San Joaquin County Employees Retirement Association A G E N D A
FINANCIAL MEETING SAN JOAQUIN COUNTY EMPLOYEES RETIREMENT ASSOCIATION BOARD OF RETIREMENT FRIDAY, JULY 24, 2015 AT 9:00 AM Location: SJCERA Board Room 6 S. El Dorado Street, Suite 400, Stockton, California.
1.0 ROLL CALL 2.0 PLEDGE OF ALLEGIANCE 3.0 APPROVAL OF MINUTES 3.01 Approval of the minutes for the Financial Meeting of June 26, 2015 3 3.02 Board to approve minutes 4.0 CONSENT ITEM 4.01 Report of Closed Session 01 On December 7, 2014, the Real Estate Committee unanimously approved Resolution 2014-12-03 titled "Angelo Gordon Fund IV" and authorized the Chair to sign the necessary documents to invest $20 million in the Fund 4.02 Board to approve consent item 5.0 ALTERNATE RETIRED MEMBER OF THE BOARD 7 5.01 RPESJC letter dated July 13, 2015, regarding Appointment of Alternate Retired 9 Member of the Board of Retirement 5.02 Board to consider request to appoint Alternate Retired Member of the Board 6.0 2015 ASSET LIABILITY STUDY 6.01 Presentation on Modeling & Considering Various Portfolio Options 10 6.02 Discussion with David Sancewich and John Linder, Principals of PCA and Robert McCrory, Executive Vice President of Cheiron 6.03 Board to discuss and give direction to staff and consultants as appropriate 7.0 ACTUARIAL VALUATION AND FUNDING POLICY 41 7.01 2015 Preliminary Valuation Results as of January 1, 2015 and Funding Policy 43 7.02 Presentation by Cheiron Executive Vice President Robert McCrory and Vice President Graham Schmidt 7.03 Board to discuss and give direction to staff and consultant as necessary 8.0 PROPOSED ANNUAL SCHEDULE OF PROJECTED CONTRIBUTIONS BY 61 MEMBER TYPE 8.01 Proposed First Amendment to Actuarial Consulting Services Agreement 63
6 South El Dorado Street, Suite 400 • Stockton, CA 95202 SJCERA Financial Meeting • 07/24/2015 • Page 1 (209) 468-2163 • (209) 468-0480 • www.sjcera.org 8.02 Proposed Resolution 2015-07-02 65 8.03 Board to approve proposed amendment and adopt Resolution 2015-07-02 9.0 REPORTS 9.01 Monthly Investment Performance Updates 01 Manager Performance Flash Report (to be provided at the meeting) 02 PCA Investment Market Risk Metrics June 2015 67 9.02 PCA Mananger Due Diligence Meetings and Reports 01 Manager Due Diligence Schedule 85 02 PCA Memo on meeting with Mount Lucas Management - July 2015 86 9.03 CIO Report 01 Proposed Financial Agenda Topics 91 9.04 Trustee and Executive Staff Travel 01 Conferences and Events Summary for 2015 93 a 2015 PRJ Public Retirement Seminar 94 02 Summary of Pending Trustee and Executive Staff Travel 98 03 Summary of Completed Trustee and Executive Staff Travel 99 9.05 Report from Real Estate Committee 01 SJCERA Committee Chair and staff will provide a brief summary of the outcome of the Real Estate Committee meeting and investments 9.06 Board to accept and file reports 10.0 CORRESPONDENCE 10.01 Letters Received 01 7/2/15 Mesa West Real Estate Income Fund IV Announcement 100 10.02 Letters Sent 10.03 Market Commentary/Newsletters 01 Research Affiliates Fundamentals June 2015 103 The Whole Story: Factors + Asset Classes 11.0 COMMENTS 11.01 Comments from the Board of Retirement 11.02 Comments from the Chief Executive Officer 11.03 Comments from the Public 12.0 CALENDAR 12.01 Regular Meeting, August 14, 2015 at 9:00 AM 12.02 Financial Meeting, August 19, 2015 at 10:00 AM 13.0 ADJOURNMENT
SJCERA Financial Meeting • 07/24/2015 • Page 2 San Joaquin County Employees Retirement Association M I N U T E S
FINANCIAL MEETING SAN JOAQUIN COUNTY EMPLOYEES RETIREMENT ASSOCIATION BOARD OF RETIREMENT FRIDAY, JUNE 26, 2015 AT 9:03 AM Location: SJCERA Board Room 6 S. El Dorado Street, Suite 400, Stockton, California.
1.0 ROLL CALL 1.01 MEMBERS PRESENT: Shabbir Khan, J.C. Weydert, Cindy Garman, Michael Duffy (left at 11:50), Michael Restuccia, David Souza, Lawrence Mills, Richard Callistro, Raymond McCray and Steve Bestolarides presiding MEMBERS ABSENT: None STAFF PRESENT: Chief Executive Officer Annette St. Urbain, Assistant Chief Executive Officer Patricia Pabst, Chief Investment Officer Nancy Calkins, Retirement Financial Officer Lily Cherng, Information Systems Manager Tallie Claypool, Retirement Investment Accountant Fe Maliwat, Management Analyst III Greg Frank, Retirement Payroll Technician Marissa Smith and Senior Office Assistant Mercy Tayabas OTHERS PRESENT: Deputy County Counsel Jason Morrish, David Sancewich and John Linder of PCA, Robert McCrory of Cheiron and Retired Member Elect Adrian Van Houten. 2.0 PLEDGE OF ALLEGIANCE 2.01 Led by Lawrence Mills 3.0 APPROVAL OF MINUTES 3.01 Approval of the minutes for the Financial Meeting of May 8, 2015 3.02 Board unanimously approved the minutes of the Financial Meeting of May 8, 2015. 4.0 CONSENT ITEM 4.01 Memo from PCA regarding Daily Cash Sweep 4.02 Proposed revisions to Cash Management and Liquidity Policy (mark-up) 4.03 Proposed revisions to Cash Management and Liquidity Policy (clean) 4.04 Proposed Resolution 2015-06-02 titled “Revisions to Liquidity Pool & Cash Management Policy” 4.05 Board unanimously approved the consent items and adopted Resolution 2015-06-02. 5.0 RAVEN PRESENTATION & DUE DILIGENCE 5.01 Presentation by Josh Green of Raven Fund III 5.02 Raven Fund III - PCA’s Due Diligence Memo June 2015
6 South El Dorado Street, Suite 400 • Stockton, CA 95202 SJCERA Financial Meeting • 6/26/2015 • Page 1 (209) 468-2163 • (209) 468-0480 • www.sjcera.org 5.03 Raven Fund II Advisory Committee 5.04 Board unanimously approved a contingent commitment of up to $50 million to Raven Asset-Based OpportunityFund III subject to legal review and successful negotiation of terms. 6.0 2015 ASSET LIABILITY STUDY 6.01 Discussion with David Sancewich and John Linder, Principals of PCA and Robert McCrory, Principal Consulting Actuary of Cheiron, on 2015 Asset-Liability Study - Modeling of Proposed SJCERA Strategic Classes 6.02 Based on the Board’s input, the asset/liability model will use five decision factors. Two pairs for funding and cost and one factor for drawdowns:
Funding Goal: 1) Reach (at least) 85% funding ratio in the next 15 years and 2) avoid a funding ratio below the current 65%. Cost Goal: 1) Seek a lower average employer cost and 2) avoid an employer cost greater than 45% of covered payroll. Drawdowns: Avoid a cumulative negative return on investments lower than -10% over a two-year period.
In addition, Cheiron will consider methods to model lowering the assumed nominal rate of return to be more in-line with market expectations. 7.0 PROPOSAL FOR ANNUAL INVESTMENT MANAGER ROUNDTABLE 7.01 Memo from PCA regarding Roundtable topics and format 7.02 Board accepted the consultants proposed 2015 Roundtable topics and format. 8.0 REPORTS FROM INVESTMENT CONSULTANT 8.01 Quarterly Investment Performance Analysis for Period Ending March 31, 2015 8.02 Quarterly Manager Certification Report for Period Ending March 31, 2015 01 Memo from PCA on Manager Certification 02 Manager Certification Update Report from PCA 8.03 Investment Manager Fees Analysis 01 Investment Management Fees Report through December 31, 2014 02 Investment Management Fees Report for 2013 (for reference) 8.04 Monthly Investment Performance Updates 01 Manager Performance Flash Report 02 PCA Investment Market Risk Metrics May 2015 8.05 PCA Mananger Due Diligence Meetings and Reports 01 Manager Due Diligence Schedule 02 PIMCO All Asset/All Authority On-Site - June 2015 03 PCA memo on meeting with Research Affiliates - June 2015 04 PCA memo on meeting with Marinus Capital - June 2015 8.06 PCA reviewed and discussed the reports in relation to the Board’s investment policies
SJCERA Financial Meeting • 6/26/2015 • Page 2 8.07 Board accepted and filed reports. 9.0 REPORTS 9.01 CIO Report 01 Proposed Financial Agenda Topics 9.02 Trustee and Executive Staff Travel 01 Conferences and Events Summary for 2015 02 Summary of Pending Trustee and Executive Staff Travel 03 Summary of Completed Trustee and Executive Staff Travel a 2015 Pension Bridge Annual Conference Report b 2015 Mesa West Annual Investors Meeting Report c 2015 World Investment Forum Report 9.03 Report from Real Estate Committee 01 Real Estate Committee Chair and staff provided a brief summary of the outcome of the Real Estate Committee meeting and investments 9.04 Board accepted and filed reports 10.0 CORRESPONDENCE 10.01 Letters Received 10.02 Letters Sent 10.03 Market Commentary/Newsletters/Articles 01 Morgan Creek Market Review Q1 2015 11.0 COMMENTS 11.01 Comments from the Board of Retirement - None 11.02 Comments from the Chief Executive Officer CEO St. Urbain Providing the following updates: 01 Board Member Elections - Congratulations to Ms. Garman and Retired Member Elect Adrian Van Houten on their success in the regular elections held earlier this month. Immediately preceding the July 10th Regular meeting, Ms. Garman, Mr. Duffy and Mr. Van Houten will take their Oaths of Office. Board Officers will be elected prior to adjournment of the July Regular Meeting. Once the Board officers are determined, the Chair will be asked to review Committee assignments for 2015-2016. 02 SJCERA’s 2014 Audited Financial Statements - Submitted to the Board of Supervisors on consent on June 23, 2015. After a few questions from Supervisor Elliott and comments from Supervisor Winn, the Board of Supervisors unanimously accepted and filed the report. 03 Statewide Ballot Initiative on Public Pensions (Chuck Reed & Carl DeMaio) - The proposed “Voter Emplowerment Act of 2016”, if qualified and passed, would place all new public employees in defined contribution plans only and require voters to approve changes to defined benefit plans for existing public employees. It is anticipated that public employee labor organizations will vigorously oppose this initiative if qualified for the November 2016 ballot.
SJCERA Financial Meeting • 6/26/2015 • Page 3 11.03 Comments from the Public - None 12.0 CALENDAR 12.01 Regular Meeting, July 10, 2015 at 9:00 AM 12.02 Financial Meeting, July 24, 2015 at 9:00 AM 13.0 ADJOURNMENT 13.01 There being no further business the meeting was adjourned at 12:30 p.m.
Respectfully Submitted:
______Steve J. Bestolarides, Chair
Attest:
______Raymond McCray, Secretary
SJCERA Financial Meeting • 6/26/2015 • Page 4 Board of Retirement Financial Meeting San Joaquin County Employees’ Retirement Association
Agenda Item 5.0 July 24, 2015
SUBJECT: Appointment of Alternate Retired Member
SUBMITTED FOR: ___ CONSENT _X_l ACTION __ INFORMATION
RECOMMENDATION Staff recommends that the Board appoint Margo Praus to serve as the Alternate Retired Member of the Board of Retirement for the remainder of the current term of office through June 30, 2018, as nominated by the Retired Public Employees of San Joaquin County (RPESJC).
PURPOSE
To fill a vacancy in the Alternate Retirement Member position of the Board of Retirement as authorized by the County Employees’ Retirement Law.
DISCUSSION
The regular election for the Eighth Member and Alternate Retired Member positions elected by retired members of SJCERA was held on June 16, 2015. Two candidates filed for the Eighth Member position, but no candidates filed for the Alternate Retired Member position. Thus, following the election, the Alternate Retired Member position is vacant.
In the event of a vacancy in the Alternate Retired Member position, Government Code sections 31520.5 and 31523 provide that the Board of Retirement may, by majority vote, from a list of nominees submitted by a recognized retiree organization, appoint a replacement alternate retired member who shall serve until the expiration of the current term of the current eighth member.
In a letter dated July 13, 2015, addressed to the Chair and Members of the Retirement Board, RPESJC describes the efforts made to identify candidates for nomination for the Alternate Retired Member position, and recommends Margo Praus as the only SJCERA retiree who expressed an interest in serving in this position.
It is staff’s understanding that Ms. Praus plans to attend the Financial Meeting of July 24, 2015. If the Board makes the recommended appointment, Ms. Praus could take the Oath of Office and fill the position immediately following the Board’s action on this item.
July 24, 2015 Page 2 of 2 Agenda Item 5.0 Alternate Retired Member
ATTACHMENT RPESJC letter dated July 13, 2015
______ANNETTE ST. URBAIN Chief Executive Officer
2015 ASSET-LIABILITY STUDY - PRESENTATION 5 Modeling & Considering Various Portfolio Options
Presented by:
John Linder, CFA, CPA - PCA Bob McCrory, FSA - Cheiron
July 2015 Agenda Items
Section Page
Asset Liability Study Calendar 2
Asset Liability Study Recap to Date 3
Today’s Objective 4
Allocation constraints that frame the analysis 5
Risk philosophy determination, a review 6
Model output based on decision factor inputs 13
Determining a consensus risk philosophy, decisions and next steps 20
Appendix: Strategic Class Modeling Assumptions and Detail
San Joaquin CERA ││ Asset-Liability Study Presentation V 1 Asset Liability Study Calendar
March 2015 Session Introductory Session - PCA Process / Schedule
April 2015 Session Discuss Class Framework / Potential New Strategic Class(es) - PCA Does the class framework provide meaningful insight? Are classes distinct?
