Memorandum

To: Board of Trustees, Fresno County Employees’ Retirement Association From: Jeffrey MacLean, CEO & Senior Consultant Date: February 5, 2020 RE: Education Presentation: parity presented by

As part of periodic Board due diligence and education efforts, Verus and FCERA staff have coordinated with Invesco to provide additional education to the Board on how risk parity strategies work and the rationale for adding them to the .

The goal of this presentation is not to determine whether to hire Invesco, rather, we thought it would be helpful for the Board to gain additional insight into what risk parity is and how it works before determining whether to incorporate an allocation into the strategic long-term .

Should the Board ultimately decide to adopt an allocation that includes risk parity, Verus can facilitate a formal search process that includes three to five of the leading firms and products for further Board consideration.

Presentation Details

Presenting: Michael McHugh, CFA, Client Portfolio Manager

Delia M. Roges, Managing Director

Risk parity is a portfolio construction methodology that seeks to generate returns through persistent exposure to global equity, global fixed income, and global inflation-protected assets. Unlike traditional portfolios where portfolio construction is based on diversifying based on capital allocations, risk parity seeks to align portfolio exposures such that each major produces an equal contribution to total risk.

Invesco’s presentation will educate the Board on how risk parity strategies work. Specifically, the presentation will look at how a risk parity portfolio is constructed, including the use of leverage, the expected risk/return profile of the strategy versus a traditional portfolio, and the underlying rationale of investing in risk parity strategies.

Past performance is no guarantee of future results. This document is provided for informational purposes only and is directed to institutional clients and eligible institutional counterparties only and is not intended for retail investors. Nothing herein constitutes investment, legal, accounting or tax investment vehicle or any trading strategy. This document may include or imply estimates, outlooks, projections and other “forward-looking statements.” No assurance can be given that future results described or implied by any forward looking information will be achieved. Investing entails , including possible loss of principal. Verus Advisory Inc. and Verus Investors, LLC (“Verus”) file a single form ADV under the United States Investment Advisors Act of 1940, as amended. Verus – also known as Verus Advisory™ or Verus Investors™.

SEATTLE | LOS ANGELES | SAN FRANCISCO | VERUSINVESTMENTS.COM A Discussion of Risk Parity Concepts and Considerations

Fresno County Employee Retirement System

For educational purposes only with FCERS

All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments there are associated inherent risks.

This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please read all financial material carefully before investing. For additional educational information about the strategy, contact Invesco. Past performance is not indicative of future results. This portfolio is actively managed. Portfolio holdings and characteristics are subject to change. The opinions expressed herein are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Investment products offered are Not FDIC Insured, May Lose Value, and are Not Bank Guaranteed. Invesco Advisers, Inc. is an investment adviser and does not sell securities. It is an indirect, wholly owned subsidiary of Invesco Ltd. 01/20 NA1310 Invesco Global Asset Allocation

For educational purposes only with FCERS Invesco Global Asset Allocation Investment strategies

Research Focus Asset Class Focus Strategies

Multi-Asset Suite

. Risk Allocation and Less More Management – balance Tactical Tactical risk exposures and create . Equities well-defined risk budgets Balanced-Risk Global Allocation Macro . Fixed Income Allocation (1/14)* Allocation . (9/08)* $0.2 Billion (9/12)* Purpose-built Portfolios – $16.3 Billion $0.7 Billion improve the expected . Commodities within asset classes Focused Outcomes Inflation Income Factor . Tactical Allocation – Implement primarily with futures and other derivatives Balanced-Risk Multi-Asset Commodity emphasize attractive assets Commodities Income Style Premia and de-emphasize providing ample liquidity (9/08)* (12/11)* (2/19)* unattractive assets though will adjust where client $2.3 Billion $3.0 Billion $0.1 Billion outcomes require (e.g., income) Equity Suite Portable Defensive Growth Alpha US Int’l Global US Small Cap (12/17)* (6/18)* (6/18)* Index Plus $5 Million $10 Million $76 Million (9/19)* $292 Million $24.6 Billion AUM**

Source: Invesco as of 12/31/19. *Inception dates. **Total GAA assets include $2.0 billion managed in multi-asset portfolios and eliminates double counting. Assets subject to rounding and may not equal total.

