How do you go about incorporating that contrarianism as the CIO of CalSTRS? It's hard to be contrarian because you have to wait a lot of times for your thesis to

play out. But as a long-term investor, I think that really gives CalSTRS an advantage that, you know, essentially we're looking at long-term and we can filter out quarterly reports that have a lot of noise to them. And I would say as a long-term investor though, there are only a few asset allocation shifts every year where something on the horizon of long-term investing

becomes more probable. As it becomes more and more probable, it starts to compel you to act or have you consider emphasizing or de-emphasizing assets. If I were to look at 2025, here's as an example what I would consider to be three of the most compelling asset allocation shifts. I think a number of that is sort of contrarian thinking, if you will. So number one, I would say that the probability that the stock market is going to generate below average returns over the next five to 10 years, it's becoming more and more probable. It's becoming higher. For a large allocator like us, we might shift a few percentage points away from global equities.

What specific assets are you shifting towards if you're shifting away from global equities. What specific assets are you shifting towards if you're shifting away from global equities? This is the first year, for example, that I remember, we entered the year and all the strategists were thinking, stock market's going up. If you roll back a year, the outlook was mixed and the markets went up significantly, right? The S&P was up over 20%.

If you think about the year before that, people in the year before that, I mean, for several years, people thought we were going to head into recession. Why? Because interest rates moved up over 500 basis points. And there has been a lot of historical precedent around when rates have gone up so much. Yet the market went up, you know, again, over 20% with the S&P. If you think about globally, the US also is likely considered probably But globally, the US also is likely considered probably the most attractive in terms of economic growth in comparison to, for example, China or for some of the other Europe, certainly. And so a lot of my peers globally, they want to continue to invest in the US.

And so the setup, the expectations, I think, for the US market and global equity as being a US market being a very large part of that, you'll call it 60% or so at this point, it's pretty high and the economy is robust. But the problem now that you're bumping into is after several years of really robust returns, you've got high valuations, even if you consider some of these large cap tech names

have higher profits and they're growing faster. Even considering that now, valuations are on the higher end. We've had a decade of outperforms, strictly in the S&P, and we're starting to see some concentration of stock performance, of course, at the top that's worrisome. So you can really never time the tops and bottoms of cycles, but I do think that it's becoming more likely that we're going to see under performance here. Number 2, I think there are many areas that with a higher probability. We're going to see them outperform the market. So I don't think we've been able to say that over the last 2 or 3 years. Right?

And these areas are going to most likely provide low risk and. And diversify the portfolio of CalSTRS. So what are these areas? Infrastructure and energy transition, equity on the private side. I think that's going to be robust and remain robust. There's certain areas of private credit that I think are going to generate more returns at a lower risk profile. And structurally, I think these premiums are going to be higher because there's going to continue to exist a supply and demand gap, the financing of that.

So these are areas like asset-backed, infrastructure debt, energy transition debt. I think those are areas. And if you think about the opposite of the S&P and the stock markets, real estate has been down two years in a row, and it's been down very, very significantly. They were the first to react to this pricing adjustment of the rise in interest rates over 5%. Every time you've seen a few significant years of decline going forward, it's led to outperformance

in the real estate segment. It's likely too early for us to call this inflection point, like here's the bottom, but I do think that you can start picking your shots. We're seeing more opportunities. And this is likely, is it one year from now, is it two years from now? We'll start to see an inflection point

where we'll go from pockets of opportunities in real estate to the sector making a comeback. Those are some areas that I think are very interesting. The third thing that may be also from a contrarian mindset is that at certain point, and it could be as early as this year, liquidity. Liquidity is gonna be more valuable than gold. There's a lot of uncertainty and risk

that's not priced in securities. The way that that tends to work is that it doesn't get priced in until there's an event, right, something actually happens, but we know that there are many triggers of potential events from the shocking 100 plus executive orders that we've seen to the potential tariffs or immigration, our fiscal deficit, geopolitics.

