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 9:05 a.m. and read the opening statement into the record. Attendance was as follows: Present: Also present: Roger Hilton, Chair; Frank Eley, Chris Prevatt, 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 discussed how the Manager Monitoring Subcommittee charter could be incorporated into the Investment Committee charter, and that he expects to bring this amendment to the next Investment Committee meeting for consideration. B. INDIVIDUAL MANAGER PRESENTATIONS CRESCENT CAPITAL GROUP Presentation by John Bowman Mr. Beeson introduced Crescent and stated that OCERS has committed $55 million to their direct lending fund. Mr. Beeson stated that Crescent s direct lending strategy is to invest primarily in senior secured loans primarily in lower middle market companies in the U.S. with EBITDA between $5 and $50 million. Mr. Beeson stated that Crescent seeks businesses that are well established, have a proven niche, and predictable cash flows. He also stated that Crescent has drawn down $34 million of OCERS commitment and the current yield of the portfolio is 7.5%. The key highlights of the presentation were: Firm update: Crescent has $15 billion in assets under management as of June 30, Crescent s management committee oversees over 100 employees and the investment team consists of approximately 60 employees based in Los Angeles, New York, Boston, and London. Crescent recently hired a new chief compliance officer, Joe Hanlon, who formerly ran a multi-billion dollar compliance operation at Fidelity. The firm s direct lending business has been growing in the U.S. and they have also added a European direct lending fund to the business. Mr. Prevatt arrived at 9:18 a.m.

2 Market Overview: During 2013 and the first half of 2014, the overall leveraged loan market continued to see yield compressions. The market has been active, but challenging in terms yield. Crescent believes there are pockets of opportunities, such as the private equity market which is creating financing opportunities. There has been a lot of money flowing into U.S. direct lending and a lot of collateralized loan obligation (CLO) activity has caused spreads to compress in both the middle market and in the broadly syndicated market since Since 2013, there has been an increase in larger borrowers leverage as the low interest rates have caused large borrowers to push the leverage, and it continues to increase towards the pre-2008/2009 economic downturn levels. Outlook for 2014: Middle market loans continue to provide attractive yield premiums to broadly syndicated loans, and lower middle market loans can offer more significant yield premiums. Crescent views the healthcare collection business as a stable profitable business to lend to. Crescent also has a positive view on education related businesses and it is countercyclical as people tend to go back to school when there are no jobs. Crescent believes the lower middle market is the least efficient segment and offers better yields and reduced risk compared to the upper middle market. Crescent tries to avoid event risk and will start to concentrate the portfolio in countercyclical industries towards the end of the cycle. Portfolio Strategy: Crescent invests in senior secured debt of private U.S. lower middle market companies, with a primary focus on private equity-backed companies. In 2013, Crescent launched three concurrent direct lending fund offerings which invest pro rata in the same senior secured loan investment of lower middle market companies. The portfolio consists of senior secured first lien, second lien, and unitranche investments. Crescent only engages in top of the capital structure investing and the senior secured focus provides strong preservation of capital and attractive asset yields: bps yield premium to the broadly syndicated loan market. Performance: The direct lending fund had its final close on September 4, 2014 with $387 million of total commitments. Crescent has had strong investment activity, with $255.9 million invested across 24 companies (looked at over 500) and a blended yield of 7.5%. Crescent is seeing consistent performance across all investments in the portfolio and positive general trends in revenue and EBITDA growth. Crescent has not had any companies trip a covenant default. The portfolio is approximately 60% invested after one year and is ahead of the two-year investment period. The average time for a loan to be re-paid is 2.5 years. Ms. Freidenrich: How are the investments allocated across funds? Mr. Bowman: Capital is allocated pro-rata across the three funds. Mr. Eley: Do you sell any of the loans? Mr. Bowman: No, Crescent is a book and hold investor. Mr. Eley: Is Crescent seeing any slowdown in the direct lending business? Mr. Bowman: We do not see any sign of a slowdown of the market and the business cycle for smaller middle market companies. Mr. Miller: Does Crescent use any particular data as a leading indicator for their direct lending business? Mr. Bowman: Crescent uses month-over-month reports that show trends, where capital intensive businesses and the more exposed markets are good indicators. 2