May 2015 Session Model Expected Return and Behavior of All Classes – PCA Education concerning class modeling process
June 2015 Session Initial Presentation of Asset/Liability Model – PCA / Cheiron Interactive discussion concerning decision factors (return driven / risk driven)
July 2015 Session Model and Consider Various Portfolio Options - PCA / Cheiron Iterative Voting process, tradeoff analysis
Sept 2015 Session Recommendation / Approval of New Strategic Policy Mix - PCA
San Joaquin CERA ││ Asset-Liability Study Presentation V 2 Asset Liability Study Recap To Date
Up to this point the Board has discussed the following items/issues:
• The purpose, role, and risk exposures of existing / potential new strategic classes
• Reorganized strategic classes to new portfolio “buckets” for modeling
• Reviewed PCA’s strategic class modeling process and approved class forward looking return/risk assumptions
• Reviewed the initial Asset/Liability Model developed by Cheiron
• The Board selected five risk factors (or “decision factors”) to further clarify a consensus overall risk philosophy
San Joaquin CERA ││ Asset-Liability Study Presentation V 3 Objective of Today’s Meeting
. Determine a risk philosophy that best represents the Board consensus view
• Review the trade-offs of different risk philosophies / allocations and the model outputs
• Prioritize the five decision factors for yourselves and as a Board
• Determined a consensus weighting of decision factors (a risk philosophy), resulting in a model policy portfolio
• Portfolio modeling is one tool to help decision-makers; indicative at best
• The Board can elect to adjust the modeled portfolio based on qualitative discussion
San Joaquin CERA ││ Asset-Liability Study Presentation V 4 SJCERA Strategic Class Allocation Constraints
• Investment Constraints used in A/L model simulations:
Strategic Purpose Main Risk Public / Current Min % Max % Class Exposures Private? Policy %
Crisis Risk Offset Crisis Risk Offset Not growth, rates Publicly-Traded 5.0% 4.0% 20.0%
Private Appreciation Return in Illiquids Growth, illiquidity Private 8.5% 4.0% 16.0%
Credit Return / Income Growth, rates Public / Private 18.0% 14.0% 26.0%
Stable Fixed Income Stability/Liquidity Rates Publicly-traded 15.0% 5.0% 30.0%
Risk Parity Balanced Return Growth, Rates, Inf Publicly-Traded 17.0% 10.0% 30.0%
Global Public Equity Return Growth Publicly-traded 36.5% 24.0% 40.0%
• Ranges result in analysis of close to 34,000 unique portfolios
• See Appendix for simulation assumptions for each class
San Joaquin CERA ││ Asset-Liability Study Presentation V 5 Risk Philosophy Review
San Joaquin CERA ││ Asset-Liability Study Presentation V 6 Risk Philosophy Review
• Risk tolerance (or “Risk Philosophy”): one of the most important inputs in a portfolio selection process
• Risk Philosophy encapsulates the Board’s priorities regarding overall Plan risks
• A Risk Philosophy is a weighted combination of the five Decision Factors
• Once a Risk Philosophy is expressed, portfolio selection is mechanical
San Joaquin CERA ││ Asset-Liability Study Presentation V 7 Risk Philosophy Review
Definition: Risk Philosophies are a weighted combination of Decision Factors:
(i) Certain sets of decision factors reflect specific sensitivities (ii) Weightings of decision factors reflect priorities unique to SJCERA
Purpose: Pre-established risk philosophies allow decision makers to rapidly establish context for their risk tolerance and, in turn, select an appropriate policy portfolio
San Joaquin CERA ││ Asset-Liability Study Presentation V 8 Risk Philosophy Review
Definition: A Decision Factor is a combination of two components:
(i) a variable that describes the financial condition of the System and (ii) an established threshold level (or goal) for that variable
Purpose: Decision Factors allow decision makers to define and quantify their tolerance for each risk using intuitive metrics, allowing the Board to arrive at a consensus risk tolerance
San Joaquin CERA ││ Asset-Liability Study Presentation V 9 Risk Philosophy Review
Descriptions of SJCERA’s Five Custom Decision Factors Decision Factor Description Long-term measure. Portfolios are ranked by counting the number of times the funding ratio Seek Funding achieves the 85% level after a 15-year period. The higher the frequency of occurrences the higher Improvement (better) the rank. Single-period measure. Rank is determined by counting the number of years a portfolio causes the Avoid Funding Plan funded ratio to fall below (breaches) 65%. A 15-year horizon is utilized and each portfolio is Deterioration examined across 1,000 simulated 15-year periods. The higher the count of breaches, the lower (worse) the portfolio ranking. Long-term measure. Portfolios are ranked by the level of average annual employer costs the Plan Seek Lower Average incurs as a result of the portfolio’s investment results over a 15-year period. The lower the employer Employer Costs cost the higher (better) the rank. Single-period measure. Rank is determined by counting the number of years a portfolio causes the Avoid Employer Cost Plan employer cost to exceed (breaches) 50% of pay. A 15-year horizon is utilized and each Spikes portfolio is examined across 1,000 simulated 15-year periods. The higher the count of breaches, the lower (worse) the portfolio ranking. Single-period measure. Portfolios are ranked by counting the number of years a portfolio causes the two-year average return on assets to fall below 0%. A two-year return below this figure would Avoid Asset Drawdown in result in two years of losses of 7.5% per year relative to the 7.5% assumed rate of return, resulting in a Any Two-Year Period 15% loss in assets below versus the expected level. A 15-year horizon is utilized and each portfolio is examined across 1,000 simulated 15-year periods. The higher the count of breaches, the lower (worse) the portfolio ranking.
Return Oriented Return / Risk Balanced Risk Avoidance
San Joaquin CERA ││ Asset-Liability Study Presentation V 10 Risk Philosophy Review
• Every potential portfolio is scored/ranked on its ability to meet each Decision Factor threshold
• While each Decision Factor has its merits, they may compete against each other
• Each Risk Philosophy offers different Decision Factor prioritization and balance options
San Joaquin CERA ││ Asset-Liability Study Presentation V 11 Risk Philosophy Review
Example of the voting criteria weighting process
SJCERA Interactive Risk Tolerance Voting Session Decision Factors: 1 2 3 4 5 Voters Funding > 85% Funding < 65% Lower Avg Cost Cost Spike > 50% 2-Yr < 0% Totals Steve Bestolarides 20.0% 20.0% 20.0% 20.0% 20.0% 100% Michael Duffy 20.0% 20.0% 20.0% 20.0% 20.0% 100% Cindy Garman 20.0% 20.0% 20.0% 20.0% 20.0% 100% Shabbir Khan 20.0% 20.0% 20.0% 20.0% 20.0% 100% Ray McCray 20.0% 20.0% 20.0% 20.0% 20.0% 100% Michael Restuccia 20.0% 20.0% 20.0% 20.0% 20.0% 100% Dave Souza 20.0% 20.0% 20.0% 20.0% 20.0% 100% J.C.Weydert 20.0% 20.0% 20.0% 20.0% 20.0% 100% Adrian Van Houten 20.0% 20.0% 20.0% 20.0% 20.0% 100% Aggregate Weights 20.0% 20.0% 20.0% 20.0% 20.0% 100%
• SJCERA trustees will establish a customized risk philosophy through a collective “voting” process
San Joaquin CERA ││ Asset-Liability Study Presentation V 12 Decision Factor / Model Output Review
There are two parts to this section:
1. Examining the strategic investment policies that reflect pre-determined example risk philosophies
2. SJCERA trustee voting session
San Joaquin CERA ││ Asset-Liability Study Presentation V 13 Decision Factor / Model Output Review
Preliminary findings:
• Strategic allocations will vary based upon the Board’s definition of its risk tolerance, but tend to show risk / return improvement versus current policy
• The Decision Factor-based approaches lead to allocations where Stable Fixed Income and Private Appreciation have the most variability
• Public Equity is reduced to satisfy all Decision Factors
• Crisis Risk Offset is allocated to its maximum in all scenarios, due to its offset to growth risk (by design), which is highly beneficial in reducing drawdowns (mitigates risk and increases long-term, compound returns)
• Risk Parity receives significant allocations (benefits from a portfolio return)
• In most cases, Stable Fixed Income does not receive a meaningful allocation when “return-driven” factors are given weights
San Joaquin CERA ││ Asset-Liability Study Presentation V 14 Decision Factor / Model Output Review Example 1
• Example 1: 100% to “avoid a < 0% return over a 2 year period” (very risk averse)
100%
90% Crisis Risk Offset, 20%
80% Private Appreciation, 4% Lower weight in 70% Credit, 14% private appreciation, 60% higher in Stable Stable Fixed, 18% 50% Fixed Income
40% Risk Parity, 20% 30%
20%
10% Global Equity, 24%
0%
San Joaquin CERA ││ Asset-Liability Study Presentation V 15 Decision Factor / Model Output Review Example 2
• Example 2: A balanced of Risk Aversion and Return Seeking 50% / 50% 100%
90% Crisis Risk Offset, 20% 80% Private Appreciation, 10% 70% Increased weight in Credit, 14% 60% private appreciation Stable Fixed, 4% and risk parity 50% (balanced), taken from Stable Fixed 40% Risk Parity, 28% Income 30%
20%
10% Global Equity, 24%
0%
San Joaquin CERA ││ Asset-Liability Study Presentation V 16 Decision Factor / Model Output Review Example 3
• Example 3: Equal weighting all of the decision factors (only 20% risk aversion) 100%
90% Crisis Risk Offset, 20% 80% Private Appreciation, 12% 70% Increased weight in 60% Credit, 14% private appreciation from risk parity, 50% Stable Fixed, 4% Stable Fixed Income remains at minimum 40% Risk Parity, 26% 30%
20%
10% Global Equity, 24%
0%
San Joaquin CERA ││ Asset-Liability Study Presentation V 17 Decision Factor / Model Output Review Example 4
• Example 4: 100% weighting to risk seeking, no risk aversion
100%
90% Crisis Risk Offset, 20% 80%
70% Private Appreciation, 16% Max weight in private appreciation 60% Credit, 14% from risk parity, 50% Stable Fixed Income Stable Fixed, 4% remains at minimum 40% Risk Parity, 22% 30%
20%
10% Global Equity, 24%
0%
San Joaquin CERA ││ Asset-Liability Study Presentation V 18 Decision Factor / Model Output Review (a continuum)
• A continuum from risk seeking to risk aversion (0% risk averse, 100% risk averse)
100% Crisis Risk 90%
20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% Offset
80% Private 4% 8% 8% 10% 10% 10% 10% 10% 10% 10% 10%
12% 12% 12% 12% 12% 12% 12% Appreciation 14% 14%
70% 16% 14%
14% 14% Credit 60% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 14% 4% 4% 14% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 50% 18% 4% 4%
4% Stable Fixed 40% 30% 30% 28% 28% 28% 28% 28% 28% 28% 28% 26% 26% 26% 26% 26% 26% 26% 24% 24% 22% 30% 20% Risk Parity
20% Global Equity Strategic Class Allocation Percentage Allocation Class Strategic
10% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
0%
Return Seeking Risk Aversion Level Avoid Losses
Compound Return 7.6% 7.6% 7.6% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% 6.7% StDev 10.3% 10.1% 10.1% 9.9% 9.9% 9.9% 9.9% 9.9% 9.9% 9.9% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.5% 9.5% 8.4%
San Joaquin CERA ││ Asset-Liability Study Presentation V 19 Determining the Board’s Risk Philosophy
. Steps in the voting process:
• Step 1: Each Board member will select a set of Decision Factor (DF) weights on a confidential basis; the collection of individual Board member weightings will be posted anonymously for all to review
• Step 2: Once the initial consensus risk philosophy and strategic allocation are determined, individual Board members will reveal their weightings to the rest of the group; each Board member can analyze their own or any other weighting scheme in isolation
• Step 3: Following discussion related to Step 2, Board members will be given the opportunity to redo Step 1 after seeing how certain DF weightings may or may not impact the policy portfolio
• Step 4: The final outcome of Step 3 represents the Board’s risk philosophy; the Board can discuss and possibly make final modification to this risk philosophy
• Step 5: Review the trade offs between different risk philosophies and allocations
San Joaquin CERA ││ Asset-Liability Study Presentation V 20 Despite Our Best Efforts to Bound the Range of Outcomes…
. A wide range of outcomes is still possible in an unpredictable world . We know that we are very unlikely to achieve the average return / path . The future will surprise us
Funding Ratio – Current Allocation (similar qualitatively to all risky allocations) (500 trials, 50 shown; average shown in red; 25th, 75th percentiles in green) 300%
250%
200%
150% FudingRatio
100%
50%
0% 1/1/14 1/1/19 1/1/24 1/1/29 1/1/34 1/1/39 1/1/44 Valuation Date
San Joaquin CERA ││ Asset-Liability Study Presentation V 21 Decisions and Next Steps
A consensus risk philosophy has hopefully emerged, suggesting various portfolio options that correspond
You can choose a portfolio that is “between the lines”, that feels better
Each portfolio option has practical implications for implementation
At the September meeting, PCA will provide a roadmap to deal with these practical implications for implementing the Board’s chosen strategic allocation • Redemptions • Searches • Pacing commitments to private / illiquid investments
Additional modeling can be sought before a new policy portfolio is accepted
San Joaquin CERA ││ Asset-Liability Study Presentation V 22 Appendix: Strategic Class Modeling Assumptions and Detail
San Joaquin CERA ││ Asset-Liability Study Presentation V 23 Appendix: SJCERA Strategic Class Assumptions
Arith. Geom. Strategic Class StDev. Historical Series Notes* Return* Return* 1973-1987 MSCI World Global Public Equity 9.35 19.00 7.55 PCA Global Equity assumption plus 50 basis points* 1988-2014 MSCI ACWI 1973-1977 BC US Govt./Credit PCA Core Fixed Income assumption plus 50 basis Stable Fixed Income 3.35 4.50 3.25 1978-1990 BC Aggregate points* 1991-2014 BC Universal Return assumption is based on historical Sharpe 1973-05/1996 Bridgewater AW Mix Simulation (10% Vol) Risk Parity 8.00 10.00 7.50 ratio adjusted downward and 10% volatility target 06/1996-2014 Bridgewater AW(10% Vol) over a 2.5% cash assumption Bank Loans: 1973-1986 Modeled 1987-2005 Citigroup HY Loan Index 2006-2008 Lehman US HY Loan Index 2009-2014 BC US HY Loan Index Return assumption is based on estimates of default High Yield: adjusted current yield, a 2.5% cash assumption, and 1973-1983 Modeled Credit 6.00 14.40 4.96 historical volatility of underlying series 1984-2014 BC US Corp High Yield Fixed Income Relative Value: Allocation is based upon current policy mix 1973-1989 Modeled 1990-2014 HFRI RV: Corporate Fixed Income CMBS: 1973-1997 Modeled 1997-2014 BC US CMBS Corporate Inv. Grade
Private Appreciation 12.35 26.00 8.97 1973-2014 Venture Capital Journal PVCI PCA Private Equity assumption plus 50 basis points* Treasury Rate Duration Existing CRO is based upon the percentage Trend Following CRO – Existing 8.63 13.28 7.82 allocations to MLM and Bridgewater PA Liquid Alternative Premia Global Macro Proposed CRO is based upon PCA proposed class CRO – Proposed 7.81 11.75 7.24 build, and modeled as 50% Trend, 25% alt premia, See series description on following pages in Appendix and 25% Treasury Duration Each return series is built over a cash assumption of 2.5% Cash 2.50 1.00 2.50 1973-2014 Citigroup 3-Month T-Bills PCA Cash assumption plus 50 basis points* For consistency in asset and liability assumptions, Inflation 3.00 1.25 3.00 1973-2014 CPI PCA has adopted Cheiron’s inflation assumption
*PCA’s generic asset class assumptions assume inflation of 2.5%. Because PCA has adopted Cheiron’s inflation assumption of 3% for this analysis, PCA has adjusted our generic asset class assumptions up by 50 basis points to reflect this inflation assumption difference.