I mean, there's so many different triggers out there. And I think because of this uncertainty, bottom line is, I think, at a certain point, maybe it's the share, most likely. We'll see the stock market down. What else are you focused on? What we're doing is, number one, we're bringing what we call our diversifying assets back to target. That's primarily fixed income, but also includes hedge funds and cash. We have been underweight that, as we were riding the tailwinds of a strong market, we're bringing that back to target from an underweight position. And number two, we're really ensuring that we have the firepower and liquidity to invest in a crisis or market downturn.

I think that's where asset allocators really can differentiate themselves, providing liquidity during extreme market sell-offs. And so we've done a lot of work over the last three years in enhancing our liquidity tools to be able to get into that position. So you're building up your liquidity in case there's a market drawdown. Do you internally sit around, wait for this drawdown and have almost a buy order if it drops by more than 20%? How do you operationalize the strategy of waiting for a trade-off? Managing a venture capital firm is complex. Fundraising, reporting, compliance, it all adds up.

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V.C. to get in touch with the Juniper Square team today. It's more on the supply of liquidity where we've identified, you know, if we went into a crisis, what sources of liquidity would we be drawing on? Where we should invest in it, that changes fairly dynamically because at the point in time, is it that the markets are down 40% and it's time to get back into the global equity markets? Are we seeing pockets of opportunity in the private markets? Right now, I could tell you what we're interested in, and maybe that would remain the same in

a market sell-up, but maybe it would be different. And so a lot of the preparation revolves just around the liquidity tools we'll be using at the time. And then we're going to be, you know, meeting with the teams to say, is it still these areas or are there different areas that we should be emphasizing? Because the market prices will be changing very dynamically along the way down. You're shifting your assets into things that could become liquid if you need them to. What are some of those assets?

Obviously, you don't want to be in equity, so maybe that's it's not equities, but what are some assets that have that option for liquidity? Fixed income would have a lot of liquidity, for example. That includes our hedge fund book, which we call risk mitigating strategies. If the market downdraft comes, taking profits from those two areas is gonna be a great thing for us to do at that time. Cash is also part of that diversifying set of asset base

that we have, the diversifying portfolio. In other words, the other element is that we can draw down on our balance sheet. And so are there ways that we want to create leverage during that time to be able to provide liquidity, which we would believe would be sort of short-term in nature over a cycle? How would we want to draw upon those sources, particularly in times of great discounts and dislocations in the market. You've been in the capital markets for more than two decades. Is it always the case that when public markets sell off, the real opportunities are in the

illiquid alternative assets or is that an oversimplified way to look at it? Every crisis and recession is different. We had a contest internally to CalSTRS. We got all our divisions together. We're like, we want everyone to present their best ideas and we're gonna have some fun with this and it's gonna be like a contest and we'll rate it and we'll get the best idea.

The best idea that won that year was really from our private equity division head of our private equity division, Margot Worth, who thought that preparing for a recession is like the best idea. And that won because as we were thinking about how we handled the 08-09 crisis, we thought we could improve on this. And so we spent a year, year and a half in front of before actually COVID hit, how are we going to plan for the next crisis? And so we were ready to deploy significant amounts of capital over a pathway to the private markets.

That didn't happen. What happened was we saw a V-shaped recovery. The biggest thing that we were able to do was really invest back into the global equity markets, which if we didn't rebalance the portfolio, say, we might have been 10% off of our target in global equity, because it kept declining rapidly at that point in time. So we rebalanced, and we were getting

set to really target a lot of dislocation in the private markets. But it rebounded in a V-shaped way way to the degree that no one got the opportunity really to place significant amounts of capital in that. Now, that was way different than 08, 09, where there was this long path of being able to deploy capital, and some of the best opportunities were in the private markets. What's interesting about market dislocations is the cause and what tends to be an opportunity at that time, it changes dramatically from one crisis to the next.