3 For educational purposes only with FCERS What is Risk Parity?

For educational purposes only with FCERS An Improvement on Traditional Asset Allocation

Traditional Risk Parity • Generate attractive • Generate attractive long-term risk long-term risk Goal adjusted return Goal adjusted return

• Diversify assets • Diversify risk across across geography and geography and asset How asset classes How classes

• Allocation policy is • Allocation policy is When revisited infrequently When revisited frequently

5 For educational purposes only with FCERS Asset classes behave differently through economic environments Best Environment For Assets Real Growth Inflation 60% 2/26/10 53.30%

0%

9/30/74 Excess Return Excess -44.96% -60% 25% 3/31/86 19.84%

0% Bonds 7/31/81 Excess Return Excess -12.48% -25% 80% 2/28/74 75.98%

0% Excess Return Excess 4/30/09 Commodities -60.62% -80% 12/73 12/74 12/75 12/76 12/77 12/78 12/79 12/80 12/81 12/82 12/83 12/84 12/85 12/86 12/87 12/88 12/89 12/90 12/91 12/92 12/93 12/94 12/95 12/96 12/97 12/98 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10 12/11 12/12 12/13 12/14 12/15 12/16 12/17 12/18 12/19

Sources: Invesco analysis and DataStream. Time period represented: 11/30//73 – 12/31/19. Rolling 1-year excess return to cash. Commodities are represented by the S&P Goldman Sachs Commodity Index. Bonds are represented by the Barclays Treasury Index. Stocks are represented by the S&P 500 Index. Indices chosen based on length of track record. Past performance is not a guarantee of future results.

6 For one-on-one institutional investor use only Asset class risk, return & correlation Range of portfolio construction approaches

Risk is multi-dimensional. Portfolio construction goal is to build practically optimal portfolios that consider both risk-adjusted returns and risk concentration.

Risk, Return & Correlation Assumptions

Equal-Weighted Balanced-Risk Optimized Solution Solution Solution*

Risk: Unknown Known Known Return: Unknown Unknown Known Correlation: Unknown Known Known

For illustrative purposes only. *The Optimized Solution is theoretical. Past performance is not a guarantee of future results.

7 For educational purposes only with FCERS Risk Parity theory: All assets have the same Sharpe Ratio

MSCI World S&P 500 BBG Barc Global Agg BCOM 2.0

1.5

1.0

yr Rolling) yr 0.5

0.0

Sharpe Ratio (5 - -0.5

-1.0

-1.5

Sources: DataStream and Invesco analysis. Time period represented: 01/31/96 – 12/31/19. MSCI World is the MSCI World Index. S&P 500 is the S&P 500 Index. BBG Barc Global Agg is the Bloomberg Barclays Global Aggregate Index. BCOM is the Bloomberg Commodity Index. Past performance is not a guarantee of future results. 8 For educational purposes only with FCERS Relaxing Constraints to Improve Diversification

Traditional Approach Risk Parity

9 For educational purposes only with FCERS Standard allocations might not be diversified Dollar weight vs. risk weight

Traditional balanced portfolios* lack diversification risk drives portfolio behavior

80% Correlation: 0.98 Dollar Weight ≠ Risk Contribution 60% Bond risk 40% 10% Bonds Dollar 20% 40% weights returnyr - drive risk Stocks 0% 60% allocation Stock risk 90% -20% Rolling 1

-40% Global Stocks 60% Stocks / 40% Bonds -60%

. Stock risk dominates a traditional balanced portfolio

. Traditional balanced portfolio highly correlated to stocks

. Equity bull market masks lack of diversification

Sources: Invesco analysis and DataStream. Time period represented: 08/31/73 to 12/31/19. *Traditional balanced portfolio represented by 60% Stocks (MSCI World Index) and 40% Bonds (BBG Barc US Aggregate Bond Index). Over this time period, a hypothetical portfolio of 60% stock and 40% bonds derived 90% of its overall risk from stocks and 10% from bonds based on historical correlations and standard deviations. An investment cannot be made directly in and index. Past performance is not a guarantee of future results.

