Proposed Investment Commitment Staff requests Board approval of a $50 million allocation to the Molpus Woodlands Fund III, L.P.

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1 March 11, 2011 To: Board of Retirement Mr. Brian White, CEO Mr. Lee Partridge, Salient Partners, Portfolio Strategist Ms. Lisa Needle, Acting CIO From: Loren de Mey, Investment Officer RE: Discussion / Action on Molpus Woodlands Fund III, L.P. I. Executive Summary Proposed Investment Commitment Staff requests Board approval of a $50 million allocation to the Molpus Woodlands Fund III, L.P. Fund Strategy The fund s strategy is to acquire and actively manage a diversified portfolio of timberland properties located in the timber-rich regions of the United States and Eastern Canada. The Fund seeks long-term capital appreciation with moderate current income and will maintain a diversified portfolio of timberland assets by timber type, age and geographic region to optimize risk-adjusted returns. Fund Terms Fund: Molpus Woodlands Fund III, L.P. Structure: Delaware Limited Partnership Target Fund Size: $400 million Final Close: March 31, 2011 Investment Period: 3 years Term: 10 years (plus two optional 2-year extensions)

2 Management Fee: 1% (on called/invested capital) Incentive Fee: 15% Preferred Return: 7% Legal Counsel: Bradley Arant Boult Cummings LLP, Pillsbury Winthrop Shaw Pittman LLP Fund Auditors: KPMG SDCERA Portfolio Considerations Previous SDCERA Commitments to Investment Manager: none Recommendation s Portion of Total SDCERA Portfolio: 0.63% Recommendation s Portion of Exposure Target for Real Assets: 3.6% II. Overview Staff, along with SDCERA s Portfolio Strategist, requests Board approval for a $50 million commitment to the Molpus Woodlands Fund III, LP. The fund s objective will be to target timberland acquisitions that generate a nominal, unlevered internal rate of return of 8-12% (net of all fees and expenses). The manager will seek long-term capital appreciation with moderate current income while maintaining a diversified portfolio of long-duration timberland assets. Molpus will seek to achieve the target return through strategically marketed timber sales, disciplined acquisitions, land appreciation and dispositions, operating efficiencies and tactical risk management. Molpus expects to source proprietary, offmarket acquisitions through their broad network of relationships. Key attributes of the investment include: Well established, proven timber manager with experienced professionals Attractive fundamentals and valuations in the timber market Provides income, diversification and an inflation hedge III. Molpus Woodlands Group Molpus was established by Richard Molpus in 1996 as a TIMO (Timber Investment Management Organization) with executive and operational headquarters based in Mississippi. Molpus is fully independent and privately held, owned by Richard Molpus. The firm currently manages over $1 billion in timber assets and 840,000 acres on behalf of their clients. The firm is registered with the SEC as a Registered Investment Advisor under the Investment Advisors Act of Discussion/Action on Molpus Woodlands Fund III, L.P. 2

3 Molpus performs timber management for its clients, which include endowments, pension funds and family offices. Molpus has 11 additional offices throughout the United States, each staffed with foresters and forestry technicians. The firm also manages a tree nursery in Elberta, Alabama, and the Wild Fork Tree Orchard in Monroe County, Alabama, where tree seeds are harvested. Since 1996, Molpus and its affiliates have acquired 1.8 million acres of timberland in the United States, deploying $2 billion in total invested capital on behalf of its clients. Molpus is an independent, privately held firm focused solely on timberland. The firm is represented by a strong and diverse team of 50 investment and forestry experts. All functional areas of forestry management are handled in-house, including forestry, biometrics, soil analysis, geographic information systems, seedling production and other functional areas that add value to the investment rather than hiring contractors. Molpus s compensation programs are structured to directly link the compensation of its employees to the performance of the funds and separate accounts that they manage, providing strong alignment of interests. IV. Timberland Investing According to the American Forest & Paper Association, products derived from timber accounted for an average of 5% of the total US manufacturing GDP. Products such as pulp, paper, and lumber are the drivers that dictate demand for timber as a raw material for manufacturing. Each product inherently has different supply and demand economics. For example, population growth and economic conditions impact the demand for pulp and paper, while new housing starts, general construction and industrial use impact the demand for lumber and structural products such as plywood. Today the global timberland universe is estimated to be about $450 billion, of which $120 billion is investable (with the remainder being government-owned or protected). North America accounts for 66% of the investable universe. The remainder is primarily located in Latin America, Southeast Asia, Southern Africa, New Zealand and Australia. Timber can be divided into two basic classifications: hardwoods and softwoods. Eighty percent of the world s timber production comes from softwoods. Softwoods can be used in a wide variety of industrial applications, including construction and paper. Examples of end products are structural building components, furniture, paper and Discussion/Action on Molpus Woodlands Fund III, L.P. 3

