private asset class roles and benchmarks2. based on fy 2016 annual report – risk appetite – the...

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Item 6a, Attachment 1, of 30

Private Asset Class Roles

and Benchmarks

April 17, 2017

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Item 6a, Attachment 1, of 30 Private Asset Class Roles and Benchmarks

What We Hope to Accomplish Today

• Review – Asset Liability Management Timeline (Progress and Goal)

• Discuss – Benchmark Selection for Private Asset Classes

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2017-18 ALM Timeline | Board Review & Decision Making

July Implementation

Strategic Asset Allocation Policy Portfolio

January Board Offsite

Public Asset: Roles, Segments, Benchmarks

• Global Equity, Global Fixed Income, Inflation

June Investment Committee

Adopt Capital Market Assumptions

February Board Meeting

Adopt Strategic Asset Allocation Policy

Portfolio

• Current Approach: Asset Class

• Alternative Approach: Asset Segment

November ALM Board Workshop

Strategic Asset Allocation Approach

• Current Approach : Asset Class

• Alternative Approach: Asset Segment

July Board Offsite

Alternative Strategic Asset Allocation Approach

• Use of Leverage

April Investment Committee (information)

Private Asset: Roles and Benchmarks

• Real Assets, Private Equity

2017 2018

May Investment Committee (Action)

Private Asset: Roles and Benchmarks

• Private Equity, Real Assets

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Real Assets

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Real Assets| Introduction

• Maintain the Real Asset role adopted in April 2016

– The role of Real Assets is to own real assets with stable cash yield and act as an

economic diversifier to equity risk.

• Diversification

• Income

• Inflation

• Recommend two modifications to Real Assets within the Strategic Asset Allocation

– Consolidation of segments

– Benchmark

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Real Assets| Recommendation

Consolidation of segments

• Current:

– Forestland 1%

– Infrastructure 1%

– Real Estate 11%

• Proposed:

– Real Assets 13%

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Real Assets| Why

• Focus Strategic Asset Allocation on asset classes / segments with sufficient

materiality

• Underwrite in Real Estate, Infrastructure and Forestland seeking similar underlying

investment characteristics

• Retain the ability of Real Assets to invest in Infrastructure and Forestland

• Build common focus for the Real Assets team within INVO

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Existing Asset Classes | Total Fund Investment Policy

From: Current Asset Class Allocation

Towards: Reference Portfolio Construction

Global Equity 46%

Private Equity

8%

Global Fixed

Income 20%

Real Estate 11%

Infra. & Forest

2% Inflation

9%

Liquidity 4%

Growth 54%

Global Fixed

Income

20%

Real Assets

13%

Inflation 9%

Liquidity 4%

Real Estate

Infra &

Forest

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Real Assets| Recommendation

Benchmark

• Current:

– National Council of Real Estate Investment Fiduciaries (“NCREIF”) Open-End

Diversified Core Equity (“ODCE”)

• Proposed:

– MSCI Investment Property Databank (“IPD”) (U.S. Core – Fund Level)

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Real Assets| Why

• “NCREIF ODCE” and “IPD U.S. Core – Fund Level” measure nearly identical

exposures

• Simplify vendor relationships (BarraOne provider)

• Potential to extend to Infrastructure and Global Real Estate should these segments

become material enough to warrant separation

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-15%

-10%

-5%

0%

5%

10%

15%

Re

turn

Net Returns

ODCE-Net Appreciation Return ODCE-Net Income Return

ODCE-Net Total Return IPD (US Core-Fund Level) Net Capital Growth Return

IPD (US Core-Fund Level) Net Income Return IPD (US Core-Fund Level) Net Total Return

Real Assets | Net Returns – IPD (US Core Fund Level) vs. ODCE (Fund Level)

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Private Equity

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Private Equity| Introduction

• Partially address challenges identified during November 2015 Private Equity

workshop

• Recommend three modifications to Private Equity within the Strategic Asset

Allocation

– Role

– Consolidation into a growth related asset segment

– Benchmark

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Addressing Private Equity Challenges (11/2015)

Challenge Initiative to Address Challenge

• Controlling Private Equity Exposure • Liquid Public Market Proxy

• Difficult to Identify Sources of Risk

• Complex, Higher, and Non-transparent

fees

• Private Equity Accounting and Reporting

Solution (PEARS)

• Determining Appropriate Benchmark • Role of Private Markets

• Benchmark Evaluation and Discussion

• Predicting Cash Flows • Liquidity – Operations

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Private Equity | Potential Questions

• Eliminating Private Equity?

