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CHAIRPERSON JONES: I'd like to call the Investment Committee Meeting to order, please.
The first item on the agenda, roll call, please.
COMMITTEE SECRETARY HARTER: Henry Jones? CHAIRPERSON JONES: Here.
COMMITTEE SECRETARY HARTER: George Diehr? VICE CHAIRPERSON DIEHR: Here.
COMMITTEE SECRETARY HARTER: Michael Bilbrey? COMMITTEE MEMBER BILBREY: Here.
COMMITTEE SECRETARY HARTER: Julie Chapman represented by Greg Beatty?
ACTING COMMITTEE MEMBER BEATTY: Here. COMMITTEE SECRETARY HARTER: John Chiang?
COMMITTEE MEMBER CHIANG: Good morning. COMMITTEE SECRETARY HARTER: Richard Costigan?
COMMITTEE MEMBER COSTIGAN: Here. COMMITTEE SECRETARY HARTER: Rob Feckner?
COMMITTEE MEMBER FECKNER: Good morning. COMMITTEE SECRETARY HARTER: J.J. Jelincic?
COMMITTEE MEMBER JELINCIC: Here. COMMITTEE SECRETARY HARTER: Ron Lind?
COMMITTEE MEMBER LIND: Here. COMMITTEE SECRETARY HARTER: Bill Lockyer
represented by Frank Moore?ACTING COMMITTEE MEMBER MOORE: Here.
COMMITTEE SECRETARY HARTER: Priya Mathur? COMMITTEE MEMBER MATHUR: Morning.
COMMITTEE SECRETARY HARTER: Bill Slaton? COMMITTEE MEMBER SLATON: Here.
CHAIRPERSON JONES: Okay. Thank you. The next item on the agenda is Executive Report. Mr.
Joe Dear, please.
CHIEF INVESTMENT OFFICER DEAR: Thank you, Mr.
Chairman. Good morning, members. Well, today's Committee
work includes adopting three policies, and initially
reviewing one, getting a quarterly performance report from
me and the consultants, getting program reviews for the
real estate and infrastructure and forestland programs.
And then you'll get an update from the global governance
group. The quarterly performance report will be the
last of its kind. We're going to switch to semiannual
reporting next year, as we try to de-emphasize the very
short term and move towards a longer term view of
performance. But we'll start with some observations that
were prompted by the recent announcement of this
year's winners of the Nobel Prize in economics. Two giants
of economics theory, Eugene Fama of the University of Chicago
and Robert Shiller of Yale recently won the Nobel
Prize in economics. Now, a technical note, there actually
isn't a Nobel Prize in economics. It is the Swedish
Central Bank prize in memory of Alfred Nobel, but they
all show up when all the other Nobel winners do, and it's prestigious
as a Nobel in reality.
But Shiller and Fama won. Observers were startled by the choice, because their work
essentially developed diametrically opposite theories
about the efficiency of markets. Now, the Committee
hedged itself a bit, because there was a third winner. Lars
Peter Hansen also of the University of Chicago. And his
work on statistical methods to essentially bridge
the gap between Fama and Shiller was included. I'm not as
knowledgeable about Hansen's work as I am about Fama and
Shiller. The Committee recognized Fama for his development
of the efficient markets hypothesis, which in its
strongest form says that active management, that is the
search for alpha, is fruitless, because the market knows
all the information about a security as soon as it is
available. That is, accordingly, all prices are right,
bubbles can exist, and there's no way to beat the market.
So get your index funds, stay cheap, hold long, and stay
calm. Shiller found that not all investors are rational
utility maximizers, which Fama's theory assumes. They're
prone to emotional exuberance, whereby bouts of pessimism
or optimism drive market prices above or below their
correct level, and therefore bubbles are not just
possible, they're inevitable. Individuals and collective decision making
bodies, like the Board, must be on guard to detect
deviations from equilibrium prices in securities, markets,
and themselves. So which is it, rational efficient markets or irrational behavior?
Well, clearly, the Nobel committee found merit in
both views, as contradictory as they may be. And one of
the lessons I've learned over the years is when you're
faced with an either/or choice, it's a good idea to look
for the both and answer. And if you look at how the discussion at our
workshop on asset liability management went last week, we
could say that you passed novelist F. Scott Fitzgerald's
test of a first rate intellect as the ability to hold two
opposed ideas in mind at the same time and still retain
the ability to function. Now, in practice, no one theory can provide
a formula to calculate the appropriate asset
allocation for CalPERS. A deep understanding of our risk
tolerance and judgment informed by well-grounded Investment
Beliefs and thoughtful considerations about the trade-offs
between return, risk, volatility, funded status are
the best guides to finding a sustainable path forward.
Our Investment Beliefs tackle this divergence. Subbelief 7B says markets are not perfectly
efficient, but inefficiencies are difficult to exploit after
costs. We assume active risk, that is going after alpha,
when we employ managers who attempt to produce an
above-market return after fees. This is an explicit statement
that we believe the selected managers have the knowledge
and skill to persistently find and exploit market and
price inefficiencies.
There's a lot of evidence that this is a fool's errand in line with Fama's efficient market's
hypothesis. And that's why the global equity portfolio
is 70 percent indexed, with the remainder devoted to active
strategies that are generally focused on well researched
anomalies, such as fundamental index's superiority to
capital-weighted ones, and evidence of informational advantages that exist in places likely emerging
or frontier markets.
The ARS program also reflects support for active
strategies, since the only characteristic that unites
hedge fudge strategies, besides their exorbitant compensation, is that they're trying to beat
the market, whatever market they're in.
So pension funds have to be rational in assessing the capability of their managers, internal
and external, to succeed with active strategies. Given the
wave of terminations we've made following the global
financial crisis, the evidence for us is that the set
of managers who can actually beat the market is smaller
than we thought it was, but we need them.
With our target rate of return of seven and a
half percent, we necessarily end up with a portfolio that
contains what we expect are some market-beating strategies, the global fixed income, active
equity, particularly the Corporate Governance Program,
and private equity portfolios are evidence of this need.
So here we line up with Shiller. Whether the managers actually achieve their goal is not
a matter of theory however. It's the capability of our
own portfolio managers to pick the winners.
Then to conclude on winners, unlike the Nobel committee, with its disparate winners, we
want one, our beneficiaries and participants in the program,
our members and beneficiaries. We'd like them secure in
the knowledge that their benefits will be there as promised,
because they, in large part, are generated by a disciplined
investment program that is built on solid theory, and
sound judgment. So that's my report, Mr. Chairman, this morning.
I'd be happy to answer any questions. CHAIRPERSON JONES: Yes, we do have one.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: Joe, I don't
understand why you are confused that the Nobel Prize for
economics would go to two opposing viewpoints. I mean,
isn't the prayer for a one-handed economist? CHIEF INVESTMENT OFFICER DEAR: That's right.
That's what Harry Truman Hair wished for. COMMITTEE MEMBER JELINCIC: Because it's always
on one hand or on the other. It seems to me the Nobel
Prize committee got it right this time, if you're talking
about economics. CHIEF INVESTMENT OFFICER DEAR: Well, you have
to choose between the one hand and the other.
CHAIRPERSON JONES: Okay. Thank you. Yeah. Seeing no other requests to speak. I
would just like to say, Joe, that about two weeks ago, I
participated in three different forums in China discussing
the reforms in China and its impact on the global economy.
And I just wanted to say that it included over 100
different pension funds all over the world, the China
banks, and the finance ministers of China. And CalPERS
had a prominent role in those discussions. And I just
want to thank the staff, Eric and the rest of the
Investment staff, and the Public Affairs Office, and Mary
Ann Burford for all of the work getting me ready for those
discussions and dialogue. The material was outstanding
and very well received. So thank you all. CHIEF INVESTMENT OFFICER DEAR: You're welcome.
