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NATIONALCONFERENCEONPUBLICEMPLOYEERETIREESYSTEMS[NCPERS]–75thANNIVERSARY
ANNUALCONFERENCE/EXHIBITS-MAY15-19,2016
PREPAREDFORREAOCANDAEROCBOARDSBYLOUSCARPINO
Withnationwideresourcesfromall50statesplusterritories,andindustryprofessionalsandpractitionersspanningthepublicretirementsystemsandinvestmentcommunities,theintrinsicvalueofREAOCandCRCEAmembershipinNCPERSwasreadilyapparent.Infact,continuedandpotentiallyincreasedinvolvementbytheREAOCandAEROCboardsappearsjustifiedinordertoprovidegreaterprotectionandservicetoourconstituency.Thislaststatementmayappearboldatfirstreading.However,giventhecontent,resourcesandcontactsavailableandmade,andthatwillbehighlightedherein,Isuspectthereaderwillcometothesameorsimilarconclusion.InattendingthisconferenceIhadthreegoalsinmind.Specifically:1)AssessthevalueofNCPERStoREAOC/AEROCaswellasCRCEAgoingforward-completewithanassessmentoforganizationalresourcesandcontactsthatNCPERSbringstothetable;2)Getafirmerhandleonhowwidespreadandvalidaconsensusexiststhatfundrevenueswillbedownforanumberofyears-aswellastheexistenceandviabilityofmitigatingalternatives;and3)GetamoreconcretehandleonthepoliticalstatusandcloutofNCPERS.I’llbetouchingonthesethroughoutthereport.Asexpected,theconferenceprogramwasbroadbased,extensiveandheavilydetailedinnature.Thisreport,willforgomostdetailinfavoroffirstfamiliarizingthereaderwithNCPERS,itsoperations,policiesandpositions,andsecondprovidingthemajortakeaways,resourcesandcontactsmadethatshouldproveusefultoREAOCandAEROCinthefuture.Further,thediscussionwillcenteronthefollowingsixmajorcategories:
1. NCPERSConferenceandStructure2. ProgramDrivers,PoliciesandOperatingEnvironment3. LegalandLegislative4. Costs&PensionReform5. InvestmentPerformanceAnalysis6. InvestmentStrategyOptions
Thisreportisintendedtoinformandeducatethereader,notpitchspecificrecommendations.Forthatreason,noexecutivesummaryisprovided,sowithapologiesupfrontforthelength,enjoytheread.Thisisnottosaythattherearenotanumberofnewopportunitiesforfollow-upactivitiesthatcouldpotentiallyfurtherourwork.That,however,shouldbethesubjectoffurtherdiscussion.
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1.NCPERSCONFERENCEandSTRUCTURE:SincemyattendancewasourREAOCBoards’firstcoverageofthisconferenceaswellasfirstchancetogetabetterinsidelookatNCPERS,anoverviewoftheAnnualConferenceandNCPERSstructureisinorder.TheConferenceformatusedworksexceptionallywell.GeneralSessiontopicsofinterestwereruneachdayfrom8to11AM,followedbyahalfhourbreaktoallowtimetointeractwithexhibitorsonsite,aswellasrefresh.ThenexttwotimeslotsconsistedoftwosetsofconcurrentthreetofourBreak-Outsessionsthatallowedpursuitofspecificinterestsandeducationtrackopportunities.Specializedtopicsaswellastheelectionoftheexecutiveboardandclosingbusinessmeetingswereheldlaterintheafternooninrecognitionofthelimitedaudienceforthosesessions.NCPERSmakesuseofasixteenmemberExecutiveBoardrepresentingStateEmployeesandsevenspecificclassificationsconsistingofFire,Education,Protective,CountyEmployees,LocalEmployees,PoliceandCanadian.AnewExecutiveBoardwaselectedattheconferencebydelegatesfromeachstateandterritory.OfficerswerethenchosenbythenewExecutiveBoard.Aclosingbusinessmeetingwasheldlateafternoononthefinaldayoftheconference.TheExecutiveBoarditselfissupportedbyeightAdvisorsandNCPERSStaffincludingHankKim,theExecutiveDirectorandCounsel,andDr.MichaelKahn,DirectorofResearch.Exhibitorsconsistedofforty-ninefirmsfromthelegal,financial,healthandotherinsurance,investing,investinganalytics,realestateinvestingandtechnologysectors.Ofcourse,firmsandparticipantswerefreetoenhancetheirnetworkingandpitchtheirproductsthrougheveningeventstheysponsored,aswellasattheclosingdinnerevent.WhileImadeclearthatIdidnothaveasayonfundinvestments,IwasneverthelessinvitedtodinneralongwithNCPERSExecutiveDirectorHankKim,AlanMarin(whoadvisesOCERSandothersystems),andthreefundmanagers.Thisprovidedanexcellentopportunitytogetasenseofhowthisprocessworksaswellasobtainsomevaluableinformationthatwillbediscussedlaterinthisreport.Over800participantsattendedincludingsomeretireesandmanyothersthatsitonplanboards,planadministrators,chiefinvestmentofficers,andarangeofspecialtyandsupportplanandfinancialandlegalindustrypersonnel.Themedianagelookedtobeabout40to45.Thegeneralperspectivecanbesaidtobeverysupportiveofdefinedbenefitplans,butnotweddedtospecificDBplansystemparametersinplacetothesamedegreeweseewithpredominantlyretireemembergroups.OurownGerardMillerhadaprominentroleonseveralGeneralSessionpresentationsandalsomoderatedaclosed-doorChiefInvestmentOfficerandInternalInvestmentStaffForumaimedatstrengtheningthenetworkofinvestmentprofessionalswithinNCPERSonanongoingbasis.ThreecategoriesofMembershipsinNCPERSare“Fund”,“Corporate”,and“CorporatePensionEducationandResearchSupporter”(CorPERS).Thisthirdgroup,previouslyunknowntome,werenevertheless,quitevisibleattheconferencewithidentificationbadgesandanexclusiveCorPERSlounge.At$10,000peryear,CorPERSmembershipis
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designedtoenhanceacorporatemember’svisibilitybyincreasinginvolvementinNCPERSandfurtheringtheeducationandresearchmission.Oftheeightperkslisted,preferredstatusforCorPERSMemberpresentationandarticleproposals,aswellaseducationwebinarproposalsarenoteworthy.2.PROGRAMDRIVERS,POLICIESandOPERATINGENVIRONMENTThirteen NCPERS Resolutions are in place and serve as an anchor and driver for theorganizations ongoing program activities as well as, to some extent, their conferenceprograms.Theseareworthsummarizingbrieflyasfollows:RESO.1:
- Support retirement benefits composed of a DB plan, an add-on DC plan, retireehealthcarebenefits,andlifeinsurancecoveragetoensureretireestandardofliving;
- Taketheleadinfightingtoprotectandensuretheretirementandhealthbenefitsofretirees and in-service employees through education of its membership andeducationofelectedgovernmentofficials;
- Offer member fund group life insurance and group long-term care insurance tohelpfulfilltheretirementneedsofpublicemployees.
RESO.2:
- Supportsoundactuarialvaluationspracticesforvaluingpublicpensionfunds;- Oppose using financial economics or market valuation of liabilities for public
pensions.
RESO.3:- Reaffirmitsoppositiontoallpresentefforts torequiremandatorySocialSecurity
coverageofnon-coveredstateandlocalgovernmentemployees;- Publically oppose all attempts on the part of the US Congress or federal
administrativeagenciestomandateSocialSecuritycoverageforallstateandlocalgovernmentemployees.
RESO.4:
- GoonrecordinoppositionofestablishmentofprivateretirementwithintheSocialSecuritySystem;
- PublicallysupportcontinuationandstabilizationoftheSocialSecuritysystemandreaffirm support to improve the financial security of the Social Security systemwithouttheestablishmentofprivateretirementaccounts.
