South Carolina Retirement System Investment Commission 2015-2016 Annual Investment Report Photos courtesy of the Governor’s Office and the SC National Guard. South Carolina Retirement System Investment Commission Annual Investment Report Fiscal Year Ended June 30, 2016 Capitol Center 1201 Main Street, Suite 1510 Columbia, SC 29201 Edward Giobbe, MBA Chair For the period July 1, 2014 - June 30, 2016 Table of Contents Chair Report .....................................................................................................1 Consultant’s Letter ............................................................................................3 Overview ...........................................................................................................5 Commission ......................................................................................................6 Policy Allocation ...............................................................................................9 Manager Returns (Net of Fees) .......................................................................10 Securities Lending ..........................................................................................14 Expenses ..........................................................................................................15 Risk ..................................................................................................................17 Appendix Appendix A: Summary Schedule of Assets and Derivatives .....................19 Appendix B: Cash & Cash Equivalent Holdings .........................................20 Appendix C: Short Duration Holdings.........................................................25 Appendix D: Fixed Income Holdings ...........................................................28 Appendix E: Equity Holdings ........................................................................65 Appendix F: Infrastructure Holdings ........................................................ 129 Appendix G: Alternative Holdings and GTAA ........................................ 130 Appendix H: Futures Holdings ................................................................... 134 Appendix I: Swaps and Options Holdings ................................................ 135 South Carolina Retirement System Investment Commission Chair Report The Honorable Nikki R. Haley, Governor State Fiscal Accountability Authority Members of the General Assembly of South Carolina Dear Ladies and Gentlemen: On behalf of the South Carolina Retirement System Investment Commission (RSIC), it is my pleasure to provide the enclosed report on the investments and operations of the South Carolina Retirement Systems portfolio for Fiscal Year Ending 2016. FYE 2016 Investment Performance Review Capital markets continued to be challenging during the fiscal year as global equity markets, in aggregate, declined. Although large cap domestic equity was generally positive, small and mid‐cap domestic stocks, developed international, and emerging equity markets were all significantly negative. Private equity, domestic fixed income, and emerging market debt showed positive results, while the Plan’s credit strategies and global tactical asset allocation were flat to negative. The real estate asset class posted very strong positive results. The RSIC Plan return was a negative 0.39 percent net of fees for the fiscal year ending June 30, 2016 compared to the Policy benchmark’s return of 0.82 percent. The three‐year annualized net of fees return was 5.28 percent compared to the Policy benchmark return of 5.25 percent. The five year annualized Plan return and Policy benchmark return were 5.19 percent and 4.86 percent, respectively. The Plan’s actuarial assumed rate of return is 7.50 percent. As of June 30, 2016, total Plan assets were valued at $28.0 billion, reflecting a $1.2 billion decrease in assets over the fiscal year. This decrease resulted from an outflow of $1.1 billion in net benefit disbursements and a $152 million net outflow from investment performance. Asset Allocation A new asset allocation policy was adopted at the June 19, 2015 Commission meeting for the 2016 fiscal year. At the recommendation of staff and RSIC’s independent consultant, Aon Hewitt Investment Consulting, this new policy contained relatively modest changes, while maintaining a similar risk level, from the previous fiscal year. 1 2015-2016 Annual Investment Report Effective September 30, 2015, Chief Investment Officer (CIO) Hershel Harper announced his resignation, and Geoffrey Berg was named Acting CIO. Immediately after assuming his interim role, Mr. Berg began a challenging convictions exercise that comprehensively reviewed the Commission’s asset allocation and studied numerous alternative portfolios with varying allocations in order to generate higher absolute and relative returns. At the November meeting, the Commission approved staff’s initial recommendations resulting from the early stages of the challenging convictions exercise. These changes took effect in January 2016 and included increasing the target allocation in public equities from thirty‐one percent to thirty‐four percent which was funded with a reduction in the allocation to cash from five to two percent. The Commission also abolished static target weights for private equity and private debt. At the February meeting, the Commission adopted a new and markedly different asset allocation for Fiscal Year 2017. The new plan, which began implementation on July 1, 2016, introduces several new strategies to the asset allocation including portable alpha, equity options, infrastructure, and real estate investment trusts. Other important asset class changes include raising equity exposure from forty‐three percent to forty‐seven percent, reducing opportunistic strategies from twenty percent to twelve percent, and raising real assets exposure from eight percent to eleven percent. While many of these changes will be made during the first year, the new allocation will require approximately three years for full implementation. Mr. Berg was formally selected as CIO in September 2016 and plans to continue the focus on asset allocation and implementing the improvements to the portfolio that have already been adopted. Conclusion RSIC continues to seek the highest returns with an acceptable level of risk, but also recognizes the imperative to improve its absolute and relative performance. Capital markets will continue to present challenges for the foreseeable future, but RSIC is confident that its newly adopted asset allocation and its commitment to the continual challenge of its investment convictions will improve its performance on an absolute and relative basis. RSIC also remains committed to working with our stakeholders, elected officials and fellow fiduciaries, as we explore the most feasible means of improving the health of the Plan itself for our current and future beneficiaries. We are deeply honored to serve our beneficiaries and participants and have confidence in our talented and dedicated staff’s ability to manage the Systems’ funds and assets. Thank you for the support you have given us. Sincerely Edward Giobbe, MBA Chair for the period July 1, 2014 – June 30, 2016 2 South Carolina Retirement System Investment Commission Consultant’s Letter August 29, 2016 The Honorable Nikki Haley, Governor State Fiscal Accountability Authority Members of the General Assembly of South Carolina RE: FYE 2016 Report Dear Governor and Members: As the investment consultant for the Retirement System Investment Commission (RSIC), Aon Hewitt Investment Consulting (AHIC) is pleased to submit this summary of the investment structure and performance of the South Carolina Retirement System (SCRS) investment portfolio for the fiscal year ended (FYE) June 30, 2016. The 2015-16 fiscal year was once again marked by the continued outperformance of U.S. equities. Central bank activity continued to drive investor sentiment and market returns. Equity markets were quite volatile during the period, experiencing three sharp downturns, but rebounding quickly each time. The first downturn occurred in August 2015 following an unexpected decision by the Bank of China to devalue its currency. The next decline occurred in January 2016 when concerns over slowing global growth led risk markets to retreat. The most recent drawdown occurred in June 2016 following the British vote in support of exit from the European Union. Continued accommodative monetary policy by the Europe Central Bank and the Bank of Japan, along with expectations that the U.S. Federal Reserve would further delay its policy rate hikes, helped to fuel positive investor sentiment for much of the second half of the fiscal year. Throughout the fiscal year, the Commission and its staff worked hard to further several long-term initiatives, including: . Reviewing asset allocation and adopting a new long-term asset allocation policy in February with the objective of enhancing expected portfolio return and mitigating risk . Refining investment strategy to lower costs, where possible During the fiscal year ending June 30, 2016 the SCRS investment portfolio returned -0.4% on a net-of- fee basis. This return trailed that of the Policy Index by 1.2 percentage points. Over the trailing three- and five-year periods ending June 30, 2016, the SCRS portfolio returns were 5.3% and 5.2%, respectively, which exceeded the returns of the Policy Index. All returns are reported on a time-weighted return basis. Aon Hewitt | Retirement