CalSTRS Aims to Reduce Volatility

PHOENIX - The California State Teachers’ Retirement System’s recent decision to change to its investment policy and reduce expected asset return volatility is credit positive for California and its school districts, Moody’s Investors Service said.

The rating agency made that assessment in a report issued late last week.

The analysis comes in the wake of CalSTRS’ decision earlier this month to try to reduce expected asset return volatility, partly through a reduction in exposure to public equities over three years. The fund is the second-largest U.S. public pension fund with assets of more than $180 billion, trailing only the California Public Employees’ Retirement System.

“CalSTRS’ move is credit positive for the state and school districts because it will modestly reduce their exposure to pension contribution spikes stemming from very negative investment environments,” Moody’s said. “Under its new policy, CalSTRS will forego some investment return upside in strong markets in order to lower its risk.”

The updated investment policy will decrease the expected volatility of CalSTRS’ portfolio to 13.0% from 13.8%, and will reduce expected losses in extreme downside “tail” market conditions to 15.4% from 16.8%, according to its capital markets assumptions, Moody’s said.

California school districts face a multi-year increase in contribution requirements to CalSTRS as a result of a state law passed two years ago.

After years of setting funding through a formula that was below actuarial requirements, the state imposed through Assembly Bill 1469 a multi-year contribution rate increase that will require school districts to annually contribute 19% of payroll by fiscal year 2021, compared to 8.25% in fiscal 2014.

The Moody’s report comes on the heels of a Standard & Poor’s analysis issued earlier this month that concluded that those increased contribution rates could strain California and some school districts, while putting CalSTRS itself on a more sustainable track. Moody’s said it expects CalSTRS’ unfunded liability to grow slowly to almost $90 billion until 2022 before leveling off.

CalSTRS will not reduce its 7.5% annual investment return assumption, which doubles as its discount rate, as part of its asset allocation shift.

This contrasts with a policy adopted by CalPERS, which has said it plans to modestly drop its discount rate and annual return assumption.

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