San Joaquin CERA ││ Asset-Liability Study Presentation V 24 Appendix: Adjusted Forward Looking Return Streams
Global Cash Equity Stable FI Risk Parity Credit Priv Appr CRO 1973 3.05 (16.85) (0.41) 3.16 (15.83) (27.13) 30.85 Shading = difficult period for equities 1974 3.31 (27.86) (1.82) 7.61 (21.39) (23.79) 22.48 1975 2.70 34.06 6.25 15.81 30.44 26.24 (9.80) 1976 2.45 13.34 8.45 14.57 29.83 45.57 23.49 1977 2.55 (0.13) 0.08 7.09 1.05 40.32 25.46 1978 3.09 16.56 (1.01) 12.47 (0.53) 46.28 (1.25) 1979 3.92 10.09 (0.66) 18.57 6.42 25.52 18.28 PCA’s forward-looking 1980 4.35 25.52 (0.14) 4.80 4.59 70.32 (1.92) 1981 5.24 (5.23) 2.23 (10.02) (11.14) (7.01) 13.14 1982 4.20 9.04 19.80 8.68 33.68 19.75 28.01 return streams (supplied 1983 3.53 22.04 3.64 17.00 8.48 31.63 0.35 1984 3.83 4.24 8.16 7.70 4.85 (5.00) 15.46 1985 3.22 41.09 12.80 25.94 20.81 6.35 23.89 to Cheiron) as inputs to 1986 2.77 41.72 8.22 16.98 11.05 0.45 11.96 1987 2.68 15.18 (0.10) 3.58 (1.04) 1.87 0.76 1988 2.92 22.46 3.31 12.89 8.11 6.54 5.80 1989 3.44 16.00 7.74 18.55 0.51 3.07 1.14 the Cheiron Model 1990 3.24 (18.80) 3.78 (4.87) (11.55) (3.26) 3.15 1991 2.63 18.30 9.02 15.31 35.52 16.09 0.86 1992 2.03 (6.31) 3.08 2.15 12.36 10.01 (1.02) 1993 1.88 23.37 4.99 22.36 15.22 20.53 22.27 Simulations rely on 1994 2.20 3.13 (3.99) (10.61) (5.51) 5.20 (8.75) 1995 2.63 17.84 10.37 20.25 16.34 12.46 14.05 1996 2.49 11.46 1.03 20.93 7.28 27.59 17.20 these inputs to estimate 1997 2.49 13.30 4.57 10.87 8.51 22.63 9.80 1998 2.44 20.40 2.93 (4.47) (2.42) 18.01 14.35 1999 2.35 25.38 (1.83) 11.39 (0.48) 72.96 (18.32) 2000 2.69 (16.23) 5.27 6.22 (5.59) (24.76) 7.29 1000’s of portfolios to 2001 2.17 (18.22) 3.45 (8.25) 2.57 (21.70) 2.77 2002 1.49 (21.34) 4.61 6.44 0.85 (29.50) 14.48 2003 1.32 33.31 1.94 12.39 20.17 48.61 8.82 judge / rank them on 2004 1.37 14.06 1.37 13.30 7.05 14.07 4.58 2005 1.86 9.60 (0.13) 11.34 0.14 3.44 3.81 2006 2.35 19.95 1.37 (1.75) 5.58 7.08 6.52 financial criteria versus 2007 2.35 10.42 2.39 7.91 (2.02) 8.54 1.99 2008 1.52 (44.66) (0.36) (21.18) (28.08) (39.40) 20.00 2009 1.06 34.11 3.79 5.74 41.04 64.13 (18.56) defined threshold levels 2010 1.05 11.47 2.83 13.26 11.47 14.66 (0.89) 2011 1.04 (8.99) 2.99 13.67 0.86 (5.62) 11.94 2012 1.04 15.13 1.75 10.57 9.79 3.63 (4.86) 2013 1.03 21.90 (2.83) (6.35) 2.99 23.31 (2.43) (i.e. decision factors) 2014 1.03 2.80 1.76 3.98 (0.01) (10.94) 11.07
Arith. Average 2.50 9.35 3.35 8.00 6.00 12.35 7.81 relative to one another Std Dev 1.00 19.00 4.50 10.00 14.40 26.00 11.75
San Joaquin CERA ││ Asset-Liability Study Presentation V 25 Appendix: Generic PCA Assumptions
San Joaquin CERA ││ Asset-Liability Study Presentation V 26 Appendix: Generic PCA Assumptions
San Joaquin CERA ││ Asset-Liability Study Presentation V 27 Appendix: Underlying Strategies for CRO Class
Strategy Description / Definition Treasury securities (bonds) have duration, a measure of their sensitivity to interest rate changes. Since Treasury bonds are considered to be essentially default-risk free, pricing of Treasury bonds benefits from Treasury rate something called price certainty, given a level of yields across the yield curve. That is, all you need to duration price Treasury bonds is the level of interest rates. This means that Treasuries will rise, if interest rates decline, something that they have tended to do in most growth crises. Trend following (trend capture) investing involves going long markets that have been rising and going short markets that have been falling, betting that those trends continue. This strategy is particularly suited to futures markets, where establishing a position long or short is effective zero cost. Opening Trend futures position doesn’t cost anything, but movement of futures prices results in either gains or losses to following the position, which result in a transfer of funds (margin) to or from the position holder. This strategy is often called systematic global macro in its hedge fund form (as opposed to discretionary global macro). Liquid Alternative Risk Premia investing involves going long and short securities and markets, in a market Liquid neutral fashion, to isolate returns historically attributable to the various factors of value, carry, Alternative momentum (cross-sectional), and low-volatility. These factors have historically been rewarded. The Risk Premia reasons ascribed to these structural “excess “ returns vary. Academics and practitioners provide both behavioral- and risk-based explanations, but their historical existence is not in dispute. Global macro strategies focus on investing in instruments whose prices fluctuate based on the changes in economic policies, along with the flow of capital around the globe. These strategies generally focus on financial instruments that are broad in scope and move based on systemic risk. Systemic risk or Discretionary market risk is not security specific. In general, portfolio managers who trade within the context of global Global macro strategies tend to focus on currency strategies, interest rates strategies, and stock index Macro strategies. Discretionary global macro strategies are not systematic (rules-based), but rather rely upon discretionary decisions. Uncorrelated returns produced by global macro managers can rightly be called alpha, but are difficult to model. True alpha is difficult to source and maintain, valuable, and typically expensive.
San Joaquin CERA ││ Asset-Liability Study Presentation V 28 Appendix: CRO Class Component Modeling Detail
• Treasury Duration excess return is the excess return on the 10 year “constant maturity” security for the year is calculated as, the coupon [average of year end rates (e.g. (Dec 1969 rate + Dec 1970 rate)/2)], minus duration times the change in rates, minus the return on cash (T-bills) for the year. The excess return is the return of the strategy in excess of cash. Leverage can be added (subtracted) to increase (decrease) the strategy volatility and return. The Treasuries data in the GRO/CRO class is scaled to match the volatility of longer-maturity Treasuries.
• Trend Capture (or Trend Following) investing involves going long markets that have been rising and going short markets that have been falling, betting that those trends continue. The construction of the data set is an equal weighted combination of 1-month, 3-month, and 12-month time series momentum strategies for 59 markets across 4 major asset classes – 24 commodities, 11 equity indices, 15 bond markets, and 9 currency pairs. Leverage can be added (subtracted) to increase (decrease) the strategy volatility and return.
• Alternative Risk Premium investing involves going long and short securities and markets, in a market neutral fashion, to isolate returns historically attributable to the various factors of value, carry, momentum (cross- sectional), and low-volatility. The excess return is the return of the strategy in excess of cash. Leverage can be added (subtracted) to increase (decrease) the strategy volatility and return.
• Trend Capture and Alternative Risk Premium strategies might be considered active management. However, the strategies modeled here are highly systematic in nature, utilizing rules-based approaches to structuring portfolios and capturing the associated risk premiums.
San Joaquin CERA ││ Asset-Liability Study Presentation V 29 DISCLOSURES: This document is provided for informational purposes only. It does not constitute an offer of securities of any of the issuers that may be described herein. Information contained herein may have been provided by third parties, including investment firms providing information on returns and assets under management, and may not have been independently verified. The past performance information contained in this report is not necessarily indicative of future results and there is no assurance that the investment in question will achieve comparable results or that the Firm will be able to implement its investment strategy or achieve its investment objectives. The actual realized value of currently unrealized investments (if any) will depend on a variety of factors, including future operating results, the value of the assets and market conditions at the time of disposition, any related transaction costs and the timing and manner of sale, all of which may differ from the assumptions and circumstances on which any current unrealized valuations are based.
Neither PCA nor PCA’s officers, employees or agents, make any representation or warranty, express or implied, in relation to the accuracy or completeness of the information contained in this document or any oral information provided in connection herewith, or any data subsequently generated herefrom, and accept no responsibility, obligation or liability (whether direct or indirect, in contract, tort or otherwise) in relation to any of such information. PCA and PCA’s officers, employees and agents expressly disclaim any and all liability that may be based on this document and any errors therein or omissions therefrom. Neither PCA nor any of PCA’s officers, employees or agents, make any representation of warranty, express or implied, that any transaction has been or may be effected on the terms or in the manner stated in this document, or as to the achievement or reasonableness of future projections, management targets, estimates, prospects or returns, if any. Any views or terms contained herein are preliminary only, and are based on financial, economic, market and other conditions prevailing as of the date of this document and are therefore subject to change.
The information contained in this report may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond the control of the Firm, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect PCA’s current judgment, which may change in the future.
Any tables, graphs or charts relating to past performance included in this report are intended only to illustrate investment performance for the historical periods shown. Such tables, graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision.
All trademarks or product names mentioned herein are the property of their respective owners. Indices are unmanaged and one cannot invest directly in an index. The index data provided is on an “as is” basis. In no event shall the index providers or its affiliates have any liability of any kind in connection with the index data or the portfolio described herein. Copying or redistributing the index data is strictly prohibited.
The Russell indices are either registered trademarks or trade names of Frank Russell Company in the U.S. and/or other countries.
The MSCI indices are trademarks and service marks of MSCI or its subsidiaries.
Standard and Poor’s (S&P) is a division of The McGraw-Hill Companies, Inc. S&P indices, including the S&P 500, are a registered trademark of The McGraw-Hill Companies, Inc.
CBOE, not S&P, calculates and disseminates the BXM Index. The CBOE has a business relationship with Standard & Poor's on the BXM. CBOE and Chicago Board Options Exchange are registered trademarks of the CBOE, and SPX, and CBOE S&P 500 BuyWrite Index BXM are servicemarks of the CBOE. The methodology of the CBOE S&P 500 BuyWrite Index is owned by CBOE and may be covered by one or more patents or pending patent applications.
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San Joaquin CERA ││ Asset-Liability Study Presentation V 30 Board of Retirement Financial Meeting San Joaquin County Employees’ Retirement Association
Agenda Item 7.0 July 24, 2015
SUBJECT: Actuarial Valuation and Funding Policy
SUBMITTED FOR: ___ CONSENT l_X_l ACTION ___ INFORMATION
RECOMMENDATION
Staff recommends the Board: • Review the preliminary results of the Annual Actuarial Valuation performed by Cheiron, the plan actuary, as of January 1, 2015. • Give direction to actuary and staff regarding layered amortization and the amortization period(s) to be used. • Defer consideration of direct rate smoothing as an alternative to the current asset smoothing methodology, until the next annual actuarial valuation and triennial experience analysis is performed in 2016.
PURPOSE
For the Board to provide the direction needed for the plan actuary to finalize the annual actuarial valuation report as of January 1, 2015, and make the related revisions to SJCERA’s Funding Policy, which will be submitted to the Board for formal action at a subsequent meeting.
DISCUSSION
Preliminary Valuation Results The preliminary valuations results indicate that the composite employer contribution of 41.41% is consistent with the 41.21% as projected for this year in last year’s actuarial valuation report.
Funding Policy At its Regular Meeting of July 11, 2014, the Board directed that the actuaries use a “19-year closed” (rather than open or “rolling”) amortization period for completing the SJCERA actuarial valuation as of January 1, 2014, to ensure consistency with more recent guidance calling for closed amortization periods and coordinate with new GASB disclosure rules. The actuaries committed to presenting a more comprehensive discussion and recommendation regarding revisions to SJCERA’s Funding Policy prior to finalizing the valuation as of Januaryl1, 2015.
July 24, 2015 Page 2 of 2 Agenda Item 7.0
At the Board’s Financial Meeting held February 27, 2015, Robert McCrory and Graham Schmidt of Cheiron reviewed and discussed SJCERA’s current funding, amortization, and asset smoothing policies. The actuaries recommended the Board incorporate layered amortization into SJCERA’s funding policy, as encouraged by the California Actuarial Advisory Panel and the Conference of Consulting Actuaries. The actuaries agreed to provide the Board further analysis and discussion of the impact of various layered amortization periods on plan cost and funding when the preliminary valuation results as of January 1, 2015 are presented. This information is included in the presentation from Cheiron included in this agenda item.
Smoothing Methodology Also in February, Cheiron presented information about direct rate smoothing for consideration as an alternative to the current asset smoothing methodology, and planned to provide examples under the alternatives discussed to facilitate the Board’s consideration. Subsequently, the actuaries and staff concur on the current recommendation that the Board defer consideration of direct rate smoothing as an alternative to the current asset smoothing methodology until the next annual actuarial valuation and triennial experience analysis are performed in 2016.
Robert McCrory and Graham Schmidt will present the information for the Board’s discussion and action at the Financial Meeting of July 24, 2015.
Any necessary revisions to SJCERA’s Funding Policy will be submitted to the Board for formal action at a subsequent meeting.
ATTACHMENTS
2015 Preliminary Valuation Results and Funding Policy presentation from Cheiron
______ANNETTE ST. URBAIN Chief Executive Officer
San Joaquin County Employees’ Retirement Association
2015 Preliminary Valuation Results and Funding Policy
July 24, 2015
Graham A. Schmidt, ASA, FCA Robert T. McCrory, FSA, CERA, FCA Topics for Discussion
Preliminary 2015 Valuation Results • Executive Summary and Highlights • Changes Since Last Valuation Funding Policy Discussion
July 24, 2015 1 Executive Summary
• Current valuation will determine the CY 2016 contribution rate • Based on asset and membership data on December 31, 2014 • No changes in assumptions or plan provisions • Preliminary results shown using current funding policy (18-year closed amortization period)
July 24, 2015 2 Executive Summary
San Joaquin County Employees' Retirement Association Summary of Preliminary Key Plan Results January 1, 2014 January 1, 2015
Actuarial Liability (AL) $ 3,561.9 $ 3,731.6 Actuarial Value of Assets (AVA) 2,285.2 2,471.3 Unfunded Actuarial Liability (UAL) $ 1,276.7 $ 1,260.3 Funded Ratio (AVA) 64.2% 66.2% Funded Ratio (MVA) 65.3% 65.6% Inactive Funded Ratio 57.5% 59.4%
Contributions as a Percentage of Payroll Normal Cost Rate 17.28% 16.86% Unfunded Actuarial Liability Rate 23.74% 23.63% Administrative Expense 0.91% 0.91% Total Contribution Rate 41.93% 41.40% Total Contribution Rate after Phase-In 39.69%
July 24, 2015 3 Preliminary Results - Highlights
• Not much changed during 2014. The 2015 employer contribution, 41.41% of payroll, is close to what was projected last year, 41.21% of payroll.