RESO.5:
- EndeavortosupportDBsystemsforallworkers.
RESO.6:- CallonsponsorstomaketheirARCS;- Work with plans and plan sponsors during this economic crisis to ensure that
publicplansarewellfundedandwillcontinuetothrivewellintothefuture.
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RESO.7:- WorktointroduceandenactlegislationtoestablishSecureChoicePensions(SCPs)
forthePrivatesector;- DBbased,the(SCP)proposeddesignisenvisionedtoprovideretirementsecurity
toprivatesectorworkersusingapublicprivatepartnershipmodel.RESO.8:
- SupportonlythoseeffortswherebyaDCplanisanoptionaladditionalsupplementtoaDCplan;
- Strongly oppose efforts to use DC plans as replacements for DB plans for anyreasonandfurtheropposeDCplansthaterodeDBplantrustfundassetsthroughconversion;
- Continue efforts toward strengthening DB plans, adequate and timely funding,maintenance and improvement of benefit levels, and support of DC planswhereusedasasupplementtoDBplans.
RESO.9:
- Encourage member funds to exercise their proxy voting in a manner that isconsistent with fiduciary responsibility, including the welfare of all Americansaffectedbycorporateperformance.
RESO.10:
- Member fundsand theirparticipantsurge theirmembersofCongress toapprovecorrective legislation to eliminate undue tax regulation and application of ERISAprinciplesthatthreatenconstitutionallyprotectedpensionrights;
- Affirmitssupportfortherightofstateandlocalgovernmentstoself-determinationinthedesignandadministrationoftheirretirementsystems;
- Encourageallpublicplanstomakeavailable,totheirparticipants, informationontheirbenefitandinvestmentportfoliosonaregularbasis.
RESO.11:
- Support additional improvements to the healthcare system that encompass theprinciples of health coverage for all citizens, cost containment, quality-of-careimprovements,equitablefinancing,andsimplifiedadministration;
- WorkwiththeNationalCoalitiononHealthCareandotherorganizationstoachievetheseprinciplesthroughlegislation;
- SupportMedicare,thathassuccessfullyprovidedhealthcaretomillionsofseniorsformorethan50years,toremainfundamentallyunchanged.
RESO.12:
- Supportallowingretireesandemployeesnearretirementtorolloverassetsformagovernmentalplan,suchas401(a),403(b),457plans, intoqualifiedmedicaltrustorvoluntaryemployees’beneficiaryassociationsforthesolepurposeofpurchasinghealthcareinretirement.
RESO.13:
- Publically thank all attendees, sponsors, speakers and exhibitors for their role inmakingthisyear’sAnnualConferenceandExhibitionasuccess.
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NCPERSCodeofConduct–UpdatebyHankKimIn 2015NCPERS issued a 10 Point “Code of Conduct” (Code)with the goal to have DBPensionPlanserviceproviderssignontocommit toall10points (Attachment1) HankKimprovidedbothabasicoutlineandstatusofsignatoriesthatnownumberinexcessof50organizations. ThedrivingpurposeoftheCodeistoprovideatooltopublicplanstohelp identify conflicts of interest between Public DB plan Boards and their serviceproviders,andintheprocess,strengthencommitmenttoDBPlanuse.WhilethefirsteightpointsoftheCode,thatdrawsheavilyfromtheCFAInstitute’sCodeofEthicsandStandardsofProfessionalConduct,addressnorms fora fiduciary, it is the9thand10thpointsthatarekey. Thesearedesignedtoferretoutserviceprovidersthatdobusiness with DB Plan Boards and then use some of the proceeds earned to fundopponents’effortsagainstpublicplans.Hankpointedoutthat,NCPERs’acknowledgesthatreformsarenecessary toensure sustainableplans foranother150years. But theyalsorecognize that in some instances where plans are clearly sustainable and viable,opponentsarestillpushingreforms–toooftenunreasonable.Therefore,Point9requiressignatoriestotheCodeofConducttoNotAdvocatefordiminishmentofpublicDBplans.Point 10 requires disclosure of all contributions made to entities that advocate fordiminishing public DB plans including all entities listed in “Schedule A” of the Code(Attachment2)Hankprovidedtheinaugurallistof49signatoriesandtwothatcouldnotsignduetocontractualissueswithclients.ScheduleAentitiesarethoseidentifiedbyNCPERS’membersasholistically,asanenterprise,antiDBplanadvocates.Theseincludevariousfoundations,thinktanksandnon-profitsthatpublishand/oractivelyadvocateagainstDBplanstopolicy-makingbodiesandthepublic.ScheduleAgroupshaveallgonebeyondnormalcritiquingandevenincludegroupsidentifiedasprogressive.Thecriteriaforgettingonthelistincludessuchthingsas:
• AdvocatesfortheunsustainabilityofDBPlans• AdvocatesforDCplanstoreplaceDBplans• AdvocatesforpoorlydesignedDCplans• LinkspoorschoolperformanceevaluationstoitsDBPlan
Finally,itisrecognizedthatthereisvalueinunderstandingthatCodeofConductsignatoriesmayhavenon-pensionrelatedrelationswithoneormoreScheduleAgroups.Thecodeonlyrequiresthatdonationsbeidentifiedandcategorizedaccordingly.
TheAnnualupdateprocessreliesonmembersforinputusingtheCodeofConductsubmissionformforStafftovetforsubmittaltotheNCPERSExecutiveBoardforapproval.ForfundmembersthatbelieveprotectingDBplansisapartoftheirfiduciaryresponsibility,NCPERSasksthattheyreachouttoserviceproviderstohopefullyendorsetheCodeofConduct.Hankwillbehappytogiveapresentation.Moreinformationisavailableatwww.ncpers.org/conduct.
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TODAY’SENVIRONMENTAFFECTINGPOLICY:HankKimreportedthat,inthis75thanniversaryyearofNCPERS:
• 40statesnowparticipateSocialSecurity;• DefinedBenefitpaymentshavebeenpaidouttoteachersofNYCity(theNCPERS
President’sclient)for99years,yetwearestillfightingtoprotectpensionsystemsthathaveexistedforover150years;
• TheSecureChoicePensionproposalfortheprivatesectorisbeinglookedatby12states;
• Areengagedintryingtoensurethatserviceprovidersarenottakingourmoneyandgivingittopensionoppositiongroups;
• Aresquaringoffagainstfoesateveryturnbyrespondingconsistentlyandtakingonfoundationsandthinktanksthatarecreatingintellectuallydishonestandbiasedworks;
• ArestewardsforovermanyTrillionsofdollars;• Wouldliketoseeallpublicfundsusetheirinfluenceandproxyvotesincompanies
tofightback;• NCPERSEducationFundisactive(e.g.$100,000CesarChavezaward,tohelpbuild
confidence,competenceandfuture);• NCPERSEncouragesmemberstotaketimetosharestoriesandmovepublic
pensionsforward.Robert A. Wylie provided a presentation on Flexible Defined Benefit Designs for NextGeneration of Public Employees,with a focus on the South Dakota Retirement System.Notably, thesystemhasremainedwell fundedwithastatutorydeterminedcontributionratethatdoesnotgetadjusted.Goodgovernance,anindependentinvestmentboard,andstatutoryrequirementtoadjustbenefitsifcertainthresholdsareexceeded,allarepartofthesuccessofthissystem.Thislastpointwasonethatcausedmeconcern.GerardMiller–OCERS,ChairedapanelwithAlanMartin,NEPCandScottSimon,ColoradoFire&PoliceAssoc.Plan,entitled:InvestmentGovernance–AFamilyDiscussion.Salientpointsnoted:
• Sizematters.Forexample,OrangeCountydoesnotmovemarketsbutratheruseswhatisavailable;
• GoodGovernanceiscritical-decidingwhomakesdecisionsanddevelopinganddocumentingprocessestodosoarekey;
• Weareina2%mostprobablereturnenvironment.(Thisthemewasrepeatedinanumberofpresentations).Thisenvironmentimpliesmorediversificationandadditionofnon-traditionalassetclasses,associatedincreasedcomplexityincluding,forexample,moreuseofemergingmarkets.Alongwiththiscomestheneedformoremanagersandmoreoversightashighlyvolatilemarketsmaydemandmorefrequenttimelyactionsregardingmanagerhiring,funding,defunding,terminating,etc.;
• Onesizedoesnotfitall.Successfulinvestmentprogramscanincludeoutsourcing.Whileagreattool,internalstaffcanalsobegreatandcosteffective.Staffprovides
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alotofopportunityifyouhaveagovernancestructuretotakeadvantageofthem;• Mustalsohaveastrongphilosophyregardingthelong-termgoalsoftheprogram
andlong-termbehaviorofcapitalmarkets.Thisrequiresastablesupportivegoverningboard,knowledgeablefiduciaries,alignmentofresponsibilitieswithcapabilities,-fortitudetowithstandshorttermbumpsintheinvestmentperformanceoffunds,confidencetoappropriatelydelegatematterstostaffandtheabilitytodesignreportingsystemsforoversight;
• Estimatedvalueaddedbygoodgovernanceis100-300bps;• StaffManagementofthefundmanagersiskey.Iftheplanboardchoosesfund
Managersandgoesaroundstaff,won’twork;• Mostboardsfocussolelyongoalsandinvestmentstrategy.Butyouneedawell
educated/briefedboard,staff,consultants,legalandactuarialprofessionalsinthemix.Andnewboardmembersneedhistoryindoctrinationandtraining,soeducationeventsareimportant,notbeautypresentationsfromfundmangers;
• Goalsandobjectivesmustbestrategicandaligned;• Mustbeclearroledelineation,accountability,staffresourcescontinuityand
appropriateuseofexternalresourcesincludinggeneralistsandspecialtyconsultants;
• Mustquestionwhatwearegettingforexpense,notjusttheexpense.Hedgefundshavenotproventoliveuptotheirstatedpurpose.(Thisthemewasechoedinotherpresentationsaswellasknownandhiddencostburdensintheseandotherinvestmenttypes).
