ORANGE COUNTY EMPLOYEES RETIREMENT SYSTEM BOARD OF RETIREMENT 2223 E. WELLINGTON AVENUE, SUITE 100 SANTA ANA, CALIFORNIA

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1 ORANGE COUNTY EMPLOYEES RETIREMENT SYSTEM BOARD OF RETIREMENT 2223 E. WELLINGTON AVENUE, SUITE 100 SANTA ANA, CALIFORNIA INVESTMENT MANAGER MONITORING SUBCOMMITTEE MEETING 9:00 a.m. MINUTES The Chair called the meeting to order at 9:14 a.m. and read the opening statement into the record. Attendance was as follows: Present: Absent: Also present: Roger Hilton, Chair; and Chris Prevatt Frank Eley and Shari Freidenrich Steve Delaney, Chief Executive Officer; Girard Miller, CFA, Chief Investment Officer; Shanta Chary, Director of Investment Operations; David Beeson, Investment Officer; Anthony Beltran, Visual Technician; and Stina Walander-Sarkin, Recording Secretary A. CIO COMMENTS Mr. Miller briefly introduced the presenting managers: Perry Capital and PIMCO. Mr. Miller stated that PIMCO as a firm is on watch, but the Global Credit Opportunity Fund (GCOF) is not directly impacted by Bill Gross departure. B. INDIVIDUAL MANAGER PRESENTATIONS PERRY CAPITAL Presentation by Dan Adan & Yinh Hinh Mr. Beeson introduced Perry Capital and stated that they are an event driven hedge fund manager that focuses on corporate events. He explained that Perry manages $51.7 million on behalf of OCERS, which represents 6.5% of OCERS hedge fund portfolio. Mr. Beeson stated that Perry Capital strives to find distressed, stressed, or mispriced securities that are expected to have some type of event/catalyst. He also stated that Perry Capital tends to be opportunistic and follow opportunities across geography, asset classes, and the capital structure. Mr. Beeson stated that Perry Capital had a strong year in 2013 and was OCERS top performing manager in the hedge fund portfolio and delivered a 20.7% return. He also stated that Perry Capital has struggled in 2014, mainly due to several of its special situations equity positions. The key highlights of the presentation were: Firm update: Perry Capital has $10.4 billion in assets under management and 101 employees, of which 38 are investment professionals, with offices in New York and London. The senior investment team, on average, has approximately 17 years of industry experience and 9 years of experience working together at Perry Capital. The firm has a two member management committee: Richard Perry and Dave Russekoff. Paul Leff, one of the two co-founders, retired at the end of 2013 to pursue personal interests