• Investment return on the market value of assets was 4.7%, net of investment expenses, compared to the 7.50% assumed rate of return
• The actuarial return on valuation assets was 7.47%
• Increases in pay among active members were lower than anticipated in 2014, resulting in an Actuarial Liability gain of roughly $36.7 million
• Normal cost rates decreased slightly (by ~0.4%) as PEPRA members replace Legacy members
• Results have not yet been subject to full peer-review process
July 24, 2015 4 Funding Policy • Current Policies: – Actuarial smoothing of assets used to compute contribution rates • Spread investment gains/losses over five years • Remain within 20% of market value – Special closed amortization base for the 2008 losses • 25 years remaining as of the 2014 valuation – Unfunded Actuarial Liability amortized over a closed period • Payments computed as a level percentage of payroll • 19 years remaining as of the 2014 valuation
July 24, 2015 5 Funding Policy • Consider potential changes in funding policy • UAL Amortization • With closed amortization period, need to develop policy to deal with future changes in unfunded liability (layers) • Consider appropriate length of period • Smoothing • Consider Asset-only vs. Direct Rate Smoothing
July 24, 2015 6 UAL Amortization
• Conference of Consulting Actuaries (CCA) and California Actuarial Advisory Panel (CAAP) both encourage use of layered, level-percentage of pay amortization • For actuarial gains/losses: • Layers of 15-20 years is “Model – Most consistent with the level cost allocation model”
• Layers up to 25 years is “Acceptable, with Conditions”
• Layers of 26-30 years is “Not Recommended”
• Layers greater than 30 years are “Unacceptable” (also may violate CERL)
July 24, 2015 7 UAL Amortization
• For assumption and method changes, CCA/CAAP recommends 15-25 year layers • Argument for wider range based on re-measurement of liabilities to reduce future anticipated gains/losses • For benefit changes, recommendations call for:
• Shorter of 15 years or expected future working lifetime of affected members for active changes
• Shorter of 10 years or average expected remaining lifetime of affected members for retiree changes
• Changes to past service benefits largely prohibited under PEPRA
July 24, 2015 8 UAL Amortization
• Interest on unfunded liability will exceed payment if period exceeds 19 years
• Length of gain/loss amortization periods for other ‘37 Act counties using layered, level percentage of pay amortization • 15 years: 6 counties • 18 years: 3 counties • 20 years: 7 counties • 25 years: none (used by CalPERS) • 30 years: 1 county (LACERA); also used by UC system
July 24, 2015 9 Amortization Modeling
• Measure potential impact of different amortization periods on future contribution rates, funded status, and annual expected change in contributions • Based on preliminary assets, liabilities, assumptions, and methods as of December 31, 2014, including 5-year asset smoothing (ignoring AVA/MVA corridor) • Use Monte Carlo simulation (1000 trials) to produce “nth percentile” results for contribution rate and funded status in a given year • Also compute average and standard deviation of annual increase in contribution rate over an n-year period • Based on expected return (7.50%) and asset volatility assumptions from PCA, the “nth percentile” and standard deviation would represent the following level of returns over one, five, and ten year periods from our simulation: One Year Five Year Ten Year 50th Percentile 7.7% 7.6% 7.4% 80th Percentile -2.2% 3.1% 4.3% 95th Percentile -9.7% -0.5% 2.0% Standard Deviation 11.7% 5.2% 3.7%
July 24, 2015 10 Amortization Modeling - Current
July 24, 2015 11 Amortization Modeling Actuarial Cost (% of Pay) Determined in 2025 Valuation Percentile Current Alt #1 = Alt #2 = 15 Alt #3 = 20 Policy 12 Year Layers Year Layers Year Layers
50% 39.2% 38.7% 38.8% 38.7% 80% 60.2% 59.0% 55.6% 52.2% 95% 75.4% 73.3% 67.3% 61.6% Funded Ratio in 2025 Percentile Current Alt #1 = Alt #2 = 15 Alt #3 = 20 Policy 12 Year Layers Year Layers Year Layers
50% 81.3% 81.6% 81.3% 81.4% 80% 67.9% 68.1% 67.1% 66.2% 95% 58.3% 59.4% 57.6% 56.1%
July 24, 2015 12 Amortization Modeling
Annual % of Pay Increase* in Contribution Rate (2015-2025)
Current Alt #1 = Alt #2 = 15 Alt #3 = 20 Measure Policy 12 Year Year Layers Year Layers Layers Average 1.1% 1.1% 0.9% 0.7% Annual Increase Average Annual Increase Plus One 5.0% 3.7% 3.6% 2.5% Standard Deviation 95th Percentile 9.6% 6.7% 5.7% 4.5% Annual Increase
* Years with no change or contribution decline included as 0% increase
July 24, 2015 13 Amortization Modeling • Takeaways from modeling: – 20-year layers for future UAL changes provides significant enhancements to volatility management (reduced annual volatility and moderated increases in down markets), while maintaining consistency with “Model” CCA/CAAP/Blue Ribbon Panel recommendations, without significant sacrifice in expected funded ratio – 15-year future layers provides closer match to generational equity and maintains consistency with recommendations, but more contribution volatility – 12-year layers provides closest match to generational equity (current average expected future working lifetime of active employees ~ 11 years), but even more contribution volatility, which is not consistent with “Model” policy under CCA/CAAP (for gains/losses)
July 24, 2015 14 Smoothing Policy
• Goal of smoothing is to produce more stable and predictable contribution rates – Traditional asset smoothing operates by deferring a portion of investment gains or losses (use Actuarial Value of Assets) – Rate smoothing operates by phasing in contribution rate increases or decreases from any source (adjust UAL amortization schedule) • Discussed as possibility under several guidance documents (CAAP, CCA, Blue Ribbon Panel) • Recently adopted by CalPERS and at least three ’37 Act systems • More practical than before with issuance of GASB 67/68 • Recommend consider Direct Rate Smoothing in conjunction with next Actuarial Valuation and Experience Study
July 24, 2015 15 Next Steps • Provide direction to Actuary on funding policy to complete Actuarial Valuation Report – Amend funding policy as necessary • Present the full 2015 Actuarial Valuation – Perform peer review process – Including final CY 2016 employer and employee contribution rates – Include calculation and projection of General vs. Safety contribution rates
July 24, 2015 16 Required Disclosures
The purpose of this presentation is to present preliminary actuarial valuation results and funding policy considerations for the San Joaquin County Employees’ Retirement Association. This presentation is for the use of the San Joaquin County Employees’ Retirement Board in accordance with applicable law.
In preparing our presentation, we relied on information (some oral and some written) supplied by the San Joaquin County Employees’ Association. This information includes, but is not limited to, the plan provisions, employee data, and financial information. We performed an informal examination of the obvious characteristics of the data for reasonableness and consistency in accordance with Actuarial Standard of Practice No. 23.
We hereby certify that, to the best of our knowledge, this presentation and its contents have been prepared in accordance with generally recognized and accepted actuarial principles and practices that are consistent with the Code of Professional Conduct and applicable Actuarial Standards of Practice set out by the Actuarial Standards Board. Furthermore, as credentialed actuaries, we meet the Qualification Standards of the American Academy of Actuaries to render the opinion contained in this presentation. This presentation does not address any contractual or legal issues. We are not attorneys, and our firm does not provide any legal services or advice.
This presentation was prepared exclusively for the San Joaquin County Employees’ Retirement Association for the purpose described herein. This presentation is not intended to benefit any third party, and Cheiron assumes no duty or liability to any such party.
The actuarial assumptions, data and methods are those that will be used in the preparation of the actuarial valuation report as of January 1, 2015.
The assumptions reflect our understanding of the likely future experience of the Plan, and the assumptions as a whole represent our best estimate for the future experience of the Plan. The results of this presentation are dependent upon future experience conforming to these assumptions. To the extent that future experience deviates from the actuarial assumptions, the true cost of the Plan could vary from our results.
Graham A. Schmidt, ASA, EA Robert T. McCrory, FSA, EA Consulting Actuary Principle Consulting Actuary July 24, 2015 17 Board of Retirement Financial Meeting San Joaquin County Employees’ Retirement Association
Agenda Item 8.0 July 24, 2015
SUBJECT: Proposed Annual Schedule of Projected Contributions by Member Type
SUBMITTED FOR: ___ CONSENT l_X_l ACTION ___ INFORMATION
RECOMMENDATION
Staff recommends that the Board direct the plan actuary to annually provide a schedule of estimated annual employer contribution rates projected for five years specific to the benefits for each member type (General and Safety), in addition to the composite information and projections currently provide in the annual actuarial valuation report prepared for SJCERA. It is anticipated the actuary could provide this new schedule by April 1st each year.
Staff further recommends that the Board approve the proposed first amendment to the Actuarial Consulting Services Agreement with Cheiron, Inc. and adopt Proposed Resolution 2015-07-02 to incorporate this schedule into the services to be provided and amend the fee schedule accordingly.
PURPOSE To enhance the timing, content and usefulness of the actuary’s projections of future years’ retirement plan costs for participating employers separately by member type.
DISCUSSION
SJCERA’s plan year and fiscal year is January 1 through December 31. The annual actuarial valuation as of January 1st each year is completed in late fall of the same year. The employer and employee contributions rates reported in the valuation are adopted not later than December of the same year, and are applicable for the immediately following calendar year January 1 through December 31.
The fiscal year for SJCERA participating employers is July 1 through June 30. It is SJCERA’s understanding that the County and most participating employers begin their budgeting cycle in the Spring for the fiscal year that begins July 1st,, and use the current year’s contribution rates to determine the amount to budget for pension costs for the first six months of the budget year (July through December), and then apply the contribution rate for the subsequent year as projected by the latest valuation report to estimate pension costs for the last six months of the budget year (January through June).
July 24, 2015 Page 2 of 2 Agenda Item 8.0
For employers who do not employ both General and Safety members, the composite employer contribution rate projections in the annual valuation report are less useful for budgeting and estimating future pension costs. Having the plan actuary provided distinct cost estimates and trend information for the General and Safety plans would better facilitate all employers’ estimates for projecting pension costs through the end of the fiscal year when preparing their annual budgets.
Cheiron has advised that a fairly good estimate of employer contribution rates—General, Safety, and Composite—could be generated quite promptly once SJCERA’s actual prior calendar year investment return, year-end reserve balances, and preliminary income statement is available (generally in March). If approved by the Board, this change would provide cost and trend information to participating employers six to nine months earlier than they are able currently to obtain that information from the final annual actuarial valuation report.
This information would likely benefit all SJCERA participating employers, as most have only General Member employees, or only Safety Member employees, but few employers, other than the County, employ both General and Safety members.
BACKGROUND
This five-year schedule of projected employer costs by plan type was among the requests outlined in a joint letter to SJCERA’s CEO dated March 4, 2015, from the Chiefs of participating Lathrop-Manteca and Waterloo-Morada Fire Protection Districts.
FISCAL IMPACT
Costs for providing the new schedule of projected plan costs and trends by member type were estimated by Cheiron to be $10,000 in the first year for initial set up, and $5,000 for each subsequent year this new schedule is produced.
ATTACHMENTS
Proposed First Amendment to Contract for Actuarial Consulting Services Proposed Resolution 2015-07-02
______ANNETTE ST. URBAIN Chief Executive Officer
FIRST AMENDMENT TO ACTUARIAL CONSULTING SERVICES AGREEMENT Between CHEIRON, INC. and SAN JOAQUIN COUNTY EMPLOYEES' RETIREMENT ASSOCIATION
Pursuant to Paragraph 7, ''Amendment," of the Actuarial Consulting Services Agreement effective January 1, 2015, the following provisions are hereby amended as specified:
Section 2, Scope of Services, paragraph A.1.c is amended to read:
The Valuation will contain a projection of future plan funding. If the economic assumptions differ from those used in the prior year's Valuation, Cheiron will produce valuation results using both the old and new assumptions.
Cheiron will provide separate employer rates and trends for the cost of the Safety plan and the cost of the General plan when preparing the Valuation.
Section 3, Fees and Payment, is amended to read:
Item 2015 2016 2017 2018 2019 Annual Retainer Fee, payable quarterly $9,750 $9,975 $10,225 $10,500 $10,750 Annual Fee for calculation of benefit limits 6,575 6,725 6,900 7,075 7,250 under Section 415 of the Internal Revenue Code, payable quarterly Annual Actuarial Valuation of Pension Plan 49,000 50,125 51,250 52,375 53,500 Separate contribution rates and trends for 10,000 5,000 5,000 5,000 5,000 the General and Safety plans Stand-alone Annual GASB Report, 12,500 12,750 13,000 13,250 13,500 including roll forward of liabilities and related computations Actuarial Experience Studies for the Plan 50,125 54,000 years from 2013 through 2015 and 2016 through 2018 Benefit projections for all active members to 5,225 5,350 5,500 5,625 5,775 be used for annual statements
All other terms and conditions of the original agreement shall remain in full force and effect throughout the term of this agreement as amended herein.
(Remainder of page intentionally left blank; signature page follows)
FIRST AMENDMENT TO CONTRACT FOR ACTUARIAL CONSULTING SERVICES
SIGNATURE PAGE
BY THE SIGNATURES affixed below, this First Amendment to the January 1, 2015 contract is hereby accepted as to all the terms and conditions:
For the Client: For the Consultant: SAN JOAQUIN COUNTY CHEIRON, INC. EMPLOYEES’ RETIREMENT ASSOCIATION
By: ______By: ______
Name: Raymond McCray Name: Gene M. Kalwarski Title: Chairperson, Board of Retirement Title: Chief Executive Officer
Date: ______Date: ______
APPROVED AS TO FORM:
By: ______Name: Andrew Eshoo Title: Deputy County Counsel San Joaquin County
Date: ______
San Joaquin County Employees' Board of Retirement Retirement Association Resolution
RESOLUTION TITLE: FIRST AMENDMENT TO ACTUARIAL CONSULTING SERVICES AGREEMENT
RESOLUTION NO.: 2015-07-02
WHEREAS, the San Joaquin County Employees’ Retirement Association (SJCERA) was established as a public sector defined benefit retirement system under County Ordinance 485 on the 29th day of April, 1946, pursuant to the County Employees’ Retirement Law of 1937 (California Government Code Title 3, Division 4, Part 3, Chapter 3 and 3.9 Sections 31450-31899.10); and
WHEREAS, the Board of Retirement has retained Cheiron, Inc., to perform actuarial services and consulting for SJCERA; and
WHEREAS, Cheiron has assisted the Board of Retirement in conducting actuarial valuations and experience studies and is therefore familiar with the requirements of the 1937 Act as well as the benefits provided by SJCERA; and
WHEREAS, all participating employers in SJCERA have a July to June fiscal year, while SJCERA has a January to December plan year and fiscal year, and the timing of the issuance of the final annual valuation report for the plan is less than optimal for participating employers’ budget cycles; and
WHEREAS, some SJCERA participating employers have requested that a separate schedule of cost and trend information specific to the benefits for each member type (General and Safety) and projected for five years be provided by April 1st each year to assist employers in preparing annual budgets; and
WHEREAS, Cheiron has advised that a reasonably good estimate of employer contribution rates—General, Safety, and Composite—could be generated quite promptly once SJCERA’s actual prior calendar year investment return, year-end reserve balances, and preliminary income statement is available (generally in March); and
WHEREAS, staff has advised that this information may benefit all participating employers, as many non-County employers have the majority of members in either the Safety or General plans, but few have members in both plans; and
WHEREAS, Cheiron has estimated both the initial and ongoing costs for such an additional schedule prepared for SJCERA;
SJCERA Board of Retirement Resolution No. 2015-07-02
NOW, THEREFORE, BE IT RESOLVED that the Board hereby approves the First Amendment to the Actuarial Consulting Services Agreement to:
1) Specify that Cheiron will annually provide a separate schedule of estimated annual employer contribution rates projected for five years specific to the benefits for each member type (General and Safety), in addition to the composite information and projections currently provide in the annual actuarial valuation report prepared for SJCERA.
2) Add a line item to the fee schedule specifying a cost of $10,000 in the first year, and $5,000 for each subsequent year of the agreement to provide the new, separate schedule of estimated costs by plan type.
PASSED AND APPROVED by the Board of Retirement of the San Joaquin County Employees' Retirement Association on the 24th day of July, 2015.
AYES:
NOES: ______RAY McCRAY, Chair ABSENT: Attest:
ABSTAIN: ______MICHAEL RESTUCCIA, Secretary PCA INVESTMENT MARKET RISK METRICS
Monthly Report
July 2015 Takeaways
• U.S. growth oriented assets; equity, private equity, and private real estate (on a cap rate basis), are all registering top decile valuation levels relative to their histories.
• Due to recent events in China and Greece, equity volatility (VIX) spiked in late-June / early-July, but still remains below the long-term average level of roughly 20.
• U.S . credit spreads widened during June and early-July.
• Even prior to early-July price declines, international equity valuations were below their historical average valuation levels.
• Interest rate risk, as measured by the duration of the U.S. 10-year Treasury Note, remains near historic highs.
• Commodity prices and breakeven inflation levels indicate that inflation is under control.
• The PCA Market Sentiment Indicator remained neutral. (page 4)
1See Appendix for the rationale for selection and calculation methodology used for the risk metrics.
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 2 Monthly Report - July 2015 Risk Overview
Valuation Metrics versus Historical Range A Measure of Risk
Unfavorable Top Decile Pricing
Average Neutral
Bottom Decile Favorable Pricing US Equity Dev ex-US EM Equity Private Private Private US IG Corp US High (page 5) Equity Relative to Equity Real Real Debt Yield Debt (page 5) DM Equity (page 6) Estate Estate Spread Spread (page 6) Cap Rate Spread (page 8) (page 8) (page 7) (page 7)
Other Important Metrics within their Historical Ranges Pay Attention to Extreme Readings
Top Decile Attention!
Average Neutral
Bottom Decile Attention!