Thank you. CHAIRPERSON JONES: Okay. The next item on
the agenda is the consent item. It's an action
item, action consent items. So we -- Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: Yes. CHAIRPERSON JONES: This is action consent.
COMMITTEE MEMBER JELINCIC: Right. And I had a --
CHAIRPERSON JONES: Wait a minute. Let me go get
your mic. COMMITTEE MEMBER JELINCIC: Yeah, in the minutes,
I had voted against the capital market assumption, and I'd
like to see the minutes reflect that. CHAIRPERSON JONES: Okay. Mrs. Mathur.
COMMITTEE MEMBER MATHUR: I'll move the consent items as amended.
CHAIRPERSON JONES: Okay. It's been moved by Mrs. Mathur, as amended.
VICE CHAIRPERSON DIEHR: Second. CHAIRPERSON JONES: Second by Dr. Diehr.
All those in favor? (Ayes.)
CHAIRPERSON JONES: Opposed? Hearing none. The item passes.
The next item is consent items, information consent items, and I have received no requests
to pull or speak to any of those. So we will move on
to the next action agenda item of Policy and Delegation,
revision of the Global Equity Program policy.
Mr. Dear. INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Dan Bienvenue, Acting SIO of Global Equity. And
Geraldine Jimenez will be presenting this item.
AFFILIATE INVESTMENT PROGRAMS DIVISION CHIEF JIMENEZ: Good morning. Last month we presented
the global equity policy with the intent to clarify
it, and to focus on the total global equity portfolio.
The Committee requested two changes, one was to incorporate
the Investment Beliefs policy, which you see we've
done, and then to clarify that we will incorporate this
policy when investing and making decisions. So today,
we're here for approval, unless you have comments.
CHAIRPERSON JONES: Okay. This is an action item. Seeing no -- Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: And my traditional comment that I'm glad we have no risks in
adopting this policy. I know you've had some discussions,
pros and cons, but fortunately there were no risks.
Thank you. COMMITTEE MEMBER LIND: I'll move approval.
COMMITTEE MEMBER MATHUR: Second. CHAIRPERSON JONES: It's been moved by Mr.
Lind, second by Mrs. Mathur.
Any discussion? Seeing none.
All those in favor? (Ayes.)
CHAIRPERSON JONES: Opposed? Hearing none. The item passes.
We'll move on to the next item on the agenda, Adoption of Global Derivatives and Counterparty
risk Policy and Repeal of Legacy Policies.
SENIOR INVESTMENT OFFICER BAGGESEN: Good morning. Eric Baggesen, Senior Investment
Officer for Asset, Allocation, and Risk.
Before you, you have a second reading and an
action item trying to adopt a new derivatives policy that
will supersede the existing policies and also lead to an
amendment of an array of different policies from an
administrative perspective to remove derivatives language
from specific asset class policies and replace that
language with a reference back to this core policy that
would guide both internal and external manager derivatives
activity. And I would just ask if you have any questions.
CHAIRPERSON JONES: Okay. Seeing no questions. This is an action item.
VICE CHAIRPERSON DIEHR: Move staff's recommendation.
CHAIRPERSON JONES: It's been moved by Dr. Diehr.
COMMITTEE MEMBER BILBREY: Second. CHAIRPERSON JONES: Seconded by Mr. Bilbrey.
Seeing no further discussion. All those in favor say aye?
(Ayes.) CHAIRPERSON JONES: Opposed?
Hearing none. The item passes. Thank you very much.
SENIOR INVESTMENT OFFICER BAGGESEN: Thank you.
CHAIRPERSON JONES: The next item on the agenda, Revision of the Private Equity Delegation
Resolution for Professional Staff.
SENIOR INVESTMENT OFFICER DESROCHERS: Good morning. Réal Desrochers, Senior Investment
Officer, Private Equity.
We have a proposal to -- I don't want to use the
word "clean-up", but I will, to change, not fundamentally,
the policy as it relates to administrative thing and for a
co-investment, and to be able to purchase secondary
interest. We have that, but we want to make clear, I
think, to have really a clear policy. There were also a suggestion from the Treasurer's
Office, that on the co-investment that we have -- we add
the word "co-investment" there, if you're okay with that.
It's absolutely perfect with me and Mike. MR. MOY: Yes. If you look at the policy --
CHAIRPERSON JONES: Mic. MR. MOY: Oops. If you look at the policy,
it's C1, the word at the last line in the sentence,
"...and the co-investment is smaller than CalPERS' PE
commitment. And it -- it's debatable the co-investment clarifies
specifically that you do not want the co-investment to be
larger than CalPERS commitment. CHAIRPERSON JONES: Okay. Thank you.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: Yeah, on page --
Attachment 1, page five of nine, and it's page 128 of the
iPad, can you explain how three and the new six fit
together? MR. MOY: Are you talking about B3 and B6?
COMMITTEE MEMBER JELINCIC: Yes. MR. MOY: Secondary, market purchases are to
be treated in isolation. The reason that the
two and four percent were picked without having some limitations
on it, you would revert to the top quartile. And
we felt that that was probably reaching too far, so we
picked somewhere between first and second quartile and said
that that would be an appropriate level. And the reason we
thought that made the most sense was, in the secondary
market, you actually know the underlying assets, and you
are doing an evaluation of those underlying assets when
you enter into a transaction. It's not a blind pool, which
you would have when you're making a commitment to a
fund. COMMITTEE MEMBER JELINCIC: So a secondary
market purchase of a second quartile fund could be
larger than entering into a quartile -- second quartile
fund initially. And that's because you have some
idea what you're buying, is that --
MR. MOY: You have a complete idea, because you
probably are not going to be making a secondary purchase
that has significant uncommitted funds. They will have
committed most, if not all, of the funds to underlying
portfolio companies. COMMITTEE MEMBER JELINCIC: And in 7, without
limitation, do you mean including, but not limited to, or
do you really mean without limited -- without limitation,
because conceivably you could make a -- you know, this
would allow you to make a waiver that's in violation of
all the other policies, if it's really without limitation.
SENIOR INVESTMENT OFFICER DESROCHERS: No, the
policy would be the driver. Always the policy is the
driver, so it's really to -- oh, okay. I say the policy
would always be the driver, the number one, the core, by
which we operate. And when we meet without limitation,
it's like, yeah, interesting. Amendment, consent, waiver,
sale and disposition, yes. COMMITTEE MEMBER JELINCIC: Okay, except that,
you're right, the policy will be the driver, but we're
putting a section in the policy that says you can manage
all ongoing portfolio maintenance, including amending
anything you want to amend. You could amend a -- you
know, if this really means without limitation, you could
approve an amendment that allowed them to go 90 percent
dead to equity under this clause. So I really -- I think what you mean is
including, but not limited to, amendments because that's
really without limits, unless I'm not understanding what
you're saying. CHAIRPERSON JONES: The suggestion that Mr.
Jelincic is making, does that change the outcome of this,
in any way? MR. MOY: It's not intended to no, no, no.
CHAIRPERSON JONES: Okay. So why don't we -- whoever makes the motion to approve this,
approve it with that amendment.
COMMITTEE MEMBER JELINCIC: I had a question about C1, but I think you explained it, and
this is simply a commitment that the co-invest will never
be larger than the initial invest, is that --
MR. MOY: The commitment, that's correct. COMMITTEE MEMBER JELINCIC: Okay. And in E1,
which is on page six of seven, again you've got "without
limitation", and I think you really mean, "included, but
not limited to". SENIOR INVESTMENT OFFICER DESROCHERS: Right.
COMMITTEE MEMBER JELINCIC: And so if we can include those when we make the amendment,
I'm happy. CHAIRPERSON JONES: You want to move it?