• Useinvestmentmanagerstoeducateandnotjustmake“beautypresentations”.IncludeinyourRFP’sthefewwaystoqualifyandthemanywaysnottoqualify,soyougetsubstantivedowntoearthproposals;
PensionObligationBonds-dohaveawindowofopportunitywhentheirusemakessense.Essentially,thisisinthetroughperiodofacyclewhenbondproceedscanbeinvestedinthestockmarketandearnmorethantheypay–thatis,withoutfacingstockpricesevenorlowerthanpurchasepriceininevitablesubsequenteconomicrecessions–i.e.apositivearbitrage.Ofcourse,thisinvolvessomeamountofmarkettimingandstockvetting,soisnotfortheuninitiatedorfaintofheart.3.LEGALANDLEGISLATIVELegal:AlternativeInvestments:-Thereisageneralconsensusthatalternativeinvestmentsneedtobeusedgoingforwardinordertoattracthigherreturns.Whilehedgefundsarelookeduponaslessfavorable,theytooarestillinuse,butwillprobablybeusedlessasmoreperformanceinformationbecomesapparent.Fromalegalperspective,alternateinvestmentsespeciallyposelegalrisksthatgowellbeyondequityandbondinvestmentvehicles,especiallywhentheinvestorisalimitedpartner.Equityandbondinvestmentsareprotectedbyfederalandstatelaws.Alternateinvestments,especiallythroughlimitedpartnerships,donotbackplanboardsastheyaretiedtocontractsandnotbackedbygovernment.ToolatemanyLLCpartnerinvestorslearnthattheyhavegivenLLCpartner
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managementalltheirfiduciaryresponsibilities.Accordingly,investorplanboardsmustincludeinanyLLCagreementtermsforanLLCmanagertoberesponsibleforhonoringtheplanboard’sfiduciaryresponsibility,anddisclosurerequirementsthatareinsecuritieslaw-orevengreater.U.S.SupremeCourt:ThepassingofJusticeScaliaandabsenceofhisconservativevoiceonthecourt,asweknow,isnowamajorpoliticalfootball.Inaddition,3to4morevacancieswilllikelyoccurinthenextpresidentialadministration.TheSupremeCourthashadastronginterestinsecuritycasesandstabilityforinvestors–therebysupportinginvestorrights.JusticeScaliaauthoredadecisionthatwasnotopposedtoinvestorrightsbutmoreopposedtoclassactionsuitsthatmadeitmoredifficulttopursueclassactionsuits.ShareholderAppraisalActions-allowsshareholderstogotocourttocontestvaluationofshares.Thistypeofactionisaimedatprotectingagainstmanagementbuy-outs,takeovers,etc.Groundedinstatecorporatelaw,theactiondoesnotaccusefraudorwrongdoing,itjustconteststhefairvalueofshares.Itpitsyourevaluationexpertsagainstthecompany’s.Theriskinthisactionisthatthefairvaluecouldbelessthantheacquisitionpriceoffer.Also,gettingacontingencydealforcounselisdifficultunlesstheamountsinvolvedarehigh.BreachofFiduciaryDuties-isakindofaction.Courtlookstoseeifavaluefallswithinarangeoffairness.Plaintiffallegingan$11persharevaluewouldlosewith$9.10offeriftherangeoffairnessis$9to$11pershare.Also,moneycouldbetiedupforyears,buttheinterestismandatedbystatute.Whilecontingencydealsaremorereadilyavailable,thisformoflitigationhasaspottytrackrecord,andshareholdercouldlosemoney.InternationalActions–bynaturearemorecomplicatedandcomewithsomanymovingpartsthatcontingencydealsareproblematic.Litigationfundershaveemergedtotakeonthesekindsofcases.Theseentitiespayhourlyratesandlosses,butalsotake30%to40%onaverageandashighas60%oftheproceedsinparticularlyriskycases.BoardsinvolvedinthiskindofactionneedtobecertainthattheirLitigationfunderentityknowsandabidesbyinternaldisciplineandproceduresthatfullyoutlinetheplayers,environmentandissuesinvolved.FeeShifting–isanissuethathasdevelopedovertimeandissometimescontrolledbycontractorbylawprovisions.TheDelawareSupremeCourtruledthattheBoardofDirectorscouldfeeshift.Thereisalegislativefixproposedthatthusfarhasbeenstoppedbylobbyefforts.Currently,theGovernorwantstohearfrominvestors.Feeshiftingprovisionsforalternateinvestmentswilllikelyrequirefederallegislation.SECConcernforTransparencyandAccountability–NCPERSbelievestheirvoicehasbeenheardandhelpedprompttheSECintoaction.Moretocomeonthistopic.FederalRegulatoryUpdates – noted efforts topush such things as aUnityAccumulationPlanandAccumulationRetirementPlan. Whileonlybrieflyoutlined, theseplansdonotappearviable,wouldbeproposedtocrowdoutorreplaceDBplans,andareopposedbyNCPERS. Annuity plans and plans allowing only employer contributions were alsodiscussed.Ingeneral,noneappearedpalatable.