Equity Volatility Yield Curve Slope Breakeven Inflation Interest Rate Risk (page 9) (page 9) (page 10) (page 11)
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 3 Monthly Report - July 2015 Market Sentiment PCA Market Sentiment Indicator (1995-Present)
Positive Positive
Neutral Neutral
Negative Negative
Avoid Growth Risk Growth Risk Neutral Embrace Growth Risk PCA Sentiment Indicator
PCA Market Sentiment Indicator - Most Recent 3-Year Period
Positive Positive
Neutral Neutral
Negative Negative
Information Behind Current Sentiment Reading Avoid Growth Risk Growth Risk Neutral Embrace Growth Risk PCA Sentiment Indicator
Bond Spread Momentum Trailing-Twelve Months Negative Equity Return Momentum Trailing-Twelve Months Positive Agreement Between Bond Spread and Equity Spread Momentum Measures? Disagree Growth Risk Visibility (Current Overall Sentiment) Neutral
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 4 Monthly Report - July 2015 Developed Public Equity Markets U.S. Equity Market P/E Ratio1 versus Long-Term Historical Average 50 45 2000 US Markets 40 Current P/E as of 35 1929 6/2015 = 26.6x 30 1901 25 1966 20 P/E Ratio P/E 15 10 2009 US Markets 5 1981 1921 Long-term Average 0 (since 1880) P/E = 16.6x
1 P/E ratio is a Shiller P/E-10 based on 10 year real S&P 500 earnings over S&P 500 index level.
(Please note the different time scales) Developed ex-US Equity Market P/E Ratio1 versus Long-Term Historical Average2 45 40 35 Average 1982- 6/2015 EAFE 30 Only P/E
= 23.9x 25 Long -Term Average 20 Historical 2
P/E Ratio P/E P/E = 16.9x 15 10
5 Intl Developed Markets Current 0 P/E as of 6/2015 = 15.0x
1 P/E ratio is a Shiller P/E-10 based on 10 year real 2 To calculate the LT historical average, from 1881 to 1982 U.S. data is used as developed market MSCI EAFE earnings over EAFE index level. proxy. From 1982 to present, actual developed ex-US market data (MSCI EAFE) is used.
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 5 Monthly Report - July 2015 Emerging Market Public Equity Markets Emerging Markets PE / Developed Markets PE (100% = Parity between PE Ratios) 275% 250% Russian Crisis, LTCM implosion, 225% currency devaluations Mexican 200% Peso Technology EM/DM 175% Crisis and Telecom World relative PE ratio Financial 150% Crash is in-line with the Crisis historical average 125% 100% 75% 50% Asian Commodity 25% Crisis price runup 0%
Source: Bloomberg, MSCI World, MSCI EMF EM/DM PE Average EM/DM PE Parity
US Private Equity Quarterly Data, Updated to Mar. 31st
Price to EBITDA Multiples Disclosed U.S. Quarterly Paid in LBOs Deal Volume* 250 11.0 (updated to May 31st)
10.0 200
9.0 150 Deal volume
8.0 remains in an upward trend. 100
7.0 Multiples have risen above ($) Billions the pre-crisis highs. 50 6.0
5.0 0
Source: Thomson Reuters Buyouts Source: S&P LCD study, data presented is on 1-month lag * quarterly total deal size (both equity and debt)
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 6 Monthly Report - July 2015 Private Real Estate Markets Quarterly Data, Updated to Mar. 31st Core Real Estate Current Value Cap Rates1 10.0% Core real estate cap rates remain low by 9.0% historical standards (expensive). 8.0% 7.0% 6.0%
5.0% 4.0% 3.0% Core Cap Rate Cap Rate Cap 2.0% LT Average Cap Rate 1.0% 10 Year Treasury Rate 0.0%
Sources: NCRIEF, www.ustreas.gov 1A cap rate is the current annual income of the property divided by an estimate of the current value of the property . It is the current yield of the property. Low cap rates indicate high valuations.
Core Cap Rate Spread over 10-Year Treasury Interest Rate 5.0% Spread to the 10-year Treasury widened due to recent compression of U.S. interest rates.
4.0%
3.0%
2.0%
1.0% Core Cap Rate Spread to Treasuries LT Average Spread Cap Rate Spread Rate Cap 0.0%
Transactions as a % of Market Value Trailing-Four Quarters (a measure of property turnover activity) 20.00%
Activity has plateaued over the 15.00% last 2-year period.
10.00%
5.00%
0.00%
Source: NCREIF, PCA calculation
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 7 Monthly Report - July 2015 Credit Markets US Fixed Income
Investment Grade Corporate Bond Spreads
700
600
500 Investment grade spreads widened slightly during June, but remain below 400 Investment the long-term average level. Grade Bond Spreads 300
200 Average spread
Spread Over SpreadTreasuries (basis points) 100 since 1994 (IG Bonds) 0
Source: LehmanLive: Barclays Capital US Corporate Investment Grade Index Intermediate Component.
High Yield Corporate Bond Spreads 1800
1600
Likewise, high yield spreads 1400 widened during June, but remain 1200 below the long-term average level.
1000 High Yield Bond 800 Spreads
600 Average 400 spread
Spread Over Over points)TreasuriesSpread (basis since 1994 200 (HY Bonds)
0
Source: LehmanLive: Barclays Capital U.S. Corporate High Yield Index.
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 8 Monthly Report - July 2015 Other Market Metrics
VIX - a measure of equity market fear / uncertainty
80.00
70.00 Equity market volatility (VIX) remained compressed throughout 60.00 the majority of June, but spiked near the end of the month to finish near the long-term average level at roughly 18.2. 50.00
40.00
30.00
20.00
10.00
0.00
Source: http://www.cboe.com/micro/vix/historical.aspx
Yield Curve Slope 5.0 The average 10-year Treasury interest rate increased during June. The average short-term rate (the one-year Treasury) remained at low levels (≈ 30 bps). The change in slope over 4.0 the month was up, and the yield curve remains upward sloping.
3.0
2.0
1.0
0.0
-1.0 Yield curve slopes that -2.0 are negative (inverted) portend a recession. -3.0
Source: www.ustreas.gov (10 yr treasury yield minus 1 year treasury yield) Recession Dating: NBER http://www.nber.org/cycles.html
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 9 Monthly Report - July 2015 Measures of Inflation Expectations
10-Year Breakeven Inflation (10-year nominal Treasury yield minus 10-year TIPS yield) 3.00%
2.50%
2.00%
1.50% Breakeven inflation ended June at 1.87%, increasing from the end 1.00% of May. The 10-year TIPS real-yield ticked up to 0.48%, and the nominal 10-year Treasury yield increased to 2.35%.
0.50%
0.00%
Source: www.ustreas.gov
(Please note the different time scales) Inflation Adjusted Dow Jones UBS Commodity Price Index (1991 = 100) 160
140
120
100
80
60 Broad commodity prices ticked up during June, but remain near the 40 lowest levels (inflation adjusted) since the dataset began in 1991.
20
0
Source: Bloomberg Commodity Index, St. Louis Fed for US CPI all urban consumers.
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 10 Monthly Report - July 2015 Measures of U.S. Treasury Interest Rate Risk
Estimate of 10-Year Treasury Forward-Looking Real Yield 10.0
8.0 The forward-looking annual real yield on 10-year Treasuries is estimated at approximately 0.22% real, assuming 10-year annualized inflation of 6.0 2.14%* per year. Year Treasury -
4.0
2.0
0.0 Expected Real Yield Yield Real of 10 Expected
-2.0
Sources: www.ustreas.gov for 10-year constant maturity rates *Federal Reserve Bank of Philadelphia survey of professional forecasts for inflation estimates
10-Year Treasury Duration (Change in Treasury price with a change in interest rates) 9.50 Interest rate risk is off the 30 year high, but not by much. Higher Risk 9.00
8.50 8.00 7.50 7.00 6.50 If the 10-year Treasury yield rises by 100 basis points from today's levels, the capital loss from the change 6.00 in price is expected to be -8.8%.
Year TreasuryDuration Bond 5.50 -
10 5.00 4.50 Lower Risk 4.00
Source: www.ustreas.gov for 10-year constant maturity rates, calculation of duration
PENSION CONSULTING ALLIANCE, LLC. • Investment Market Risk Metrics 11 Appendix
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 1 Appendix
METRIC DESCRIPTION, RATIONALE FOR SELECTION AND CALCULATION METHODOLOGY
US Equity Markets: Metric: P/E ratio = Price / “Normalized” earnings for the S&P 500 Index
To represent the price of US equity markets, we have chosen the S&P 500 index. This index has the longest published history of price, is well known, and also has reliable, long-term, published quarterly earnings. The price=P of the P/E ratio is the current price of the market index (the average daily price of the most recent full month for the S&P 500 index). Equity markets are very volatile. Prices fluctuate significantly during normal times and extremely during periods of market stress or euphoria. Therefore, developing a measure of earnings power (E) which is stable is vitally important, if the measure is to provide insight. While equity prices can and do double, or get cut in half, real earnings power does not change nearly as much. Therefore, we have selected a well known measure of real, stable earnings power developed by Yale Professor Robert Shiller known as the Shiller E-10. The calculation of E-10 is simply the average real annual earnings over the past 10 years. Over 10 years, the earnings shenanigans and boom and bust levels of earnings tend to even out (and often times get restated). Therefore, this earnings statistic gives a reasonably stable, slow-to-change estimate of average real earnings power for the index. Professor Shiller’s data and calculation of the E-10 are available on his website at http://www.econ.yale.edu/~shiller/data.htm. Wehaveusedhisdataasthebaseforourcalculations. Details of the theoretical justification behind the measure can be found in his book Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005].
Developed Equity Markets Excluding the US: Metric: P/E ratio = Price / “Normalized” earnings for the MSCI EAFE Index
To represent the price of non-US developed equity markets, we have chosen the MSCI EAFE index. This index has the longest published history of price for non-US developed equities. The price=P of the P/E ratio is the current price of the market index (the average daily price of the most recent full month for the MSCI EAFE index). The price level of this index is available starting in December 1969. Again, for the reasons described above, we elected to use the Shiller E-10 as our measure of earnings (E). Since 12/1972, a monthly price earnings ratio is available from MSCI. Using this quoted ratio, we have backed out the implied trailing-twelve month earnings of the EAFE index for each month from 12/1972 to the present. These annualized earnings are then inflation adjusted using CPI-U to represent real earnings in US dollar terms for each time period. The Shiller E-10 for the EAFE index (10 year average real earnings) is calculated in the same manner as detailed above.
However, we do not believe that the pricing and earningshistoryoftheEAFEmarketsarelongenoughto be a reliable representation of pricing history for developed market equities outside of the US. Therefore, in constructing the Long-Term Average Historical P/E for developed ex-US equities for comparison purposes, we have elected to use the US equity market as a developed market proxy, from 1881 to 1982. This lowers the Long-Term Average Historical P/E considerably. We believe this methodology provides a more realistic historical comparison for a market with a relatively short history.
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 2 Appendix
METRIC DESCRIPTION, RATIONALE FOR SELECTION AND CALCULATION METHODOLOGY
Emerging Market Equity Markets: Metric: Ratio of Emerging Market P/E Ratio to Developed Market P/E Ratio
To represent the Emerging Markets P/E Ratio, we have chosen the MSCI Emerging Market Free Index, which has P/E data back to January 1995 on Bloomberg. To represent the Developed Markets PE Ratio, we have chosen the MSCI World Index, which also has data back to January 1995 on Bloomberg. Although there are issues with published, single time period P/E ratios, in which the denominator effect can cause large movements, we feel that the information contained in such movements will alert investors to market activity that they will want to interpret.
US Private Equity Markets: Metrics: S&P LCD Average EBITDA Multiples Paid in LBOs and US Quarterly Deal Volume
The Average Purchase Price to EBITDA multiples paid in LBOs is published quarterly by S&P in their LCD study. This is the total price paid (both equity and debt) over the trailing-twelve month EBITDA (earnings before interest, taxes, depreciation and amortization) as calculated by S&P LCD. This is the relevant, high-level pricing metric that private equity managers use in assessing deals. Data is published monthly. US quarterly deal volume for private equity is the total deal volume in $ billions (both equity and debt) reported in the quarter by Thomson Reuters Buyouts. This metric gives a measure of the level of activity in the market. Data is published quarterly.
U.S Private Real Estate Markets: Metrics: US Cap Rates, Cap Rate Spreads, and Transactions as a % of Market Value
Real estate cap rates are a measure of the price paid in the market to acquire properties versus their annualized income generation before financing costs (NOI=net operating income). The data, published by NCREIF, describes completed and leased properties (core) on an unleveraged basis. We chose to use current value cap rates. These are capitalization rates from properties that were revalued during the quarter. This data relies on estimates of value and therefore tends to be lagging (estimated prices are slower to rise and slower to fall than transaction prices). The data is published quarterly. Spreads between the cap rate (described above) and the 10-year nominal Treasury yield, indicate a measure of thecost of properties versus a current measure of thecost of financ ing. Transactions as a % of Market Value Trailing-Four Quarters is a measure of property turnover activity in the NCREIF Universe. This quarterly metric is a measure of activity in the market.
Credit Markets US Fixed Income: Metric: Spreads
The absolute level of spreads over treasuries and spread trends (widening / narrowing) are good indicators of credit risk in the fixed income markets. Spreads incorporate estimates of future default, but can also be driven by technical diiislocations inthefixed income markets. Abnormally narrow spreads (i(relative to historical levels) indicate higher levels of valuation risk, wide spreads indicate lower levels of valuation risk and / or elevated default fears. Investment grade bond spreads are represented by the Barclays Capital US Corporate Investment Grade Index Intermediate Component. The high yield corporate bond spreads are represented by the Barclays Capital US Corporate High Yield Index.
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 3 Appendix
METRIC DESCRIPTION, RATIONALE FOR SELECTION AND CALCULATION METHODOLOGY
Measure of Equity Market Fear / Uncertainty Metric: VIX – Measure of implied option volatility for U.S. equity markets
The VIX is a key measure of near-term volatility conveyed by implied volatility of S&P 500 index option prices. VIX increases with uncertainty and fear. Stocks and the VIX are negatively correlated. Volatility tends to spike when equity markets fall.
Measure of Monetary Policy Metric: Yield Curve Slope
We calculate the yield curve slope as the 10 year treasury yield minus the 1 year treasury yield. When the yield curve slope is zero or negative, this is a signal to pay attention. A negative yield curve slope signals lower rates in the future, caused by a contraction in economic activity. Recessions are typically preceded by an inverted (negatively sloped) yield curve. A very steep yield curve (2 or greater) indicates a large difference between shorter-term interest rates (the 1 year rate) and longer-term rates (the 10 year rate). This can signal expansion in economic activity in the future, or merely higher future interest rates.
Measures of US Inflation Expectations Metrics: Breakeven Inflation and Inflation Adjusted Commodity Prices
Inflation is a very important indicator impacting all assets and financial instruments. Breakeven inflation is calculated as the 10 year nominal treasury yield minus the 10 year real yield on US TIPS (treasury inflation protected securities). Abnormally low long-term inflation expectations are indicative of deflationary fears. A rapid rise in breakeven inflation indicates an acceleration in inflationary expectations as market participants sell nominal treasuries and buy TIPs. If breakeven inflation continues to rise quarter over quarter, this is a signal of inflationary worries rising, which may cause Fed action and / or dollar decline. Commodity price movement (above the rate of inflation) is an indication of anticipated inflation caused by real global economic activity putting pressure on resource prices. We calculate this metric by adjusted in the Dow Jones UBS Commodity Index (formerly Dow Jones AIG Commodity Index) by US CPI-U. While rising commodity prices will not necessarily translate to higher US inflation, higher US inflation will likely show up in higher commodity prices, particularly if world economic activity is robust. These two measures of anticipated inflation can, and often are, conflicting.
Measures of US Treasury Bond Interest Rate Risk Metrics: 10-Year Treasury Forward-Looking Real Yield and 10-Year Treasury Duration
The expected annualized real yield of the 10 year U.S. Treasury Bond is a measure of valuation risk for U.S. Treasuries. A low real yield means investors will accept a low rate of expected return for the certainly of receiving their nominal cash flows. PCA estimates the expected annualized real yield by subtracting an estimate of expected 10 year inflation (produced by the Survey of Professional Forecasters as collected by the Federal Reserve Bank of Philadelphia), from the 10 year Treasury constant maturity interest rate. Durationforthe10-YearTreasuryBondiscalculated based on the current yield and a price of 100. This is a measure of expected percentage movements in the price of the bond based on small movements in percentage yield. We make no attempt to account for convexity.
Definition of “extreme” metric readings
A metric reading is defined as “extreme” if the metric reading is in the top or bottom decile of its historical readings. These “extreme” reading should cause the reader to pay attention. These metrics have reverted toward their mean values in the past.
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 4 PCA Market Sentiment Indicator
Explanation, Construction and Q&A
By:
Pension Consulting Alliance, LLC.
John Linder, CFA, CPA Neil Rue, CFA
PCA has created the PCA Market Sentiment Indicator (PMSI) to complement our valuation-focused PCA Investment Market Risk Metrics. This measure of sentiment is meant to capture significant and persistent shifts in long-lived market trends of economic growth risk, either towards a risk-seeking trend or a risk-aversion trend.