– No, an important part of investment portfolio

• Benchmark shift due to underperformance?

– No, making an explicit link to the investible alternative (opportunity cost)

• Eliminating excess return expectation in the capital market assumptions?

– No, the excess return expectation would be extrapolated to this growth segment

(implies target weight)

• Reduce transparency?

– No, maintain commitment to all enhanced reporting and disclosure

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Private Equity| Recommendation

Role

• Current:

– Private equity allocations are a means of enhancing equity returns through a value added

approach to investment management of a diverse set of portfolio companies and to capture

the illiquidity premium. The major driver for returns is appreciation with negligible cash yield.

– High Growth Risks

– Illiquid

• Proposed:

– Private equity allocations are a means of enhancing equity returns through an active, value-

added approach. The major driver for returns is appreciation, aided by leverage, with

negligible cash yield.

– Growth

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Incorporation into growth related asset segment

• Current:

– Private Equity a distinct, stand alone asset class

• Proposed:

– Merge Private Equity with capitalization weighted Global Equity to form a combined

growth related segment

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Private Equity| Why

• Focus management of the allocation to Private Equity at the total fund level

• Enable potential portfolio construction capability to offset idiosyncratic regional,

sector and company exposure

• Enable search for additional tools to generate the expected excess return

• Link private equity commitments to funding source

• Build common focus for growth-oriented teams within INVO

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Growth 54%

Global Fixed

Income 20%

Real Assets

13%

Inflation 9%

Liquidity 4%

Private Equity| Consolidation of growth related segments

From: Current Asset Class Allocation

Towards: Consolidated Growth Bucket

Global Equity 46%

Private Equity

8%

Global Fixed

Income 20%

Real Estate 11%

Infra. & Forest

2% Inflation

9%

Liquidity 4%

Global Equity

Private

Equity

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Peer Reference Portfolio

Equity Allocation

Actual Equity

Allocation7

Ontario Teachers’ Pension Plan 42%1

38%4

Canadian Pension Plan Investment Board 72%2

52%5

New Zealand Superannuation Fund 85%3

75%6

1. Based on FY 2016 Annual Report – Exposure Policies

2. Based on FY 2016 Annual Report – Risk Appetite – The Reference Portfolio

Strategic Portfolio Asset Class is the Aspirational composition for the Investment Portfolio and carried an equity target weight of 62%

3. Based on FY 2016 Annual Report – Growth Assets of Reference Portfolio

4. As of 12/31/2016

5. As of 03/31/2016

6. As of 06/30/2016 and excludes the impact of any strategic tilts.

7. Includes both Public Equity and Private Equity

Private Equity| Who else consolidates Public and Private Equity

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Benchmark

• Current:

– 67% FTSE U.S. Total Market + 33% FTSE All World ex U.S. + 300 basis points

• Lagged one quarter

• Attempted to reflect actual geographic exposures

• Proposed:

– FTSE All World, All Capitalization (Global Equity) + Return Premium (TBD)

