WASHINGTON STATE INVESTMENT BOARD THIRTY-SIXTH ANNUAL REPORT 2017 INTRODUCTION Lett er of Transmitt al ( 3 ) Message from the Chair ( 4 ) Board Members and Committ ees ( 5 ) Executi ve Management ( 6 ) Commingled Trust Fund (CTF) Partners and Fund Managers ( 7 ) Corporate Governance ( 9 ) Enterprise Risk Management ( 10 ) Annual Budget ( 11 ) LETTER OF TRANSMITTAL Today’s investment landscape is a study in sharp contrasts. Escalati ng equity prices have persisted against a backdrop of lower long-term market assumpti ons. Economies are growing, but infl ati on remains mild. Steady growth in jobs is clouded by prolonged issues of economic inequality. Remarkable innovati on at some companies is dampened by failure of basic governance practi ces at others. Gradual progress in emerging economies is off set by unrest in developed economies. At nearly every turn, risk and opportunity coexist, someti mes indisti nguishably. It’s an unnerving environment for many investors. It creates ample opportunity for second-guessing and knee-jerk tendencies to either fl ee from or dive headlong into risk. But it’s also a ti me in which a steadfast, proven, long-term strategy can prevail. At the WSIB, a topsy-turvy mix of economic signals only reinforces the importance of our long-term investment strategy and the need to remain focused on the fi nancial needs of our benefi ciaries. Our advantage is a disciplined fi duciary role aimed at generati ng investment results over a span of generati ons rather than merely over a few market cycles. We are well-positi oned to recognize market noise without succumbing to the disrupti ve uproar. Our state’s reti rement plan benefi ciaries and other stakeholder groups such as Labor & Industries, the Developmental Disabiliti es Endowment Fund and the Permanent Funds for colleges and universiti es are depending on investment outcomes driven by decades-long strategies. Our success is not shaped by quarterly market movements or fl eeti ng investor behavior. Instead, we adhere to a published set of investment beliefs, which represent our views on risk, diversifi cati on, fund expenses, sustainability and other vitals. One of my favorites is: “Our fund should be compensated at least fairly for the investment risk it takes.” But with today’s market forces, even the most disciplined of investors will face no shortage of challenge and upheaval. Investment strategies must confront an unprecedented array of environmental, social and governance (ESG) issues that represent a dynamic wave of risk factors. Financial performance depends as much on reputati onal issues as it does on revenue streams and debt rati os. We must be able to discriminate among both fi nancial and non-fi nancial risk factors in order to prudently assign and manage capital. As responsible stewards of public assets, we also must recognize the importance of engagement with our investment partners and the corporati ons that make up our portf olios. We must work constructi vely with other like-minded investors to protect shareholder voti ng rights when, for example, some public companies act to limit the ability of share owners to vote their shares. Encouragingly, more insti tuti onal investors are moving toward long-term disciplines. Many of our investment partners and peer funds are more att uned to the value of a diversity of ideas, gender and ethnic backgrounds in our industry. More investment managers and company board members are willing to ask about the risks related to climate issues or social factors. More public plans are citi ng engagement as a bett er fi duciary soluti on than the whip-saw of divestment from unpopular investment sectors. At the WSIB, our staff is working diligently to fulfi ll a clear mission on behalf of our benefi ciaries. While we may adjust our investment exposures in the face of current market conditi ons, we won’t do so reacti vely. In even the most unclear of conditi ons, we remain committ ed to maximizing returns at prudent levels of risk over a multi -generati onal ti me horizon. This will allow us to best serve our benefi ciaries while contributi ng to a reti rement system that remains top-ranked for funding levels, performance and stability for the long run. Sincerely, Theresa Whitmarsh, Executi ve Director Page 3 MESSAGE FROM THE CHAIR Those of us serving on the Washington State Investment Board (WSIB) are proud to play an important governance role for our state’s reti rement plan system. Our board members come from a variety of backgrounds and off er a rich depth of experti se. Some are relati vely new to their seats; others have been fulfi lling this role for many years. Together, we provide a balance of fresh perspecti ve, strong benefi ciary representati on and experienced professional views. We also share a single, common interest on behalf of our benefi