This paper explores:
What is the PCA Market Sentiment Indicator (PMSI)? How do I read the indicator graph? How is the PCA Market Sentiment Indicator (PMSI) constructed? What do changes in the indicator mean?
© 2012 Pension Consulting Alliance, LLC. Reproduction of all or any part of this report is permissible if reproduction contains notice of Pension Consulting Alliance’s copyright as follows: “Copyright © 2012 byPensionConsultingAlliance,LLC.”Informationisconsideredtobereliablebutnotguaranteed. This report is not intended to be an offer, solicitation, or recommendation to purchase any security or a recommendation of the services supplied by any money management organization unless otherwise noted. PCA Market Sentiment Indicator
PCA has created a market sentiment indicator for monthly publication (the PMSI – see below) to complement PCA’s Investment Market Risk Metrics.
PCA’s Investment Market Risk Metrics, which rely significantly on standard market measures of relative valuation, often provide valid early signals of increasing long-term risk levels in the global investment markets. However, as is the case with numerous valuation measures, the Risk Metrics may convey such risk concerns long before a market corrections take place. The PMSI helps to address this early-warning bias by measuring whether the markets are begiiinning to acknowledge key Risk Metrics trends, and / or indicating non-valuation based concerns. Once the PMSI indicates that the market sentiment has shifted, it is our belief that investors should consider significant action, particularly if confirmed by the Risk Metrics. Importantly, PCA believes the Risk Metrics and PMSI should always be used in conjunction with one another and never in isolation. The questions and answers below highlight and discuss the basic underpinnings of the PCA PMSI:
What is the PCA Market Sentiment Indicator (PMSI)? The PMSI is a measure meant to gauge the market’s sentiment regarding economic growth risk. Growth risk cuts across most financial assets, and is the largest risk exposure that most portfolios bear. The PMSI takes into account the momentum (trend over time, positive or negative) of the economic growth risk exposure of publicly traded stocks and bonds, as a signal of the future direction of growth risk returns; either positive (risk seeking market sentiment), or negative (risk averse market sentiment).
How do I read the PCA Market Sentiment Indicator (PMSI) graph? Simply put, the PMSI is a color coded indicator that signals the market’s sentiment regarding economic growth risk. It is read left to right chronologically. A green indicator on the PMSI indicates that the market’s sentiment towards growth risk is positive. A gray indicator indicates that the market’s sentiment towards growth risk is neutral or inconclusive. A red indicator indicates that the market’s sentiment towards growth risk is negative. The black line on the graph is the level of the PMSI. The degree of the signal above or below the neutral reading is an indication the signal’s current strength.
Momentum as we are defining it is the use of the past behavior of a series as a predictor of its future behavior.
PCA Market Sentiment Indicator (1995 ‐ Present)
Positive Positive
Neutral Neutral
Negative Negative
Avoid Growth Risk Growth Risk Neutral Embrace Growth Risk PCA Sentiment Indicator
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 6 PCA Market Sentiment Indicator
How is the PCA Market Sentiment Indicator (PMSI) Constructed?
The PMSI is constructed from two sub-elements representing investor sentiment in stocks and bonds: 1. Stock return momentum: Return momentum for the S&P 500 Equity Index (trailing 12-months) 2. Boodnd yyedield spr ead mooeumentum: Mooeumentum of bond yyedield spr eads (ex cess ofthe measured bond yield over the identical duration U.S. Treasury bond yield) for corporate bonds (trailing 12-months) for both investment grade bonds (75% weight) and high yield bonds (25% weight). The scale of this measure is adjusted to match that of the stock return momentum measure.
The black line reading on the graph is calculated as the average of the stock return momentum measure and the bonds spread momentum measure. The color reading on the graph is determined as follows:
1. If bthboth stktock return momentum and bdbond spread momentum are positive = GREEN (iti)(positive) 2. If one of the momentum indicators is positive, and the other negative = GRAY (inconclusive) 3. If both stock return momentum and bond spread momentum are negative = RED (negative)
What does the PCA Market Sentiment Indicator (PMSI) mean? Why might it be useful?
There is strong evidence that time series momentum is significant and persistent. In particular, across an extensive array of asset classes, the sign of the trailing 12-month return (positive or negative ) is idiindica tive of ftfuture returns (iti(positive or negative ) over thenext 12 month peridiod. The PMSI is constructed to measure this momentum in stocks and corporate bond spreads. A reading of green or red is agreement of both the equity and bond measures, indicating that it is likely that this trend (positive or negative) will continue over the next 12 months. When the measures disagree, the indicator turns gray. A gray reading does not necessarily mean a new trend is occurring, as the indicator may move back to green, or into the red from there. The level of the reading (black line) and the number of months at the red or green reading, gives the user additional information on which to form an opinion, and potentially take action.
I Momentum as we are defining it is the use of the past behavior of a series as a predictor of its future behavior.
ii “Time Series Momentum” Moskowitz, Ooi, Pedersen, August 2010 http://pages.stern.nyu.edu/~lpederse/papers/TimeSeriesMomentum.pdf
PENSION CONSULTING ALLIANCE, LLC.• Investment Market Risk Metrics 7 SJCERA Manager Review Schedule Most Recent PCA Memo Under Scheduled Onsite Onsite Date Most Recent Presented to SJCERA Staff / Manager Asset Class Review Last Rvw Next Rvw Visit Date Completed Visit to PCA Board Board Meeting Comments Mgr. Location KBI Global Equity Yes 5/18/2015 7/1/2015 6/10/2015 5/8/2015 Dublin, Ireland BlackRock Large Cap Core Summer/Fall 2015 San Francisco, CA Legato Small Cap Growth Summer/Fall 2015 San Francisco, CA Capital Prospects Small Cap Value Summer/Fall 2015 Stamford, CT BlackRock Int'l Equity Fall 2015 San Francisco, CA Research Affiliates Int'l Equity 5/15/2015 1/12/2015 6/26/2015 Common clients Newport Beach, CA Research Affiliates Emerging Markets 5/15/2015 1/12/2015 6/26/2015 Common clients Newport Beach, CA Dodge & Cox Fixed Income Summer/Fall 2015 San Francisco, CA Doubleline Fixed Income Fall 2015 3/24/2015 Los Angeles, CA Mesa West Income Summer/Fall 2015 2/11/2015 Los Angeles, CA Mesa West Income Summer/Fall 2015 2/11/2015 Los Angeles, CA Prima Capital Aggregate Winter 2015 Scarsdale, NY Stone Harbor Aggregate Winter 2015 New York, NY Stone Harbor Bank Loans Winter 2015 New York, NY Bridgewater Real Assets 2/19/2015 2/24/2015 Westport, CT Bridgewater Pure Alpha 2/19/2015 2/24/2015 Common clients Westport, CT Crestline Opportunities Fall 2015 Fort Worth, TX Marinus Opportunistic 2/20/2015 6/26/2015 Darien, CT Medley Direct Lending Summer/Fall 2015 3/12/2015 New York, NY Morgan Creek Opportunistic Summer/Fall 2015 Chapel Hill, NC Mount Lucas Opportunistic 6/17/2015 2/10/2015 Newton, PA Ocean Avenue Opportunistic Fall 2015 Santa Monica, CA Raven Capital Opportunistic 5/28/2015 6/26/2015 6/26/2015 Common client New York, NY PIMCO Risk Parity (All Asset AA) 5/11/2015 Common clients Newport Beach, CA Bridgewater Risk Parity (All Weather) 2/19/2015 2/24/2015 Common clients Westport, CT Parametric Risk Parity (Custom) Summer/Fall 2015 6/3/2015 Common clients w/ firm Minneapolis, MN Northern Trust Stif - Cash Summer/Fall 2015 Common clients Chicago, IL
MEMORANDUM
Date: July 24, 2015
To: SJCERA Board of Retirement
From: Pension Consulting Alliance, Inc. (PCA)
CC: David Sancewich – PCA John Linder – PCA Annette St. Urbain – SJCERA Nancy Calkins - SJCERA
RE: Meeting with Mount Lucas Management (MLM)
Recap of PCA onsite meeting to review the MLM Managed Futures strategy
Meeting Date June 17, 2015
Tim Rudderow, CIO Manager Attendees Ray Ix, JR., Marketing, Senior Vice President Gerald Prior, Portfolio Manager
PCA/SJCERA David Sancewich, Principal Attendees
Summary and Findings
PCA met with Mount Lucas Management (MLM) on June 17, 2015 to review the organization and product performance of its Managed Futures mandate on behalf of SJCERA. From PCA’s perspective, the overall MLM team presented effectively and covered the key active philosophy and implementation issues associated with this mandate. As highlighted in the comments below, MLM covered both its business and investment philosophies. MLM is a well-regarded investment organization of seasoned investment professionals located in Newtown, PA.
Meeting Recap and Details
MLM was being interviewed as part of on-going due diligence on behalf of the Managed Futures strategy currently being managed for SJCERA.
1
During the on-site visit, PCA met with several individuals of MLM’s senior staff. A full list of MLM’s attendees and presenters, as well as their professional titles and relevant business departments, can be found on the previous page.
During the meeting, the following topics were discussed:
• Overview and update of MLM as a firm • Update of portfolio performance • Portfolio management of the MLM Managed Futures strategy • Demonstration of trading activities
During the meeting, MLM discussed the history of the SJCERA relationship, the history of the firm and why they believe their managed futures strategy has potential to add value given the current market environment (i.e. low interest rates, overvalues equities, e.t.c.). The SJCERA portfolio currently has a 0-10% fee structure with a targeted return of 6-8% and a 10% volatility expectation.
Additional items that PCA requested during the meeting were received after the visit.
Ownership and Organizational Structure
Mount Lucas Management (MLM) is organized as a limited partnership which was founded in 1986 by Tim Rudderow and Frank Vannerson.
MLM is majority held by the partners of the firm and a minority owner called the Goldman Sachs Petershill funds. The investment activities of MLM are led by Mr. Rudderow together with other investment professionals who assist in executing the investment strategy.
Track Record
As of 3/31/2015, MLM managed more than $1.7 billion across 4 firm wide products and has been managing this strategy since 1996.
SJCERA originally funded MLM in January, 2005 and as of March 31, 2015 managed $44.3 million on behalf of SJCERA.
2
MLM Managed Futures Performance Results, 3/31/2015 Manager Mkt Value Asset Class Management Quarter 1 YR 3 YR 5 YR Perf. Inception ($000) Style Date
Global Mount Lucas 44,282 Active 20.6 31.6 8.1 5.8 1/2005 Opportunistic
6% Annual +(10% 91 ------1.5 6.0 6.0 6.0 --- Day TB)
Source: MLM
Based on the table above and below, MLM’s active management track record with SJCERA has been positive. MLM’s ability to add value has varied, having outperformed in one of the last five years. Its most significant underperformance came during 2012. Offsetting this result was MLM relatively strong performance in 2014 where they outperformed the benchmark by 3.6% (360 bps) that year, net of fees.
MLM Managed Futures Performance Results, Net of Fees
Calendar Years
Performance 2014 2013 2012 2011 2010
MLM Managed Futures 9.6 2.5 -3.0 2.5 2.6
6% Annual +(10% 91 Day TB) 6.0 6.0 6.0 6.0 6.0
Difference 3.6 -3.5 -9.0 -3.5 -3.4 Source: MLM
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Investment Philosophy / Value Add (provided by the manager)
The MLM Macro™ trading strategy is designed to capitalize on the broad experience and expertise of the firm’s three senior investment principals who collaborate actively in making investment decisions for the partnership. The strategy reflects both their long histories of successful investing and diverse backgrounds in business, economics, and finance. The fund’s objective is to maximize its expected returns while assuming only manageable risks, i.e., risks between those of equities and those of bonds when measured by the standard deviation of monthly returns. It invests in fixed income, equity, currency and commodity markets throughout the world, primarily through a variety of liquid instruments traded in major financial markets. Instruments used include exchange traded securities, cash, futures, options, and OTC.
Portfolio Construction Process (provided by the manager) The strategy’s competitive advantage has three facets, as follows:
1. Organization – Individual trading results have never been the source of individual compensation at the firm. Everyone is compensated on the results of the firm as a whole. The biggest possible market edge is to not make bad trades and many can be avoided if traders are not forced to trade.
2. Experience – the principals of the firm have been trading in the capital and derivative markets for over 25 years – each. We are, as they say, mature. This is not their first business cycle, their first serious recession. This is not their first financial crisis.
3. Process – they adhere rigidly to their strategy. There is money to be earned in this work, but one must stay on message. That means maintaining risk exposure (not too high OR too low), not selling volatility, and not changing strategy in response to short term movements. If we eliminated the asset class that has done the worst in the previous 3 years, our results would be greatly diminished.
Conclusions:
Mount Lucas’s investment approach is well-supported by research and has a long track record across several market cycles, including the 2008 financial crisis and different market environments. The managed futures strategy is risk controlled, but utilizes a modest level of leverage in the management of the portfolio.
4
DISCLOSURES: This document is provided for informational purposes only. It does not constitute an offer of securities of any of the issuers that may be described herein. Information contained herein may have been provided by third parties, including investment firms providing information on returns and assets under management, and may not have been independently verified. The past performance information contained in this report is not necessarily indicative of future results and there is no assurance that the investment in question will achieve comparable results or that the Firm will be able to implement its investment strategy or achieve its investment objectives. The actual realized value of currently unrealized investments (if any) will depend on a variety of factors, including future operating results, the value of the assets and market conditions at the time of disposition, any related transaction costs and the timing and manner of sale, all of which may differ from the assumptions and circumstances on which any current unrealized valuations are based.
Neither PCA nor PCA’s officers, employees or agents, make any representation or warranty, express or implied, in relation to the accuracy or completeness of the information contained in this document or any oral information provided in connection herewith, or any data subsequently generated herefrom, and accept no responsibility, obligation or liability (whether direct or indirect, in contract, tort or otherwise) in relation to any of such information. PCA and PCA’s officers, employees and agents expressly disclaim any and all liability that may be based on this document and any errors therein or omissions therefrom. Neither PCA nor any of PCA’s officers, employees or agents, make any representation of warranty, express or implied, that any transaction has been or may be effected on the terms or in the manner stated in this document, or as to the achievement or reasonableness of future projections, management targets, estimates, prospects or returns, if any. Any views or terms contained herein are preliminary only, and are based on financial, economic, market and other conditions prevailing as of the date of this document and are therefore subject to change.
The information contained in this report may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond the control of the Firm, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect PCA’s current judgment, which may change in the future.
Any tables, graphs or charts relating to past performance included in this report are intended only to illustrate investment performance for the historical periods shown. Such tables, graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision.
All trademarks or product names mentioned herein are the property of their respective owners. Indices are unmanaged and one cannot invest directly in an index. The index data provided is on an “as is” basis. In no event shall the index providers or its affiliates have any liability of any kind in connection with the index data or the portfolio described herein. Copying or redistributing the index data is strictly prohibited.
The Russell indices are either registered trademarks or tradenames of Frank Russell Company in the U.S. and/or other countries.
The MSCI indices are trademarks and service marks of MSCI or its subsidiaries.
Standard and Poor’s (S&P) is a division of The McGraw-Hill Companies, Inc. S&P indices, including the S&P 500, are a registered trademark of The McGraw-Hill Companies, Inc.
CBOE, not S&P, calculates and disseminates the BXM Index. The CBOE has a business relationship with Standard & Poor's on the BXM. CBOE and Chicago Board Options Exchange are registered trademarks of the CBOE, and SPX, and CBOE S&P 500 BuyWrite Index BXM are servicemarks of the CBOE. The methodology of the CBOE S&P 500 BuyWrite Index is owned by CBOE and may be covered by one or more patents or pending patent applications.
The Barclays Capital indices (formerly known as the Lehman indices) are trademarks of Barclays Capital, Inc.
The Citigroup indices are trademarks of Citicorp or its affiliates.
The Merrill Lynch indices are trademarks of Merrill Lynch & Co. or its affiliates.
