CalSTRS' Michelle Cunningham on career, markets and retirement

CalSTRS' Michelle Cunningham on career, markets and retirement

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Michelle Cunningham first arrived at the investment office of the California State Teachers’ Retirement System (CalSTRS) in 1991 to a team of thirty staff managing a portfolio of roughly $30 billion; a short drive but a far cry from her previous role managing money for the more modest City of Sacramento Treasurer’s Office. “It was daunting at first. At that time, I thought thirty was a large team,” says Cunningham, who will retire from her role as deputy chief investment officer (DCIO) at the end of 2017 after 27 years of service. Today, CalSTRS has an investment team of 150 staff managing over $200 billion.

Hired as a fixed-income specialist initially - a similar position she held at City of Sacramento for six years - Cunningham’s role at CalSTRS has changed from portfolio manager to asset class director, most recently deputy CIO working under current investment chief Christopher Ailman. “I’ve always been somewhat of an investment geek, so serving in a variety of roles, working with and having access to some of the best and brightest minds in the global investment industry has been a real blessing. I’m going to miss the relationships made over the years.” 

What Cunningham will miss less, perhaps, are the challenges that come with managing money for CalSTRS, one of the largest public pension plans in the world – second in the US only to its neighbor California Public Employees' Retirement System (CalPERS).  “Managing a portfolio of this magnitude is a huge responsibility. Acting as the investment management arm of a state agency is a delicate balance. Walking that tightrope, maintaining the right culture while meeting investment objectives, has, at times, been a challenge; not to mention being a woman in the investment field in the late 80s and early 90s!”

Cunningham also hopes she’s seen the back of stock market downturns. CalSTRS’ portfolio was pummeled by steep market declines in the 2008 economic meltdown - the worst economic downturn since the Great Depression.  “That was the lowest point of my career” she admits. “I was director of fixed income around 07/08. Certainly they were the most challenging markets I’ve experienced.  I will never forget it. Long days, lots of phone calls and time spent watching and trying to digest the news and potential repercussions.”

The financial crisis proved to be a steep learning curve for Cunningham and the rest of CalSTRS’ investment team, particularly when it came to understanding the true value of communication. “We began to break down any silos among staff and asset classes instead of running each area as individual profit centers. Communication improved dramatically. With that came new investment opportunities. Not only were markets undergoing movements that we had never seen before, but new investments were presenting themselves that we needed to talk about.  Previously we had strict boundaries as to what a fixed income security was and what a stock was. Anything overlapping or caught in between, we felt we might miss.”

Today, CalSTRS has thorough risk mitigating strategies in place designed to make it more resilient to market downturns. The strategies focus on being less correlated to global stocks and uses 30-year government bonds, commodity trading advisors (CTA) and global macroeconomics focused hedge funds. This mix may prove to be important in Cunningham’s final few months at the office, particularly with investors increasingly nervous about sky-high US equity valuations. “We are concerned,” Cunningham adds. “I recently read that this has been the most distrusted or disliked US stock market rally in history. As US equities continue to trade up, we’re looking for opportunities to trim back.”

Ailman, CalSTRS’ CIO, said publically earlier this year that the fund would stay at about 50 to 55 percent global equity exposure. However, a home country bias to the US of around 65 percent, which has been in place for over a decade, is gradually being reduced down to where eventually it will be about 55 percent US, 45 percent non-US. “This is a big ship to turn,” Cunningham adds. “Changes will be gradual and well-thought out depending on market conditions.”

CalSTRS’ team has always tried to maintain a realistic, long-term view of investment markets. This hasn’t changed since day one although the means and methods of putting money to work have altered. “When I first joined, the assets CalSTRS invested in were very straightforward, some stocks and bonds, a few properties but not much in the way of real estate. Private equity was just starting. Now there are so many opportunities, things that never even occurred to me twenty years ago.”

The fund’s portfolio is now broadly diversified, holding investments ranging from publicly traded short-term bonds to privately held partnerships. The scale and breadth of investments make the management and oversight of these assets highly complex. Moreover, the fund is now a leader in investment diversity and sustainability. It is also fully focused on environmental, social and governance (ESG) investment risks, such as climate change impacts related to coal production. These principles are increasingly important to many of the 900,000+ members CalSTRS serves.

“The board has a work plan every year focusing on special projects and new ideas,” Cunningham adds. “A two-year is underway focusing on the structure of private asset classes. We’re looking at whether it makes sense to do more direct investing. It’s important to remember though that we are attached to the State of California and limited to a certain extent on what we can do. Partnerships with other more flexible organizations will perhaps be a route we consider.”

In the end, Cunningham believes that CalSTRS’ size and long-term outlook on markets will bode well in the future and that passive investment strategies will be a big part of the fund’s success. “CalSTRS has been a big proponent of index funds for very long time, partly down to our size and the cost effectiveness of those strategies. Research has shown that over the last 30 years a combination of both active and passive investments has worked for us. Periodically, we’ll go back and look at the cost-benefits of active management.  There are times when active managers have added real value. That said, we tend to be overweight passive and believe ETFs will continue to be vehicles that a lot of investors will flock to.”

Looking ahead, Cunningham is focused on the next four months and helping CalSTRS’ continue to achieve solid returns. Beyond that, she’s looking forward weaning herself off the markets and enjoying her much deserved retirement.

Securities lending

CalSTRS’s securities lending programme was one of the areas Michelle Cunningham helped build-up when first she first arrived at the fund.  “It’s evolved from having a custodian do all the lending to using several agents and managing cash collateral in house. It’s a steady source of risk-controlled incremental income, although it has to be managed carefully.”

Again, the financial crisis proved to be a valuable lesson in this regard. When Lehman Brothers (itself a significant securities borrower) defaulted, the ensuing crisis in the securities lending market created severe liquidity stress.  In some cases, securities lending agents were forced to return cash collateral—which had been reinvested in illiquid assets— to borrowers, resulting in losses on the lending side.

“We did lose money from securities lending during the crisis. It was our first and only loss of principle in the programme. It was particularly painful as it was a programme we thought we managed carefully. Even going into last week before Lehman Brothers collapsed, Lehman paper was still investment grade. We had sold off some of our holdings, stopped buying Lehman paper six months earlier, but we had some last pieces which cost us.”

The collapse of Lehman Brothers forced many financial institutions to review their lending programmes, resulting in a range of measures, from introducing more conservative guidelines to drastically scaling back or suspending lending activities.

“We spent a lot of time with the board after that. Many said “never mind, securities lending isn’t worth it, it’s too risky” but we took a hard look at the programme and felt it was still valuable to CalSTRS. Eventually, we convinced the board and I’m pleased we did because securities lending continues to add 3-4 bps per year to CalSTRS’ portfolio.”

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