August 2020
Stable Value Fund Review North Carolina Supplemental Retirement Plans
Elizabeth Hood, CFA Atlanta Fund Sponsor Consulting
Weston Lewis, CFA, CAIA Atlanta Fund Sponsor Consulting Kyle Fekete, CFA Global Manager Research Group Contents
Executive Summary Galliard Stable Value Organization People Process Performance Fees Stable Value Trends
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 2 Executive Summary Stable Value Review – Executive Summary
Callan held a conference call with Galliard on August 7th, 2020
Callan maintains a positive opinion of Galliard’s stable value strategy and the internally managed fixed income that underlies stable value accounts
In 2019, Galliard underwent several organizational changes which warranted close monitoring of the firm
Despite the founding partners’ recent retirements, the fixed income and stable value teams have experienced a low degree of turnover since firm’s inception
Succession planning appears to have been effective through the leadership transition as the firm has displayed consistency in its investment process and performance
A collaborative and structured process has aided in developing wrap contract solutions and maintaining a consistent investment approach
North Carolina’s stable value fund has performed in line with expectations and has consistently generated a crediting rate in line with peers
Market to book ratios have increased and crediting rates have declined as a result of the Federal Reserve cutting rates in 1Q 2020; going forward, crediting rates are likely to trend downward due to increased cash allocations and a low interest rate environment
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 4 Galliard Stable Value Galliard Stable Value – Organization
In 2019, Galliard underwent several planned senior level retirements as well as operational changes – Richard Merriam, Founding Managing Partner and Member of the Executive Operating Committee, retired in December 2019 – Karl Tourville, Founding Managing Partner, President and Chairman of the Executive Operating Committee retired December 2019
Andrew Owen, President of Wells Fargo Funds, assumed the role of Co-President and Member of the Executive Operating Committee on January 1, 2020
Galliard’s previous revenue sharing agreement with Wells Fargo ended upon the retirement of the founding partners. The executive committee worked with Wells Fargo to renegotiate an incentive compensation structure for the investment team.
Galliard’s risk management, compliance and technology teams began reporting to Wells Fargo’s risk and technology groups
Callan maintains an “under review” status with respect to the organization
Callan would apply a more positive opinion if Galliard continues to exhibit further stability among investment personnel, minimizes departures among leadership, and maintains stability at the firm
While Wells Fargo may attempt to eliminate redundancies over time, any sweeping and immediate personnel cuts would be viewed negatively
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 6 Galliard Stable Value – People
Fixed income and dedicated stable value teams have experienced low turnover since firm’s inception
Ajay Mirza and Brandon Kanz remain key investment professionals acting as Chair and Vice-Chair of Investment Committee
Leela Scattum, Head of Stable Value Contract Strategy, intends to retire by December 31, 2020; as a part of the firm’s succession planning, Nick Gage has assumed leadership of the stable value strategy
In 2Q20, Galliard hired two programmers as additions to the technology team and had a retirement within its operations group.