4 cardboard. Hardwoods are used in many of the same industries, but due to their higher quality, they are typically used for finished end products. While the recession of the past two years has had an adverse effect on many of the products produced from timber, long-term trends suggest that the industry will likely benefit from attractive fundamentals. Demand is Expected to Rise Long-Term Demand for timber products is expected to continue to rise in the long run. The median age of homes is 32 years, suggesting that repairs, housing starts, and remodeling will be on the rise in years to come. Also, as the average age of the United States population increases, repairs and remodeling will become more prevalent, supporting the demand for high grade materials for furniture and flooring. With a large forest resource and high production and consumption of wood products, the United States continues to play an important role in world forest product markets. However, for the past two or more years, there has been a contraction in this segment of the economy, precipitated by the decline in residential construction and production of building materials. However, long-term, demand is expected to pick up and be much stronger. Supply is Diminishing Overall, the land available for timber production is decreasing as urban sprawl generates interests from residential and commercial developers. In some cases, timberland is being converted to agricultural production. A larger impact is now being felt as renewed conservation efforts are pressuring the federal and state governments to appropriate more funds for acquiring property for public interests. Consequently, the supply of investable timberland is in a state of decline making each remaining acre more valuable. Attractive Valuations In the short-term, prices for timber are cyclical. The industry is currently at a cyclical timber price low point. Timber prices have now fallen to sufficiently conservative values making the risk/return profile for timberland more attractive. Looking forward, a slow but steady recovery is expected as housing and the economy recovery. Rural land prices are less cyclical but have just last year experienced the first price decline in over a decade. Land prices will likely remain at this depressed price level for Discussion/Action on Molpus Woodlands Fund III, L.P. 4

5 the next year or two until the overall economy shows further signs of recovery. The confluence of these pricing trends indicates that the next two years should be an attractive time to invest in timberland, as timberland properties are likely to sell at a discount to the past three-year average. Impact of Distressed Sellers Current timberland valuations are being influenced by distressed sellers including: (1) stressed owners and operators that may be requiring more liquidity; (2) timber REITs in need of cash to continue paying dividends; (3) manufacturers needing to improve efficiency or pay debt; and (4) some investors who are over-levered. These sellers are not solely motivated by price; rather, they are seeking discretion and certainty of closing. As a result, they are generally unwilling to run open auctions or bid processes. Molpus s reputation and model of negotiated deal sourcing should create access to these opportunities. Historically Low Timber Pricing Raw material prices for many major products that use timber are at historical 20-year lows, hovering 30% below the 1.2% price growth trend line. While the recession and economic turmoil of the past two years has had an adverse effect on timber prices, long-term trends suggest the resource has significant long-term viability. Population growth will continue to drive the need for wood-derived products in industries such as housing, paper products and energy. The U.S. timber market is one of the most advanced in the global economy based on a history of biological advances, climate and physical infrastructure. Many countries with vast timber resources will continue to be limited by their inability to economically access or process the resource. Unique Return Drivers Timberland has low correlation to other asset classes such as equity and fixed income, providing portfolio diversification. Timberland can also be a hedge against inflation. Approximately 65% of timberland returns are driven by the organic biological growth of the trees, which occurs on a continuous basis independent of market returns or other macroeconomic factors. This biological growth increases the volume of the trees while the market value per unit of volume increases as the trees increase in size. This is due to the lumber being more expensive for more mature trees. Discussion/Action on Molpus Woodlands Fund III, L.P. 5

