Fiddich Review Centre
Alternative Investment

CalSTRS’ costs falling despite alternatives-rich portfolio

The plan’s total portfolio costs declined even though CalSTRS’ total plan assets grew by 29% in 2021, said Mike Dunigan, associate portfolio manager at the same meeting. “That is from the collaborative model,” he said

As CalSTRS has increased its allocations to include more private market assets, pension fund officials have at the same time boosted its co-investments, which lowered fees, Mr. Dunigan said.

In 2021, the collaborative model reduced portfolio costs by 9% with most of the savings from an increase in co-investments in alternative investments.

CalSTRS had 188 co-investments last year amounting to a total of $11.9 billion, up from 135 co-investments totaling $6.8 billion in 2020.

CalSTRS had $68 billion in externally managed private assets in 2021, which cost the plan 163 basis points per dollar, compared with $40.7 billion in internally managed private assets including co-investments and joint ventures that cost 112 basis points per dollar.

Even so, private assets are much more expensive than public investments with CalSTRS’ $44.6 billion in externally managed public assets costing 48 basis points per dollar vs. $184.9 billion in internally managed public assets at a cost of 3 basis points per dollar, the report said.

CalSTRS is not alone in its interest in co-investments, with the view that they will lower fees, among other reasons, consultants said.

In private equity, for instance, co-investments are generally done on a no management fee, no performance fee basis, whereas investments in a primary fund usually have fees that start at 2% management fees and 20% carried interest, said Andrew Brown, London-based head of private equity research at Willis Towers Watson PLC.

Investors use co-investments to blend down the fund’s fees, he said. Co-investments also allow investors to get more exposure to a certain sector than the fund allows by selecting deals in the desired area as well as to participate in a deal in the manager’s “sweet spot” in terms of sector and transaction size, Mr. Brown said.

At least in theory, investors paying lower fees should reap higher returns, he said. But there is a risk that the manager is not offering its best deals as co-investment opportunities, Mr. Brown said.

“Our take is that you need to have a high bar to co-invest because, at the end of the day, common sense would suggest that managers would not be giving away (their) best deals on a no fee basis,” he said. Usually, managers offer co-investments in transactions that are larger than its typical deal and to take some risk off the table, Mr. Brown said.

Willis Towers Watson also co-invests but holds potential deals to a higher bar when deciding whether to make the investment, because the “single stock risk is quite high,” he said.

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