COMMITTEE MEMBER JELINCIC: Okay. I will move adoption of the policy with the "without limitation"
being replaced by, "but not limited to".
CHAIRPERSON JONES: Throughout the document. COMMITTEE MEMBER JELINCIC: Yeah, throughout
the document.
CHAIRPERSON JONES: Okay. It's been moved by Mr.
Jelincic. COMMITTEE MEMBER LIND: Second.
CHAIRPERSON JONES: Second by Mr. Lind. We have another question.
Mr. Beatty. ACTING COMMITTEE MEMBER BEATTY: I just wanted
to clarify that that was throughout the document,
right, because there's a couple other places that's
mentioned that you didn't highlight?
CHAIRPERSON JONES: That is correct. ACTING COMMITTEE MEMBER BEATTY: Okay. Thank
you. CHAIRPERSON JONES: Okay. So it's been moved
and seconded. All -- no further discussion?
All those in favor? (Ayes.)
CHAIRPERSON JONES: Opposed? Hearing none. The item passes.
Thank you very much. The next item on the agenda, California Public
Divestment From Iran Act. SENIOR PORTFOLIO MANAGER SIMPSON: Good morning.
This is Anne Simpson, Senior Portfolio Manager and
Director of Global Governance. And I'm joined by Bill
McGrew, who's the deputy to the program. He's a Portfolio
Manager. We're here to present the Board an item
recommending that four portfolio companies, who we
previously considered, were caught in the divestment
provisions of the Divest from Iran Act. We've had further
research and developments, which Bill has led. The
details are in the item, but our recommendation is that
these four companies not be considered divestible under
the provisions of that legislation. I'd be happy to
answer questions of course. CHAIRPERSON JONES: Okay. Seeing no questions.
Before I ask for -- well, let's go ahead and ask for a
motion on this, please. COMMITTEE MEMBER LIND: Move staff
recommendation. COMMITTEE MEMBER COSTIGAN: Second
CHAIRPERSON JONES: It's been moved by Mr. Lind
and second by Mr. Costigan. Seeing no further discussion.
All those in favor? (Ayes.)
CHAIRPERSON JONES: Oh, roll call. Electronic vote. Okay.
(Thereupon an electronic vote was taken.) CHAIRPERSON JONES: Thank you.
The item passes. Thank you. SENIOR PORTFOLIO MANAGER SIMPSON: Thank you.
CHAIRPERSON JONES: Before you move, Ms. Simpson, I am pleased to share that Anne Simpson was
recognized last month by the U.S. Green Building Council's
Northern California Chapter. And the U.S. Green Building
Council is a nonprofit organization that promotes
sustainability in how buildings are designed, built, and
operated, and is best known for its development of the Leadership
in Energy and Environmental Design, also known as LEED's
green building rating systems.
Anne was recognized in the Green Groundbreaker category for her leadership with the Fund's
sustainability effort. In addition, Anne was also formally
recognized by both House of the California Legislature for
her work in receiving this prestigious award.
So please join me in congratulating Anne for that
award. (Applause.)
SENIOR PORTFOLIO MANAGER SIMPSON: Thank you. CHAIRPERSON JONES: Thank you.
SENIOR PORTFOLIO MANAGER SIMPSON: I know I was
named and I'm greatly honored, but I really think this is
an award for the whole team, and especially for CalPERS.
Thank you. CHAIRPERSON JONES: Thank you.
Okay. We move then to the next item on the agenda, contract administration, extension
of existing investment manager agreements.
Ms. Moody. INTERIM CHIEF OPERATING INVESTMENT OFFICER
MOODY: Good morning. Carol Moody, Interim Chief
Operating Investment Officer. This is an action item. We
are seeking approval of a one-year contract extension for
the 42 external manager contracts. This is consistent
with the procurement policies adopted by the Board. And
we will be coming back annually to seek this extension.
I can answer questions. CHAIRPERSON JONES: Seeing no questions.
VICE CHAIRPERSON DIEHR: Move staff's recommendation.
CHAIRPERSON JONES: It's been moved by Dr. Diehr.
COMMITTEE MEMBER MATHUR: Second. CHAIRPERSON JONES: Seconded by Mrs. Mathur.
Seeing no further discussion. All those in favor?
(Ayes.) CHAIRPERSON JONES: All those opposed?
Seeing none. The item passes. Thank you very much.
Okay. Then we move onto the information agenda items. This first one is the CIO Total Fund
Performance and Risk Report. Mr. Dear and Mr. Baggesen.
(Thereupon an overhead presentation was presented as follows.)
CHIEF INVESTMENT OFFICER DEAR: Thank you, Mr.
Chairman. I'll be assisted by Eric Baggesen who will
cover the risk section. And if there are any particular
questions and detail on any asset class, the Senior
Investment Officers are available for you. This report is dated September 30, but the
update includes market developments since then. You
also had an economic briefing from John Rothfield, who
prepares all this material at the asset liability management
workshop last week where he was giving a 3- and 10-year
view, so you've had a lot of this.
And as I said at the outset, we're trying to
de-emphasize quarterly reporting. So my introduction may
be longer than the whole report to -- not quite.
But the economic market conditions are still good. Favorable. Not as much growth as we
would like, but growth. Unemployment -- or job creation
occurring, not as fast as one would hope, but it really
hasn't changed in several years, and for the reasons
that we've enumerated. Deleveraging fiscal drag on government
-- by government spending policies and other reasons,
we don't really expect this to change. So it's not
as good as we'd like, but it's still, for a manager of risk
assets, a pretty good environment in which to find value.
Eric will talk about portfolio risk. It does trend lower. And the total fund performance
we continue outperformance in recent periods, which is
heartening. And we are optimistic about our ability to
carry that forward.
CHIEF INVESTMENT OFFICER DEAR: One of the things
that did get updated was this chart, which shows positive
same trend and negative developments. And I have one that
was done last Friday, and there are now a lot more
positives than there were on this chart and very few same
trend. And then just a couple of negatives. But, in general, what we're seeing is slow
growth, CapEx and business coming up, continued improvement in housing, which is really important,
both from an employment and investment standpoint,
and because of ancillary developments that housing bring,
including household formation. Oil and gas prices are
favorable. And the global purchasing manager indexes
are strong. So there's a lot to be optimistic -- or to undergird
an optimistic stance.
The same trend core inflation stands where it is.
That's good in the sense that there's a lot of fear that
central bank policies in the United States and elsewhere
will lead to a bout of high inflation, but it's not
apparent in the numbers now. And on the negatives, consumer sentiment took
a dive after the problem with the budget and
the extension of the debt limit. That may come back. Home
resales are leveling out. Affordability -- housing affordability
is coming down, but it's still better than it
was pre-crisis. And exports are a little bit off. But, in
general, things are really quite good.
CHIEF INVESTMENT OFFICER DEAR: This chart on the
left is the one we look at frequently. It defines the
components of growth. And you can see there are now very
few negative elements that are inhibiting growth. In
fact, there are two, the federal government and State
government. And all the rest of them now have turned
positive, so we have this interesting situation where
fiscal policy with quantitative easing is trying to help
the economy both from an economic standpoint in terms of
jobs and a growth standpoint. And the spending side of the equation is a
drag on that. So it would be nice if we could get
a greater harmony in that approach. But that involves
things in D.C., which I don't understand about why we
can't get that.
And on the right side of that, U.S. employment growth, and you can see the average employment
growth on the red lines -- or the horizontal lines is
up, but again it's painfully slow.