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GASBUpdate–Whileanexcellenthistoricalupdatepresentation,nothingthatwearenotalreadyawareofwasoffered.ProposedNew113ofBankruptcyCode–bytheManhattanInstitute,wouldallowstatestopetitionbankruptcycourtstooverrideexistinglawsothatpensionbenefitscouldbecut.Itisnotsurprisingtoseethisdevelopmentformthisgroup,andNCPERSandallotherpensionsecurityadvocateswillhavetoworktoensuretheirproposaldoesnotgettraction.Legislation:WindfallEliminationProvision(WEP)-lawsince1983,HouseWaysandMeansChairKevinBradyhasintroducedHR711(Republican-Tx)thatwouldrepealthisprovision.ThisbillwillbeaddedtotheREAOC2016LegislativeTrackingReport.OtherFederalLegislationandRegulatoryChanges–AnumberofregulatoryandpendingIRSrulingswerediscussed,noneofwhichIcouldidentifyasrelatingtoREAOCconcerns.Whatisofconcernisattacksinproposedlegislationthatcastsuchthingsasadiscountrateof7.5%rate,forexample,asunreasonableandtherefore,presumably,unusable.4.COSTSANDPENSIONREFORM
Costs:AttheMondaybreakfastImetAlanTorrance,PrincipleatCEMBenchmarking-afirmthatauditsbothplanadministrationcostsandplanfundfeesandothercosts.Aftersomequestioningabouttheeffectivenessofrecentpushesforcosttransparency,Alannotedthattheirauditsroutinelyfind“thousands”ofcostlineitemsnotreadilyapparent.HelinkedmeupwithseveralarticlesonthesubjectthatIfoundconfirmhisgeneralassertion.AlanisscheduledtoconductanOCERSfundauditinthenearfuture.Follow-uponthistopicshouldnetsomesignificantopportunityforreformthatREAOC,CRCEAandNCPERSmaywanttohelpchampion.Ofcourse,theextentthatNCPERScantaketheleadandbeeffective,givenitscloserelationshipwithinvestmentfirms,isanobvioustopicfordiscussion.Reform:BradHeinrichs–whoisanActuary,presentedandopinedonthelimitedopportunityforpensionreformbybreakingdowntheareasinatypicalpublicDBplanthatcanbeimpacted.Heaskedthatifyouhavetoundergoreform,howcanitbeapproached?Bradnotedthatthewellknowpensionformula:Benefits+Expense=Contribution+InvestmentRevenue(B+E=C+I)isagoodstartingplace.Costdriversincludeactuarialassumptions–thatcanchangeannualcostsbutnotactualcosts,administrativeexpense,timing,demographics,entryrulesetc.SinceIknowtheREAOCboardgenerally
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understandscostdriversinthepensionsystemletmeskiptothegeneralthesisespoused.Specifically,Bradusedanexampleofanaveragesystemstructurefromhisclients.Afterdrillingdowntojustthoseelementsthataresusceptibletochange,heproposedthatthesavingsmagnitudeeachpossiblechangewouldproduceshouldbeconsidered.Inadditiontocrunchingthenumbers,Bradopinedthatplansconsideringreformshould:1.Worktoeliminateinequities–forexamplejointandsurvivorbenefitmarriedcouplesinsomesystemsreceivehighervalueatnoadditionalcosttoindividualunmarriedretirees.Thisshouldnotbefree.2.Staytruetocareeremployeesthroughdecisionssuchasextendingvestingperiods,removingearlyretirementsubsidies,andmakingsuredisabilitybenefitsarenottoorichsoasnottoincentivizedisabilitycases.3.BesympathetictothoseclosesttoRetirement.Ifpensionreform,allowforhighercontributionstokeepcurrentbenefits4.Beclever-projectionscanbeyourfriendandcanbeusedtogetpositiveheadlines.HealthCare–OverAge65Costs(Basics)–Presenter:TroySimmons,NationwideInsuranceTroydidanexcellentjobdetailingthecostcomponentsofoutofpocketcosts,includingpremiums,that65andolderindividualswillspendovertheirremaininglife.Again,sincemostofthemedicatecoststructureisknowntoREAOCBoardmembers,sufficeittosaythatitwascrediblydemonstratedthatlifetimecostseasilyadduptobetween$259,000and$398,000intoday’sdollars.Inthefirstyearbabyboomersstartedretiring,healthcarecostsintheU.S.reached$1.5trillion.Aseriousburdenexistsforplansonthehookforpayingthesecosts.Likewise,effortstoreduceOPEBoractualpensionamountspaidoutwouldincreasetheburdenonindividualretireeswithoutvestedhealthsupportfromtheirretirementplansoremployer.ForourmembersitisworthnotingthatMedicarePartBhasbeenincreasedfor2016to$121.80orup$17.00permonthfromthe2015rateof$104.80.Economic Volatility: Hidden Societal Costs of Prevailing Approaches toPension Reform - Michael Kahn, PhD, NCPERS, Director of Research,Presenter,andContributortothisstudy.
Author’sNote:Dr.MichaelKahnsatnexttomeattheclosingWednesdaynightdinner.Weendeduphavingalivelyandveryinformativediscussiononthenationalandlocaleconomicsofpensionsandimplicationsfornationalpolicy.WithasolidbackgroundinacademiaandeconomicsandhispositionofNCPERSResearchDirector,Dr.Kahniswellpositionedtohelpdefineandmarketparametersthatinfluencethecurrentragingpensiondebate.Our
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discussionincludedmoredetailontheEconomicVolatilitystudythatwillbediscussedbelow,mythoughtsonAlanGreenspan’sheavyweightingofsavingsascriticaltoGDPgrowthcomponent(DBpensionsfundsbeingamajorpartofthosesavings);andpotentialstudyconceptsthatcouldinfluencenationalpolicytowardDBplanuseexpansion,(SomeofwhichIpreviouslysenttoDianeOakleyofNIRSandpensioneconomistDr.TeresaGhilarducci–bothcolleaguesofDr.Kahn).Afteraboutanhourofdiscussion,Dr.KahnaskedifIwouldbeinterestedinjoininghisadvisoryboardaswellasattendeventssuchasonetheDr.Ghilarducciwillbeplayingaprominentrole.ItoldhimIwouldbehappytoconsiderthis,andwouldtakeitupwithmyboards.Movingtothestudyitself,thisnewEconomicVolatilitystudyisnextintheongoingseriesofNCPERSworksthatfocusedlastyearonindividualimpacts.ItwasbornfromtherealitythatlittlesolidresearchhasbeendoneontheadversesocietalandassociatedeconomicconsequencesofshiftingtoDCPlan’sanddismantlingpublicpensions.ThestudydoesnotprovidehardmodelinginformationgoingforwardtoshowtheU.S.economyprojectedinfuturetimeincrementswithandwithoutDBplans,butitdoesprovidevaluablehistoricandcohesiveinformationandconclusionsthatgetsatthenegativeslookforwardmodelswouldbeexpectedtoshow.Usinghistoricaldata,thisstudyexaminesthecalculatedvolatilityincreasessince1980forthenationallevelinthreemajorareas:
• EconomicVolatility-asmeasuredbychangestothemedianincome• FinancialVolatility–asmeasuredbychangesinS&Preturns• RevenueVolatility–asmeasuredbychangesinrevenues.
Atthenationallevel,thestudyfoundthatforeach1%shiftoftheworkforcetoDCplans:
• Economicvolatilityrisesby2%• Financialvolatilityrisesby8%• Revenuevolatilityrisesby54%
Atthestatelevel,thestudyexaminedtherelationshipbetweennegativepensionchanges,suchascutsinbenefitsandincreasesinemployeecontributions,andconversionofDPplanstoDCplans.Thestudyfoundthatforeachnegativepensionchangeastatemakes:
• Economicvolatilityinthatstateincreaseby10.5%,and;• Revenuevolatilityinthatstateincreasesby65.1%.