But it appears that the availability of liquidity would have been helpful in both of the crises. So that's the lesson learned. Yeah, the lesson learned is keep enough firepower and liquidity to really invest when there are dislocations. In this case, we end up putting on some very, very significant futures positions in the global IP markets. That's a form of leverage, for example. And we were very much rewarded in rebalancing the portfolio

in that way, you know, and that's hard to do. You got to check your gut because the markets are down, you know, they can be down 20%, 30%, even 40%. And here you are buying into it. That is not easy to do, even if you have a plan, right? Because it just doesn't feel right. You feel that the next day and the next day after that, markets can continue to go down.

It's hard to have the discipline to do that in reality. You need to really have a prepared mind. You need to be ready for it, almost a visualization exercise to get the whole organization behind the strategy ahead of time. I think that really helps to have a prepared mind to have a. Have a plan that's ready, even though, you know. That everything's going to be different the next time we go through it. You and I, we won't be able to guess what the.

Cause of that crisis is, and you realize certain things become. More dislocated and more interesting in terms of a pricing perspective than others. You won't be able to guess that either right until it actually happens. Implicit to this is CalSTRS seems to have a very flexible governance structure that you're able to move very quickly on opportunities. Talk to me about your governance. This is a really interesting point, David. To me, if I looked globally at the. At all the different asset allocators, and certainly over my lifetime, one of the biggest changes has been global competition. I mean, you think about CalSTRS, $350 billion in assets, we're now,

and I don't know the exact number, I stopped checking this, but at a certain point, we're like 25 on the list of global allocators in terms of size, right? The other big trend is every asset allocator has become more and more like an asset manager. The staff has become more and more professional to different degrees. But I think what differentiates, one of the things that differentiates all the global allocators and one of the advantages we have is great governance. That starts with our board. And you need a board that's innovative and that's able to delegate and be strategic with staff.

We have that and they delegated the authority of the investment decisions, how we have flexibility to react to the markets. We do that by policy. They approve the policy. We've got great governance starting with the board. But then from staff's perspective, I think one of the things that has made us really successful is how we invest, how you make money, I believe, given my

experiences in the market, is bottom up. It's transaction by transaction. And that can only be done through building expertise across all these different segments in the market, which we've done to mirror our partners as well. I think those have been really keys. And then we've delegated the authority down to that level. People that have the greatest insight into the assets, and I would say 80% of our transactions work this way, they go into the division, And I would say 80% of our transactions work this way. They go into the

division, is it private equity, is it real estate, is it fill in the blank? And they decide. They have a mature investment committee and they decide. And they can decide quickly, which has made us very dynamic in the marketplace. But we have a proven history of generating alpha in pretty much every major asset class, every major division here at CalSTRS. CalSTRS is famous for utilizing structural alpha. What is structural alpha? To me, it's a couple things. So, number one, I would define it as being embedded in the structure of the dealer, the transaction. And then number two, I would say it's not taking any additional market risk, but what we're doing is we're trying to take operational risks that we think we can mitigate. And how we would mitigate that is through resources, through expert staff who are capable

of being able to structure these transactions and mitigate the operational risks of it. It's best just to provide a simple example, if I look back at some of the early days of investing in private direct lending, we decided to structure a cloud model deal with one of our managers where half of our investment, we were in their LP. We were a limited partner and half investment, we were co-investing with them. Right there, we captured a 50 percent discount in fees because we're no fee, no carry on the co-investment side while paying full fees on the LP side of it. But we're also, because we're anchoring some of their funds going forward,

and we have the expertise with staff to be able to assess that. Because some of these were newer endeavors with less of a track record than you might see, we were able to gain economics in those funds as well. In this case, we had a revenue sharing arrangement. So if you think about every part of the return distribution, because it was direct lending, we were penciling out while we're getting on low teens on our investment. And as that fund grew, because we were sharing the revenue, as long as the returns were positive, we're going to generate, you know, 3 to 8% additional IRRs, given the economics that

we're sharing by anchoring the funds with them. And so, if you think about it from that perspective, yeah, we had the operational risk of how do we structure this, the legal costs of making sure we had the right vehicles and structures. But at the end, we have the potential of adding three to 8% IRRs on top of the IRRs that we expect. And that could be a considerable amount of value for CalSTRS. Speaking to people about David Swenson, this really reminds me of his style, where he would both advocate for Yale,

he would advocate for other LPs, and he would also advocate for the GPs. You take a step back and you say, that kind of sounds nonsensical. But really, it's non-zero sum. If CalSTRS comes in and anchors a fund or anchors a new strategy, that's massive alpha for the GP. CalSTRS is able to come in and capture some of that alpha.