CHIEF INVESTMENT OFFICER DEAR: Households are
doing better. And this, as I said earlier, is a big
driver for growth, so a return to health of the housing
market, which has been -- which we've been seeing is good
on the left side. The housing debt to income ratio is
falling. In the middle chart, the household net worth as
a multiple income is increasing, and, then as, said
affordability is coming down, but it's still a lot better
than it was pre-crisis. CHIEF INVESTMENT OFFICER DEAR: So if we can
turn now to market environment, we look at the
10-year treasury yield. And you can see that it's still a low
interest rate environment. That's what the Fed intends.
The old adage, don't fight the Fed, is still I think
good advice. And the Fed is certainly signaling an intent
to keep rates low until they see significant improvement
in the labor market.
And after the experience of May, where some signals were given about tapering in the QE2,
and the market reacted fairly significantly with 100
basis point rise in interest rates and a five percent
drop in equity markets, that the Fed has their very able
staff recalibrating how to communicate and stage
that tapering activity.
And the relative slow down due to the problems on
the fiscal side in D.C. have also given the Fed some
caution. And, of course, the Fed is undergoing a
leadership transition, but it's expected that Ms. Yellen
will be approved and is highly likely to continue the
policies of her predecessor -- soon-to-be predecessor Ben
Bernanke. On the right side, the spreads between corporate
bonds an 10 years remain narrow, so it's still an
environment where the risk takers are not being really
rewarded. It's therefore still a fairly benign environment.
The actual markets themselves, the upper right the U.S. S&P 500, nice, huh? I mean, it's
just solid increase. And over the three years since June
30, 2020, a 66.7 percent increase. Eric, did a lot of
that when he was in global equity, but it's steadily up.
But that's not the picture for Europe or emerging markets. Emerging markets are below that on
the left side. And you can see they're actually down
from two years ago, June 30, 2011 up only 12 percent
from three years ago. And the recent bounce after the
drop that occurred when the Fed did its taper announcement
in May has it up nine and a half percent.
The Euro -- the European markets, on the upper right show some increase from three years
ago and flat from two years ago, and definitely benefiting
from a stabilization of concerns about the future
of the Euro, and the reasonable progress the Europeans
and their central bank are making to make the fiscal,
monetary, and structural adjustments to keep the European
Union together.
And finally, we have commodities in the lower right. And you can see commodity prices are
relatively stable, made about mid-point from their highs
prior to the crisis.
CHIEF INVESTMENT OFFICER DEAR: Okay. Mr. Baggesen, risk.
SENIOR INVESTMENT OFFICER BAGGESEN: Yes. Good morning again. Eric Baggesen, Senior Investment
Officer for Asset Allocation and Risk. As you can
see on page eight of the material in the PowerPoint deck
that the total fund risk profile is within all of its
tolerance zones. The active risk has actually dropped
just below one percent with a little bit more than 90
basis points of tracking error. The total fund forecast risk
is still coming in approximately 11 and a half percent.
That number is -- it's drifted a little bit lower, but it's still a bit elevated. And
should the easing or the backing away of the easy monetary
policies of the Federal Reserve take place, we would
expect probably that we would see potentially some
additional volatility in these numbers.
That volatility is expressed as a value at risk.
You see a 10-day VAR number. And that is in a normal
market environment, where we have the potential to have a
variation in the value of the fund of up to $10 billion in
a 10-day period. And should the market become a very
extreme kind of event, that VAR number could expand to
over $12 billion. So that is, again, the degree of potential
volatility that we could experience. And that volatility
is in large measure centered still on the growth assets.
SENIOR INVESTMENT OFFICER BAGGESEN: If you recall from the ALM work that we did last
week -- CHAIRPERSON JONES: Excuse me, Eric. Back to
that previous chart for a moment. SENIOR INVESTMENT OFFICER BAGGESEN: Sure.
CHAIRPERSON JONES: The 10-day value at risk, is
that something we instituted on our own or are there
requirements, such as banks have a requirement to do that,
or are there requirements? SENIOR INVESTMENT OFFICER BAGGESEN: Yeah.
This ends being pretty much just a standard VAR
number, Mr. Jones, that is looked at. I think that there
are some BIS standards that are applied to the calculation
of VAR numbers. And this interval, I believe, is
consistent with what they applied to some trading operations
and investment bank numbers
CHAIRPERSON JONES: Okay. Thank you. SENIOR INVESTMENT OFFICER BAGGESEN: But there
is no -- there's no magic behind that. You can
calculate VARs based on almost any time interval that
you'd care to look at.
CHAIRPERSON JONES: Thanks. SENIOR INVESTMENT OFFICER BAGGESEN: Are there
other questions on this particular slide? CHAIRPERSON JONES: No.
SENIOR INVESTMENT OFFICER BAGGESEN: Okay. Again, contributions to risk. We see the main
risk coming from our growth related assets. These are
the gray bars on the chart. Both private equity and public
equities contribute more in risk than they actually
represent in asset allocation weight. I think beyond this,
the only other comments that I would make is that Attachment
3 to this agenda item has the full risk report.
And it includes information such as leverage levels,
which are all within policy limits and tolerances.
It also includes information about counterparty risk. And that was one element that was noted
in the Wilshire opinion letter that was attached
to the derivatives policy. Wilshire made a note that
that -- the monitoring of that counterparty risk has been
delegated to the staff, but you still can see this information
attached to the risk reports in the book. And I think,
at that point, I would just stop and ask if you have
any questions.
CHAIRPERSON JONES: None so far. Wait. Wait. We've got one.
VICE CHAIRPERSON DIEHR: Just if my calculations are right. Back on the previous slide where
you've got private equity at 11.84 as the asset allocation,
right, and -- so the -- I'm surprised, I guess a
little, that the private equity -- the private equity's risk
is about 25 percent, three parts out of 11.84, more than
the allocation. The public equities is on the
order of 40 percent. Can you explain that?
SENIOR INVESTMENT OFFICER BAGGESEN: That's a
great question, Dr. Diehr. And I should note that Alan
Milligan asked me the same question last week and I don't
think I have a perfect answer for it, other than I believe
that what you end up seeing is that the way the
calculations are done coming out of the system is it
identifies the greatest bucket of volatility, which
happens to come from the degree of assets that are exposed
to the public markets. And then you are, in essence,
calculating residuals that are not explained by that
calculation. So I believe that what you see is that
there's some residual effect that takes place. And we also identify with private equity a
less than perfect correlation with public equities.
So the private equity correlation comes in around,
I believe, about a 0.7. Although I don't have that number
right in front of me. So I think that when it calculates
this relationship, I think it's a phenomena of
that, but we'll have to check and see if I can get a better
answer for you next time we bring this material together,
because that is counterintuitive.
VICE CHAIRPERSON DIEHR: Yeah. Thank you. CHIEF INVESTMENT OFFICER DEAR: I think it
also may be that observed volatility in private
equity is less than actually exists, because you're making
sampling at quarter intervals, and you're appraising a
significant part of the portfolio value.
CHAIRPERSON JONES: Okay. Thank you. Seeing no
further questions. CHIEF INVESTMENT OFFICER DEAR: Now, the total
fund. CHAIRPERSON JONES: We go now to the next item,
consultant's total fund. CHIEF INVESTMENT OFFICER DEAR: Well, if you
want to, you can skip the performance report.
CHAIRPERSON JONES: Oh, no, I'm sorry. That was
a question, right? Go ahead.
CHIEF INVESTMENT OFFICER DEAR: It's pretty good,
so you might want to do it. I'll do it quickly though,
Mr. Chairman. CHAIRPERSON JONES: No, go ahead.
CHIEF INVESTMENT OFFICER DEAR: So this is the --
for the one-year period ending September 30, 13.7, 140
basis points over the benchmark.
CHIEF INVESTMENT OFFICER DEAR: So as I said, for
the shorter time periods, three years or less, the
portfolio is performing reasonable well. For the
five-year, it's not good, and for 10-year, it's behind.