10 For one-on-one institutional investor use only Outsized Returns for Traditional Allocations

US 60/40 benchmark Excess Return Historical returns over every 8-year period since 1973

140% 1991–1998 120%

100%

80%

60%

40% Total Excess Return 20%

0%

-20% 2001–2008 -40% 0 1 2 3 4 5 6 7 8 Year 2009-2016 2010-2017 2011-2018 2012-2019

Sources: DataStream and Invesco analysis. Time period represented: 1/31/73 – 12/31/19. Past performance is not a guide to future returns. The US 60/40 benchmark is represented by 60% S&P 500 and 40% Bloomberg Barclays Aggregate Index. Each line represents the excess return of the 60% S&P 500 and 40% Bloomberg Barclays Aggregate Index over cash. Based on monthly returns.

11 For educational purposes only with FCERS Risk Parity Approach Diversification framework and objectives

Inflationary Growth Non-Inflationary Growth . High correlation with unexpected . Positive beta to real economic inflation growth Inflation Growth Hedges Assets . Commodities . Developed Equities . Direct Real Estate . Emerging Equities . Infrastructure . Private Equity . TIPS . High Yield/Credit Deflation Hedges

Recession . Effective “shock absorber” during recessions and crises

. Long-Term Government Bonds (hedged)

Source: Invesco analysis. For illustrative purposes only. Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss.

12 For educational purposes only with FCERS Risk Parity vs. Traditional Allocation Asset weight vs. risk weight

1 TraditionalTraditional Balanced Balanced Portfolio Portfolio1 Asset Weight Risk Contribution1 (%) 100 Bonds 80 Bonds

60 Asset weights drive risk allocation Weight (%) 40 Stocks 20 Stocks 0 Risk = 10%

Risk Parity Approach Risk Contribution (%) Representative Asset Weight 160

120 Bonds Commodities Stocks Risk allocation 80 Bonds

drives asset weights Weight (%) Commodities 40 Commodities Stocks Stocks Bonds 0 Unlevered Portfolio Levered Portfolio Risk = 5.9% Risk = 8%*

1 Sources: Invesco analysis and DataStream. Time period represented: 08/31/73 to 12/31/19. Over this time period, a hypothetical portfolio of 60% stocks and 40% bonds derived 90% of its overall risk from stocks and 10% from bonds based on historical correlations and standard deviations. Bonds are represented by the Bloomberg Barclays U.S. Treasury Index. Stocks are represented by the S&P 500 Index. An investment cannot be made directly in an index. Past performance is not a guarantee of future results. 2 For illustrative purposes only. Risk contribution refers to Invesco’s targeted strategic allocation whereby 1/3 of the overall targeted portfolio risk is assigned to various asset classes used within the strategy. *Risk target (standard deviation of monthly returns).

13 For educational purposes only with FCERS What is the Cost of Diversification? Risk parity and conventional portfolios in different cycles

Market Indexes – 5-Years Ended 12/31/08 Market Indexes – 5-Years Ended 12/31/13 Market Indexes – 6-Years Ended 12/31/19

10 14 10 12 8 12.71 8 8.74 10 11.08 10.94 6 6 8 6.42 6.75 4 5.18 6 4 4 2 2 1.80 0.71 2

Annualized Return (%) 0 Annualized Return (%) Annualized Return (%) 0 0 -2 -2 -2 World 60 / 40* US 60 / 40** HFR RP 10% World 60 / 40* US 60 / 40** HFR RP 10% World 60 / 40* US 60 / 40** HFR RP 10% 2 3 4 Return 1.80 0.71 5.18 Return 11.08 12.71 10.94 Return 6.42 8.74 6.75 Risk 9.05 8.04 10.25 Risk 10.41 9.52 7.74 Risk 6.68 6.78 6.81 Sharpe -0.17 -0.32 0.18 Sharpe 1.05 1.32 1.39 Sharpe 0.82 1.15 6.81

Annualized Annualized Max Sharpe Tracking Down Jan 2004 – Dec 2019 (%) Beta1 Correlation1 Up Capture1 Return Risk Ratio Error1 Capture1 1 World Balanced (60/40) Index 6.37 8.74 -35.0 0.57 0.60 0.99 5.83 64.3 54.8

US Balanced (60/40) Index 7.36 8.18 -32.5 0.73 0.55 0.96 6.86 63.4 47.5

HFR RP 10% Instl. Index 7.52 8.28 -22.4 0.74 0.40 0.69 10.55 50.3 27.3

MSCI World Index (net) 7.40 14.33 -54.0 0.42 1.00 1.00 – 100.0 100.0

Data as of 12/31/19. Sources: Bloomberg and Invesco analysis. All periods greater than one year are annualized. Past performance is not a guarantee of future results. *World Balanced 60 / 40 represented by 60% MSCI World Index and 40% Bloomberg Barclays Aggregate Bond Index. **US 60 / 40 represented by 60% S&P 500 and 40% Bloomberg Barclays Aggregate Bond Index. 1 Statistics relative to the MSCI World Equity Index.