Overall, Galliard maintains a deep stable value team comprised of eight wrap contract negotiating professionals, four external management oversight professionals, six contract administration professionals and 10 stable value accounting and operations professionals
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 7 Galliard Stable Value – Process
BBB Exposure for 5 Years Ended June 30, 2020
25 Galliard conducts a collaborative and structured process in implementing 20 stable value portfolios 15 (%) Wrap negotiation has benefitted from 10
the firm’s dedicated resources and BBB experience in wrap contract 5
management as well as asset size 0
Galliard has held slightly more (5) corporate credit risk as exhibited by 2015 2016 2017 2018 2019 2020 BBB-rated exposure relative to peers Callan Stable Value SA Galliard Stable Value
Effective Duration Duration has been held at an for 5 Years Ended June 30, 2020 adequate level through multiple 5.5 stages of the market cycle 5.0 4.5
Galliard has effectively diversified 4.0
risk utilizing subadvisors with 3.5 Duration
complementing investing styles 3.0
External management oversight, led Effective 2.5 by Elizabeth Smithley and Peter 2.0 Schmit, appears to be thorough and 1.5 1.0 robust 2015 2016 2017 2018 2019 2020
Callan Stable Value SA represents the stable value separate account peer group Callan Stable Value SA Galliard Stable Value
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 8 Galliard Stable Value – Performance
Crediting Rate for 5 Years Ended June 30, 2020 The NCSRP stable value fund has 3.5 produced a crediting rate above or in-line with the peer median 3.0
2.5 Rate
Market to book value ratios started declining in 2016 as the Federal 2.0 Reserve began raising interest rates, Crediting falling below 100% in 2018 1.5 Market to book began increasing in 1.0 December 2018 as the markets 2015 2016 2017 2018 2019 2020
experienced a flight to quality and Callan Stable Value SA Galliard Stable Value
the Fed announced a pause to rate Market/Book Ratio hikes for 5 Years Ended June 30, 2020 108 Market to book increased and 106 crediting rates decreased in 1Q 2020 as central banks cut interest rates to 104 Ratio all time lows in order to support their 102 economies through the Covid-19
crisis Market/Book 100
98
96 2015 2016 2017 2018 2019 2020
Callan Stable Value SA represents the stable value separate account peer group Callan Stable Value SA Galliard Stable Value
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 9 Galliard Stable Value – Performance
Returns Calendar Year Returns for Periods Ended June 30, 2020 for Periods Ended December 31, 2019 Group: Callan Stable Value SA Group: Callan Stable Value SA 3.5 3.5
3.0 3.0 A (13) A (15) A (20) 2.5 A (27) A (19) A (19) 2.5 A (26) A (30) 2.0 A (29) A (23) A (30) 2.0 A (31) 1.5 1.5 1.0 A (18) 1.0 0.5 0.0 0.5 Last Quarter Last Year Last 3 Years Last 5 Years Last 7 Years 2019 2018 2017 2016 2015 2014 2013 2012
10th Percentile 0.65 2.84 2.87 2.87 2.81 10th Percentile 2.93 2.78 2.65 2.46 2.52 2.45 2.61 3.17 25th Percentile 0.62 2.67 2.55 2.33 2.28 25th Percentile 2.70 2.46 2.18 2.13 2.20 2.18 2.48 2.82 Median 0.60 2.56 2.44 2.29 2.22 Median 2.62 2.34 2.08 1.99 1.98 1.94 2.11 2.59 75th Percentile 0.57 2.46 2.26 2.06 1.89 75th Percentile 2.51 2.13 1.83 1.77 1.68 1.56 1.69 2.25 90th Percentile 0.46 2.09 1.91 1.71 1.61 90th Percentile 2.21 0.85 1.58 1.60 1.51 1.37 1.39 1.84
Galliard Stable Value A 0.64 2.70 2.54 2.38 2.30 Galliard Stable Value A 2.74 2.45 2.18 2.13 2.13 2.06 2.42 3.05
Scatter Chart Portfolio Characteristics For Periods Ended June 30, 2020 for 5 Years Ended June 30, 2020 Group: Callan Stable Value SA 3.25 0 10 3.00 20 Galliard Stable Value 30 40 2.75 50 A (50) 60 2.50 70 80 A (80)
Returns 2.25 90 100 Yield on Underlying Assets Number of Wrap Providers 2.00 Callan Stable Value SA 1.75 25th Percentile 1.18 12.00 Median 0.98 9.00 75th Percentile 0.90 5.75 1.50 90th Percentile 0.83 1.50 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20 0.22 Standard Deviation Galliard Stable Value A 0.98 5.00
