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Minnesota State Board of Investment Date This document is made available electronically by the Minnesota Legislative Reference Library as part of an ongoing digital archiving project. http://www.leg.state.mn.us/lrl/lrl.asp MINNESOTA STATE DATE: January 17, 2020 BOARD OF INVESTMENT TO: Legislative Reference Library FROM: Mansco Perry III /J1. f ~ Executive Director and chfuf Investment Officer SUBJECT: Report on Investment Consultant Activities Board Members: The provisions of Minnesota Statutes, Section 1 lA.27 require the State Board of Investment to file with the Legislative Reference Library a report on investment Governor Tim Walz consultant activities. State Auditor The State Board of Investment (SBI) contracts with Aon Hewitt Investment Julie Blaha Consulting, Inc. (AON), Chicago, Illinois and Meketa Investment Group, LLC Secretary of State (Meketa), Portland, Oregon. AON serves as the SBI's general consultant and the Steve Simon annual contract fees are $515,000. Meketa serves as the SBI's special projects consultant and the contract fees are $285,000 per year. Attorney General Keith Ellison As part of their consultant services, AON and Meketa are available to the Board, staff and Investment Advisory Council to provide perspective, counsel and input on relevant investment related issues. Executive Director & Chief Investment During the period July 1, 2018 through June 30, 2019, AON and Meketa were Officer: involved in the following projects: Mansco Perry • AON provided research and implementation considerations in the Return­ Seeking Fixed Income asset group. 60 Empire Drive • Meketa reviewed the potential impact that climate change may have on Suite 355 St Paul, MN 55103 long-term investment risks to the SBI's investment portfolio and indicate (651) 296-3328 approaches that the SBI may take to address and mitigate identified investment risks. Fax: (651) 296-9572 E-mail: [email protected] • Periodic background information for evaluating SBI investment managers. Website: http://mn.gov/sbi Attached is an example of the work product each has provided. An Equal Opportunity Employer This page intentionally left blank. t - • ,l 1. Growth Income – Return-Seeking Fixed Income Minnesota State Board of Investment | June 2019 Aon Hewitt Retirement & Investment Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. Nothing in this document should be construed as legal or investment advice. Please consult with your independent professional for any such advice. To protect the AON confidential and proprietary information included in this material, it may not be disclosed or provided to any third parties without the approval of Aon Hewitt. Empower Results® Contents . Return-Seeking Fixed Income: Opportunity Set and Portfolio Modeling . Implementation Considerations . Appendix Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 2 Empower Results® Return-Seeking Fixed Income: Opportunity Set and Portfolio Modeling Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 3 Empower Results® MSBI Strategic Allocation Category Framework 3/31/lll . The Board approved the following Strategic ($ millions} 3/31/19 Weights Cate0 orY Ranees G)"(m1h - A1,rnredation Asset Allocation Framework Public Equity $ 43,593.78 63.3% Private Equity $ 5,325.65 7.7% on-Core ReaJ Assets $ 2,4 19.17 3.5% Distressed/Opportunistic $ 1,172.16 1.7% . Most recently, the Protection category was s 52 ,510.76 76 ..3 % 50% 75% fully funded with U.S. Treasuries G)"(mih - Income-01iented Core Fixed Income $ 7,870.10 11.4% .r-nn "ln Private r r,,,-'" <' /l!1% ~ . Constructing the Growth-Income-oriented -"=t,.;n" Fixed Income 0 00/_ s 8,450.40 12 ..3 % 15% 30% category is among the next priorities, which Real Assets includes: Core Real Estate 0.()% Real Assets $ 517.76 0.8% – Core Fixed Income s 51 . 6 0.8% 0% 10% – Private Credit Inflation l"rotection TIPS 0.0% – Return-Seeking Fixed Income Commodities 0.0% 0.0% 0% 10% Protection U.S. Tre.asuries $ 6,203.01 9.0% . The following analysis focuses on potential s 6,203.01 9.0% 5% 20% construction of the Return-Seeking Fixed Liquidity Income component Cash $ 1,133.23 1. 