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Private Equity| Why

Example 2016 Capital Markets Assumptions

Arithmetic Return Geometric Return Volatility

Public

Equity

Private

Equity

Arith. Rtn

Premium

Public

Equity

Private

Equity

Geo. Rtn

Premium

Public

Equity

Private

Equity

Wilshire(1) 7.8% 12.1% 4.3% 6.5% 8.9% 2.4% 17.1% 27.5%

Meketa 9.7% 13.2% 3.5% 7.9% 9.6% 1.7% 19.0% 27.0%

PCA 9.1% 12.1% 3.0% 7.5% 9.1% 1.6% 19.0% 26.0%

JP Morgan 8.8% 10.6% 1.7% 7.5% 8.5% 1.0% 17.3% 21.8%

BNY N/A N/A N/A 7.3% 9.1% 1.8% 16.6% 19.1%

Callan(2) 8.6% 12.5% 3.8% 7.0% 7.4% 0.4% 19.0% 32.9%

Blackrock(2) N/A N/A N/A 5.24% 5.8% 0.6% 16.3% 24.6%

Median: 3.4% Median: 1.3%

1. Based on email request on 11/1/2016

2. No Global Equity estimate given. Used a blend of 50% Broad US Equity and 50% Global ex-US

as the estimate for Public Equity asset class for both geometric return and volatility

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Private Equity Relative Performance| Problem with Compounding

• Data Source: CalPERS PE Benchmark (StateStreet); SSGX PE (SSGX); Quarterly data from Q2

2011 to Q3 2016

• CalPERS PE Bench: 67% FTSE US TMI + 33% FTSE AW ex-US + 3%

Cumulative Return: StateStreet Private Equity Index versus CalPERS Private Equity Benchmark

Annualized

Return

11.3%

8.1%

3.2%

-40%

-20%

0%

20%

40%

60%

80%

100%

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16

Cu

mu

lati

ve R

etu

rn %

SSGX CalPERS PE Bench CalPERS PE PE Bench After Removing 3% Spread

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Appendix

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Appendix: Role Definitions

Role Definition

Income Generate current cash flow

Inflation Provide protection against inflation

Diversification Reduce risk associated with public equity exposure

Growth Increase sensitivity to economic growth

Liquidity Ability to convert assets into cash

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Private Equity| Target versus Actual Allocation

0

2

4

6

8

10

12

14

16

Mar-90 Nov-91 Jul-93 Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 Mar-10 Nov-11 Jul-13 Mar-15 Nov-16

PE

Allo

cati

on

(%

)

Historical Private Equity Strategic Allocation & Actual % Holdings

PE Holdings as a % of the Total Fund Strategic Allocation to PE

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0

500

1000

1500

2000

2500

0

2

4

6

8

10

12

14

16

Mar-90 Nov-91 Jul-93 Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Mar-05 Nov-06 Jul-08 Mar-10 Nov-11 Jul-13 Mar-15 Nov-16

S&

P 5

00

Co

mm

itm

ent

($B

)

Historical Private Equity Commitment by Vintage Year & S&P 500 Index

Commitment by Vintage Year (Left Axis) S&P 500 Index (Right Axis)

Private Equity | Pro-cyclicality of Commitments

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Private Equity | High Risk Levels

0%

5%

10%

15%

20%

25%

30%

35%

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Private Equity - Realized Tracking Error - 1 yr

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• Data Sources: Public Index data (Bloomberg), Private Equity Index (SSGX), PERS Global Bench

(State Street) using quarterly horizon return data from Q4 1996 to Q2 2016

0%

2%

4%

6%

8%

10%

12%

14%

Pre

miu

m

(Pri

vate

Eq

uit

y -

Pu

blic

Ind

ex)

Rolling 10 YR Annualized Compound Return

ACWI Developed ACWI Emerging and Developed FTSE All World

S&P 500 Russell 3000 Public Bench

3% Premium

Private Equity | Historical Private Equity Premium

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• Data Sources: Public Index data (Bloomberg), Private Equity Index (SSGX), PERS Global Bench

(State Street) using quarterly horizon return data from Q4 1996 to Q2 2016

-10%

-5%

0%

5%

10%

15%

20%

Pre

miu

m

(Pri

vate

Eq

uit

y -

Pu

blic

Ind

ex)

Rolling 5 YR Annualized Compound Return

ACWI Developed ACWI Emerging and Developed FTSE All World

S&P 500 Russell 3000 Public Bench

3% Premium

Private Equity | Historical Private Equity Premium

private asset class roles and benchmarks2. based on fy 2016 annual report – risk appetite – the...

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