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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: _________________________________