And for the 20-year, it's just off slightly 10 basis
points underneath. The 10-year number at 7.22 is below our target
seven and a half percent return. But the 20-year at 7.7
is above it. And then our inception-to-date from 1988 at
8.65, this is some validation for wanting to look at a
seven and a half percent return going forward for the
fund. Let's see. We'll just skip this page -- and
cumulative returns. CHIEF INVESTMENT OFFICER DEAR: This chart
we've talked about before. When you look at 2009,
which is about in the middle where everything dips,
those are the large drawdowns I keep telling you I worry
about. They hurt. And then when you see the gap of the
bottom line, which has the triangles, is it falls below
the line -- red line with the squares. That's the gap between
what we had expected and what we've actually earned. And
it reflects the realized losses which were incurred in
2008 and 2009. That's an expensive gap. And the actuary is
often called to step in with contribution rate increase
recommendations to help close it.
We're obviously moving in towards getting back to
that expected line of seven and a half, but there's just
no doubt the obvious when you lose a significant part of
assets and include that with realized losses, it does
create a drag on performance, which persists for quite
awhile. CHAIRPERSON JONES: Just a minute, Joe. We
have a question.
CHIEF INVESTMENT OFFICER DEAR: Sure. CHAIRPERSON JONES: Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: When I was looking at
the financial statement, which is over in another
committee, I thought we had reported out a 15 something in
that -- in the financial earning, in the financial statement?
CHIEF INVESTMENT OFFICER DEAR: I'm sorry, a
fifth? COMMITTEE MEMBER JELINCIC: Well, in the
financial statement, I'm looking for it to try and find
it, but I thought we reported out a 15-point something
earnings. In the discussion in here we're talking 13.
And I'm just wondering how I reconcile those two.
CHIEF INVESTMENT OFFICER DEAR: My -- highly probable that the CAFR rolls up the quarter
lag for real estate and private equity, and makes it concurrent.
And that the reports you typically get from us
have the appraised assets on a one quarter lag basis.
COMMITTEE MEMBER JELINCIC: Okay. And just for --
CHIEF INVESTMENT OFFICER DEAR: I will check. COMMITTEE MEMBER JELINCIC: Well, just for
you information, there's a lot of heads behind
you going yeah. CHIEF INVESTMENT OFFICER DEAR: Okay. Good.
COMMITTEE MEMBER JELINCIC: Okay, but thank you.
CHAIRPERSON JONES: Okay. Continue. CHIEF INVESTMENT OFFICER DEAR: Okay. Three-year
rolling excess return. This is a little better picture,
because it does show the improvement in portfolio performance, where we're beginning to gain
an advantage and produce returns above those expected by
the benchmark. And then we go into relative returns within
here. CHIEF INVESTMENT OFFICER DEAR: And I'd just
draw your attention to two. Public equity with
its -- versus private equity. So the hashed bars are 10-year
returns. And you can see private equity beating public
equity handily 12.8 to 7.9. But on a one-year basis,
public equity beats private equity 20.8 to 19.0.
You know, it's not a so what, but it's not, you know, an
amazing finding. But it does show that the private equity over
the longer term is producing the excess return we hoped
for. We want three percent over the public markets.
The liquidity line further down, which shows 2.3
percent return on a 10-year and then 11.1 -- 11.7 is some
of the work of improvement in treasuries and commodities.
I will skip over the other side, unless there are
questions. They generally show what we've been talking
about before that real assets still kill us over the
longer term. Private equity on a one-year basis is a bit
of a performance drag, but I just wouldn't -- since the
assets are appraised, I just wouldn't worry about a
one-year number. And the other performance is pretty
steady. CHAIRPERSON JONES: Okay. We have a question.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: This goes back
to slide 14. And for the color blind members
of the Board, I thank you for using the hash marks.
CHIEF INVESTMENT OFFICER DEAR: Yes. You're welcome.
CHAIRPERSON JONES: Mrs. Mathur. COMMITTEE MEMBER MATHUR: Thank you. On real
assets, the 10-year turns, does that -- that doesn't --
does that include infrastructure? Obviously, there was
some forestland -- CHIEF INVESTMENT OFFICER DEAR: Yes.
COMMITTEE MEMBER MATHUR: But does infrastructure --
CHIEF INVESTMENT OFFICER DEAR: It's the Infrastructure, forestland, and commodities.
COMMITTEE MEMBER MATHUR: How far back does the
infrastructure program go? I guess what I'm wondering is
whether it would make sense to break out a real
estate -- you know, real estate from the other real assets
just because of the timing? CHIEF INVESTMENT OFFICER DEAR: It does if
you want any kind of understanding about individual
program performance. It's just how much stuff we can
put on one slide. And having asked, you will now see
something next time we come back.
COMMITTEE MEMBER MATHUR: I guess also sort of in
terms of looking forward, I know it's impossible to sort
of reflect -- or maybe -- let me ask the question instead
of saying it's impossible. We have changed our strategy
in our policies, particularly with respect to real estate,
but maybe even with some of the other assets classes.
Have we done sort of a look-back to see what our
performance would have been if we had had the policy in
place? So how much of our current policy would have
resulted in terms of returns? Because it's so hard -- if you looked at this,
you would say, "Oh, why are you even in assets? Obviously, they're such a killer". But there
are -- we have a belief that our current strategy is
going to deliver much better returns.
CHIEF INVESTMENT OFFICER DEAR: Yes. You'll see
that when we do the Real Estate Program review later
today. Ted can talk about that. COMMITTEE MEMBER MATHUR: Yeah. Okay. Thanks.
CHIEF INVESTMENT OFFICER DEAR: This interesting box chart here on page 16 sort of what are
we -- what did we get versus what did we expect by asset
allocation? So in the center, where the two lines intersect,
is the total fund what we would ex- -- what we expected to
get. And then the square of the same -- sorry Mr.
Jelincic -- color -- we're not consistent yet -- what we
actually got. So the total fund performed somewhat wetter
with a bit less risk than we had expected for us on a
three-year basis. So that's an encouraging number.
You can play with this at your leisure. You can
see grouped in the area of a lower return and lower risk,
the inflation-linked bonds, fixed income, and
inflation -- you know, the expectations of the actual
returns are very close together, so that tells us, you
know, we're sort of on target with how we do the
portfolios, but the asset class itself has been impacting.
And then a really healthy disparity on private equity where we expected much higher risk
than we got, and lower return above the market. And that's
the triangle on the far right in the upper right quadrant
back to what we actually got. So, you know, that's good news.
And this is a way of looking at expectations versus performance, which our performance
group is trying to come up with more and better ways visually
of illustrating portfolio performance. And this
is one of the improvements.
CHIEF INVESTMENT OFFICER DEAR: Asset allocation is basically on target.
CHAIRPERSON JONES: Just a minute. Joe? CHIEF INVESTMENT OFFICER DEAR: Yes.
CHAIRPERSON JONES: We have a question -- Dr. Diehr -- on the previous chart.
VICE CHAIRPERSON DIEHR: Thank you, Mr. Chair. And why was the expected return on private
equity was so dismal there? It looks like about eight percent.
CHIEF INVESTMENT OFFICER DEAR: Well, we're running three percent over with the public
markets are generating and we got better than that on
the three-year. VICE CHAIRPERSON DIEHR: Okay.
CHIEF INVESTMENT OFFICER DEAR: And then we want
to go back to this question about how much of the
volatility that's really there do we actually observe?