3 Mr. Miller stated that he will work on including a direct lending index in the quarterly dashboards. Mr. Hilton: Is the direct lending business getting too crowded? Mr. Bowman: The upper middle market has a lot of players pushing yields down, but the lower middle market is still very attractive. There is a nice barrier to entry which Crescent benefits from due to the extensive involvement with the borrowers. Mr. Eley: What is the overall volatility of direct lending for OCERS? Mr. Miller: Overall, direct lending has very little volatility as the loans are basically just sitting there. Loans are re-priced, but the volatility is still low. Mr. Bowman: There are no actively traded prices for the loans and 100% of the portfolio today is marked at cost and it is never marked above par. Overall, volatility is nominal in the direct lending space, most likely less than 1% in total over a 5-year portfolio. The Committee recessed at 10:17 a.m. The Committee reconvened at 10:29 a.m. KTR CAPITAL PARTNERS Presentation by Robert Savage and Lauren Ores Mr. Beeson introduced KTR and stated that OCERS committed $50 million to KTR s Industrial Fund III in July He also stated that this is the only industrial focused fund in OCERS real estate portfolio. Mr. Beeson stated that KTR focuses on distributions centers across the U.S. and they do not take any opportunistic risk and would therefore be considered more of a value-add manager. The key highlights of the presentation were: Firm update: KTR has $4.6 billion in assets under management as of June 30, KTR has a national operating platform comprised of 88 employees across 8 offices: New York (headquarter), Chicago, Miami, Dallas, Los Angeles, Las Vegas, Seattle, and Conshohocken. KTR is currently undergoing an identity refresh, including an enhanced web presence. KTR has had no changes to the management or ownership of the firm. Market Overview: It has been a very good fundamental investing period for the industrial real estate sector, with vacancy rates at 7.2% today, which is below the historic long-term average. Currently, KTR believes it is a healthy landlord environment and it is driven by healthy local economies. KTR has seen in the demand across a wide range of tenant types and sizes. Outlook for 2014: As vacancies have come down, new industrial construction has increased, but it is still well below 2007 levels. KTR expects the regional hub allocation in the portfolio to decrease as it continues to be built out. There is a high demand for infill markets, where there are mostly older age buildings and no available land for new construction to compete. Portfolio Strategy: KTR is a real estate operating company with a singular investment focus on industrial real estate across North America and they focus on the local market presence in the top industrial 3

4 markets. KTR has a knowledge-based approach with substantial in-house market research, including a proprietary transaction database which tracks lease and sales activity. Performance: Fund III closed in July 2013 with $1.2 billion of capital commitments and approximately 34% of the capital has been called and 50% has been committed. The fund s occupancy was 89.7% as of June 30, million square feet of build-to-suit projects are under development and an additional 1.6 million square feet of speculative development are under way or in pre-development. Currently, 45% of the portfolio is in regional hubs, of which 90% is warehouses, but that is expected to decrease as the portfolio moves toward being fully invested. The fund holds 103 properties across 43 investments. The fund is currently 58% leveraged with 13% fixed and 87% floating rate debt. KTR tends to use floating rate debt while the properties are being stabilized, but the portfolio will be balanced at 50% fixed and 50% floating rate debt once it is fully invested and stabilized. Approximately 50% of the new construction is already pre-leased. KTR is anticipating the yield to stabilize at 7%-7.25%. Mr. Hilton: How do you define non-core real estate? Mr. Savage: KTR s definition of non-core would be enhanced returns and not just enhanced risk. For KTR that does not mean secondary markets. KTR only focuses on top tier markets where liquidity remains during economic downturns. Ms. Freidenrich: What has happened in prior cycles in the industrial space during downturns? Mr. Savage: In terms of prior cycles, they all had very different types of cyclical drivers. The last economic downturn heavily impacted consumption and when consumption dries up there is automatically less demand for warehouses. KTR focuses on the health of consumers and businesses. Housing is a driver in local areas due to construction demand, but the health of housing is not a major concern for KTR s business; it is rather a nice upside. Mr. Miller: Please comment on the environment for deploying remaining capital given where we are in the business cycle. Mr. Savage: Where we sit today, the fund is in a very good spot. For the first half of the capital, 90% is leased. Currently, there is a lot of capital in the market and it is competitive. Therefore, it is a more difficult environment to deploy capital, but that is KTR s normal operating environment. KTR s approach is patience, there are opportunities out there and KTR is comfortable, but the pace will be slower for the remaining 50% of the capital. Mr. Prevatt: In terms of the decentralization of the distribution network, will it centralize again in a downturn? Mr. Savage: The distribution network has changed and is unlikely to centralize again. The cost of transportation was the main driver for decentralization and the need to be more close to individuals as well. Ms. Freidenrich: Please discuss the vacant land in the portfolio. Ms. Ores: Half of the vacant land in the portfolio is a site in Pennsylvania. It was acquired at a low cost and where there is a demand for new construction. It will be used for speculative development in the next few months. Ms. Freidenrich: What are the yield components? Mr. Savage: 50-60% of the return comes in the form of income during the life of the fund and the balance comes from appreciation. During the investment period the income is being reinvested instead of distributed. There will be quarterly distributions after the fund is fully invested. 4

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