CalSTRS Offers Rare Look into How Much Pensions Pay to Invest

Even though costs increased after a strong year in alternatives, the pension plan’s strategy to reduce fees is working.

Sacramento, California. (David Paul Morris/Bloomberg)

Sacramento, California.

(David Paul Morris/Bloomberg)

The California State Teachers’ Retirement System’s innovative plan to keep costs down looks like it may be working. The latest cost analysis comes as the pension has said it will award its Chief Investment Officer, Chris Ailman, with a $1.1 million bonus based on a 27.2 percent return for the latest fiscal year.

Since 2017, the pension has been redesigning its collaborative strategy, which was originally created 20 years ago to reduce portfolio management costs by bringing investments in-house and working with external partners on co-investments and joint ventures to save money.

Although the pension paid more in fees for the first time since 2015, CalSTRS is still paying less than peers, according to the pension fund’s annual investment cost report for 2020. According to the report, last year CalSTRS paid, excluding incentive fees, 46.7 basis points (on its total assets), while 14 global peers paid 49.2 basis points on average. In addition, 43 pension funds general paid 61.5 basis points on average.

The report tracks all expenses the pension paid to have its investments managed, including operational and other charges directly deducted from funds and carried interest — incentive fees. The cost report also includes the detailed comparison of CalSTRS’ costs with peers. CalSTRS is particularly focused on reducing fees and costs paid for private equity and other alternatives. While all costs reduce returns, alternatives are notoriously expensive, with some expenses hidden or not clearly disclosed. While alternatives can be among the highest returning investments, pensions like CalSTRS also have to split profits with asset managers, reducing their share of overall gains.

Last year, CalSTRS’ investment costs rose 11 percent According to the report, much of that — 8 percent — could be attributed to paying more in carried interest. In other words, because the portfolio performed better in 2020, the cost of managing it rose. Incentive fees themselves climbed 60 percent from 2019, reflecting those high returns in private markets and the exits from many underlying investments.


“When we end up paying out carried interest, it means we’ve actually realized larger gains for the fund,” said Mike Dunigan, associate portfolio manager at CalSTRS, during the pension fund’s board meeting this week.

CalSTRS attributed the 11 percent increase in costs to three parts, including 8 percent from asset growth and 4 percent from asset allocation changes. The collaborative model decreased costs by 1 percent. ”By managing more assets internally instead of solely relying on external fund managers, CalSTRS said the model helped “reduce costs, control risks, and increased expected returns,” according to the cost report.

The giant pension paid $1.1 billion to have $94 billion overseen by external managers. In contrast, it cost the pension $439 million to manage $168 billion internally. As a result, externally managed funds generated 71 percent of costs even though they only made up 36 percent of invested capital.

What’s more, “Externally managed private assets cost $915 million in 2020. On a per dollar basis, this equates to 173 basis points vs 115 basis points per dollar for internally managed private assets,” according to the report. In comparison, external traditional managers of public securities cost 42 basis points for every dollar. CalSTRS itself managed public assets for approximately 4 basis points (although that big gap partly reflects the fact that CalSTRS mostly manages passive investments in-house.) Still, “when strategies are directly compared, internal management is significantly less expensive,” according to the cost report.

The collaborative model has helped CalSTRS beat its peers in terms of cost structure, Dunigan added.

“The savings were well above our four-year average because we have more collaborative investments now than we did [at] the beginning of this timetable,” Dunigan said.