Thesefindingsweretestedandfoundtoholdtrueevenwhencontrollingforothervariablesthatmayimpacteconomicorrevenuevolatility.Inadditiontothedemonstratedvolatilityincreasefindings,thisstudyconcludesthatthatunderminingDBplansincreasesvolatilityspecifically:
1. Byunderminingfinancialeconomicstabilityprovidedbypensionfundsduring
economicandfinancialdownturns.Putanotherway,whenothersrunfromthestockmarket,pensionfundsarelongterminvestorsthatdonotrun;
2. Byunderminingtheeconomiccushionthatpensionchecksprovidetolocal
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economiesduringeconomicdownturns;3. Byincreasingtheprobabilityofanirrationalriseinassetpricesdrivenby
inexperiencedinvestors’mistakes.Thisinturncreatesbubblesthatburstcausingrippleeffectharmtoall;
4. Byincreasingtheexposureofinexperienceinvestorstotheeconomicsofmanipulationanddeception.Whilemarketforcestendtobalanceandmorereputableresourcesmayultimatelygetemployed,thereisnoguarantee,andtheriskofsubstantiallong-termdamagetoindividualretirementsavingsishigh;
5. Foravarietyofreasons,incomeinequalityisexacerbated.Inadditiontotheabove,amajorfindingofthestudyisthatthemoveofsome36millionworkersawayfromDBplanshasresultedin$7trillionofDBandDCplansavingscombined.Thisishalfofthe$14trillionprojectediftheconversiontoDCplanshadnottakenplace.Whilenotcoveredinthestudy,giventhedemonstratedimportanceofsavingstoGDPgrowth,this$7trillionamountoflowersavingsisripeareaforresearch.Thedominantquestionis,whatgrowthimpactwouldtherevolvingcontinuousinvestmentofanadditional$7trillionofsavingsintheUSeconomyhave.
5.INVESTMENTPERFORMANCEANALYSIS Fiveinvestmentriskmeasurementsaremajorcomponentsofmodernportfoliotheory.Thesewereconstantlyreferencedbyinvestmentandinvestorprofessionalsinnumerouspresentationsthroughouttheconference.Themeasuresareintendedtobetterassessriskforgiveninvestmentsusedtochaseafterreturns.Attheriskofbeingredundantforthosefamiliarwith thesemeasures, and for the benefit of those not familiar, below is a briefoutlineoftheirpurpose.
Alpha: Simply stated, Alpha is often considered to represent the value that aportfoliomanageraddsorsubtractsfromafundportfolioreturn.A1%positiveornegative alpha indicates the investment has over or underperformed its indexcomparisonby1%.Therefore,thehigherpositivetheAlpha,thebetter;
Beta (Beta Coefficient): Measures volatility or system risk in comparison to themarketasawhole.ABetaof1.0indicatestheinvestment’spricewillmoveinlockstepwiththemarket.ABetaoflessthan1.0meanstheinvestment’spricewillbeless volatile than the market and more than 1.0, more volatile. ConservativeinvestorslookingtopreservecapitalwantlowBetainvestments.Investorswillingto take on more risk in search of higher returns should look for high Betainvestments.
R-Squared: This isa statisticalmeasurement that represents thepercentageofafund portfolio that can be explained bymovements in a benchmark index. Theindex for fixed-income securities is theU.S.TreasuryBill. The index for equitiesandequity funds is theS&P500. R-Squaredvaluesrangefrom0to100. Valuesbetween85and100correlatescloselytotheindex. A70orlessvaluewouldnotperformliketheindex.Accordingly,anactivelymanagedmutualfundwithahighR-Squaredratiomightbeconsidereda“closet”indexfund. Putanotherway,why
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paymanagementfeeswhenyougetthesameresultsfromalowercostindexfund.
StandardDeviation: Measures thedispersionofdata from itsmean. Essentially,themore thedata isspreadapart, thehigher thedifference is fromthenorm. Infinance, Standard Deviation it is applied to the annual rate of return or aninvestment to measure its volatility (risk). A volatile stock would have a highStandardDeviation.WithMutualfunds,theStandarddeviationtellshowmuchthereturn on a fund is deviating from the expected returns based on its historicalperformance.
SharpRatio:Thismeasuretellsinvestorswhetheraninvestment’sreturnsaredueto smart investment decisions or the result of excess risk. It is very useful todetermineinvestmentsthatproducereturnswithorwithoutexcessiverisk. ThegreatertheSharpRatio,thebetteritsriskadjustedperformance.Theactualratioisderivedby:subtractingtherisk-freerateofreturn(theU.S.TreasuryBondrate)from the investment rate of return, and then dividing the investment’s StandardDeviation.
PENSIONOBLIGATIONBONDS:HankKim–Moderator;GregSmith,ColoradoPublicEmployeesRetirementAssociation(COPERA;)JimLink,PFM(POBconsultant);GerardMiller,CIO,OCERSPensionObligationBonds,touchedonearlier,werethesubjectofapaneldiscussionthatprovidedafrankdiscussionofthemanycomplexissuesinvolved.Whileeachparticipantprovidedsomewhatdifferingperspectivesontheissues,thefollowingsalientpointscameoutofthediscussion.
• POBsareissuedforthearbitragevaluethat,intoday’sinvestmentenvironmentrequiresuseofalternative–potentiallymoreriskyinvestments.
• IssuingPOBsreplacesasoftliabilitywithahardliability(butitisonlysoftliabilityif,forexample,membersarewillingtotakea20%haircutifafundremains80%funded);
• POBscannotbeignoredastheyarealiabilitythatmustgoonthebalancesheet;• POBsmustbeissuedonataxablebasis;• Financialadvisorspitchthatarbitragewillalwaysbeearned,butthebusinesscycle
willnotallowforfixedrates,soiffundatthewrongtimeorinthewrongway,theoverallplanliabilitywillincrease.Variousmistakestobeavoidedwerediscussed.
• Arbitragemodelingprojectionsneedtotakeintoaccountthattheaveragebearmarketlastsonlysolong,soactualarbitrageearningswillbearound80%to85%oftopmarket.
• IssuingPOBs,thennotpayingtheARC,isaformulafordisaster.Accordingly,bondissuesshouldborrowfromtheprivatesectorpracticebyincludingcovenantstorequireorotherwiseincentivizetheARCtobepaid.SamplelanguagewillbedistributedtoCIO’s.Essentially,thelanguageproposedwouldmakenotpayingtheARCatechnicaldefaultthatthengetsreportedtothenationalregistrythatthenhurtsnexttimealegislaturegoestomarket.Therefore,thereisnodictate,justa
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pricetagissuewhereinthecostofcapitalgetsraised.• Timingofthemarketcycle–namely,issuePOB’sduringthetroughperiodof
economicdownturnsjustbeforetheupturnstarts(toughcallatbest);• MultiplePOBissuancescanmitigaterisk,butwon’tknowthefinaloutcomeuntil
thefinalbondispaidoff;• Fortheretirementplan,gettingalumpsumPOBcontributionmustbecoordinated
asaplandoesnotwanttobeonthehooktocreditrevenuenotbeingearned.Planning,modeling,andongoingassessmentandcommunicationwithallplayersiscriticaltosuccess.
• IfpaytheUAALusingPOB’stobecome100%funded,youruntheriskofopeningthedoortobenefitincreasepoliticalpressuresandforcallsnottopaytheARC.
• Attheendoftheday,useofPOBsaretheemployer’schoice.
