E296: Former CIO of CalSTRS on Why LPs Overpay for ‘Innovation’

0:00Christopher J. Ailman:Chris, I've been very excited to chat. Welcome to the How to Invest podcast. Thank you.

0:04David Weisburd:Honored to be here. Enjoy it.

0:06Christopher J. Ailman:You were CIO at CalSTRS for 23 years. Now that you're a little bit removed from that position, what were the key decisions that you made over those 23 years that really shaped the fund and your pool of capital?

0:20David Weisburd:Governance in public funds really does drive return and it drives the CIO and the team. One of the early decisions that board made in literally the 1990s before I got there was to delegate broad authority to run the investment portfolio to the staff. At the time, it was very cutting edge in the States, but they were modeling it after, sure enough, the Canadian model, even though we didn't call it back then. That's what attracted me to the role. The other thing was I knew some of the core of the staff. It was a fairly small team. Back then, it was a $100 billion fund, only 35 people. But I knew that I wanted to take us from kind of a sleepy, small shop to a world-class institution and running a good chunk of the assets in-house.

1:11David Weisburd:And that's what we achieved over that time period. We're very proud to say that we moved from the number three to the second largest fund in the USA, and I think built a consistent track record of being above median to top quartile among public funds.

1:31Christopher J. Ailman:Today, it's$350 billion. How were you able to achieve above median returns? Is it just siloing and giving the governance to individual teams, or was there more to it?

1:41David Weisburd:In any portfolio, asset allocation does really explain close to 90 % of the return. So when I got there, the fund was roughly about a 75, 30, 25 asset to debt mix, didn't have much in the way of private markets. And that was my big push was to, and I told them that when I joined, was to move bigger into private equity, real estate. Down the road came opportunities like infrastructure and private debt much later. But the asset allocation operating very cost effectively. But when you're a big fund, you're going to hopefully capture the beta of whatever the markets give you any given year. Boss are a headwind in that and a drag and portfolio changes then kick up more transaction costs.

2:34David Weisburd:So trying to be a steady long term investor, I constantly told the staff that, you know, one year is like a mile in a marathon. What we care about is the pace and keeping our eyes on the long term.

2:48Christopher J. Ailman:Unpack that. How were you able to lower costs?

2:51David Weisburd:Britt Harris said it in one of your podcasts. At that scale, you've got the power of negotiation, using your size to an advantage when you negotiate. But also by not chasing the latest, greatest ideas. So often I would see investors go after new ideas here and there that prove to be very, very expensive. and by paying attention to the net cost, we did a lot more passive. We spent the money on active management fees where we thought it made sense. We ran our fixed income in-house. We ran most of our passive equity in-house, very, very low cost. And even back then in private equity, we were trying to negotiate.

3:31David Weisburd:We didn't really get into co-investments until later on, But trying to pay attention in real estate, we started investing in real estate operating companies literally before the 07, 08 crash. But that provided another opportunity where instead of partnering with a firm and paying them a fee to manage your assets, you could own part of that firm. Because one thing is clear in money management, they do make money up and down markets and you're going to pay fees.

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5:53Christopher J. Ailman:And then you also look to have stakes of the manager, essentially.

5:59David Weisburd:Better said than I could. I borrowed ideas from everybody. Early in my career, I'll give credit to Steve Myers in South Dakota, Matt Clark now. I copied some of their ideas in terms of how to operate like a money manager inside the government business model, which is not easy to do. Government business model is not a good model for almost anything and certainly not money management. But learning how to operate, working with the board, we were blessed in that we had fairly good governance. Yes, our board turned over. I think I had over 200 trustees sit in front of me over my 20 years. But what I found by being a teacher system is teachers are focused on education.

6:41David Weisburd:They think long term. They care about the future of children and they know what they know, but they also know what they don't know. So they were willing to learn when it came to the investment portfolio. Give us some latitude to operate. As I said, discretion. I can't hit it on. Governance really does matter, whether you're a private firm or a public firm, institutional investor, the governance structure of how you make decisions, who has what role and are those clear and clarified, literally adds a lot of value. We talk a lot about, you mentioned the Canadian model and the fact that it's a very different structure.

