Real Return Review Lane Transit District Why Are We Reviewing Real Return?
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July 18, 2018 Real Return Review Lane Transit District Why are we reviewing Real Return? In December 2017, RVK provided a downgrade memo for the Fidelity Real Return Fund and recommended a replacement search alongside taking the opportunity to provide a comprehensive review of the Real Return composite. The rationale for a replacement search for the Fidelity Real Return Fund was specifically for the following reasons: • Departure of key personnel • Negative cash flows and AUM decline • Declining competitiveness as peers have reduced fees in recent years Given the above concerns and continued outflows experienced by the Fund, RVK recommends replacing Fidelity with another real return manager. Current LTD Real Return Portfolios Real Return Union Salaried Target PIMCO:All Asset;Inst (PAAIX) $1,678,901 $1,081,123 6.00% Fidelity Strat Rl Rtn (FSRRX) $1,171,299 $749,658 4.00% Total $2,850,200 $1,830,781 10.00% Market Values as of June 30, 2018. Page 2 Introduction What is a “Real Rate of Return”? A real rate of return is the percentage return realized on an investment, which is adjusted for changes in price due to inflation or other external effects. • RVK’s current long-term inflation assumption is 2.50%. Historical inflation rates are shown below. • While recent inflation has been low (near or below the long run average), the US has experienced several periods of high inflation in the past and current break-evens indicate market participants are bracing for upward trending future inflation. Annual US Inflation Return 20% 15% 10% 5% 0% -5% -10% -15% 1926 1936 1946 1956 1966 1976 1986 1996 2006 2016 Annual US Inflation Return Arithmetic Average Annual Return: 2.98% thru Dec-2016 Page 3 Introduction The Role of Real Return/Real Asset Investments in Institutional Portfolios Real Return/Real Asset investments are typically expected to provide: 1. long-term returns in excess of inflation, 2. a return stream that is not highly correlated to traditional assets, and 3. meaningful diversification during periods of rising inflation and/or times of unexpected inflation. Potential Real Return and Real Asset investments include both public (liquid) and private (illiquid) investment strategies and can be both real and financial assets. Public Investments Private Investments • Treasury Inflation Protected Securities • Private Real Estate (TIPS) • Private Natural Resources • Commodities – Oil and Gas, Mining and Minerals, • Master Limited Partnerships (MLPs) Timber, Agriculture, Renewables • Natural Resource Equities • Private Infrastructure • Listed Infrastructure – Transportation, Energy, Power, Water, • Real Estate Investment Trust (REITs) Communications, Social Infrastructure 4 Page 4 Introduction The Role of Real Return/Real Asset Investments in Institutional Portfolios Rising Inflation is a Headwind for Traditional Assets Annualized Real Returns (1974 – 2016) 40.0 35.6 35.0 Rising Inflation Frequency: 18% 30.0 26.9 25.0 21.9 20.0 14.8 15.0 10.0 4.5 5.0 1.9 0.0 -0.4 -0.5 -5.0 World Equity US Fixed Income REIT US TIPS Infrastructure Natural Commodity Gold Resource Equity Sources: RVK, ThompsonOne, Bloomberg, Morningstar, Federal Reserve. Rising inflation is defined as a +0.30% change in the CPI YoY rate from the prior month. Annualized real returns are calculated by subtracting the monthly equivalent of the YoY change in the CPI and annualized returns. 5 Page 5 Real Return Candidates Portfolio Characteristics RVK considered the following investment managers, all of which are currently approved for client use by RVK’s Investment Manager Research Group: Cohen & Steers: PIMCO: Inflation PIMCO: All Asset Fidelity: Strategic Real Assets Multi- Response Multi- Strategy Real Return Strategy Asset Fund (Incumbent) (Incumbent) Fund Assets ($M) $1,171 M $1,259 M $19,801 M $513 M Stated Return CPI + 6-7% 3x CPI CPI + 5% CPI + 2.5% Target Target Volatility 12% 7-8% 6-8% 5-10% Shorting Allowed Yes Yes Yes No •REITs •REITs • Commodities •REITs •TIPS • Commodities • Natural Resource • Commodities • Commodities • Natural Resource Equities • Currency •REITs Allowable Asset Equities • Global Listed • TIPS & Other Bonds • Equities •MLPs Classes Infrastructure •Gold • Fixed Income • Bank Loans • Short Duration • Equity •Alts •TIPS Credit • Currency •Gold Investment Vehicle Commingled Fund Mutual Fund Mutual Fund Mutual Fund Management Fees 0.75%* 0.69% 0.865% 0.81% *Cohen and Steers expense ratio is for the commingled fund. It’s 0.81% for the mutual fund RAPIX. Page 6 Real Return Candidates Asset Allocation Real Return Allocations Allocations for PIMCO All Asset are as of December 31, 2017 due to guidelines set forth by the manager. • 1 - Includes global listed infrastructure. • 2 - Includes real estate related fixed income. Allocation to "Other" consists of cash unless noted: • 3 - Cohen & Steers: Cash and gold • 4 - PIMCO IRMAF: foreign currencies, tail risk hedges & other derivatives • 5 - PIMCO All Asset: tail risk hedges & other derivatives, cash Page 7 Real Return Candidates Trailing Returns and Ranking RR REIT-Comm-US TIPS Blend is a 1/3 weighting to the Bloomberg Commodity, MSCI US REIT and Barclays US TIPS. Performance is gross of fees. Page 8 Real Return Candidates 5 Year MPT Statistics RR REIT-Comm-US TIPS Blend is a 1/3 weighting to the Bloomberg Commodity, MSCI US REIT and Barclays US TIPS. Performance is gross of fees. Page 9 PIMCO Inflation Response Multi-Asset Fund (PIRMX) Fund Snapshot Investment Strategy Product Snapshot The fund is managed by PIMCO's Real Return team and designed to take a Strategy: Inflation Response Multi-Asset comprehensive approach to help hedge inflation risks. The team incrementally Benchmark: PIMCO IRMA Index tilts tactical positioning given relative valuations and considering overall Product AUM: $1.3B portfolio volatility. By investing in a blend of TIPS, Commodities, Currency, Annual Mgmt. Fee: 0.69% Real Estate and Gold, the fund seeks to help preserve and grow purchasing Recommendation: Hire power, enhance portfolio diversification, and guard against market shocks across varying inflation environments. RVK Comments PIMCO is one of the largest U.S. investors in TIPS and is led by a deep and experienced investment team. The Inflation Response Multi-Asset strategy has generally produced positive returns during the recent low inflation environment. The strategy offers exposure to diversifying asset classes under a single fund while offering a relatively low fee compared to its peers. Comparative Fund Performance (Period Ending March 31, 2018) 1 3 5 7 10 2017 2016 2015 2014 2013 2012 Year Years Years Years Years PIMCO:Infl Rsp MA;Inst (PIRMX) 6.04 3.14 0.51 N/A N/A 8.59 10.53 -6.77 1.57 -9.29 9.56 PIMCO IRMA Index 2.65 1.15 -1.28 0.16 1.30 5.08 6.76 -7.47 -0.34 -8.89 6.58 Difference 3.39 1.99 1.79 N/A N/A 3.51 3.77 0.70 1.91 -0.40 2.98 REITS/Commodity/TIPS Blend 0.17 0.01 -0.60 0.77 1.17 3.32 8.72 -8.01 4.26 -5.07 8.00 Difference 5.87 3.13 1.11 N/A N/A 5.27 1.81 1.24 -2.69 -4.22 1.56 Performance is net of fees and product specific. PIMCO IRMA Index consists of 45% Bloomberg Barclays U.S. TIPS Index, 20% Bloomberg Commodity Index Total Return, 15% JPMorgan Emerging Local Markets Index Plus (Unhedged), 10% Dow Jones U.S. Select REIT Total Return Index, 10% Bloomberg Gold Subindex Total Return Index. Page 10 PIMCO Inflation Response Multi-Asset Fund (PIRMX) Historical Asset Allocation Maximum and Minimum Allocations by Policy/Prospectus Fixed Income Equity Securities - Commodity Fixed Income - Equity - Non Inflation Linked REIT Other Natural Resources Contracts/ Index Nominal Real Asset Securities MinMaxMinMaxMinMaxMinMaxMinMaxMinMaxMinMax 0% 25% 0% 50% 0% 70%1 0% 15% 0% 25%2 0% 25% 0% 15% 20 quarters ending December 31, 2017. Allocation to “Other” for PIMCO consists of foreign currencies, tail risk hedges, and other derivatives. 1 - Does not have a prospectus maximum allocation pertaining to inflation-linked bonds, allocation shown is tactical maximum. 2 - Maximum prospectus allocation to "Fixed Income - Nominal" pertains to non-USD bonds. Page 11 LTD’s Current Real Return Composite Overview Non-traditional real return asset classes that are represented elsewhere to varying degrees in other portions of the portfolio (international equity, fixed income and GTAA composites) 35% 30% 25% 20% 15% 10% 5% 0% PIMCO:All Asset;Inst (PAAIX) Fidelity Strat Rl Rtn (FSRRX) Page 12 Recommendation RVK recommends LTD liquidate both the Fidelity Strategic Real Return Fund and PIMCO All Asset Fund and allocate the proceeds to the newly funded PIMCO Inflation Response Multi-Asset Fund for the following reasons: 1. PIMCO IRMAF is run by a strong portfolio management team with a focus on true real return/inflation hedging characteristics 2. Liquidate Fidelity Strategic Real Return for departure of key personnel, current negative cash flow and AUM decline, and declining competitiveness 3. Given the evolution of LTD’s Fixed Income and GTAA composites, which now include managers with overlapping exposures represented within PIMCO AA, RVK believes better true real return exposure can be obtained through a sole allocation to PIMCO IRMAF 4. Overall portfolio fees will be reduced by approximately 15bps as outlined in the graphic below Current Real Return PortfolioTarget Fee PIMCO:All Asset;Inst (PAAIX) 6.0% 0.865% Potential Target Fee Fidelity Strat Rl Rtn (FSRRX) 4.0% 0.80% PIMCO:Infl Rsp MA;Inst (PIRMX) 10.0% 0.69% Total 10.0% 0.84% The recommended portfolio would save approximately 15 basis points a year or $1,500 per $1 million invested.