GerardMilleropinedthatOrangeCountyasthusfartakenahatchetapproachwithrespecttousingPOB’s,andthrownthebabyoutwiththebathwater.HeconcludedthatPOB’sareviablewhenputinplaceattherighttimeandintherightway.Ashisjobandinclinationistogetaclosetobeingfullyfundedassoonaspossible,hehasbegunthemodelingprocesstogetcontext.Theintentistohelpanswerquestionlikewhatisgoingtohappenifyoubondyourwayoutwithrespecttoemployercontributionsandfundinglevels.It’satoughsellsocompleteinformationisessential.Gerardalsoaskedthequestion-whatisdifferencebetweenre-amortizingvs.thecountygoingoutandsellingnewbonds.Hedidnotopinefurtheronthis,butIcanonlysurmisethathewasspeakingaboutthedebtserviceonaPOBbeingroughlycomparabletoincreasedcostsassociatedwithare-amortization.Ofcourse,thiswouldseemtoignorethepositiveeffectofarbitrageearning.Onthequestionofwhataplanshoulddowithbondproceeds,thestrategyeachspeakerwouldemploywasdifferent.Gregstatedhewouldputproceedsina75/25portfoliousingthe25asahedge.Gerardrespondedthatsinceitwouldbeallnewmoneyhewouldproposedealingwithitdifferently.Whileitwouldbethesubjectofintenseinternaldiscussions,modelingandeducation,onepossibilitywouldbetoestablishaspecialpensionfundreserveinvesteddifferently.Thereserve,might,forexample,beusedasasecondarysourcetopayannualobligationsunderspecifiedcircumstances.Inshort,thequestioniscomplexwithmultipleanswers.Theoverarchingtake-away fromthisdiscussionwasvoicedbyGerard. Specifically, it isnotalwaysclearthatissuingPOBsconstitutesafix,buttheuseofPOBsisinherentlynotasevilassomethink,andtheiruserequiresfundamentaldiscipline.Heseesonlyafewplansthatwould usePOBs at this time and advises that theyworkmanymonths in advance,startwithmodeling,begindiscussionsearlyandmakesureallplayers/decisionmakersstaytotallyinformed.Inshort,thisisaverygoodstrategicplanningtopic.WhyGlobalDiversificationMattersNow–Moderator:JohnNiemiee,FairfaxCountyProf.Firefighters&Paramedics,Speakers:MaryBowers,HSBCGlobalAssetsManagement;TendaiMusikavanhu,OneStoneCapital
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Thissessionmadeastrongargumentthatchangesintheworldwideinvestmentlandscaperequiressignificantrestructuringofinvestmentfirmstaffingandmanagementtobettertakeadvantageofthosechanges.Failuretodosoincurssignificantopportunitycostsinunrealizedrevenue.ThekeypremiseisthattheU.S.investmentindustryandinvestorstendstoutilizeexistingstructuresthatarepre-disposedtostickwithwhattheknow.Asaresult,theopportunitycostfromunrealizedrevenueishigh.Someofthemajorstudyfindings:
1. GreaterDiversificationproducesbenefitstoassetallocationandrevenue.2. Worldchangesshouldimpactinvestmentdecisionsincludepopulationdistribution.
But,forexample,whileEuropeancountriesareconsideredamajorinvestmenttarget,theworld’stop10populationsarenotinEuropeancountries.
3. U.S.investorsneedtodiversifystaff&assetmanagerswhowillbeabletotapintotheunfamiliar,reduceassetmanagementconcentrationthroughdiversity,andincreaserevenues.DiverseFundmanagerstructuresproducehigherfundingratios–15%duetoGenderdiversity,and35%duetoEthnicdiversity.
4. 6%peryearlostperformancebynotinvestinginemergingmarketsistheestimatedopportunitycost;
5. TheU.S.focusresultsinmissing40%globalhighyieldmarket.Iaskedthequestionabouthowthelackofruleoflawandstableinstitutionsimpactsthediversificationthesis–especiallyinemergingmarkets.Thebasicanswerfromtheparticipantswasthatvettingiskey,butyoufirsthavetohavemanagersandstaffthatarecomfortablegettingintothenon-traditionaldiversifiedinvestmentlandscape.Vettingthentakestheformofrecognizinganddealingwiththecultureasmisrepresentationscomeinmanyforms.IntheU.S.,asuitwearingprofessionaltakesyoutolunch.InAfrica,youmeetwithaplayerwithanAK47slungoverhisshoulder.Vettingneedstobedisciplinedandcognizantofthefactthatthingscangowrong.Ultimately,itcomesdowntothedifferencebetweenrealityandperception,butthatiswherepeoplemakemoney.JPMorganenticedpeopleintoinvesting-andmademoney.Inthevettingprocess,knowingthepopulationandpoliticsiscritical.Forexample,IsishasnotattackedBrazil.Infact,theyareonlyattackingcertaincountriesinvestorsshouldstayclearof.Onepurposeoftheirattacksistodestabilizecountries’economies–buttheygenerallyarenotsuccessful.Whileinvestinginterroristhatchinggroundsisruledout,itisimportanttonotethatmanycomeupwithreasonsnottoinvestinAsia,Korea,etc.,buttakingthisapproachiscounterproductive.PerspectivesofMarketReturn –Moderator: PeterCarozza, Jr.,UniformedProfessional Fire Fighters Association of Connecticut. Speakers: DinahKoehler,UBSAssetManagement;RichardYasenchak,INTECH.Thissessionpresentedstudydatathatcanbestbesummedupbytheclosingstatement:“TheRevolutionaryIdeaThatDefinestheBoundaryBetweenModernTimes
andthePastisTHEMASTERYOFRISK”(Recallthe5VolatilityRiskMeasures)
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Insupportofthis,datawasproducedthatshowedtheincreasingnumberoffunddrawdowns(akalosses)andthecomponentbreakdowns.ThedatashowsthatLowVolatilityStrategies,forexample,produceda23%drawdowncomparedtoa29%drawdownforstrictlyManagedfundstrategies.Inaddition,therecoverytimeisdifferent–withsomestrategiestakingmuchlongertorecover.And,compoundinglossesoverashorterrecoverytimevs.alongertimeisasignificantandpowerfulcomponentTheimportanceofmanagingriskiscritical.Absolute-riskstrategiesareoutthereandgobymanydifferentnames.Theironecommonsharedgoalistoprovideinvestorsexposuretoequitymarketsandtheirpotential–butwithlowerlevelsofrisk.NotethattheGlobalFinancialCrisisresultedina51%drawdownthattook3yearstoregainbacktothe105%level.Absolute-riskstrategiesprovidedalowerthanmarketriskprofilethoughtime.DinahKoehlerprovidedinsightsonfactorstobetterensuresustainabilityininvesting.Shepointedoutthatcompanyfinancials,certainly,needtobeexaminedwheninvesting.However,inthismodernage,Environmental,SocialandGovernment(ESG)factors,canbeascriticalasfinancialstatements.Typically,companiescandealdirectlyandeffectivelywithgovernmentregulators,tangibleassets,etc.However,nowtheymustbeconcernedwiththeirbrandimagewhendealingwithenvironmentalandsocialissues.Theymustalsotakecaretoensurethattheirgovernancestructureandphilosophydoesnotalienatecustomers.TheESGfactorshaveprovenavulnerabilityforcompaniesandthereforeneedstobeincludedinthevettingofthemasasustainableinvestment.Unfortunately,ifacompanysowstheseedstoalienatetheircustomerbase,theresultwillultimatelyshowupinthemarketresults,andnotinhistoricalcompanyfinancials.6.INVESTMENTSTRATEGYOPTIONS
AllAboardtheAltsTrain:AllocatingtoAlternativesinaLowReturnWorld-Moderator:PatMcElligott,NCPERS.Speakers:TonyGould,J.P.Morgan;JenniferPedigo,TIAA-CREFTonyGouldsetthestageforthisdiscussionbynotingthatthereissomethingwrong–enginetroubleifyouwill,withthedriversofGDPgrowth.Fundsprojectedatsay7.25%nowareat6.25%.AllovertheworldGDPgrowthisprovingelusiveandassumptionsareprovingwrongalongdemographiclinesandothers.Fundingislower,assetvaluesdown,liabilitiesareup,benefitsareup,longevityisup,expectationsarehardening,morecontributionsareneededbuttoohardaselltorelyon.Investmentrevenuesarenowpaying(orexpectedtopay)70%orsoofthetotalretirementpie,sohowcanwereasonablyexpecttogetmore.Today’sreturnplannedexpectationsaverage7.7%,butthegeneralexpectationisthatthis
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willcomedown.Soagainstallofthis,Tonyposes7ideastohelpgetontheRightTrackandminimizetheexpectedearningsratedrop.
1. Leveragetogainadditionalassetexposureandatthesametimereducerisk;2. Allocatetoalternativesthatemployleverage-suchasprivateequity(i.e.Typically
hassomeleveragebuiltin);3. Directinvestmentsinilliquidassets;4. Investopportunistically;5. Investwithactivemanagers-workinginscalecanuncovermorehidden
investments;6. Increasealternativebetaexposure(i.e.risk)-addreturnstreamswithlow
correlationstotraditionalmarketfactors.7. Addtacticaloverlay-systematicbetaandlessoverlays.