6% s 1,133.23 1.6% 00/4 5% OpportunitY Opporturuty s - ll.0% ()% 10% Total s 68,815.51 100.0% Illiquid Asset E.I.posm·e s 10,015.03 14.6% 00/4 30% Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 4 Empower Results® Return-Seeking Fixed Income: Broad Opportunity Set High Yield Contingent Convertibles (CoCos) Bank Loans Securitized Emerging Market Debt Structured Credit/CLOs Distressed Opportunistic Taxable High Yield Municipals Convertibles Global Credit Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 5 Empower Results® Credit Sector Risk vs. Return Example Risk/Return Profiles Distressed Credit Emerging Market Debt Loans Return High Yield Bonds Asset Backed Securities Investment Grade Bonds Cash Risk Source: Aon Hewitt, illustrative only • Credit sectors exhibit different risk and return characteristics • Combining sectors can result in superior risk/return characteristics, potentially offering reduced volatility per unit of return on the portfolio Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 6 Empower Results® Return-Seeking Fixed Income Portfolio Analysis: Background . Considered broad return-seeking fixed income (FI) opportunity set . Utilized Aon’s applicable Capital Market Assumptions* (CMA’s) to project risk and return expectations for various Return-Seeking FI portfolios – Modelled 5 portfolios with different risk levels (Standard Deviation) ranging from 5% to 9% . Optimized allocations to return-seeking FI asset classes across risk targets to generate expected 10-year: – Returns – Sharpe Ratios –5th Percentile (pessimistic case) 1-year returns . Included expectations for Aon’s Model Portfolio** return-seeking fixed income allocation which is modelled as solely multi-asset credit and represented as 1/3 each to high yield, bank loans and emerging market debt . The following page summarized the return and Sharpe Ratio outcomes across the various return-seeking fixed income portfolio risk profiles *Aon’s Capital Market Assumptions (CMAs) are 10 and 30-year risk, return and correlation assumptions. Please see appendix or additional detail **See Appendix for details on Aon’s Model Portfolios Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 7 Empower Results® Return-Seeking Fixed Income Portfolio Analysis: Summary Optimization Public Fund 5% Risk 6% Risk 7% Risk 8% Risk 9% Risk Model Portfolio1 Contraints High Yield 5% 5% 5% 11% 23% 33% 5%- 30% Bank Loans 30% 30% 30% 30% 27% 33% 5%- 30% Convertibles 10% 10% 10% 10% 10% 0% 0%- 10% Hedge Fund - Distressed Debt 1% 4% 8% 10% 10% 0% 0%-10% Emerging Market Debt 16% 23% 29% 30% 30% 33% 0%- 30% MBS 28% 18% 8% 0% 0% 0% 0%- 30% IG Credit 10% 10% 10% 9% 0% 0% 0%-10% Total 100% 100% 100% 100% 100% 100% Expected 10-yr Return 5.03% 5.35% 5.64% 5.89% 6.07% 5.98% Expected Risk 5.00% 6.00% 7.00% 8.00% 9.00% 9.00% Sharpe Ratio 0.51 0.47 0.45 0.42 0.40 0.39 5th Percentile 1-Yr Return -2.87% -4.05% -5.24% -6.43% -7.68% -7.77% 1) Exposures based on MAC CMA. Model portfolio (highly liquid) only has MAC exposure for return-seeking Fl. *Aon’s Capital Market Assumptions (CMAs) are 10 and 30-year risk, return and correlation assumptions. Please see appendix or additional detail Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 8 Empower Results® Return-Seeking Fixed Income Portfolio Analysis: Risk vs. Return Expected 10-Year Risk vs. Return* 7.0% Convertible Bonds EMD(Sov. Local) Bank Loans 9% Risk J( I 6.0% I Model Portfolio • •8% Rsk Hedge Funds- Distressed Debt •7% Risk HY •6% Risk 5.0% EMD (Sov. USD) •5% Risk 4.0% Core U.S. FI 3.0% t MBS 2.0% 1.0% 3.0% 5.0% 7.0% 9.0% 11.0% 13.0% 15.0% 17.0% There is a spectrum of asset types within return-seeking fixed income that have varying risk/return characteristics, which provides the opportunity to maximize return per unit of risk when utilizing the full opportunity set *Based on Aon’s 1Q 2019 Capital Market Assumptions Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 9 Empower Results® Implementation Considerations Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 10 Empower Results® MN SBI Growth-Income: Return-Seeking Fixed Income . Growth-Income: 15% - 30% of Total Fund . Dollar values assume middle of range allocation: Approx. 22.5%, or $16B in assets . Below sub-category allocations are general assumptions and not set Policy Growth-Income Category 100% 21%, $3 Private Credit 80% 29%, Return-Seeking Fixed Income 60% $5B 40% 50%, $8B Core Fixed Income 20% 0% Growth Income Aon Hewitt | Retirement & Investment AON Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 11 Empower Results® Implementation Considerations . Risk and return goals and expectations . Liquidity profile . Control vs. discretion – i.e. tactically shifting within preset underlying strategic ranges vs. investment manager discretion to invest across the return-seeking FI opportunity set . Number, type and size of mandates .
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