CHAIRPERSON JONES: And also on this chart it
kind of answers Mrs. Mathur's question. You see the real
estate is a higher return, even though a little bit more
risk, but it's higher. And than the infrastructure is
lower, so that kind of gets to -- CHIEF INVESTMENT OFFICER DEAR: Yeah, it is
getting better. CHAIRPERSON JONES: -- Mrs. Mathur's question.
CHIEF INVESTMENT OFFICER DEAR: So I'll just skip
the asset allocation. Everything is within range or we
still have an overweight in equity, but, you know, we're
comfortable with that still, because we don't know where
else people are going to go with their money with all of
the intervention in the markets, and the concern about
fixed income. CHIEF INVESTMENT OFFICER DEAR: So to summarize,
the portfolio is in good shape. The performance is quite
like it was three months ago at the end of June, that's
why we're going to semiannual reporting. But we're
pleased with the direction, and believe that we have a
good grip on where things are going. And we're looking
forward to the potential adjustments in the asset
allocation the Committee may make in February, I guess,
and get ready for those, but things are pretty good.
Something can happen out there. As you all know,
the world is full of risk and mistakes can be made outside
the investment world that affect what we do. But right
now, I think we are justified in maintaining what I've
called a cautiously optimistic stance with a tilt towards
overweight of some of our risk assets. That concludes the report, Mr. Chairman. And
no further questions, Wilshire will come up and
add some detail for you.
CHAIRPERSON JONES: Okay. So seeing no further questions on this item, the next item is the
Consultant's Total Fund Performance and Risk Report.
(Thereupon an overhead presentation was presented as follows.)
MR. SCHLACHTER: Good morning. Michael Schlachter, Wilshire Associates. Given I think
the comments you've already received from the
CIO and from Mr. Baggesen, as well as the very thorough economics
presentation you received last week as part of the asset
allocation workshop, we're going to keep these comments
pretty short. MR. SCHLACHTER: As you can see, the first
page of this was produced before the shutdown thankfully
ended. At this point, we're living, I think, crisis
to crisis with the next one expected now to occur I
think it's February 7th or 8th is the next one of these
we get to go through. I think each time it seems like we
go from a 99 percent certainty that it will get resolved
in time. This time I was down to about a 90 percent certainty
they might resolve it.
Hopefully, with an election approaching, that will not push them in the direction towards
more brinksmanship is good. Hopefully, resolutions
will keep happening. But nonetheless, these are coming
at a faster and furiouser rate. And each time, it seems
as if they become much more severe, these self-imposed
crises. So again, thankfully, we averted this one. Although
the cumulative damage to interest rates, to our
standing in the world, to public perception of the U.S.
as truly being a safe haven I think is beginning to weaken
thanks to these, again, constant crises.
MR. SCHLACHTER: The next couple of slides, slide -- page four does repeat some of the
data that Joe had showed in his presentation, so I'll skip
ahead to page five.
MR. SCHLACHTER: And I'll just very briefly talk
about the consumer. Obviously, the consumer drives about
70 percent of the U.S. economy. And so while the last
couple of recessions and fiscal crises have been driven
largely by consumer behavior, we certainly can link it to
other things in the bigger economy. But overall, the
consumer certainly had a large role to play and bore most
of the weight and most of the pain the last couple of
recessions. Page five does show is it possibly sewing
the seeds of the next one of these? And Joe had
talked about some similar page -- some similar slides to
this showing that the consumer is showing some improvement.
There is some pick-ups here.
If you look at the top of page five, the two lines I think tell an interesting story. The
blue line is essentially debt levels for individuals. And
that has come down pretty significantly since the beginning
of the recession. There's a very, very small leveling
and potentially an increase at the very end of
this. I have no idea if that's simply an anomaly or a transient
spike or if, indeed, the consumer has begun to level,
given the economic, employment picture, continued improvement
in GDP, it wouldn't surprise me if the consumer
is beginning to move in the other direction, levering the
balance sheet up again. But at least we've -- the deleveraging
process appears to be slowing.
Now you combine that with the fact that debt
service is a fraction of income is really at a 30 or 40 or
50 year low. That's largely because of low interest
rates. So consumers have slowed their deleveraging and
they're doing so at a very low service level. And the
question becomes how much of that debt really is tied to
variable rates, certainly credit card debt, some student
loans, an increasing number of mortgages again, auto
loans, a variety of things can be tied to variable rates.
And so to the extent that the consumer has said
the economy is getting better, employment is getting
better, let's begin to at least stop taking things off our
balance sheet, maybe let's take some fresh debt again. If
doing so with an adjustable rate and these very enticing
times of very low rates, that does set you up potentially
for another credit issue down the road when rates begin to
spike. So we are keeping an eye on this obviously.
And that could be a sign of potentially things
to come. The bottom of page five showing the big spike
in credit, especially revolving credit, again the numbers
aren't huge on this page, but it does show that the lessons
we learned five or six or seven years ago, the pain people
took appear to have been lessons that were forgotten
and revolving debt is beginning to come back on
the balance sheets again -- or variable debt is coming
back on the balance sheets. And we'll see what happens
down the road as rates inevitably begin to rise.
MR. SCHLACHTER: The next page or two does show
some good news. Housing, of course, is usually the
largest item on anyone's personal balance sheet, for those
who are lucky enough to be homeowners. And we have seen
some generally steady improvements over the last few
years. As you can see on page six that delinquencies are
beginning to decline. Housing starts and prices, while
they've spiked a little bit downward over the last couple
of months are still long term over the last few years back
on a positive trend again. So from the standpoint of the wealth effect
of people thinking again that large piece of
their balance sheet has at least leveled or is improving
again, that might be leading to some of the optimism we
saw in the previous slide, when it comes to the rest
of the personal balance sheet.
So on the one hand it's good news obviously that
the biggest asset has stabilized and might actually be
improving in value again. The bad news, of course, is
what that drives from a confidence perspective. The last
page I'll show of economic information is on page seven.
MR. SCHLACHTER: And this was added, at least in
part, because of a question I think came from this Board a
quarter ago. The bottom of this page refers to that. The
top part I'll cover first. And the part -- the top part just shows something
of a long-term historical view, the last 50 or 60 years,
and the structural change that really has happened in the
American workforce over the last several decades, as you
can see, largely as a result of economic troubles. The gray bars, or whatever color that is,
those thin narrow vertical bars indicate recessions.
And as you can see during each recession we've had over
the last, again, 50 or so years, not surprisingly the
fraction of people, or the number of people, who are willing
to take a part-time job for economic reasons, any job
is better than no job, obviously spikes up during each recession.
The interesting thing is how some of those spikes
have actually become permanent over the course of time.
This line does not just increase with population, it moves
in a stair-step pattern, and in many cases, for example,
the mid-1970s, even the 1980s to some extent, those steps
have become somewhat permanent. So a strong economy drove
down the number of part-time workers, a recession happens,
and that level becomes somewhat fixed. Now, we saw a very dramatic spike, almost
a doubling, from four and a half million to
about nine million people taking part-time jobs as a
result of the last recession. That number has begun to trail
about a million jobs back down again, but it is still
very close to an all-time high. And certainly, the current
levels are far higher than they've ever been in history
prior to this last recession.
That indicates a very large structural change in
our workforce. And while I don't want to get mired in a
political debate, discussions about some of the increases
in benefits these days, things like the Affordable Care
Act as well as other workers' rights issues that have come
to the fore are driving more companies towards part-time
workers. It's obviously, if we were to suffer another
recession, it's easier to reduce part-time workers or
contract workers than it is full-time workers. And so
these structural shifts during each recession I think
indicate to employers it can be more a stable for you at
least, as an employer, to change your workforce. The
bottom of this page really shows the impact of that. So
while the top part talks in numbers of people, which isn't
really scaled to population growth, the bottom is straight
in percentages. And you can see the very large widening we've
seen between the typical unemployment number, that blue
line that's a number you hear repeated every month on the
news reports as reported by the government. The orange
line is a bit less widely reported, and that is the number
of workers who would take a better job, essentially, if
they could. Those who are taking part-time work again for
economic reasons or those who have left the workforce and
don't count as unemployed, but would take a job, would
reenter the workforce, if possible. And you can see that percentage typically
has been two or three percent throughout history.