Callan Stable Value SA represents the stable value separate account peer group
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 10 Galliard Stable Value – Performance Diversification by Wrap Issuers and Subadvisors as of June 30, 2020
Wrap Issuer Exposure Subadvisor Exposure
TCW Transamerica PGIM Liquidity 10% BlackRock 23% 10% Buffer STIF 5% 5%
Payden & American Rygel General 10% 19%
Jennison Prudential 10% 25%
Galliard Nationwide 45% Life Dodge & Cox 18% 10% Metropolitan Life 10%
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 11 Galliard Stable Value – Performance Subadvisor performance for periods ended June 30, 2020
Since Manager 1 month 1-quarter 1-years 3-years 5-years Inception Inception Date
Galliard 0.46% 2.60% 4.81% - - 4.63% June 1, 2018
BB 1-3 yr Gov’t/Credit 0.20% 1.17% 4.20% - - 4.07% - Index
Galliard 0.77% 3.43% 6.89% - - 6.75% June 1, 2018
Dodge & Cox 0.82% 4.10% 7.14% 4.69% 3.92% 3.52% Mar 1, 2015
PGIM Fixed Income 0.97% 4.45% 6.42% 4.52% - 3.90% Feb 1, 2016
BB Intermediate 6.38% / 3.14% 0.41% 2.13% 6.60% 4.28% 3.40% - Aggregate Index / 3.43%
Payden & Rygel 0.81% 2.90% 6.95% 4.68% 3.28% 2.73% July 1, 2009
1Linked Benchmark 0.41% 2.13% 6.60% 4.45% 3.04% 2.25% -
Jennison 0.61% 3.28% 9.02% 5.22% 4.07% 7.62% 1See Note
TCW 0.96% 3.47% 7.54% - - 7.18% June 1, 2018
BB Intermediate 0.62% 2.81% 7.12% 3.79% 2.76% 6.73% / 6.70% - Gov’t/Credit Index
1Payden Linked BM: Bloomberg Barclays U.S. Intermediate Aggregate Bond Index. Prior to June 1, 2018 benchmark was Bloomberg Barclays U.S. 1-3 Year Government/Credit Bond Index. Performance inception: June 1, 2018. Prior to June 1, 2018 returns are linked to Wells Fargo Fixed Income Fund N (Jennison).
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 12 Galliard Stable Value - Fees Wrap/Subadvisor and Management Fee Comparison
Fee Comparison Management Fee Comparison Ended June 30, 2020 Ended June 30, 2020 Group: Callan Stable Value SA Group: Callan Stable Value SA
0 0
10 10
20 20
30 30
40 40
50 50 A (56) 60 60
70 70
80 A (79) 80 A (83)
90 90
100 100 Wrap Fees Sub‐Advisor Fees Effective Annual Fee
25th Percentile 0.16 0.10 25th Percentile 0.16 Median 0.16 0.08 Median 0.10 75th Percentile 0.16 0.07 75th Percentile 0.09 90th Percentile 0.16 0.03 90th Percentile 0.00
Galliard Stable Value A 0.16 0.06 Galliard Stable Value A 0.06
• Galliard recently reduced the management fee to 0.062% which is competitive among reported management fee schedules.
• Galliard has also been assertive in negotiating wrap contract fees—they expect fees to remain between 15-16 bps for the foreseeable future. Callan Stable Value SA represents the stable value separate account peer group
Knowledge. Experience. Integrity. North Carolina Supplemental Retirement Plans 13 Stable Value Trends Factors Impacting Stable Value Environment
Current Rate Environment ● A period of rising interest rates and increased allocations to spread product helped increase crediting rates from 2017 through 2019. ● Going forward, crediting rates may trend downward. – The Covid-19 crisis has spurred central banks to support their economies by lowering interest rates to all time lows. – Cash allocations within stable value funds have increased due to the flight to quality, lowering average yields within SV funds.
Wrap Capacity ● Wrap coverage and investment guidelines tightened after the 2008 financial crisis. ● Insurance companies have since become the dominant players within the wrap industry. – Increased competition has helped wrap fees decline to 16-17 bps from the 25-30 bps range immediately after the GFC. – Investment guideline negotiation leverage has shifted back in favor of stable value managers. ● Wrap coverage has remained robust through the Covid-19 crisis, however, vigilance of the health of the wrap provider community is prudent.