It's truly as a win-win, it's truly a non-zero-sum arrangement. That is the case. And again, it's one of the keys, and you'll see this in our numbers, that we're not taking additional market risk in generating, I think, uncorrelated alpha on top of that. And again, I recognize that it brings

some additional operational risks. We've spent a lot of time mitigating that with our expert staff and increasing resources. I mean, in the time we were accelerating the cloud model, think back, in 2017, we had a run rate of 106 cloud model transactions. On 2023, we had a run rate of 46 cloud model transactions. In 2023, we had a run rate of 425 cloud model transactions. So we've really accelerated that.

And what has that done to return on the risk? Well, if you think about the cost savings, we estimate greater than 2 billion in cost savings over the last six years. And I love that because I think every successful corporation or business, they should have that mentality of like, how can I deliver a streamlined, more cost-effective business like a Costco, delivering value to the clients?

We're delivering those costs right to the teachers' bottom line. On the flip side, you don't want to be penny wise and pound foolish. Every time we're doing the Cloud for model, we have to think about it from the perspective of would we just be better off as an LP and a fund for folks with a competitive advantage? Would we have a sourcing advantage with them? Can we add additional value to it? And if you look back, we've had one of the strongest periods of alpha generation. If you look back five or six years, we have over 10 billion in value added returns over

our benchmarks. You could say maybe 20% of that was cost savings and maybe 80% of that is the structural alpha that we're talking about. But also the expertise of the team and the beam will select better risk reward for the fund. If you think about the alpha, 63 basis points over the last five years, that's on top of if you looked at 10 years and we were 63 basis points over the last five years. That's on top of, if you looked at 10 years and we were 48 basis points.

And so continue to see this upward trajectory. We estimate we're in the bottom quartile for costs in our peer group. So we're very cost-effective. We're the bottom quartile of risk, but we're in the upper part of the return spectrum. You manage 350 billion or over a third of a trillion dollars, kind of a crazy number.

In what way is your capital base an advantage and what way is it a disadvantage? That's a great question. It's two sides of the same coin here. One thing that we've talked about is we just have a very long-term horizon. You're labeling me as contrarian. I think thinking long-term gives you the capability to be contrarian because most of what you're seeing in the short term is noise. Number two, I think the way you make money with a high degree of probability is bottom up transaction by transaction, deal by deal. Our science gives us the capability to build an expertise, expert team across

markets. And I think what we've done, which is not typical for an organization of our side, is create a nimble and dynamic decision-making structure at the division level, right? That's something that's unique. The second thing is scale economics, right? Some of the transactions we can negotiate from a cloud model perspective is the scale, right? So if we're gonna be a significant size, it just aids us in being able to negotiate better

when wins with our partners. Given our size, our ecosystem continues to grow. And so more and more in the future, as we connect our own ecosystem together, we can create even more advantages. A simple example recently that I give you is we became one of the top life sciences, real estate developers in the country. We have Bigfoot Print and Cambridge Crossing, for example. And we connected private equity debt in the sense that within some of the real estate embedded, we can offer some of the space to venture capitalists who… So we can gain equity

interest in that. But at the same time, we have this robust return just on the economics of the real estate itself. Connecting the ecosystem, how can we do that? But then there's significant challenges, right? I mean, the market has to be a certain size for us to even play in. And so we're going to X out a lot of the world just because it's not scalable enough for us. And there's not much we can do about that, right? Because our check sizes are going to be, you know, very minimum, 100 million, but most likely more in the $500 million range. That, otherwise, that's going to be a pretty significant market. But I would say that probably the largest challenge

is us coordinating our approach across divisions. If you think about coordinating across so many different divisions at scale dynamically, if you underline dynamically, that's hard to do. That's very, very hard to do. And so there are a number of challenges that we've identified that I think are difficult. We talked five years from now, I'd say, David,

those are some of our competitive advantages now, but I think are difficult. We talked five years now, I'd say, David, those are some of our competitive advantages now, but I think shifting allocation, the relative value amongst, should we be, give you another example, our diversifying space, fixed income is generating a lot more returns than it had over the last decade, right? I remember a time during the zero interest rates, we were forecasting sub 2% returns in fixed income.