6 Timberland has shown attractive stable returns over time. According to the NCREIF Timber Index, historical returns on US timberland have averaged 13.5% since inception in 1987 through V. Investment Strategy The fund will acquire and actively manage a diverse portfolio of timberland properties located in the timber-rich regions of the United States and Eastern Canada. Within the US, the team expects to focus on properties within the US South, Appalachia, Lake States, and the Northeast. All timberland assets are managed according to sustainable forestry principles. The manager s objective will be to target acquisitions that generate a nominal, unlevered internal rate of return of 8-12% (net of all fees and expenses). The manager seeks long-term capital appreciation with moderate current income (2-4%), and will seek to maintain a diversified portfolio of timberland assets by timber type, age, and geographic region. Molpus will seek to achieve its target returns through strategically marketed timber sales, disciplined acquisitions, land appreciation and dispositions, operating efficiencies and tactical risk management. The fund s investment strategy will also focus on timberland properties that are noncontiguous in structure, with significant biological growth and income potential. Additionally, the fund will seek properties that are diverse in geographical locale, species and age classification. The team will seek to acquire properties with a balanced mix of timber products that can provide a hedge against unpredictable timber market swings. The team will also invest in locations where the manager perceives value due to changing micro-market conditions. Responsible Land Stewardship The firm has a long history of responsible land stewardship. All timber investments will be sustainably managed in accordance with the Sustainable Forestry Initiative (SFI). The SFI promotes guidelines and principles for responsible timberland ownership such as reforestation, protection of water resources and biological diversity. Discussion/Action on Molpus Woodlands Fund III, L.P. 6

7 Portfolio Construction Depending on available opportunities during the investment period, the Team expects to build a portfolio of properties that complement each other and create a return profile diversified by a number of unique drivers. The portfolio allocation is expected to be comprised of 50% emerging growth properties and 50% higher income properties. An emerging growth property is one that is populated with younger trees and exhibits more rapid early growth. A more mature property has higher income potential and can provide consistent cash flows while the younger trees are growing. Additional diversification will be achieved by targeting a mix of properties that have variability in timberland characteristics such as topography, species composition, product diversity, age class distribution, and geography. Many end-use products are derived from a variety of timber species. For example, softwood lumber may be used in building construction, hardwood veneer may be used in furniture making, pulpwood used for papermaking, and biomass for energy consumption. Leverage The Fund may leverage up to 10% of the total assets of the Fund. Decision Making All investment decisions will be made by the Investment Committee comprised of the following five senior investment professionals: Richard Molpus, Bob Lyle, Terrell Winstead, Charles Manogue and Ken Sewell. Biographies are included in Appendix B. VI. Investment Team Molpus employs a strong team of 50 timber professionals and forestry experts with a great depth of experience. The firm has an integrated cross-functional organizational structure that is vertically integrated with all core business and forestry functions. Richard Molpus, Bob Lyle and Terrell Winstead, who each have been involved with the acquisition, management, value creation and disposition of timberland across North America for a minimum of 25 years, are the senior executives at Molpus. Mr. Molpus, Mr. Lyle, and Mr. Winstead have worked together for over 19 years, and specifically at Molpus for over 14 years. Discussion/Action on Molpus Woodlands Fund III, L.P. 7

8 Molpus has developed an integrated and unique cross-functional organizational structure that is fully vertically integrated. All core business and forestry functions are executed and supervised by in-house experts as opposed to being outsourced to contractors. Molpus has also tied a significant portion of each team member s compensation directly to the performance of its investments. VII. Track Record Molpus s prior funds and separately managed accounts in aggregate have generated strong returns since inception. As of September 30, 2010, the firm s 27 underlying investments in separate accounts and three commingled funds have generated gross and net returns of 10.6% and 8.9%, respectively. This compares to the NCREIF Timberland Index gross return of 7.7% for the same period. Periodic Returns October 1997 through September Year 3-Year 5-Year 7-Year 10-Year Since Oct. 97 Molpus Composite 3.92% 6.59% 10.53% 14.48% 7.98% 10.63% NCREIF Timberland -3.93% 4.71% 9.62% 9.99% 6.86% 7.69% Index VIII. Due Diligence Staff met with the senior members of the investment team in Mississippi where an onsite meeting was conducted to review the organization and investment operations. Additionally, Staff conducted an operational tour of one of Molpus s current timberland properties. Staff was impressed with the efficiency of the firm s operations as well as the depth of experience of their staff and field employees. Waller Lansden has conducted a review of the Fund documents. There are no material legal concerns with respect to the Fund or its structure. Counsel is in the process of negotiating a side letter with the manager which will be finalized prior to making an investment. Staff also utilized a third party provider to conduct background checks on the firm and senior investment professionals and no material issues were noted. Additionally, Albourne Partners conducted an operational review of Molpus. IX. Placement Agent Policy Molpus Woodlands Group has engaged Eaton Partners, LLC as a placement agent in connection with fund raising, marketing and investor relation activities for Molpus. Discussion/Action on Molpus Woodlands Fund III, L.P. 8