It's lately widened to more than six or seven percent.
So a significant change has occurred really in
the population of American workers over this last recession.
And the true unemployment picture, while we throw
these numbers of seven or eight around it seems like every
month for the last couple of years, the true numbers are
really much more in the low- to mid-teens as far as the
fraction of people who would like a more full-time job
or a better job, if the opportunity was provided to them.
So that really, I think, shows much more clearly, if anything a counterpoint. Joe mentioned
the Nobel Prize in economics went to both sides of the argument.
Well, here we're talking about both sides of the
argument as well. I think those who are employed, those
who have good assets on their balance sheet are beginning
to move in the direction of everything is wonderful again,
let's keep expanding, but a large fraction of the population,
unfortunately as you can see, is still mired in a
situation which things are not improving as quickly as
we'd like. CHAIRPERSON JONES: Okay. Just a minute,
Michael. MR. SCHLACHTER: Yes.
CHAIRPERSON JONES: Dr. Diehr. VICE CHAIRPERSON DIEHR: I'm not sure.
(Laughter.) VICE CHAIRPERSON DIEHR: It looks to me -- it
looks to me like the orange line is about 90 percent -- if
you'd use a percentage basis and not the absolute gap,
that the -- it's -- the orange line is not quite twice as
high. I mean, you go back way over to the left and it's
six and a half, and a little under 12, right? So it's
something like the orange line is 90 percent higher, and
percentage of it. And it's -- you know, of course when
these lines are very steep, it's sort of hard to see the
difference. I think the eye tends to go partly horizontally, and when -- in fact, you need
to go vertically. And so the spreads have really
been in that measure, I would say.
MR. SCHLACHTER: No, I think it's a fair observation. I think, if I can summarize,
I think the point you're trying to make it's that this
fraction of workers has tended -- the folks who are taking
either part-time work or would take a job, if possible,
is usually about equal again to the unemployed
workforce. VICE CHAIRPERSON DIEHR: Yeah, not quite as
much, but somewhere.
MR. SCHLACHTER: Exactly. But the recent levels of unemployment, which are certainly the highest
they've been on this chart, and the highest they've
been probably since the 1970s, imply that that other half
of the workforce, or other half of the unemployed
picture is far, far, far larger.
So you're absolutely right, I think there's some
proportionality here. But if you just think about the
mere fact that seven or eight percent of 120 million
workers is simply a very large absolute number of people.
It's far harder to absorb that than it would be say in
2000 when that number was three or four percent of the
same kind of workforce. VICE CHAIRPERSON DIEHR: No question about
that. And by the way, all of the speculation that
Obamacare will cause employers to cut back on their full
time -- I mean, I've seen studies that suggest that's -- it's
almost all due to just the high level of unemployment
we have and not -- you can't really track anything particular
to the Affordable Care Act.
MR. SCHLACHTER: No, that's absolutely the case.
And I also -- I've had this debate with a few clients or
discussion with a few clients, and I've likened it to --
this is the -- maybe it's the rosy picture I hope we can
move into. I liken it to airbags. When companies -- when
the government began requiring cars to add airbags, the
car manufacturers complained it will kill our margins.
We'll never be able to build a cost-effective car again.
And now you can't watch an ad without seeing them compete
against who has the most airbags. This obviously is a benefit being mandated.
Employers are complaining they can't possibly afford it.
I certainly hope that in a few years we live in a world in
which employers compete on who offers the best benefits to
attract workers again, just like airbags have become a
selling point, but I can cross my fingers and hope this is
possible. VICE CHAIRPERSON DIEHR: Yeah, it's the cry
wolf. They cried about pollution controls. Now,
you can almost breath the exhaust out of new cars and they
have 400 horsepower and so on and so forth. They sort
of -- they've kind of lost their credibility a little
bit in this whole thing.
MR. SCHLACHTER: They have, absolutely. The last -- there's another question, the
last page I will focus on is simply just page nine.
MR. SCHLACHTER: I know there was some debate obviously about staff's risk contribution
-- or risk calculations. I will say that ours are, I
think, very similar to staff. We completely agree with
at least the sum conclusion. We'll work with staff to figure
out the private equity numbers, as far as the contribution,
but in aggregate our chart shows complete -- I'm
sorry, total equity as opposed to public versus private
equity. You can see that that 90 percent number. This
is the bottom right-hand chart, 90 percent of your risk
still comes from those growth assets, the public and private
equity. The discussions we had last week with the
asset liability workshop, which might take private
equity from -- I won't say hypothetically from 14
down to 12 percent, and would keep global equity, public
equity somewhere in the same ballpark of where it
is, is not going to move a needle on this chart.
If you were to radically reduce your allocation to equities by even say 10 percent, I'm not
sure how you get seven and a half percent making that kind
of a shift. But were you to do so, even that would not
have a dramatic shift on the overall fraction of risk that
comes from equities. You need to be well below 40 or
50 percent in total exposure to all forms of equity to see
risk begin to decline, so -- and we can argue or discuss
certainly exactly what those numbers were on our chart
or on staff's chart.
But at the end of the day, the bottom line is you
are wedded to the markets. Last time I checked a few
minutes ago, thankfully, the Dow has crossed 16,000, the
S&P has crossed 1,800. So it's another good day. The
markets keep going up. And obviously, this risk is paying
off for you. But long term, considering the ramifications
of this is very important as we finalize the work we began
last week with the asset allocation workshop. MR. JUNKIN: So I'm going to take over and
go rather quickly. I'll start here on page 11,
which is a recap of performance, which shows already
given, this has a few additional periods, so you can see some
additional time frames that were not present earlier.
But I think it's important to note that you know
I Joe's comments and in Michael's comments we're hearing a
lot of the same kind of it's kind of slow and steady, it's
nothing earth shaking, in terms of the economic growth,
the economic landscape. A yet on the back of that, we've
seen equity markets roar ahead 20 percent. So I find that to be sort an interesting
conundrum. And I think the takeaway is in times where
equity volatility falls, and we've seen that happen right
now, and prices are up, maybe you should start to be a
little bit nervous. Historically, that's been a moment of
inflection. The problem is this time where do you go?
Historically, you would say well we'll go hide in bonds.
Right now you get paid next to nothing for that, and I
think most people would say, if interest rates just held
steady, that would probably be good news for the bond
market. I think the preponderance of the opinions are
that rates will rise. So I'm not sure that there is a place to go
hide right now. And comparing stocks to bonds,
our view is that stocks relative to bonds are probably
a little bit cheap. And bonds relative to their history,
relative to inflation, relative to other asset classes
are still quite pricey.
MR. JUNKIN: I'm going to jump ahead and cover a
bit of -- sorry, I'm trying to use two machines for the
first time. I've got to make sure I get the page numbers
right here. Page 27, and I don't want to steal all of
PCA's thunder about private equity, but I just wanted
to give a quick overview of the market. We've shown
this page before. Global private equity fundraising,
you can see, I think has stabilized at a lower level than
what we saw pre-global financial crisis. Multiples are
kind of in the middle of the range. So prices that people
are paying, they're not low, they're not high historically.
They're just somewhere in the middle.
MR. JUNKIN: Percentage of deals getting done by
size though is really tilted towards the smaller end of
the market. And I think that that's one of the challenges
that CalPERS faces right now in this particular environment. As a large deployer of private
equity capital, unless you consume all of the small
deals, it's hard to get a significant portion of your
portfolio put to work.
