Why did CalSTRS change its investment allocations from 100 percent fixed to 80 percent equity and 17 percent fixed securities?
Until 1966, CalSTRS was statutorily prohibited from purchasing any assets other than fixed income securities. In 1970, Proposition 6 was passed, which permitted the system to invest in real estate and equities but limited the percentage exposure.
For six years, equities remained between 3 and 5 percent of the portfolio, and thereafter grew. At that time all pensions utilized a ‘legal list’ of legislatively approved investments, and later in the decade Blue Chip corporate stocks were also approved. In 1984 California voters passed Proposition 21, which changed the standards for managing the State’s pensions from a ‘legal list’ to the ‘Prudent Person’ standard, and to allow diversification of assets.
With the broader authority to invest in many more types of asset classes, CalSTRS is able to invest in accordance with Modern Portfolio Theory. The theory states that investors can increase their return without an increase in overall risk by diversifying their assets across a wider variety of types of investments.
The validity of this theory is underscored by the fact that CalSTRS averaged a 6.9 percent rate of return annually in the 20 years ending in 1984, even though the overall market earned an average of 7.6 percent annually, whereas CalSTRS has averaged 8.1 percent in annual returns in the last 20 years.