FTSE is a trademark of the London Stock Exchange Group companies and is used by FTSE under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. No further distribution of FTSE data is permitted with FTSE’s express written consent.
5
SJCERA - CIO Report July 24, 2015 Calendar Year 2015 Proposed Topics and Meeting Schedule
January 23, 2015 February 27, 2015 March 27, 2015
1. Monthly Perf. (Nov/Dec 2014) 1. Monthly Perf. (January) 1. Monthly Perf. (February) 2. General Investment Consultant 2. Quarterly Reports (Q4) Interviews 3. Real Estate Implementation Plan 3. Discussion on 2015 Roundtable & 4. General Pension Consultant Contract Due Diligence meetings 5. Managed Futures Account - Mt. Lucas General Pension Consultant Plan/Transition 6. Funding Policy Cheiron Transition Data from SIS Asset/Liability Introduction
4. RE Committee Meeting 4. RE Committee Meeting Implementation Plan Quarterly Report
April 24. 2015 May 8, 2015 June 26, 2015
1. Monthly Perf. (March) 1. Monthly Perf. (April) 1. Cash Mgt and Liquidity Policy 2. Quarterly Reports (Q1) 2. Raven Fund III presentation & due diligence 3. Initial Asset Liability Modeling Results & Asset/Liability Study- Class Framework Model Expected and Behavior for all Asset Class Discussion PCA/Cheiron Classes 4. Proposed Outline for All Asset Roundtable 5. Quarterly Reports 6. Reports: Monthly Perf. (May), Due Diligence, CIO, Travel, RE Committee June 4, 2015 RE Committee Quarterly reports & Real Estate Roundtable June 26, 2015 RE Committee July 24, 2015 August 2015 September 25, 2015
1. Model and Consideration of Various August 19 & 20 1. Monthly Perf. (August) Portfolio Options PCA/Cheiron Financial Board meeting 2. Actuarial Valuation and Funding Policy 1. Monthly Perf. (July) Recommendation / Approval of New 2 Quarterly Reports (Q2) Strategic Policy Mix Reports: Due Diligence, CIO, Travel, Reports: Monthly Perf. (June), Due Diligence, RE Committee CIO, Travel, RE Committee Education Session? 10th Annual Roundtable Event RE Committee meeting RE Committee Qtrly Report
October 23, 2015 November 13, 2015 December 11, 2015
1. Monthly Perf. (September) 1. Monthly Perf. (September) 1. Monthly Perf. (October) 2 Quarterly Reports (Q3) 2. Annual Review - RE Delegation Policy Begin Investment Policy Review to Update Policies to Reflect A/L decisions Discussion/Evaluation - 2015 Roundtable Consultant/Actuary Evaluations Begin Risk Parity Review Quarterly RE Committee meeting 1. Quarterly Reports 2. RE Delegation Policy Review \ SJCERA
Topics of Interest to Bring Forward: Alpha Generation (low correlation to equities) Asset/Liabilty Study - March thru September 2015
Recent Topics Brought to SJCERA Board: - Agriculture/Farmland - investment opportunities - October 2014 - Venture & Growth Equity Educational Session - October 2014 - Real Assets Structure - May 2014 - Revisit Infrastructure - Educational Session April 2014 Continue to Monitor—Look for Right Opportunities; Portfolio Fit - Operational Due Diligence - March 2014 – Risk Parity Review - February 2014 – Global Opportunistic Strategies - ongoing – Hired PIMCO All Asset All Authority - October 2013 - Fixed Income—Floating Rate Notes (Bank Loans) - February 2014 - Real Assets (Education and Manager Structure) Review - Infrastructure - April 2014; AA Policy revision for Real Assets - May 2014
\ 2015 CONFERENCES AND EVENTS SCHEDULE 2015
EVENT DATES 2015 REG. WEBLINK EVENT TITLE EVENT SPONSOR LOCATION BEGIN END FEE FOR MORE INFO SACRS Public Pension Investment Jul 26 Jul 29 SACRS Berkeley, CA N/A sacrs.org Management Program
Aug 23 Aug 25 Public Pension Funding Forum NCPERS & IPPS Berkeley, CA $400 ncpers.org
Principles of Pension Management for Aug 25 Aug 28 CALAPRS Malibu, CA $2,500 calaprs.org Trustees at Pepperdine FIS Group's 4th Annual Investment Sep 10 Sep 11 FIS Group San Francisco, CA N/A fisgroup.com Symposium
Sep 24 Sep 25 Public Pensions & Investment Forum Nossaman San Francisco, CA $250 nossaman.com
Sep 30 Oct 2 CALAPRS Adminstrators' Institute CALAPRS Carmel, CA $1,000 calaprs.org
Oct 1 Oct 1 Public Retirement Seminar Public Retirement Journal Sacramento, CA $200 publicretirementjournal.org
Investment Strategies & Portfolio Oct 26 Oct 30 Wharton School of Business Philadelphia, PA $10,000 wharton.upenn.edu Management Oct 1 Oct 2 PIMCO Client Education Seminars PIMCO Newport Beach, CA N/A pimco.com Oct 5 Oct 8 Nov 3 Nov 5 Invesco Real Estate US Client Conf Invesco La Jolla, CA N/A invesco.com
Nov 17 Nov 20 SACRS Fall Conference SACRS San Diego, CA $120 sacrs.org
Printed 7/9/15 2:57 PM PRJ THE PUBLIC RETIREMENT JOURNAL th The Inside Stories on Retirement in California 27 Annual Northern California PUBLIC RETIREMENT SEMINAR October 1st 2015
Join us in Sacramento at the CalPERS Auditorium for a day of in- depth retirement discussions led by leading experts from around the state.
DON’T MISS OUT - REGISTER TODAY! PUBLICRETIREMENTJOURNAL.ORG (916) 341-0848 KEYNOTE SPEAKER John A. Pérez was elected to the Assembly in November, 2008, representing Downtown Los Angeles and communities of East Los Angeles. In January, 2010, his colleagues elected him California’s 68th Assembly Speaker. He was subse- quently reelected in 2010 and 2012, making him one of the longest serving JOHN A. PÉREZ Speakers in the era of term limits. Prior to his service in the Assembly, Speaker SPEAKER EMERITUS Emeritus Pérez was a lifetime member of the Labor Movement, eventually serving as the Political Director for the California Labor Federation. CALIFORNIA STATE In 2010, he successfully blocked former Governor Schwarzenegger’s final budget ASSEMBLY proposal, which would have wiped out 430,000 jobs for police officers, firefight- ers, teachers and nurses. His California Jobs Budget¸ which balanced the budget and created a ten billion dollar private sector job creation fund, forced Gov. Schwarzenegger to agree to a compromise which protected virtually every job eliminated by the initial proposal.
As Speaker, he brought together his colleagues to end California’s era of chron- ic budget deficits. He worked with Governor Brown and members of the Senate to eliminate the structural deficit that left California’s budget imbalanced for more than a decade.
Speaker Emeritus Pérez lead California’s implementation of the Patient Protec- tion and Affordable Care Act. He authored AB 1602, which was signed into law in 2010, creating California’s first-in-the-nation Health Benefits Exchange, Cov- ered California.
He has made affordability and accessibility of higher education one of the most important statewide priorities through passage of the Middle Class Scholarship Act. This effort, which brought together thousands of California’s students and parents, sought to reduce student fees by two-thirds for middle class families, and was later adopted in a modified capacity by the 2013 State Budget. The landmark Middle Class Scholarship Act, has provided tuition relief of up to 40 percent for nearly 100,000 California State University and University of California Students.
In 2012, he was the only state legislative leader in the United States to address the Democratic National Con- vention. In August of 2012, he was elected by fellow Speakers from across the nation to serve as President of the National Speakers Conference. He has previously been appointed by President Bill Clinton and President George W. Bush to serve on the President’s Commission on HIV/AIDS and is a longtime member of the Demo- cratic National Committee. He currently serves as an appointed member of the UC Board of Regents.
LOCATION SEMINAR DATE October 1, 2015 CalPERS Auditorium 400 Q Street 9am - 4pm Sacramento, CA Registration: 8am
Register Today! PUBLICRETIREMENTJOURNAL.ORG
REGISTRATION : $200 Cancellation Policy Full refund if notified by 5pm Includes breakfast, on September 18, 2015 lunch & seminar materials SEMINAR TOPICS Defined Benefits Are Under Attack on current events. How is the PEPRA going to affect bargaining? What will happen on the statewide bal- We will hear from experts about the history behind the lot in 2016? failed attempts to end defined benefit plans and cut pensions for existing workers and the likelihood of a Management and Labor 2016 initiative. We will have attorneys from both sides discussing the CalPERS - Rate Increases on the Horizon? implications of the recent ruling on Chapter 9 bank- ruptcies, concessions at the bargaining table, in- We’ll explore why CalPERS actuaries believe the pen- creases in rates and how that will play into decisions sion fund needs to be taking less risk, and we’ll take made at the state and local level. look at why, when and how contribution rate will in- crease over the next five to ten years, and beyond. Local Agency Bankruptcies - A U.S. Bank- Legislators at Work ruptcy Court Ruling The pension gurus of the Legislature will be on hand Bankruptcy has become a bigger issue for local gov- to discuss the current legislative session - the current ernments that anyone would liked. Speakers will talk political climate, issues of importance, and an over- about those who have gone down this path and view of the bills that may become law by January what it means for employees’ pension benefits and 2016. the employers’ pension liabilities.
Actuarial Realities of Pension Benefits - GASB Retiree Health Care 68, Are You Ready? Are these vested benefits? In the wake of the Afford- able Care Act implementation and the rising costs of Despite politics and legislation, there’s still the reality health care coverage, are your retiree benefits vola- of funding promised benefits. We’ll hear from a top tile? pension actuary about the impact of GASB 68, as public agencies grapple with implementation, other Local Ordinances to Scale Back Pensions changes being discussed by GASB, issues on the hori- We will discuss the legal challenges facing local zon, and other current topics. agencies whose elected bodies vote to either scale
back existing benefits, implement new tiers, or termi- Labor’s Perspective on Retirement - Is a nate their contracts with their retirement systems. Statewide Initiative Expected for 2016? We’ll hear from labor representatives about their take
Stay informed about future seminars and public retirement news.
/publicretirement @Cali_PRJ THE PUBLIC RETIREMENT JOURNAL
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PRJ DELIVER TO: THE PUBLIC RETIREMENT JOURNAL The Inside Stories on Retirement in California
27th Annual Northern California PUBLIC RETIREMENT SEMINAR October 1, 2015 $200
Organization Name: ______
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2015 Estimated BOR Approval Event Dates Sponsor / Event Description Location Traveler(s) Cost Date SACRS Public Pension Investment Jul 26 - 29 Berkeley, CA Van Houten $3,000 Approved by Board Policy Management Program Van Houten, Principles of Pension Management for Aug 25 - 28 Malibu, CA St. Urbain $4,500 Approved by Board Policy Trustees at Pepperdine (as Program Faculty) Sep 24 - 25 Public Pensions & Investment Forum San Francisco, CA Eshoo $1,000 June 12, 2015
Sep 30-Oct 2 CALAPRS Adminstrator's Institute Carmel, CA St. Urbain $2,000 Approved by Board Policy
Printed 7/10/15 11:53 AM SAN JOAQUIN COUNTY EMPLOYEES' RETIREMENT ASSOCIATION
SUMMARY OF COMPLETED TRUSTEE AND EXECUTIVE STAFF TRAVEL
Event Estimated Actual Event Report Dates Sponsor / Event Description Location Traveler(s) Cost Cost Filed 2015 Jan 13 Due Diligence visit Portland, OR St. Urbain, Calkins $1,320 $1,334 N/A Jan 15 Due Diligence visit Santa Monica, CA St. Urbain, Calkins $1,100 $979 N/A 2015 Visions, Insights & Perspectives Restuccia, Garman, Jan 28-30 Dana Point, CA $4,265 $1,977 2/20/15 (VIP) Calkins St. Urbain Advanced Principles of Pension (Audit course as Jan 28-30 Los Angeles, CA $300 $942 N/A Management for Trustee at UCLA CALAPRS Board Member) Garman, McCray, Souza, Weydert, Approved by Mar 7-10 CALAPRS General Assembly Monterey, CA $5,000 $7,392 Duffy, St. Urbain, Board Policy Pabst, Calkins, Mar 17-19 2015 Real Asset Conference Dana Point, CA Calkins $1,950 $1,130 4/10/15 Apr 7-8 Pension Bridge San Francisco, CA McCray, Calkins $2,370 $1,495 6/26/15 Apr 8-9 Miller Global Annual Investor Meeting San Antonio, TX St. Urbain $2,000 $1,387 4/24/15 Approved by Apr 20-21 CALAPRS Management Academy Pasedena, CA St. Urbain $1,250 $385 (as Program Faculty) Board Policy Apr 21-23 IREI Editorial Board Meeting San Diego, CA Garman $1,750 $371 N/A Apr 28-29 Mesa West Annual Investors Meeting Santa Monica, CA Calkins $1,500 $632 6/26/15 Garman, Khan, Mills, Eshoo, St. Approved by May 12-15 SACRS Spring Conference Anaheim, CA $12,000 $8,443 Urbain, Pabst, Board Policy Calkins, May 17-20 World Investment Forum Newport Coast, CA Calkins $1,250 $1,024 6/26/15 May 31 - Jun 3 GFOA Annual Conference Philadelphia, PA Cherng $2,500 $2,305 Pending Jul 20-23 FileMaker DevCon 2015 Las Vegas, NV Claypool $2,850 TBD Pending
Printed 7/13/15 1:54 PM July 2, 2015
Dear Investor:
We are pleased to announce that we are launching Mesa West Real Estate Income Fund IV, L.P. (“Fund IV”). This vehicle carries on the successful lending strategy of our previous three funds which are focused on providing high levels of current income and downside protection to our investors.
We believe Fund IV is well positioned to provide outsized risk-adjusted returns given the demonstrated low volatility of previous Mesa West funds. We expect the return target of 9-11% net to be particularly attractive for investors seeking yield in this low rate environment.
Given that market conditions appear biased toward low rates and low growth, we believe that generating income that meets actuarial yields on a current basis is a prudent strategy for many of our investors. In addition, although growth remains steady we are historically overdue for a market correction and our investment strategy has proven to be a good defensive position to volatility in the overall markets should this occur.
We remain bullish on the supply/demand imbalance in the lending space for our market niche. The recent news of GE Capital exiting the lending space is a tremendous benefit to our market position and we are already seeing direct business as a result. Banks continue to face increased scrutiny and regulation which is steering them toward a very defined lending space. Life insurance companies are already running at maximum capacity. Fannie Mae and Freddie Mac have had restricted activity because of their newly imposed lending limits and are expected to decrease their volume over time.
We continue to view our fund series as a strategic addition to our investors’ portfolios rather than a tactical one. We believe that conservative real estate debt should have a permanent home in any portfolio given the high levels of income and downside protection, plus the ability to deliver yields that are consistent with many plan liabilities.
We anticipate a first closing of Fund IV this fall, ideally consisting of our existing investors who wish to recommit. I will be reaching out shortly to discuss your level of interest in this fund and appreciate any feedback you can provide in terms of timing and size so that we may plan accordingly.
On behalf of Mesa West Capital, thank you so much for your support of our investment strategy. We appreciate the opportunity to continue to work hard on your behalf to deliver the risk and return profile that you desire from us.
Best regards,
Ryan Krauch Principal
11755 Wilshire Blvd. │ Suite 2100 │ Los Angeles, CA 90025 p: (310) 806-6300 │ f: (310) 806-6301 www.mesawestcapital.com Mesa West Real Estate Income Fund IV, LP
Mesa West Real Estate Income Fund I V, LP (“Fund IV”) will continue the successful lending platforms of Mesa West’s Funds I through III by originating a portfolio of custom first mortgage loans on value-added commercial real estate properties.