9 SDCERA will not bare any charges or fees regarding this relationship. Any fees will be paid directly by Molpus. Eaton Partners Founded in 1983, Eaton Partners is a placement agent, dedicated to raising institutional capital for investment managers globally. The firm has over 40 employees across five offices. Eaton Partners is an SEC registered broker dealer, is authorized and regulated by the FSA and is a member of FINRA. Molpus and Eaton Partners have complied with SDCERA s Placement Agent Policy. Staff and legal counsel have received the Placement Agent Initial Disclosure from Molpus and Eaton Partners which states that there have not been any campaign contributions made by any person of Eaton Partners to any elected member of the Board in the past 24-month period. Nor has there been any gifts given by any person of Eaton Partners to any elected member of the Board in the past 24-month period. Eaton Partners has disclosed that one of the firm s partners, David Love, served on the SDCERA Board of Retirement from July 15, 1982 through January 19, Counsel has advised that this does not pose any restrictions or violate the Placement Agent Policy given that Mr. Love served on the Board over 25 years ago. X. SDCERA s Real Assets Portfolio The SDCERA Fund has a 10% target allocation to Real Assets, with strategic targets of 7% to Natural Resources and 3% to Infrastructure and Other Real Assets. Within Natural Resources, SDCERA is currently invested in 7 Oil & Gas funds and one Agricultural Fund with a total commitment size of $217 million. A commitment to the Molpus Woodlands Fund III of $50 million would be SDCERA s first commitment to the timberland sector and represents a 0.63% allocation of the total SDCERA Fund. XI. Concluding Comments Staff believes that an investment in Molpus Woodlands Fund III will be a strong addition to the Real Assets portfolio. An investment in the Molpus Fund will provide diversification and an inflation hedge with low correlation to many traditional asset classes. Molpus brings an experienced team in the timber sector with a strong track record. Given the key attributes and diversification benefits of the Fund, Staff recommends a $50 million commitment. Discussion/Action on Molpus Woodlands Fund III, L.P. 9

10 Appendix A Real Assets Portfolio Plan (5)=(4)-(3) Pro-Forma (1) (2) (3)=1+2 (4) Room for Current Proposed Pro-Forma Exposure Future Exposure Additions Exposure Target Additions Natural 2.6% 0.6% 3.2% 12.25% 9.05% Resources Molpus Infrastructure 3.9% 0.0% 3.9% 5.25% 1.35% & ORA Total 6.5% 0.6% 7.1% 17.5% 10.4% Discussion/Action on Molpus Woodlands Fund III, L.P. 10