7:20David Weisburd:Back in 1991, Ontario teachers and California teachers were almost identical. California teachers was bigger, but they were very similar. But Ontario teachers at that point had a crisis of paying their benefits. And the government said, hey, we're going to take this full government or we need to go private. And that sort of branch in a tree, I think CalSTRS became more public, unfortunately, and government and teachers became the Canadian model.

7:48Christopher J. Ailman:And you said that you stayed away from chasing shiny objects when it comes to asset allocation. Why is that upstream of paying more fees or getting worse returns? Give me maybe a concrete example of that.

8:05David Weisburd:Wall Street's very famous for creating new products and new fancy ideas. Global GTAA, Global Tactical Asset Allocation, was the idea that, you know, give somebody some money and they're going to pick the best market, the best asset class and the best place to be in the world. You know, we call them GTAA back in the early 2000s, 1990s. Now you probably call them global macro. But they proved to be incredibly expensive, even though they were using index funds. And sure enough, they couldn't time the markets around the world. Running an institutional portfolio is always a challenge. You see that with the turnover in CIOs.

8:46David Weisburd:But for me, it was about building a culture of a team. Brett Harris said it too, empowering those people to outperform, giving them targets, get them the right tools, and then get out of their way. Far too often on Wall Street, people get promoted because they're good at selling or they're good at transactions. That doesn't necessarily mean they're good at managing people. And this is still a human being interest business, despite AI and all the futures. This is a people business and managing people and culture is critical.

9:21Christopher J. Ailman:How does a CIO build a world-class culture?

9:25David Weisburd:You have to identify what kind of culture you want on Wall Street. We have seen firms that have competitive cultures, dog-eat-dog and the winner rises to the top. I wanted, knowing my business model, I wanted a collegial culture. I was in Sacramento. I wasn't in a financial city center. I needed to home grow my talent. Or you have to go kind of with the superstar idea of I'm going to hire somebody, pay them to come here. They probably won't stay because I'll probably lose them to somebody else that will pay more. But what I found most critical is if a culture produced alpha, when that culture started to change, the alpha disappeared.

10:05David Weisburd:And it's really hard to see that because you have to be on the ground with that team. But when you talk to people after a firm is blown up, you realize how things changed from talking about stocks to suddenly talking about wealth management and tax projects and that, you know, people get rich and suddenly that alpha disappears.

10:27Christopher J. Ailman:There may not be a objectively good or objectively bad culture, but that doesn't seem to be the case with governance. There does seem to be a right model, which is decentralized versus a wrong model versus centralized. Is that still debated? And why do some organizations still have this highly centralized model that doesn't seem to play out in any good way in any case? Let's be honest. Subscriptions out of fast. Streaming services, apps, memberships you forgot you even signed up for. And canceling them is usually a pain. That's where Experian subscription cancellation comes in. Experian can take the pain out of canceling subscriptions by handling it for you.

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11:43David Weisburd:I'll push back on your idea that there are, you know, if you have a sole leader at the top, I can think of one that comes to mind, and that's Berkshire Hathaway. And we all know up until this year who made decisions there. Seemed to be incredibly successful, but obviously not repeatable because there's not a whole lot of them. So a decentralized model, I think, brings the best of everybody's mind together and you get the best of the team. A centralized model does one thing, protect the center. I found personally, I didn't have God's single wisdom about which way the market was going to go. And what I found was valuable was constantly checking in with lots of different groups and different asset classes to get their feeling on the market.

12:27David Weisburd:Where's the best opportunities? Because they were specialists in their reflective fields. and bringing them together and smashing them together, came up with some very clever ideas and some good thinking. I remember particularly in a crisis in 08, we created what we called the ER team. We had the fixed income team debating TARP transactions. We had the real estate team debating acquisitions. We had the private equity team figuring out their capital flows and exits or entrances. And I think that brought people together. It's difficult to be an expert in all the asset classes. It's better to specialize in one, but then to get those specialists to work together as a team.