It turned out, you know, 1.7% over kind of the last five years. But if you look forward, you know, that's 6%, 7% now with interest rates where they are, and they're most likely to remain higher for longer, right? So we have to get better and better at how do we shift capital from the divisions based on better risk reward. And I think the other element is really capitalizing and managing the risk and the opportunities

of what I would call mega themes. It's across all geographies, it's across all asset classes, sectors and companies, has a huge TAM. And we're seeing that convergence right now in AI and power on the infrastructure side. You've likely seen the headlines of 80 billion from Microsoft and 75 billion from Google. And so how can we best benefit from the convergence of AI and power when I've got data centers that are being built in real estate, they're being built and held in the infrastructure division, in power, we have an infrastructure division,

but it's also on the higher end of the risk curve in private equity. It's somewhere in the middle in our sustainable investing group. And so coordinating all of that across CalSTRS would be really beneficial if we could connect the divisions together. But that takes time, and we need to react more dynamically. across CalSTRS would be really beneficial if we could connect the divisions together, but that takes time and we need to react more dynamically.

So these are some of the challenges, we're taking them head on and I hope that, like I said, we'll develop them eventually into better advantages going forward. When we last chatted, you mentioned that you look for supply, demand and balances in the market. How do you find markets with supply, demand and balances? Thank you for listening. To join our community

and to make sure you do not miss any future episodes, please click the follow button above to subscribe. I think you're right. We have to look for sizable imbalances that we think are going to last a long period of time so that calcers can benefit. Let me just offer up three areas that over my experience, one I would say is crisis's provide a lot of supply demand gaps in financing for long periods of time. Number two, and some of this we've alluded to is new and emerging areas. I think are at times you can see a supply demand gap

that for a very long time for these changes, particularly around technology and innovation. And the third is complexity. Let me just kind of go through each one just briefly. But if I think about the crises, like today, we're interested in the asset-backed part of private credit. I mentioned that to you.

Because banks and levered financial institutions have begun in earnest to move that segment off their balance sheet, right? They started with the direct lending and now they're moving to the outside back portion. But this goes all the way back to the global credit crisis of 08, 09, right? And even you saw this with Silicon Valley Bank, you have this fundamental mismatch

between the asset and liabilities of the bank. Essentially, the deposits would be short-term. How short-term? Well, they could evaporate within days. That's how short-term it is in seeing Silicon Valley Bank. And yet, some of their investments are going long-term. So there's this fundamental mismatch. And that would be difficult enough to manage alone, but there are highly levered institutions

on top of that. Right? And so you're levering up this fundamental mismatch. If you think about that system, it's bound to go wrong. It's bound for something to go wrong. In fact, every crisis in the US, you see 500 to 1,000 banks go under. We have this generational shift of assets that most likely never belonged on banks' balance sheets, shifting to balance sheets where they do belong.

So if you think about a CalSTRS on the other hand, we don't have leverage or we have a very small amount of leverage, or horizon is super long-term. So we never have a run on the bank, and we can match that asset with the appropriate long-term horizon and duration. So I think we'll see this generational shift of assets that are moving, and there can be cycles where there's more or less of it, providing better or worse pricing opportunities. But this is something that it's going to take years. It's a generational shift of assets that are going to be moving to different hands, right?