MR. JUNKIN: And then last, we've given an update
on the private equity overhang for several years now. And
you can see that the total private equity overhang has
decreased from north of 500 billion to 300 or so, at this
point. And I think that that's good news to have less
money sloshing around in the system chasing deals. That's
one of the reasons we haven't seen prices push up to the
really high levels that lead ultimately to less favorable
private equity returns going forward. MR. JUNKIN: Since you've seen performance
several times, I'm not going to go asset class by asset
class. I will jump ahead to page 51. A quick overview of
the real estate market. And you can see fundraising here
has ticked up a little bit in the last couple of quarters
at kind of the $20 billion range. Most of the fundraising
continues to be North American dominated. Activity seems
to have picked up some relative to the very low levels
that we saw coming out of the global financial crisis.
On the next page for infrastructure, you can see -- now these charts look the same, but
the scales are very different. And so you can see the amount
of infrastructure capital that's being deployed
globally is considerably smaller. And in the last quarter,
less than $2 billion of funds raised in infrastructure.
So it's a harder market to invest in clearly, and that's
one of the things that we talked about extensively at
the asset liability management workshop.
MR. JUNKIN: We've got an item coming up on timber as well. So I wanted to bring up an
update on timber prices here. And you can see southeastern
timber prices are essentially flat. That's the bulk
of the U.S. portfolio here. Pacific northwest, that's
the area where prices have rallied pretty significant. Northeastern,
it looks like prices have kind of turned down
there a little bit.
But I think as we get to the annual review for
that, one of the things that you'll hear, and we've talked
about it quite a bit, is more diversification would be
better in an asset class that's obviously very lumpy and
it's hard for you to transact in huge tracts of land. So,
you know, you have to kind of do what you can.
MR. JUNKIN: And I'll end with a couple of pages
on -- CHAIRPERSON JONES: Just a minute.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: Before you leave
timber, I think it's important to point out that those
scales again are very different. MR. JUNKIN: Those scales are very different.
That's right. Southeastern timber is the lowest price per
ton, per unit. COMMITTEE MEMBER JELINCIC: A board foot.
MR. JUNKIN: Yeah. Thank you. Board foot. So I'll jump ahead to ARS performance. We'll
end here. The program had a good quarter. It has
had a very good year, so we're a year into the new head
here. So performance is doing well. The distribution
of returns, as you can see again, as Michael likes to
point out, it's not exactly a normal shaped distribution.
It's skewed the right way. More often than not, you're getting
the positive returns that you were looking for
when you started this program. Certainly, at a level
of complexity that comes with it, but it has worked.
So I think we'll stop there, Michael unless you
have anything you want to add or unless there are any
questions? CHAIRPERSON JONES: No. I see no further
questions. Thank you very much. We'll ask Michael Moy
and Glickman to come forward for PCA, for their consultant
total fund performance and risk. MR. MOY: We'll do private equity first. I'm
Mike Moy from PCA. Since we are between everybody and
lunch, and we don't want to become lunch, we'll go fast.
It's a pretty easy report. If you flip to page
five of 28 where the performance is set forth, you can see
that vis-à-vis the benchmark, we're not doing very well.
And I believe that's, as you've heard many times from me
and from staff, is a benchmarking issue, and -- but if you
look at the actual performance vis-à-vis your expected
rate of return, the program continues to deliver what it's
designed to deliver. You flip over to page seven of 28, which it's
not very clear on there, but from a cash flow
perspective, the program has been a net generator of cash for
the three
years ended September 30 of about $12.3 billion. The
managers consistently have been realizing investments and
making distributions back to you all, which is presenting
a unique issue, or that you are -- that all investors are
being confronted with in terms of how do we turn around
and redeploy that money, because it's not being put out as
fast by them. Page eight of 28 --
CHAIRPERSON JONES: Hold on just a minute, Michael, a question.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: On the portfolio
cash flows being positive, do you expect that to
continue? Do you -- you know, what's your crystal ball
tell you where that's going?
MR. MOY: My crystal ball says never make a projection.
(Laughter.) COMMITTEE MEMBER JELINCIC: But you're a
consultant, you don't get to do that. (Laughter.)
MR. MOY: I would say as long as the markets continue to behave the way they have been
behaving, and as long as they have assets to sell, they will
continue. I think quantitative easing has really played
a large role in the ability to monetize what they've had
in their portfolios. The question mark is how that's
going to -- how the -- if there is a tapering and
when it starts to occur, how that's going to impact what's
going on in private equity.
COMMITTEE MEMBER JELINCIC: Thank you. Page eight of 28, you can see we're heavily
buyout tilted. And that's a function of what Andrew was
talking about in terms of the activity in the marketplace
has been in the lower middle market. And big investors
have trouble accessing that, because the managers who
typically play in that space don't have capacity to absorb
as much capital as the large investors want to deploy.
You have got some representation there, but it's
still -- you tend to focus and depend more on the large
buyout space to generate the earnings. Page 12 of 28, your vehicle of choice to this
point has been partnerships. They're about 84 percent of
NAV. And you're attempting to move further and further
away from that by concentrating on co-investments and
that's going to take quite some time to do. It's not
something you can do very quickly. Page 14 of 28, when you look at vintage year
concentration six, seven, and eight have been the years
where you've made substantial commitments. But if you go
to page 16 of 28, you'll see that the three-year return,
the two large bubbles on that come from 05/06, 07/08. So
that the three-year return is really being generated by
the commitments that got made in those time periods.
Contrary, I think to the interpretation that some
people could draw, I do believe purchase price in debt
multiples have been escalating somewhat, which is why
everyone has been a seller. It hasn't been a real good
time to be a buyer. And equity contribution is
diminishing, as well as the stock repurchase and recaps
are continuing to be the -- let's call it the monetization
vehicle of choice by many managers. So there are signs that there could be some
issues down the road. They're not overwhelmingly bad, but
they are indicators that it's a little bit more like
2007/2008 again. With that, I'll be happy to take any questions.
CHAIRPERSON JONES: Okay. Seeing no questions. Michael -- Mr. Glickman.
MR. GLICKMAN: Good afternoon. David Glickman from PCA Real Estate.
At the risk of preempting the presentations that
are going to be later in the program today, which will
deal with a lot of the real estate performance in much
further depth, let me just comment to say that for the
quarter ending, the return was below the benchmark, we are
very cautious about ascribing much -- many conclusions
from a quarterly report in real estate, in large part
because much of the return comes from appreciation or
depreciation based on appraisals rather than actual sales.
And CalPERS policy is to appraise once a year. The index appraises across the year, so their
appreciation is spread over four quarters reports, whereas
ours is generally recorded in one quarter. And so
there isn't much to be terribly concerned about the delta
in the most recent quarter.
For the year, the performance of the portfolio exceeded the benchmark. And as you will remember
both on the way up and on the way down in valuation,
leverage is going to contribute to the increase or decrease
in appraised value. Your portfolio carries more
leverage as a percentage of the total asset value than
the benchmark's level of leverage. And so in a period of attractive
leverage, which is one that we have now, your assets are
likely to perform a little bit better. And similarly in a
period of declining underlying debt fundamentals, your
portfolio will underperform a little bit. So for the year, a very good performance overall,
both in terms of meeting the expectation and in terms of
exceeding the benchmark. At this point, I'll pause and ask if there
are any questions at the moment?
CHAIRPERSON JONES: There's no questions at this
time. MR. GLICKMAN: Thank you, Mr. Chairman.
CHAIRPERSON JONES: Okay. Well, thank you. That
completes the consultant's report on performance and risk.
And I think what we will do now is take a lunch
break. We will return and reconvene at 1:15.