11 Appendix B Biographies Richard Molpus Founder and President Richard Molpus, received a bachelor of science degree in business administration from the University of Mississippi. After graduation, he served for a number of years as the vice president of Manufacturing for Molpus Lumber Company, based in Philadelphia, Mississippi. In 1980, Molpus was selected as executive director of the Governor s Office of Federal- State Programs under Governor William Winter, and in 1983 was named Mississippi s Public Administrator of the Year by the American Society of Public Administrators. While at the governor s office Molpus helped guide the historic Education Reform Act of 1982 to passage. In 1983, Molpus was elected Secretary of State of Mississippi; he was re-elected in 1987 and In 1995, he won the Democratic nomination for governor of Mississippi but, after a strongly contested race, was defeated in the general election by the incumbent governor. In 1996, Molpus decided to form The Molpus Woodlands Group and utilize his unique background in both the timberland industry and as a fiduciary for public assets. In 2005, Molpus was inducted into the Mississippi Business Hall of Fame, and in 2008 he was honored as a Champion of Justice by the Mississippi Center of Justice. He currently is a member of the Board of Directors of the Wilson Research Foundation, the fundraising arm of the Methodist Rehabilitation Center in Jackson, Mississippi. From 2007 to 2009 he served as the founding chairman of the United States Endowment for Forestry and Communities, a $200 million endowment funded by the U.S./Canada Softwood Lumber Agreement. The endowment is focused on improving forest health and assisting timber-reliant communities in the U.S. Molpus is also a founding board member of the National Alliance of Forest Landowners ( NAFO ), which is dedicated to protecting and enhancing the economic and environmental values of privately owned forests through targeted policy advocacy at the national level. Bob Lyle Executive Vice President Mr. Lyle is Executive Vice President of The Molpus Company, The Molpus Woodlands Group, LLC, and Molpus Timberlands Management, LLC. He is a graduate of Millsaps Discussion/Action on Molpus Woodlands Fund III, L.P. 11

12 College (BBA 1979) and Mississippi College School of Law, earning his juris doctorate degree in He has continued his post graduate education, having completed several executive business courses at the University of Chicago Graduate School of Business and at Duke University. Prior to attending law school, Mr. Lyle worked extensively as a real estate broker and appraiser of timber and agricultural properties, and he has considerable experience in negotiating the buying and selling of land and timber. Mr. Lyle is a licensed real estate broker in nine states where the Molpus entities currently manage properties. Richard Molpus asked Mr. Lyle to serve on staff at the Mississippi Secretary of State s office in 1989, where his duties included assisting some 90 school districts with management of more than 600,000 acres of public trust school lands. He served as Assistant Secretary of State until 1995 and then joined Molpus in Mr. Lyle is a member of the Board of Directors of PriorityOne Bank, where he serves on the Executive, Compensation, and Loan Committees, and the Board of Directors of Crossgates United Methodist Children s Center. He also is a Trustee of the Mississippi Agricultural and Forestry Museum and a member of the American and Mississippi Bar Associations. Terrell Winstead CFO and Vice President of Finance Mr. Winstead, Vice President of Finance and Chief Financial Officer of The Molpus Woodlands Group, LLC, The Molpus Company, and Molpus Timberlands Management, LLC, grew up working in his father s logging business. A graduate of Mississippi State University, Mr. Winstead began his career with Molpus in 1987 as Vice President of Finance with responsibility for all administrative and financial functions of the company. He is also responsible for the computerized systems that produce timely cash flow information for all properties managed by the company. Previously, he has worked in consultation with the forestry schools at both Mississippi State University and the University of Georgia, as well as with the Molpus foresters to refine Molpus s timberland investment model. Mr. Winstead is a member of the American Institute of Certified Public Accountants and the Mississippi Society of Certified Public Accountants and serves on the Board of The Citizens Bank of Philadelphia. Discussion/Action on Molpus Woodlands Fund III, L.P. 12