2 and currently has a teaching fellowship at University at Wisconsin. Mr. Leff has kept all of his investments in the main fund. In 2012, Dave Russekoff was appointed co-cio and is responsible, together with co-founder Richard Perry, for allocation of resources and capital, position sizing, hedging, and portfolio construction. Market Overview: Perry Capital does not invest based on a top-down macro view, but hedges the portfolio on a position basis by taking out macro, geography, and sector risks to create alpha on the short side. The active hedging program is used to protect against a sharp decline in the market, shortterm. In August, Perry Capital took down the risk in more marginal positions, but has put risk back on after the September market correction. Outlook for 2015: Perry Capital tries to find positions that have a catalyst attached to them, irrespective of market conditions, throughout the year, and they forecast that each position should play out in the following 9-12 months. Portfolio Strategy: Perry Capital s investment strategy focuses on a dynamic asset allocation based on deep fundamental research with an emphasis on downside protection in building and sizing trades. Perry Capital has three primary investment goals: generate long-term capital appreciation while preserving capital and minimizing volatility; invest in uncorrelated, mispriced securities and asset classes worldwide; and deliver risk-adjusted returns. The core alpha generator for Perry Capital is the event driven investment process with a focus on fundamental analysis and security selection. The event driven investment process starts with sourcing ideas, followed by deep fundamental research, and lastly, portfolio construction and hedging. Perry Capital s core positions generally represent 3-10% of the portfolio, where the top 10 positions typically represent 40-60%. Currently, the top 10 positions represent 49% of the portfolio. Performance: As of October 31, 2014, the fund s performance was down 2.5% year-to-date was a strong year for Perry Capital and they returned 20.7% (net of fees) to OCERS, with half the beta and volatility compared to the S&P 500 index. Since OCERS inception (January 2013), Perry Capital has delivered an annualized return of 10.2% (net of fees). The largest contributors to the performance in 2013 were Fannie Mae/Freddie Mac preferreds, as well as Argentine sovereign bonds. In 2014, the broader portfolio hedges and the Fannie Mae/Freddie Mac preferreds underperformed, while credit sovereigns, such as Argentine sovereign bonds, and asset-backed securities/residential mortgagebacked securities (ABS/RMBS) positions contributed to performance. Perry Capital has filed a lawsuit against the government/treasurer for taking Fannie Mae/Freddie Mac dividends. A judge recently threw out the lawsuit, causing the negative performance. Perry has appealed the ruling. Mr. Hilton: Do you still hold any positions in Fannie & Freddie? Ms. Hinh: Yes, it will take a while before it is all worked out. Mr. Prevatt: What do you do with the cash position in the portfolio? Mr. Adan: The cash is not invested; it sits in a cash account with the custodian. Mr. Hilton: Please discuss hedge fund investing in light of the recent media coverage. Ms. Hihn: CalPERS decision to divest their hedge fund portfolio has raised a concern among large institutional funds. When investing in hedge funds, it is important to have a meaningful position and understand the role of hedge funds in the portfolio; diversification and protection on the downside. Hedge funds have historically outperformed the overall markets in the long-term. 2

3 The Committee recessed at 10:08 a.m. The Committee reconvened at 10:23 a.m. A motion was made by Mr. Prevatt, seconded by Mr. Hilton to receive and file Perry Capital s presentation. The motion carried unanimously. PIMCO Presentation by Jon Horne, Neal Reiner & Richard Fulford, CFA Mr. Beeson introduced PIMCO and the Global Credit Opportunity Fund (GCOF). He stated that PIMCO manages $48.7 million on behalf of OCERS in GCOF, which represents 6.1% of OCERS hedge fund portfolio. Mr. Beeson also stated that OCERS has PIMCO on watch, but staff and Aksia do not have any concerns for this particular fund since Bill Gross was not involved with the product. GCOF is primarily comanaged by two portfolio managers, Dan Ivascyn and Jon Horne. Mr. Beeson noted that Dan Ivascyn has been named PIMCO s group CIO, and the committee should inquire to make sure Mr. Ivascyn is still devoting his time to GCOF as promised. Mr. Beeson stated that GCOF is a long/short credit fund in the relative value space and currently, 49% of the portfolio risk is in structured credit and 41% is in corporate credit. He also stated that GCOF has produced a 4.5% return over the last 12 months, with the structured credit side being the main contributor while the hedging overlay has been the main detractor. Mr. Hilton: Is the 4.5% return in line with the return objective? Mr. Beeson: Yes. Ms. Chary: The performance for the last quarter of 2013 was challenging, but it is important to note that it is idiosyncratic to the strategy and has not been impacted by the organizational changes at PIMCO. Mr. Beeson: It is also important to note that GCOF has had minimal net outflows this year. The key highlights of the presentation were: Firm update: PIMCO has $1.8 billion in assets under management in GCOF. GCOF is led by Dan Ivascyn and Jon Horne (30 years of collective experience), and they are supported by seven senior strategy level portfolio managers. GCOF has a large dedicated team and leverages extensive PIMCO resources across portfolio management, credit research, and risk management. Market Overview: The low volatility environment leading up to the month of September this year, is an unfavorable market environment to a relative value structured fund, such as GCOF. Outlook for 2015: PIMCO believes that capital markets volatility is likely to remain elevated and there are continued concerns about deteriorating fundamentals in certain industry sectors. They also believe that the global economic uncertainty will persist which is attractive to the corporate part of the book. The increase in both the number and scale of material dislocations in valuations are favorable market conditions for GCOF. GCOF will continue to focus on relative value and/or event driven opportunities and they believe the next 12 months will be a good environment for relative value, including opportunities in energy, metals, and retail corporate names. PIMCO also sees significant opportunities across all broad areas of credit, such as mispriced capital securities in select European banks, continued 3