13:13Christopher J. Ailman:Could you build your portfolio in anticipation that there's going to be a crisis every so amount of years and build that into the actual execution of the strategy?

13:23David Weisburd:Portfolio resiliency is exactly what an institutional portfolio should be and wants to strive for because you're long-term. But it is one heck of a challenge to pull off because it's counter to normal psychology. I love to quote Warren Buffett's phrase, and it's simple, which is when everybody's greedy, you should be fearful. When everybody's fearful, you should be greedy. The reality is people are fearful for really short bits of time, and people are greedy for, as we now know, decades. So it's hard to be patient. And what we tried to do to answer your question is put a little bit of that in portfolio, maybe 10%, recognizing that because we're a 30-year horizon, we're going to capture and try to capture the beta of the market.

14:11And if we can just limit a little bit of the downside

14:16David Weisburd:and still capture 90 % of the upside, It is amazing how you improve the risk return profile of a big giant portfolio like that.

14:27Christopher J. Ailman:During your time at CalSTRS, you really focused on hiring the very best talent internally to manage different asset classes. What were you looking for from those LPs, essentially, that would be allocating capital for you?

14:42David Weisburd:I wish I could tell you. They don't come in with a flag waving it or a badge. They come in all shapes and sizes. They all come in both genders. They come in different colors, different backgrounds. Often challenged people is so much of Wall Street. It's not a complaint. It's just a reality. It's from the Ivy League schools. But that doesn't mean they're great investors. You can find people with all kinds of backgrounds. And that's kind of what I love about this day and age is that young kids are getting exposed to the markets. You know, I remember in my generation growing up on the West Coast, nobody read the Wall Street Journal.

15:21David Weisburd:No, you couldn't even see the markets on TV. It was on a little bit of a show in public broadcasting. But now it's out in front of them and they've got Robin Hood and they've got the opportunity to look at this. And I think we're going to find some very talented people in different places. And I would tell you that picking investments was, frankly, a lot easier than picking people. what you're trying to find is somebody who's self-reflective because investing is hard. As I said, it's really about trying to anticipate the future and you got to be humble and realize you can't. It's taking all kinds of data.

16:00David Weisburd:And you want some people who think linearly, A, B, C, D, 1, 2, 3, 4. You want other people who think tactically in patterns. So you need different types of, I always said, I want somebody who thinks like Excel. everything's relative and down and up, but then I need somebody who thinks like an access database who can take all these random facts. And I found that was true almost in every asset class. You didn't need just one discipline for one type of one asset class. You needed people who could think differently, had different backgrounds, different education styles.

16:34Christopher J. Ailman:Somebody that's good at Excel and somebody that's good at multidisciplinary thinking, it's almost never in a single person.

16:42David Weisburd:I didn't tend to find it. I tended to find people who, like we said, personalities and a mental process. When you study books about thinking processes, it is very rare to find somebody that can accomplish both very efficiently. You'll see people at the two extremes and they still could be brilliant. And it takes a culture then to bring those different people together with different thinking patterns. We tend to like people who think like us and act like us. Look at any accounting firm and you're probably going to find, you know, when you think about all those personality types, pretty similar personality types.

17:25David Weisburd:I found the value, which was having a lot of people who didn't necessarily think alike. and but could work together could be collegial and support each other last weekend i spent 10

17:36Christopher J. Ailman:hours with with a famous investor who wanted to be off the record so we'll keep him off the record but he had done multiple deals with buffett with bill ackman with tony james and all these famous investors one of the things i realized very quickly that i fallaciously thought that these were very similar people and what i realized is they were extremely different distinct styles And my theory, not his, is that if you had actually moved that investor into another space, they'd be maybe median. Maybe they'd still be top core talent, but they would not be a Bill Ackman. They wouldn't be a Warren Buffett if they were in a different context.