ciaries. The Board wants to ensure our state enjoys a well-funded reti rement system and a fully accountable investment program that produces strong long-term investment returns so that benefi ciaries and other stakeholders achieve a healthy fi nancial future. We have created a globally respected program because of a singular focus on a core mission – maximizing long-term returns at a prudent level of risk. Those words express a simple and clear-headed concept. But in practi ce, implementi ng such a mission can be far from simple. Market uncertainti es, geopoliti cal unrest, shift ing social and politi cal interests, competi ti ve pressures all come to bear on our investment program. Historically, we have relied on a strong, honest and longstanding relati onships to build an investment program focused on global diversifi cati on, private and public markets exposure, and long-term results. In various market environments, our board has consistently recognized that risk must be managed rather than averted, and returns must be projected over ti me rather than promised at shorter, unpredictable intervals. Our job here is to help state and public employees, teachers, law enforcement offi cers, fi refi ghters and others achieve a secure and benefi cial fi nancial future so they, in turn, can help their own families and our communiti es for the long run. Our state’s reti rement system results in approximately $4 billion in benefi t payments each year, or about $333 million per month. Our projecti ons show that over future decades, our investments will generate enough returns to cover at least 75% of the full cost of a benefi ciary’s reti rement benefi ts. This eases the costs otherwise borne by taxpayers, public agencies, educati on programs and public employees. The WSIB’s investment earnings also help cover more than 2.5 million workers under the state Department of Labor & Industries’ workers’ compensati on program, and they generate vital benefi ts for families relying on the $60 million Developmental Disabiliti es Endowment Fund. As of the end of this fi scal year (FY), the rate of return (net of fees) for the CTF since incepti on is 8.73 percent. Three-, fi ve-, and 10-year return rates are 6.91 percent, 9.95 percent, and 5.47 percent, respecti vely. These results put us among the top performers in public pension programs and give our benefi ciaries confi dence that we are well-equipped to fulfi ll our mission for generati ons. We remain committ ed to an investment discipline that serves us well during both favorable and unfavorable economic conditi ons. We must not allow market diffi culti es to hamper our willingness to invest in promising opportuniti es; likewise, we must not allow market hubris to cloud our understanding of risks. We must conti nue to ensure transparency and integrity in order to earn the trust and support of our stakeholders. We are pleased to present the WSIB’s Annual Report for the fi scal year ending June 30, 2017. Sincerely, Kelly Fox, Chair Page 4 BOARD MEMBERS AND COMMITTEES The WSIB is an independent Board of Trustees whose fi duciary responsibility is to manage reti rement and public fund investments with the highest standard of professional conduct. The Board’s primary investment objecti ve is to maximize returns at a prudent level of risk for the exclusive benefi t of fund parti cipants and benefi ciaries. Individual Board members are recommended by the Chair and appointed by the Board to serve on any of the Board’s four diff erent committ ees to more effi ciently analyze investment and governance issues. Committ ee recommendati ons are brought to the Board for considerati on and a vote. Administrati ve Committ ee The Administrati ve Committ ee has oversight of general policy and organizati onal issues: personnel, budget, legislati ve program; legal services; nominati on of non-voti ng Board members, and other issues not included in other committ ee charters. Audit Committ ee The Audit Committ ee has oversight of audits of Board acti viti es and operati ons: compliance, risk management, internal/external audits, fi nancial reporti ng, and internal controls. It is also responsible for development of policies and procedures for corporate governance and oversight of the Confl ict of Interest Policy. Private Markets Committ ee The Private Markets Committ ee develops strategy, provides oversight, and makes recommendati ons to the Board for investments in real estate, private equity, tangible assets, and other direct or private Judy Kuschel Vice-Chair Treasurer Duane Davidson Guerin Tracy Fox Kelly Chair transacti ons. Joel Sacks Public Markets Committ ee The Public Markets Committ ee ve develops strategy, provides ti oversight, and makes recommendati ons to the Board for public markets investments, Yona Makowski Yona Representa Timm Ormsby Arlista D.