13 Charles Manogue Vice President of Acquisitions Mr. Manogue is Vice President Acquisitions of the Molpus Woodlands Group with responsibility for coordinating timberland acquisitions for clients interested in timberland investments in the U.S., other North American regions, and certain international locations. He graduated from Purdue University in 1977 with a bachelor of science in forest management and received a master of science in forest biometrics from Purdue in In 1999, Mr. Manogue joined Molpus Timberlands Management and served until early 2007 as Chief Operating Officer with responsibility for all forest management operations on up to 1.3 million acres during his tenure. Previously, Mr. Manogue gained almost 20 years of technical, operational and managerial experience with American Can Company and Kimberly-Clark Corporation (formerly Scott Paper Company). Mr. Manogue is a member of the forestry associations in Alabama, Mississippi, and Louisiana and is active in the Mississippi Forestry Association where he has served on the Board of Directors since 1993 and on the Executive Committee in 1998 and He also has served on the Board of Directors of the Forest Resources Association since Ken Sewell Chief Operating Officer Mr. Sewell, Chief Operating Officer of Molpus Timberlands Management, LLC, received a bachelor of science degree in forest resources from the University of Georgia in In 1999, Mr. Sewell joined The Molpus Woodlands Group as Director of Acquisitions, responsible for the identification and evaluation of forest investment opportunities. During his tenure, he participated in acquiring over 900,000 acres of timberland for clients of the company. In 2003, Mr. Sewell was promoted to Managing Director within the Molpus Timberlands Management organization. As Managing Director, his responsibilities included the overall management of forestry operations on approximately 465,000 acres located in Southeast Texas. In 2006, he relocated to Hattiesburg, Mississippi, and assumed the same responsibilities on approximately 230,000 acres located in Alabama, Mississippi, Louisiana, and Oklahoma. In 2007, he accepted his current position as Chief Operating Officer. Prior to his employment with the Molpus companies, Mr. Sewell gained ten years of technical, operational, and managerial experiences in the forest industry through his employment with Champion International Corporation in Cantonment, Florida, and Packaging Corporation of America (formally Tenneco Packaging), in Haleyville, Alabama. Discussion/Action on Molpus Woodlands Fund III, L.P. 13

14 Edgar Marshall Vice President of Business Development Mr. Marshall is Vice President - Business Development with the responsibility of strategic improvement and growth of The Molpus Woodlands Group, LLC. He also serves on the company s Executive Acquisitions Team. Mr. Marshall is a forestry graduate of Mississippi State University and received his masters of business administration from Mississippi College with foreign studies at TiasNimbus. Mr. Marshall has both international and multi-industry experience in strategic growth, asset management and value creation. Prior to his employment with Molpus, he worked as a Vice President with Greif, an industrial shipping containers company, in The Netherlands. He led Greif s performance improvement initiative focusing on building internal capabilities in both strategic marketing and manufacturing processes. Previous to that, he was the Vice President and General Manager for Soterra LLC, a timberland company in the United States and Canada. Mr. Marshall also has an extensive background in large timberland transactions. Michael Cooper General Counsel & Chief Compliance Officer Michael R. Cooper is General Counsel, Chief Compliance Officer and Risk Manager for The Molpus Woodlands Group, LLC and Molpus Timberlands Management, LLC. He is responsible for the management of the legal matters of each company; and maintaining all legal instruments that relate to the properties of Molpus s clients. He is also involved in managing the risks of Molpus and its clients by overseeing Molpus s risk management strategies. Additionally, Mr. Cooper serves as Molpus s contact for the Limited Partners of its Prior Funds and is responsible for Molpus s marketing information. Mr. Cooper earned a bachelor of business administration in banking and finance from Mississippi State University in 1992 and a Juris Doctorate from the University of Mississippi School of Law in Prior to joining Molpus, Mr. Cooper was engaged in a diversified corporate law practice in Jackson, Mississippi. He was selected as one of Mississippi s Top 40 Under 40 for 2009 by the Mississippi Business Journal and is a member of the following: the Mississippi Ethics Commission, the Mississippi Corporate Counsel Association (where he served as past President), the American Bar Association s Advisory Committee for the Paralegal Studies program for the University of Southern Mississippi, and the Mississippi Bar (where he serves as Chairman of the Clients Security Funds Committee). Discussion/Action on Molpus Woodlands Fund III, L.P. 14

15 Keith Williams Director of Value-Added Division Mr. Williams is the Director of the Value-Added Division for The Molpus Woodlands Group, LLC. In this position, Mr. Williams is responsible for evaluating and implementing opportunities for non-timber revenue for client properties. These opportunities include higher and better use land sales, alternative energy opportunities, conservation easements, endangered species habitats, etc. Mr. Williams previously served as Property Manager for 63,000 acres in Southeast Oklahoma under management by Molpus Timberlands Management, LLC (MOLPUS). He has been an employee with MOLPUS since Mr. Williams has extensive experience managing timberlands in several states. Prior to joining Molpus, Mr. Williams served as a District Forest Manager for International Paper Company and Area Forester for Champion International Corporation. Discussion/Action on Molpus Woodlands Fund III, L.P. 15