Insurance companies and pension funds, for example. There's crises that could be born. Number two, there are new areas, right? So, if you think about technology, what's different today? A tech CEO might be spending half their time in power and in data centers three years ago, it probably was delegated to somebody where the CEO or president ever got involved, right? This year, if you looked at some of the public companies,

it's like over 300 billion in capital expenditure that they want to start to deploy. And so there's such a big demand in a new area. And because they're trying to move it off the balance sheet, a lot of it's gonna go into the private markets, whether it be private credit, or the development and building of the real estate. So there are new areas.

And then I think there's also a complexity premium, right? So if something is complex that takes, for example, mature technology, but you're trying to scale it in a new area. What's the minimum amount of time frame that this supply demand imbalance needs to exist for it to be interesting for CalSTRS? It's hard for us to think of something not, you know, at least in a five-year set, you know, or more, to think about taking advantage of a structural shift. If you think about CalSTRS, if we're successful with $350 billion today, 10, 12, 13 years from now,

we will have created a whole new CalSTRS. We will have doubled our asset base. So this idea of how we invest with scale is a compounding idea because as our returns compound, we become larger and larger as an organization. Your wife has been a teacher in California for over 30 years. Does that impact how you go about investing the pensions of California teachers? It a hundred percent does.

One of the things as I've gotten older is very important to me is being well rested. Sleep, you know, I need to be mentally sharp. But here's the catch, if CalSTRS doesn't do well, I might be sleeping on the couch because Heather is a teacher, has been a teacher for over 30 years. And so he talked about alignment of interest. Not only is my wife a teacher, but a lot of her friends are teachers and her sister is a teacher as well. So I've got a tremendous alignment of interest around the mission here at CalSTRS. You mentioned you focus on optimizing yourself, sleep. How else do you become better as a CIO?

What do you read? What do you listen to? And how do you become better as a CIO? I think it's a blessing and a curse that, so I live in the Bay area, but I work in Sacramento. And the blessing is that I have a lot of time in the car. And so I spend a lot of time listening to podcasts and just picking up things. Or I spend the time talking with folks.

Gives me time, because I'm in the car and driving, to really focus on relevant issues and casting a wide net, being well read. And in my case now, I'm listening to a lot of that on podcasts where I'm listening to it on books that I have through audio books. The seat that I'm in gives me a wide purview of meeting with a lot of our partners. And so I would be remiss if I didn't meet with them

at least quarterly, and understand some of the brightest minds in the world. Where's capital going? I do that with my team as well. Well, lucky I wake up every day. It's like I love the markets and here it is, I'm in the center of a lot of that surrounded by great minds. Those supply, demand, and balances become more obvious if you talk to enough people, you start to connect the dots, right?

Absolutely. I mean, doing it for a long period of time, I think you recognize where there can be some alignment, you know, misalignment, you know, in terms of what you might be hearing or talking to with partners. But I think over time too, you develop real relationships, trusted partnerships, where you're removing the incentive, you know, just to hear what you want to hear, for example, or, you know, something that might just come as a commercial advertisement from one party because they just want to sell their book. Well, Scott, this has been a masterclass on how to invest $350 billion. What would you like our listeners to know about you, about CalSTRS and anything else you'd like to shine

a light on? I'd like to finally just highlight the team and culture of CalSTRS, which I think is the ultimate competitive advantage. And so much of what I do now as the CIO is leading through people. So the reason for my success with this success of CalSTRS really is the team.

I have an amazing senior leadership team. Geraldine, Jimenez, Mike DeRay, June Kim, Kirstie Jenkinson, April Wilcox. It's the strength of this greater CalSTRS team, not only the senior leadership, that's gonna be the reason for our success going forward as well. To me, it's a team sport.

And thankfully I have an amazing team. Thank you, Scott. I learned a lot and thank you for taking the time. I will fly out to Sacramento and I have a couple of people to see there and I would love to host you in New York as well. Would love to host you here in Sacramento and yeah, I'll hit you up when I head out to New York.

Great, thank you, Scott. Thank you, David. It's been an honor. Thanks for listening to my conversation with Scott Chan. If you enjoyed this episode, please share with a friend. Thank you, David. It's been an honor.