4 opportunities in U.S. and European commercial and residential mortgage-backed securities, and corporate credit is becoming increasingly interesting. Overall, the balance of the book will remain the same with 49% of the capital allocation in structured credit, 41% in corporate credit, 4% in sovereign/emerging markets, and 6% in macro/hedging overaly. Portfolio Strategy: GCOF is a multi-strategy credit relative-value hedge fund with a fluid capital allocation across the broad credit spectrum: corporate, structured, emerging market, and sovereign credit. GCOF has a comprehensive risk management system; a multi-level hedging strategy which provides a muted market beta and limited volatility. The active hedging strategy also effectively limits volatility during a market crisis. GCOF strives to be a diversifier and provides uncorrelated returns to the overall markets. GCOF s objective is to provide 8-12% annualized net returns over a full credit cycle, with 5-7% annualized volatility. Performance: As of September 30, 2014, the strategy has returned 5.1% year-to-date and 6.1% since OCERS inception (March 2013). Since the inception of the fund (2006), GCOF has significantly outperformed the major indices and minimized drawdowns during the most volatile market periods. Also, GCOF has shown negligible correlations to traditional asset classes. Over the last 5 years, GCOF has provided a return equal to 80% of the S&P 500, but with half the volatility. Mr. Hilton: Please discuss Dan Ivascyn s added group CIO responsibilities. Mr. Horne: Mr. Ivascyn s management and portfolio management responsibilities have not changed. The only thing that has changed is his stature in meetings. Mr. Fulford: Mr. Ivascyn s portfolio management responsibilities have not changed. He has one added responsibility by being added to the unconstrained Bond Fund management team, but without any lead portfolio management responsibilities. Mr. Hilton: Please discuss the recent organizational changes and the in/outflows of capital in GCOF. Mr. Reiner: The organizational changes have had limited impact on GCOF. GCOF has experienced steady inflows of capital and PIMCO is anticipating that the fund will have around $2 billion in assets under management by the end of Mr. Horne: GCOF s strategy has a capacity of $2.5-3 billion in the current market volatility environment. Mr. Beeson: Is Mr. Ivascyn still involved in the day-to-day decisions for the structured credit side? Mr. Horne: Sharad Bansal and Russell Gannaway have been in the frontline in managing the structured credit book for the last 2-3 years. Mr. Ivascyn sets the focus areas (what kinds of risk to take and not take) and I am involved in the management of the risk. On a day-to-day basis, I make sure hedges make sense against the risks in the mortgage book. I do not choose mortgage securities on a day-to-day basis, but I am directly involved with hedging that part of the book. Mr. Beeson: Please discuss the competitive landscape within structured credit going forward. In particular in comparison to what other hedge funds are doing. Mr. Horne: In the last 6 months, there has been a hand-off from distressed hedge funds that bought assets at very low levels. These hedge funds have been looking at it from an unlevered internal rate of return (IRR) perspective; seeking to hit a 15% IRR from an unlevered basis. There are a lot of securities that cannot hit a 15% IRR on an unlevered basis, but PIMCO thinks these are extremely attractive securities and have relatively safe cash flows. This hand-off has been a very important source of new opportunities for GCOF and dominates any opportunity in the high yield market. 4

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