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South Carolina Retirement System Investment Commission Annual Investment Report Fiscal Year Ended June 30, 2017 Capitol Center 1201 Main Street, Suite 1510 Columbia, SC 29201 Rebecca Gunnlaugsson, Ph.D., Chair Chair for the period July 1, 2016 - June 30, 2018 2016-2017 ANNUAL INVESTMENT REPORT RETIREMENT SYSTEM INVESTMENT COMMISSION TABLE OF CONTENTS CHAIR REPORT Chair Report ............................................................................................................................... 1 Consultant Letter ........................................................................................................................ 3 Overview ................................................................................................................................... 5 Commission ............................................................................................................................... 6 Policy Allocation ......................................................................................................................... 9 Manager Returns (Net of Fees) .....................................................................................................10 Securities Lending .....................................................................................................................14 Expenses ...................................................................................................................................15 Risk ...........................................................................................................................................17 Appendix A: Summary Schedule ........................................................................................ 19 Appendix B: Cash and Equivalents ..................................................................................... 20 Appendix C: Short Duration ................................................................................................ 25 Appendix D: Fixed Income .................................................................................................. 28 Appendix E: Equity ............................................................................................................. 68 Appendix F: Infrastructure ............................................................................................... 136 Appendix G: Public Real Estate ......................................................................................... 137 Appendix H: Alternative Investments ............................................................................... 138 Appendix I: Futures .......................................................................................................... 141 Appendix J: Swaps & Options ........................................................................................... 142 iv 2016-2017 ANNUAL INVESTMENT REPORT RETIREMENT SYSTEM INVESTMENT COMMISSION CHAIR REPORT November 10, 2017 The Honorable Henry D. McMaster, Governor Members of the State Fiscal Accountability Authority Members of the General Assembly of South Carolina RE: 2016-2017 Annual Investment Report 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 Ended 2017. For the Fiscal Year Ended June 30, 2017, the RSIC’s investment portfolio enjoyed strong performance achieving an 11.88 percent return net of fees, which exceeded the portfolio’s Policy benchmark return of 11.82 percent. The three-year annualized net of fees return was 4.23 percent compared to the Policy benchmark return of 4.49 percent. The five-year annualized portfolio return and Policy benchmark return were 7.50 percent and 7.11 percent, respectively. The portfolio’s actuarial assumed rate of return was 7.50 percent for the fiscal year, however, effective July 1, 2017, the Retirement System Funding and Administration Act of 2017 lowered the actuarial assumed rate of return to 7.25 percent. The portfolio’s strong absolute returns had a significant positive impact on the total asset value of the fund. As of June 30, 2017, total portfolio assets were valued at $30.1 billion, reflecting a $2.1 billion increase in assets over the fiscal year net of fees and benefit payments. This increase resulted from an outflow of $1.1 billion in net benefit payments and a $3.2 billion net inflow from investment performance. We are pleased with the increase in the absolute and relative investment performance of the portfolio this past fiscal year and encouraged that the efforts we have made to significantly restructure the portfolio and our approach to investing are showing signs of progress. We are also committed to continuing this progress in pursuit of achieving the RSIC’s strategic goal of earning a three-year trailing rate of return that exceeds the median peer public pension fund and our Policy benchmark return. 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. We know that continuing to challenge ourselves to improve our investment performance must remain our focus every fiscal year. iv 1 2016-2017 ANNUAL INVESTMENT REPORT RETIREMENT SYSTEM INVESTMENT COMMISSION Page 2 of 2 We greatly appreciate the support you have provided the RSIC and, most importantly, the over 500,000 beneficiaries we serve. Sincerely, Rebecca M. Gunnlaugsson, Ph.D. Chair for the Period July 1, 2016 – Present (Ending June 30, 2018) 2 2016-2017 ANNUAL INVESTMENT REPORT RETIREMENT SYSTEM INVESTMENT COMMISSION CONSULTANT LETTER August 31, 2017 The Honorable Henry McMaster, Governor State Fiscal Accountability Authority Members of the General Assembly of South Carolina RE: FYE 2017 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, 2017. The 2016-17 fiscal year was led by strong performance across equity markets, specifically, non-U.S. equity markets as investors focused on central bank activity and election results in the U.S. and across Europe. The Federal Reserve’s decision to raise rates twice during the fiscal year, once in December and again in March, along with decreasing inflation expectations left fixed income markets muted. Non-U.S. equity markets outpaced domestic equity markets in three of the four quarters while U.S. equity markets only outpaced markets overseas following the U.S. election results in November, as the new administration’s anticipated reflation policies boosted returns. The momentum triggered by the prospects of U.S. reflationary policies that carried global equity markets higher in late 2016/early 2017 stuttered and was ultimately replaced by strong corporate and economic fundamentals. 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 April . Refining investment strategy to lower costs, where possible During the fiscal year ending June 30, 2017, the SCRS investment portfolio returned 11.9% (net-of-fee basis), and outperformed its Policy Index by 0.1 percentage point. Over the trailing three-year period ending June 30, 2017, the SCRS portfolio returned 4.2%, underperforming its Policy Index by 0.3 percentage points. Over the trailing five-year period ending June 30, 2017, the SCRS portfolio returned 7.5% and outperformed its Policy Index by 0.4 percentage points. All returns are reported on a time- weighted return basis. Aon Hew itt | Retirement and Investment 200 E. Randolph Street, Suite 1500 | Chicago, IL 60601 t +1.312.381.1200 | f +1.312.381.1366 | aonhewi tt.com Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company 2 3 2016-2017 ANNUAL INVESTMENT REPORT RETIREMENT SYSTEM INVESTMENT COMMISSION August 31, 2017 Page 2 As of June 30, 2017, the SCRS investment portfolio totaled $30.1 billion. This represented an increase of $2.1 billion from its value on June 30, 2016, due to investment gains of $3.2 billion and net outflows of $1.1 billion. The portfolio’s asset allocation at fiscal year-end was as follows: Global Public Equities 35.1% Core Fixed Income 10.0% Global Asset Allocation 9.3% Private Equity 7.6% Mixed Credit 6.7% Private Debt 5.9% Private Real Estate 5.9% Equity Options 5.2% Emerging Markets Debt 5.2% Other Opportunistic Strategies 2.8% Hedge Funds Non-Portable Alpha 1.6% World Infrastructure 1.4% Public Real Estate 1.3% Cash and Short Duration (net of overlays) 2.0%1 Total 100.0% Hedge Funds Portable Alpha 7.7%2 The investment portfolio’s June 30, 2017 asset allocation was within statutory limits and was consistent with the targets and ranges set forth in the Annual Investment Plan and in the Statement of Investment Objectives and Policy. We at AHIC have been honored to serve as the investment consultant to the RSIC. Sincerely, Suzanne M. Bernard, CFA, CAIA Partner Aon Hewitt Investment Consulting