JenniferPedigoadvisesto“FindaStation”.BythisshemeansdefinethetypesofinvestmentsRealEstate(core,valueadded,opportunistic),PrivateEquity(equity,securities,debtincompaniesnotpublicallytraded)andRealAssets(farmland,energy,agriculture,agribusiness,energyandinfrastructure).Especiallylookforoverlapsynergieswhenpickinginvestments.Droppinghertrainanalogy(thatdidnotworkwellforme),Jennifernextadvisedtoidentifythekeyentitiestobeinvolvedinyourinvestingstrategy(investmentfunds,investmentadvisors,managementcompanies,LimitedPartnersandGeneralPartners).Nextcomesdecisionstoinvestdirectlyinoperatingcompanies,investinaco-investmentoftenminoritycapacity,investinaClosed-EndMasterorFeederFund,orOpen-EndFundthatisacollectiveinvestmentvehiclewhichcanissueandredeemsharesatanytime.Fundraisingandfundclosingtimelinesinvolvemarketing,termnegotiation,initialandsubsequentclosingactivitiesthatcanspanayearplustotal.InvestmentandDistributiontimelinestypicallyinvolvefourtosixyears.Portfolioinvestmentscanbesingleormultistrategy.Thebottomlineisthatpensionfundsneedtorealizemorereturns,asmorecontributionsaredifficulttoget.Alternativeinvestmentscandothatwiththerightportfolioconstructionandmanagement.Aquestionwasraisedregardingtherolesofprivateequityvs.venturecapital.Intheresponse,itwasnotedthatprivateequity(PE)marketis25timeslargerthanthepublicequitymarketThisledtherespondertooffertheconclusionthat:“therefore”,useofinvestmentmanagersbecomescritical(–thoughtheobviouslinkageofthesetwopointseludesme).Afollow-uppointmadewasthatappreciationhappenedwhileGoogle,Apple&Facebookwerenon-publicprivateentities.Soinvestingwhiletheywereprivatepaidoffbigforinitialinvestors.Finally,onepotentialofinvestinginprivatecompaniesisthepossibilityofmorecontrolandtherefore,potentiallylessrisk.Finally,thepointwasmadethatthemarketisbeingforcedtochangetobetterdealwithtransparency.OpenEndedRealEstate(RE)fundshaveinvestorsserveinadvisorygroups.Sometimesbrokers,whohavealotofclientsininvestmentinacompany,needtobeinvolvedinthecompanytoseewhatishappening.
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Theconcludingpointwasthatinvestinginalternativesisallaboutrelationships–aligningwithmanagers,askinggoodinsightfulquestionstogetbehindthenumbers.ThisapproachcanproducehomerunsChartingtheFutureofPublicPlanInvestments:AConversationwithPlanInvestmentOfficers–Moderator:MarkAnson,CommonFund,Panelist’s:EricBaggesen,CalPERS;StephenSexauer,SanDiegoCountyEmployeesRetirementSystem.EricBaggesenstartedthisdiscussionbynotingthatworldgovernmentshaveissued$8trillionofdebtthatnowtradesatnegativeinterestrates.Thereareindicationsthatactualdebtmaybecloserto$22trillion.Astherearealwayswinnersandlosersinanypolicy,theobviousquestioniswhodoesthishurt.Pensionsandotherindividualsavingsobviouslyfallintothehurtcategoryduetolackofinterestearnings.Whilethispanelgotintoalotoftechnicaldetail,frommyperspective,andIfranklymissedpartofitduetoabadsoundsystemthatdidnotreachmyseat(Ifigureditoutandmovedafterawhile),somepointsIdidcatchandworthreportingcamethroughloudandclear(punintended).
- Toomuchmoneyischasinganyalternativetogetreturnsimplybecausetargetsarenotbeingmet;
- 12,000firmsareadvisingorsellinginvestments,andmakealotofmoneyforthemselves,notnecessarilyfortheclientasreturnsarenotconsistentlygenerated;
- Hedgefundshadequityrisklikeoverallportfoliosandthereforedidnotperformasadvertised.CalPERSdidnotgetthediversificationneeded;
- Thehedgemarketprovednottobescalableenoughandcamewithbaggageofprivateequity(i.e.contractsandhighcosts)withoutoffsettingadvantage;
- TheNationalSecuritiesImprovementActhasforcedadaptiontocomplications,buthasnotcuredallproblems;
- Sophisticatedprocessesforcashflowisusedbysomeplanswheretheymustsellsomethingtobuysomething(Itriedthatonmywife,shementioneddivorce…);
TheHiddenCostofIndexing–Presenters:GregBehar,IndexingManager;andShawnMurphybothofLegalandGeneralInvestmentManagementAmericaImetbothShawnandGregatthedinnerIwasinvitedtoonMondaynightoftheconference.GregandIspokeindetailofthehiddenfeesissuesandhenotedheandShawnwouldbecoveringitintheirpresentationthefollowingday.InourdiscussionIexploredtheextenttowhichtheircompanywassensingthatthepilingonofcostswaspotentiallykillingthegoldengoose-sincelessreturnincreasesliabilityandfeedsDBopponents’arguments.Therewasatleastatacitrecognitionofthispossibility,andmaybepartoftherationalefortheirfocusonHiddenCosts.Thatsaid,highlightpointsmadeduringthepresentationsfollowinnoparticularorder.
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- LegalandGeneralInvestmentManagementAmericaisthe11thlargestglobalassetmanager;
- Thereare,infact,hiddencostsofIndexing;- 35%ofEmergingMarketinvestmentsareinindexfunds;- Adviceofferedistogoforthelowestmanagementfee,butrecognizethesefeesare
notallcosts.Hiddenfeesareequalifnotmoresignificant;- Indexingisallaboutgettingthelowestmanagementfee;- Inassetallocation,designmatters.Dataontheirstudysampleshowedactive
managementresultedinlowerreturnsover18years=22%and$2.2billion;- Qualitybuysmakeadifference;- Whengettinginvolvedinindexfundscomparemanagers,feesandstructures,as
structuresincorporatefeesdifferently;- Disclosureoffeesisanexpensiveissueanddisclosurerequirementchangesstill
needtobemadeeventhoughDoddFranklawrequiresmoredisclosureoncost.(ThismessagewasconsistentfromShawn,GregandAlanTorrence,thefundauditorInotedearlier);
- FeesareleviedforTrustees,FundAccounting,FundCustodian,Legal,Audit,IndexLicensingFeeandothers.Theyaredifferentforeachproviderandthereisamyriadofcostswithineach.
- Togettoanactualexpenseratio,amyriadofquestionsmustbeasked.Questionsshouldincludeexplorationsofexpenseratioforeachfundinvestedin,howexpenseisdetermined,anyexpensecapandhowapplied,expensesthatfalloutsideanycap,expensesthatfallwithinthefundbutoutsidetheexpensecap,expensesthatarechargeddirecttotheclient,expenseschargedtothefundinternally,andhowoftencostschangesvaryyeartoyear.Getfulllistsandanswers.