14 For one-on-one institutional investor use only Risk Parity Volatility Tends to be More Consistent

Sources: DataStream and Invesco analysis. Time period represented: 03/31/06 – 12/31/19. Global 60/40 is 60% MSCI World Index / 40% BBG Barc Global Agg. Past performance is not a guarantee of future results. 15 For educational purposes only with FCERS Risk Parity Uses/Implementation

• Some large institutions manage Multi-Asset / Specific Risk risk parity in-house Diversifying Parity strategies Allocation • Majority of users implement through an outside manager Model For Entire Plan

Source: Invesco analysis. For illustrative purposes only. Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss.

16 For educational purposes only with FCERS In Closing

Risk Parity May Traditional Risk Parity Is Less Help Investors Allocations Have a Dependent on Achieve Long-Term Weakness Equities Return Targets

Traditional allocations are Risk Parity approaches May deliver higher returns for overly dependent on equity maintain diversification across similar risk, or achieve similar risk and are vulnerable to multiple sources of risk and returns for less risk drawdowns return

The concentrated nature of Higher levels of diversification Risk parity can perform well traditional allocations makes relative to traditional overtime, but will not their returns choppy and hard approaches results in outperform at every point in to stick with in periods of high smoother return patterns time volatility across different environments

17 For educational purposes only with FCERS Additional information

For educational purposes only with FCERS Leverage ≠ Risk

Already Present in Sensible Use of Suspect Use of Most Portfolios Leverage Leverage

Real Estate Modest amounts of High amounts of leverage leverage Private Equity Applied to liquid Applied to illiquid Private Debt instruments assets

Infrastructure In order to maintain In order to magnify an diversification across existing exposure to a Public Equity multiple sources of risk single source of risk

19 For educational purposes only with FCERS Benchmarking Risk Parity What are you seeking to measure

Has the strategy achieved its stated return objective?

• Commercially available risk parity strategies state return and risk targets • Example: T-bills + 6% for 8% volatility

How does risk parity compare to traditional asset allocation methods?

• Traditional allocations are typically allocated across various flavors of stocks and bonds • Example: Global 60/40

How do risk parity managers compare to each other or passive indexes?

• Measures a manager’s relative performance due to implementation choices: • Risk target • Purpose build asset class exposures • Tactical shifts • Risk measurement horizon • Example: HFR Risk Parity Indices, S&P Risk Parity Indicies, Sharpe ratio of individual managers

20 For educational purposes only with FCERS Low frequency of high correlation

Horizon 1 Month 3 Month 12 Months

8.4% 4.5% 1.3%

All assets negative -3.7% --6.0% -7.8% Frequency Return Frequency Return Frequency Return

+16.1%

21.0% 24.4% 34.8% +6.0% All assets +3.1% positive

Frequency Return Frequency Return Frequency Return

. Uncommon for all asset classes to fall simultaneously for extended periods . More common for all to rise, but still only happens one third of the time

Source: DataStream and Invesco analysis. Time period cover 12/31/72 – 12/31/19. Stocks represented by the MSCI World Index, bonds represented by the Bloomberg Barclays 10 Year Treasury Index and commodities represented by the S&P GSCI Commodity Index.

21 For one-on-one institutional investor use only Global Policy Uncertainty

• Policy uncertainty has been on a trend increase since before the financial crisis.

• Unconventional monetary policy has led many observers to speculate about its effectiveness and second order effects during the next recession.

Global Policy Uncertainty Index

Trade 350 Trump Dispute Election 300 Brexit Vote 250 Eurozone GFC Crisis 200 9/11 Asia / Recession LTCM 150

100

50

0 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Source: Baker, Bloom, and Davis.

22 For one-on-one institutional investor use only Thank you

For educational purposes only with FCERS