North Carolina Supplemental Retirement Plans 15 Financial Health of Wrap Issuers
Issuers Ratings S&P Moody’s Fitch June 2019 June 2020 June 2019 June 2020 June 2019 June 2020 1 American General Life A+ A+ A2 A2 A+ A+ Jackson National Life AA- A+ A1 A1 AA- A+ Lincoln Financial AA- AA- A1 A1 A+ A+ Mass Mutual AA+ AA+ Aa3 Aa3 AA+ AA+ 1 Metropolitan Life AA- AA- Aa3 Aa3 AA- AA- New York Life AA+ AA+ Aaa Aaa AAA AAA Pacific Life AA- AA- A1 A1 A+ AA- Principal Life A+ A+ A1 A1 AA- AA- Protective Life AA- AA- A1 A1 A+ A+ 1 Prudential AA- AA- Aa3 Aa3 AA- AA- RGA AA- AA- A1 A1 A A Royal Bank of Canada AA- AA- Aa2 Aa2 AA AA State Street Bank AA- AA- Aa3 Aa3 AA AA 1 Transamerica AA- A+ A1 A1 A+ A+ Voya Financial AA+A2A2A A
Sector outlook - Stable value managers maintain a positive outlook on wrap providers’ financial stability, while the major rating agencies maintain a negative-to-stable outlook on the insurance sector as a whole. Moody’s Negative - Unprecedented economic disruption from the COVID-19 pandemic and a prolonged low-rate environment are negative though the industry has strong capital position. S&P Stable - Asset risk is the immediate risk, but life insurers’ capital buffers will help cushion the blow. Manageable impact from moderate pandemic stress, gradual impact from lower interest rate. The following would trigger a negative sector outlook: higher than expected corporate downgrades or default, substantial reserve increase due to lower interest rates, higher than expected loss due to hedge breakage from equity market volatility, significant mortality rate increase. Fitch Negative - Increased uncertainties due to the material disruption in the financial markets, a spike in mortality risk, the severity of which at this point is highly uncertain, increased concern over protracted low interest rate environment
Source: Goldman Sachs Asset Management, Bloomberg Barclays as of 6/30/19; 1 Wrap provider within Supplemental Retirement Plans
North Carolina Supplemental Retirement Plans 16 Duration has Increased
4.5
4.0
3.5
3.0
2.7 - Callan Stable Value CT 2.5 Duration (Years) Duration
2.0
1.5
1.0 2003 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Wrap issuers keep a close a eye on interest rate risk. ● After stable value funds experienced volatility in 2008, wrap providers pushed for tighter guidelines. ● More recently, wrap providers have allowed more leeway on duration.
Callan Stable Value CT represents the stable value collective trust universe
North Carolina Supplemental Retirement Plans 17 Market-to-Book Ratios Have Increased
108
106
104
102 101.9 - Callan Stable Value CT
100
98
96 Market-to-Book Ratio 94
92
90
88 2003 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Market-to-book value ratio is a measure of the overall health of a stable value fund. ● Market-to-book may increase above par (100) during a declining rate environment. ● Gradual changes in interest rates are manageable.
Callan Stable Value CT represents the stable value collective trust universe
North Carolina Supplemental Retirement Plans 18 Crediting Rates May Return to Historic Lows
5.0
4.5
4.0
3.5
3.0
2.5 2.4 - Callan Stable Value CT Crediting Rate 2.0
1.5
1.0
0.5 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Post-GFC, crediting rates were impacted by strict investment guidelines and declining rates. ● A period of rising interest rates and increased allocations to spread product helped increase crediting rates. ● However, a return to low interest rates due to the Covid-19 crisis indicate a potential decline in crediting rates. ● Some investment managers have renegotiated broader guidelines, resulting in more parity among the peers.
Callan Stable Value CT represents the stable value collective trust universe
North Carolina Supplemental Retirement Plans 19 Stable Value as Qualified Default Investment Alternative
Current default investment alternative for non-participant directed monies
1.1% 100% 2.3% Other 6.9% A key provision of the Pension 2.3% Managed account 80% 1.1% Protection Act provides relief to DC Target risk fiduciaries that default participant 60% Balanced fund assets into QDIAs under regulation Stable value or money market 86.2% 404(c)(5). 40% Target date retirement Target date and managed account options have slowly replaced stable 20% value as a QDIA. 0% 2015 2016 2017 2018
Source: Callan 2018 Defined Contribution Trends Survey
North Carolina Supplemental Retirement Plans 20