Equity Investment Strategies – Moderator: Patricia Reily, Teachers’RetirementSystemoftheCityofNewYork.Speakers:DougForeman,KayneAndersonRudnick;GeorgeMathews,AnalyticInvestorsDougForemanledoffthissegmentwithapresentationonhiscompany’sphilosophyandprocesstopickonly“Quality”companies’stocks–somethinghemaintainsmostcompaniesdonotdo.Henotesthatthestocksandcompaniesintheirportfolioarenotnecessarilysexyorglitzy,butaresolidlong-termconsistentperformers.TheQualityportfolioofcompaniesofferedafterthevetting,haveprovenmuchmorestableandproducebetterreturnsatlowerrisksbylargemargins.Thishighqualityportfoliohaslostmoneyonly2timesin23years,andbothtimesrecoveredinonly5quarters.MoneyfromWallStreetisnotneededforhisportfolioofferings,andthestocksintheportfoliojustrollson.Myreactionwas,soundgreat,buthowdoesthiswork?Theanswerissomewhatoldschoolinvolvingastructuredanalysisandgoodold-fashionedshoeleather.Specifically,acandidatecompanyisvettedusingcriteriainfiveseparateassessmentcategoriesdevelopedbyandprovenovertimebyDoug’scompany.Thegoal,andactualtrackrecord,istoretainthecompanyintheportfoliofor10+yearswithoutlossesandwith
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solidperformance.Theassessmentlookslikethis:
1. ManagementExcellence–Managementmusthavedevelopedandadheretocorecompetenciesanddisciplinedcapitalallocation;
2. IncomeStatement–Mustdemonstratedurableearningsgrowthandhighreturnoncapital;
3. CashFlowStatement–Musthaveahighfree/self-financingcashflow;4. BalanceSheetStatement–Musthavealowcapitalintensityandlowdebtbalance
sheet;5. MarketControl–Abilitytodevelop,nurtureitsmarketandmusthaveeffective
competitivedifferentiation.Companiesinvolvedinoneoffive“highqualitybusinessmodels”aresoughtafterforthisportfolio.Thesemodelsare:
• BrandFranchise–e.g.WD-40,Huggies,Apple,etc.;• HighCustomerSwitchingCost–e.g.likethemajorATMsoftwaresupplierand
othercompaniesnotgenerallyknowntothepublic;• NetworkEffect–e.g.Visa;• ScaleCostAdvantage–e.g.Amazon,Costco,T-J-Maxx;• RouteDensity–e.g.WM-WasteManagement.
This“QualityPortfolio”vettingprotocolisbothintuitiveandthefirstinvestmentapproachIheard,thatdidnotappeartohaveanelementofVegasstylebetting(apointDougForemanreadilyagreedtoandamplifieduponinmyone-on-onewithhimafterthepresentation).Theapproachesvaluewasenhancedinmyestimationwhenthetwoinvestmentcompanymembersonthepanelwereaskedabouttheircompany’sexperiencewithcompanyturnoverwithintheirrespectiveportfolios.Asopposedtoanearly50%turnover,theQualityPortfoliohadveryminorturnoveroftenkeepingcompaniesintheroster10+yearsandaddingnewnamesataveryslowpace.Givencostsofchangetoinvestorsandlossesimpliedfromsomediscardedcompanies,thiselementrepresentsapotentialgain.Further,thehighqualityportfolioboaststhatqualityandcreditgohandinhand.Putanotherway,whenpricesdecline,poorqualitystocksgowaydown.QualityPortfoliostocksgodownlessandcomebackfaster-similartorealestate.Thenextspeakeronthispaneldemonstratedthat,duetocompounding,amajorgoalmustbetolimitlosses.Thisisdone,byreducingrisk.And,contrarytoconventionalwisdom,increasedriskdoesnotconsistentlyproduceincreasedrevenue.Sotherearetworeasonstoutilizealowriskstrategy.Saidinreverse,bynotlosingmoney,youendupwithalargerbaseforcompounding.Finally,sufficeittosaythatavarietyofotherpointsweremade,bythispanelandothers,thatreducingriskvolatilityisimportant.
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WhyandHowtoInvestInRealEstate–PeterPalandjian,Intercontinental;ChristopherMacke,AmericanRealityAdvisorsPeterandChristopherarecompetitorsthatrunrealestateinvestmentfunds.Theyprovidedinsightsonthecurrentrealestatemarketandthestructureandanalysistheygothroughthatiscriticaltotheirsuccess.Intheprocess,theydiscussedvariousfundingapproaches,includingdevelopingclosedandopen-endedfunds.Moneyraisedismostoftenraisedtoleveragebankorotherinstitutionalmoney.Bothcompaniesoperateonthepremiseofinvestingincore,valueadded,and,toalesserdegree,opportunisticinvestments.Bothalsoprefermarketsthatcanbeenteredandexitedrelativelyeasilypreferablyquarterly-asopposedtoa12-yearmarriage.Someadditionalpointsmade:
- Themajoradvantageofanopenendfundingapproachisthatitallowstakingadvantageofcyclechangeopportunitieswithrespecttoinflationanddeflation;
- WhiletypicallybothcompaniespreferprimarymarketslikeOrangeCountyduetoitseaseofgettinginandout,theyrecognizethattheshortsupplydoesmakesecondarymarkets,liketheadjacentInlandEmpire(IE),attractive.However,sectorsbecomeimportant.So,whenmulti-family(apartments)becomestooexpensiveinOCbutaffordableintheIE,thoseIEinvestmentsbecomeattractive;
- Newfactorsareinplay.Transportationissues,andthemillennialgroup’stendencytowardunconventionalchoicesnowhavetobetakenintoaccount.Whenmanyworkathome,morethreebedroomapartmentsneedtobeinthemix;
- Lessofficeandretailspace(duetoworkingathomeandonlinebuying)isneeded.WeareadvisedtofollowadisciplinedprotocolwheninvestinginRE.
1. AskwhatyouwantREtodo;2. Nextlookatyourexpectationsonwhattheeconomyisgoingtodogoing
forward.Willitbeincreasinglyaggressiveordeflationary;3. Assesswhatyoubelievetheeconomyisgoingtodogoingforward.Willit
increaseaggressivelyorgointodeflationarymode;4. Andespeciallyimportant,digintodetailsofexistingfundsallocationsinsectors,
primaryorsecondarymarkets,fundstatus,projectstatusetc.Ifdon'tknowfundpositioning,youwon'tknowhowtoreact.
Twofinalpointsonthecurrentmarket.First,REhasoutperformedequitiesbyonlyasmallmargin2011to2015.Inthatsametimeperiod,“Core”REhasreturnedbetween10.6%and14.5%againstanexpectationof8%to10%,withthe2014and2015returnsbeing13.2%and13.7%respectively.ThistrendmakesitdifficulttojustifytakingonadditionalriskbytakingonvalueaddedoropportunisticREinvestmentsthatriskdraggingdowntheoverallREportfolioreturn.
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ATTACHMENT1
NATIONALCONFERENCEONPUBLICEMPLOYEERETIREMENTSYSTEMS CODEOFCONDUCTFORPUBLICPENSIONSERVICEPROVIDERS
Companies,firms,andotherentitiesthatprovideservicesandproductstopublicsectorpensionplansmust:
1. Actinaprofessionalandethicalmanneratalltimesindealingswithpublicplanclients.2. Actforthebenefitofpublicplanclients.3. Actwithindependenceandobjectivity.4. Fullydisclosetopublicplanclientsconflictsofinterestthatarisethatmayimpairthe
abilitytoactindependentlyorobjectively.5. Actwithreasonablecare,skill,competence,anddiligencewhenengagingin
professionalactivities.6. Communicatewithpublicplanclientsinatimelyandaccuratemanner.7. Upholdtheapplicablelaw,rules,andregulationsgoverningyoursectorandprofession.8. Fullydisclosetopublicplanclientsallfeeschargedfortheproductsorservices
providedtosaidclient.9. Notadvocateforthediminishmentofpublicdefinedbenefitplans.10. FullydiscloseallcontributionsmadetoentitiesenumeratedinScheduleAthat
advocateforthediminishmentofpublicdefinedbenefitplans.
CERTIFICATIONOFSERVICEPROVIDERTheundersignedacknowledgesreceiptoftheNCPERSCodeofConductforPublicPensionServiceProvidersandcertifiesthatitagreestoabidebytheprovisionsoftheCode.
Signed: _________________________________
PrintName: _________________________________
PrintTitle: _________________________________
PrintCompany: _________________________________
Date: _________________________________