Facts & Figures Fund Objectives
Firm AUM (3/31/15) $3,445 million • Target IRR of 9-11% net to investors Firm Inception 2004 • Immediate and high current income • Capital preservation in downside Target Fund Size $750 million • First mortgage focus Target Return 9-11% net • Hedge against rising interest rates Minimum Investment $5 million • High quality real estate and sponsorship Portfolio LTV 65-70% • High risk adjusted return in low rate environment
Representative Value Add Investment Properties
$3,500 Firm Assets Under Management Since Inception ($MM) $3,000 $3,233
$2,500
$2,000 $1,883 $1,500 $1,659 $1,433 $1,000 $1,211
$500 $755 $754 $734 $580 $0 $271 YE 05 YE 06 YE 07 YE 08 YE 09 YE 10 YE 11 YE 12 YE 13 YE 14
Los Angeles I New York I Chicago
CONTACT INFORMATION: Ryan Krauch I [email protected] I 310-806-6323
Mesa West Real Estate Income Fund IV, LP
Summary of Terms
THE FUND A closed-end limited partnership, with a subsidiary that will elect REIT status for tax purposes
TARGET SIZE $750 million
TARGET RETURN 9-11% net to investors, predominantly in the form of current income
INVESTMENT OBJECTIVE Provide investors attractive current income and superior risk-adjusted returns primarily by originating first mortgage loans: a) Continue MWC’s Fund’s I, II and III’s focus on directly originating bridge financings for middle-market sized transitional and value-add properties; b) Target primary asset classes of rental multifamily, retail, office, industrial and hotel properties; c) Utilize various financing vehicles to enhance investor returns
MINIMUM INVESTMENT $5 million
INVESTMENT LIMITATIONS Stabilized portfolio loan-to-value of the property investments may not exceed 75% on a weighted- average basis and total capital in any transaction may not exceed 15% of commitments
PORTFOLIO LEVERAGE Portfolio-level financing shall not exceed 4:1. (60% maximum portfolio average LTV)
ASSET MANAGEMENT FEE During the Investment Period, 1.5% of total capital commitments. Following the Investment Period, 1.5% of total unreturned invested equity
DISTRIBUTIONS Cash flow will be distributed quarterly in the following order: 6.5% preferred return; 80/20 thereafter
ADVISORY COMMITTEE To consist of at least five participants. Meetings will be held not less than once per year with the General Partner to consult on issues of concern to the Fund
ORGANIZATIONAL The Fund will bear all organizational and offering expenses, up to $1,000,000 incurred in the EXPENSES formation of the Fund
This is not an offer to buy or sell securities. Please refer to the PPM for additional information Disclaimer: Past results are not necessarily indicative of future performance and there exists a possibility of loss. It should not be assumed that investments made in the future will be profitable or will equal performance referenced within this report. ™ June 2015 FUNDAMENTALS
The Whole Story: Factors + Asset Classes
Every year we invite some of the investment Cam has written about the factor proliferation industry’s most creative thinkers to speak that has resulted from extensive data-mining about their work at the Research Affiliates’ in academia and the investment industry Advisory Panel conference. Along with (Harvey, Liu, and Zhu, 2015; Harvey and Nobel laureates Vernon Smith and Harry Liu, 2015). As of year-end 2014 he and his Jason Hsu, Ph.D. Markowitz, the speakers at our 14th annual colleagues turned up 316 supposed factors
meeting included Campbell Harvey, Richard reported in top journals and selected working
Roll, Andrew Karolyi, Bradford Cornell, papers, with an accelerating pace of new We as a species “ Andrew Ang, Charles Gave, Tim Jenkinson, discoveries (roughly 40 per year). Cam’s “cannot help but give and our very own Rob Arnott.1 The richness approach to adjusting the traditional meaning to noise. of the speakers’ presentations beggars any t-stat is mathematically sophisticated but attempt to summarize them; I’ll limit myself conceptually intuitive. When one runs to the points I found most intriguing and a backtest to assess a signal that is, in illuminating. I also acknowledge that this fact, uncorrelated with future returns, the KEY POINTS account may reflect my own capacity for probability of observing a t-stat greater than
1. Collectively, academics and practi- misinterpretation as much as the genius of 2 is 2.5%. However, when thousands upon tioners run so many backtests that a t-statistic of 2 is no longer suf- the speakers’ actual research. thousands of such backtests are conducted, ficient to validate a factor strategy. the probability of seeing a t-stat greater than 2. Factors with positive premiums Factors Everywhere 2 starts to approach 100%. that do not covary with macro risks make the most attractive Cam Harvey of Duke University’s Fuqua investments. School of Business and the Man Group, who To establish a sensible criterion for hypoth- 3. Emerging markets are underfunded recently completed a 10 year stint as editor esis testing in the age of dirt-cheap comput- opportunities with problems that can affect values by eroding cash of the Journal of Finance, spoke about revising ing power, we need to adjust the t-stat for flows or driving up the discount rate at just the wrong time. the traditional t-statistic standard to counter the aggregate number of backtests that
4. A handful of persistent factors the industry’s collective data-snooping for might be performed in any given year by deliver premiums, but actual new factors. Dick Roll presented a protocol researchers collectively. Recognizing that transactions have to do with assets. Factor- and asset-based for factor identification which helps classify there are a lot more professors and quantita- approaches are incomplete with- out each other. a factor as either behavioral or risk-based in tive analysts running a lot more backtests nature. These two topics are at the center of today than 20 years ago, Cam argued that our research agenda (Hsu and Kalesnik, 2014; a t-stat threshold of 3 is certainly warranted Hsu, Kalesnik, and Viswanathan, 2015). now. Applying this standard of significance,
Media Contacts United States and Canada Europe Hewes Communications JPES Partners (London) + 1 (212) 207-9450 +44 (0) 20 7520 7620 [email protected] [email protected] FUNDAMENTALS June 2015
3. Those that seem to be correlated about factors and less about asset with sources of volatility but don’t classes (Ang, 2014). Andrew argues give rise to excess returns that factors are like nutrients as asset classes are like meals. Ultimately, what Dick proposed an identification scheme we care about are the vitamins, amino which first extracts the macro risk fac- acids, proteins, carbohydrates, and other tors through a principal component nutrients we get from meals.
approach and then determines whether
known factor strategies belong to the CAM HARVEY first, second, or third group. The princi- The newer anomalies“ pal components should be derived from are most likely results Cam also concluded that outside of the “ a large universe of tradable portfolios market factor, the other factors that of datamining. representing diverse asset classes and seem to be pervasive and believable are equity markets as well as proven sys- the old classics: the value, low beta, and tematic strategies. Think of the extracted The beauty of this analogy is that it illus- momentum effects. The newer anoma- principal components as the primary trates wonderfully both the power of the lies are most likely results of datamining. sources of systematic volatility in the factor framework for helping investors economy. A modified Fama–MacBeth invest better and the danger associated I am happy to note that at Research cross-sectional regression approach, with a narrow focus on factor investing Affiliates we adopt an even more draco- which uses only “real” assets to span the while ignoring asset classes. The factor nian approach to research. For example, cross-section, should then be applied to framework tells us that whether we invest Dr. Feifei Li requires a t-stat greater than determine which principal components in U.S., European, Japanese, or Chinese 4 from our more overzealous junior command a premium and which do not. equities, we are exposed to the global researchers. Indeed, as we add to our Then we examine the “canonical” cor- growth factor and earn a risk premium research team and thus the number of relation between the principal compo- associated with that exposure. This is backtests that we perform in aggregate, nents and the various factor strategies of similar to recognizing that whether we we recognize that our “false discovery” interest. This will help us identify which eat a steak, a duck breast, or a salmon rate also increases meaningfully. We factor strategies derive greater returns fillet—seemingly very different meals— must and have developed procedures than their exposure to systematic vola- we are nonetheless eating protein, with for establishing robustness beyond the tility would warrant, and which, in con- little other nutrients like fiber, vitamin C, simple t-stat. trast, derive less return than their expo- or complex carbohydrates. This intuition sure would suggest. For instance, Dick helps us understand more scientifically Richard Roll, who was recently concluded that momentum is almost our portfolio diversification. appointed Linde Institute Professor of certainly a free lunch: it creates excess Finance at Caltech, reminded us that returns without exhibiting any meaning- there are essentially three types of factor ful covariance with true underlying risks strategies: (Pukthuanthong and Roll, 2014).
1. Those that do not appear to be The factor emphasis of the meeting correlated with macro risk exposures continued with Andrew Ang, the yet generate excess returns Ann F. Kaplan Professor of Business at Columbia. Andrew presented a 2. Those that are correlated with framework for factor investing that macro risks and thus produce encourages investors to think more RICHARD ROLL excess returns
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I also wish to offer caution on the investor’s projected cashflow stream. In emerging trend toward “pure” factor this context, Andrew’s risk categories portfolios. Going back to the food/ can help investors decide whether it’s nutrient analogy: would one consider it more appropriate to adjust their discount wise to replace traditional home-cooked rate or their cash flow projections. meals with a chemical cocktail of For example, low investment capacity vitamins and nutritional supplements? generally translates into a higher market Similarly, would factor portfolios price impact than a naïve return forecast constructed from long–short portfolios derived from backtested results would ANDREW ANG based on complex quantitative models suggest. Similarly, foreign investability provide more effective and complete restrictions, such as dividend withholding However, there is a deeper intuition that is access to the essential drivers of taxes or advance funding requirements, unfortunately missed by most proponents long-term returns than asset classes? of factor investing. It is dangerous to I fear the definitiveness of some of often meaningfully reduce investment assume that factor loadings are the the factor gurus—a certainty that can returns as well. Such outcomes are more only salient information in investing; feel like hubris. Here, I suspect that closely associated with high implied I think it is a mistake to assume that we overestimate the current state of transactions costs than with macro risks. portfolios with similar factor exposures knowledge regarding both health and However, political instability can mean are largely identical, irrespective of the economics. that emerging market investments are prices charged. There are numerous high-beta to global growth shocks; and combinations of different assets which Asset Class Champions political instability in resource-intensive result in similar factor exposures, just as Taking us from the equity risk factor countries additionally implies high there is a large variety of foods which can domain back to the asset class domain, be combined to create different meals sensitivity to commodity price shocks. Andrew Karolyi, the current editor of providing similar nutrients. While my These co movement risks mean certain the Review of Financial Studies, shared mother cares deeply about the nutrients emerging market investments may the research set forth in his new book, in the meals she prepares, she cares just produce extremely poor performance Cracking the Emerging Markets Enigma. as much about the cost of the ingredients when investors can least afford it. Andrew summed it up well when that go into her dishes. If salmon is on sale he referred to emerging markets as at the supermarket, Mom will prepare a The shift from factor-centric investing “underfunded growth opportunities meal based on salmon. toward strategies centered on asset with problems.” He constructed risk classes continued with Charles Gave’s We need to remember that investors indicators and assigned them to six key talk on current risks in the global econ- transact in the asset space and that there categories: market capacity constraints, omy. Charles’s GaveKal newsletters are are often a dozen different asset mixes foreign investability restrictions, limits which provide exposure to the same on legal protections, operational inef- factor. The successful investor will be ficiencies, corporate opacity, and politi- the one who buys her factor exposures cal instability. cheaply. For example, we can buy global growth by buying emerging market To properly understand these risk stocks or U.S. stocks. Currently, emerging categories, it is useful to distinguish market stocks have a cyclically adjusted between risks that drive co-movement P/E (CAPE) of about 12, and U.S. stocks, and risks that are related to macro risk about 25. Does it not matter whether exposures—in other words, distinguish we purchase global growth through EM between covariance risk and the risk equities or U.S. equities? of potential negative shocks to the CHARLES GAVE
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widely distributed and devoured with demonstrated that conditioning the great interest at our own and many Shiller CAPE on real interest rate and other research shops. Amid a dizzying inflation information sharply improves array of charts and tables, he recom- its forecast accuracy. Essentially, the mended that investors raise cash, sell economy appears to support high CAPEs U.S. and Eurozone assets, and buy when there is modest inflation (about Japanese and Chinese securities. Let 2% to 3%) and a moderate real interest me commend Charles on his intrepid rate (3% to 4%). As the rates of inflation
short-term forecasting. I must confess and real interest diverge from these ROB ARNOTT that, as a two-handed economist, I only benign zones, the supportable CAPE have the conviction to report what has declines drastically. The low inflation systematic sources of volatility which occurred on average historically. It’s up and near-zero real interest rate suggest a carry little or no premium. Thus it is to my listeners to conclude, with a leap much lower CAPE for the U.S. economy more than an academic exercise for of faith, that the long-horizon future than current equity prices reflect (CAPE us to determine whether the value/ might rhyme with the past. > 25). This might presage downside U.S. rebalancing premium represents a return equity price risk. to “emotional/psychological” stress—a Professor Karolyi and Monsieur Gave’s
fear premium—or compensation for emphasis on emerging markets helps
The successful taking on more volatility or negative tail explain Research Affiliates’ position. investor will be the one “ risk. We are overweight emerging market “ equities in our portfolios. This decision who buys her factor Finally, we advocate a framework for is easy to understand in light of the exposures cheaply. understanding asset pricing that is Shiller CAPE and our firm’s contrarian simultaneously asset-class- and factor- philosophy. However, in the past three based. We acknowledge that the factor- years, cheap assets have become In Closing based analysis offers powerful insights cheaper. The Shiller CAPE’s poor track I have pointed out, in passing, the points and smartly reduces complexity: dealing record as a valuation measure with of contact between the 2015 Advisory with five primary macro factors is easier predictive power has caused investors Panel attendees’ inquiries into factor than analyzing hundreds of asset classes to question one of the crowning investing and Research Affiliates’ own and investment strategies. However, we achievements of the 2013 Nobel research agenda. Like Cam Harvey, also recognize that information about Laureate in Economics from Yale. we are deeply distrustful of the factor factor exposures is insufficient for guid- But Rob Arnott and Tzee-man Chow proliferation, which has resulted in a vast zoo of factors numbering more than ing allocation decisions. Similar factor 300 and increasing rapidly. Our own exposures can be arrived at through factor robustness research has led us different asset class mixes. In order to to conclude, as did Cam, that there are create a portfolio with the appropriate only a handful of persistent, investable exposures at an attractive price, we sources of equity returns (Hsu, Kalesnik, also need to understand the valuation and Viswanathan, 2015). Like Dick Roll, levels at which the different assets trade. we wish to increase exposure to reliable Factor-based investing and its comple- sources of returns which do not exhibit ment, asset-class-based investing are, in high covariance with systematic risk our mind, incomplete descriptions of the world without each other. ANDREW KAROLYI factors, and to eliminate exposures to
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Endnote 1. I also gave a talk based on a forthcoming paper I co-authored with Brett W. Hsu, Jason, Brett W. Myers, and Ryan Whitby. Forthcoming 2016. “Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Myers of Texas Tech University and Ryan Whitby of Utah State University Strategies.” Journal of Portfolio Management. Available at: http://papers.ssrn. (2016). The paper presents, in considerably greater detail, research that com/sol3/papers.cfm?abstract_id=2560434. Vish Viswanathan and I introduced in “Woe Betide the Value Investor” (2015): the average investor in value mutual funds squanders the value Hsu, Jason, and Vitali Kalesnik. 2014. “Finding Smart Beta in the Factor Zoo.” premium by attempting to time the market. This finding implies that the Research Affiliates (July). value premium is likely to persist, with high capacity, because value inves- tors themselves are financing it. Hsu, Jason, Vitali Kalesnik, and Vivek Viswanathan. 2015. “A Framework for Assessing Factors and Implementing Smart Beta Strategies.” Journal of Index References Investing, vol. 6, no. 1 (Summer):89–97. Ang, Andrew. 2014. Asset Management: A Systematic Approach to Factor Investing. New York, NY: Oxford University Press. Hsu, Jason, and Vivek Viswanathan. 2015. “Woe Betide the Value Investor.” Research Affiliates (February). Harvey, Campbell R., and Yan Liu. 2015. “Backtesting.” Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2345489. Karolyi, Andrew. 2015. Cracking the Emerging Markets Enigma. New York, NY: Oxford University Press. Harvey, Campbell R., Yan Liu, and Heqing Zhu. 2015. “…and the Cross- Section of Expected Returns.” Available at http://papers.ssrn.com/sol3/papers. Pukthuanthong, Kuntara, and Richard Roll. 2014. “A Protocol for Factor Identification.” cfm?abstract_id=2249314. Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2342624.
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