INTERDEPARTMENTAL CORRESPONDENCE

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1 Date: May 4, 2016 To: CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTERDEPARTMENTAL CORRESPONDENCE Retirement Board Members From: Linda P. Le, Retirement Plan Manager J~ Subject: Board Agenda Item No. 6: Discussion of Organizational Change at JP Morgan Investment Management, Inc.; and Possible Action (May 11, 2016, Regular Retirement Board Meeting) Recommendation That the Board of Administration (Retirement Board) of the Water and Power Employees' Retirement Plan (Plan) place JP Morgan Investment Management, Inc. (JP Morgan), on organizational watch status. Summary The Retirement Board hired JP Morgan to manage a core fixed-income mandate for the Retirement Fund (RF) and the Retiree Health Benefits Fund (RHBF) in In September 2015, under the new fixed income structure, JP Morgan began managing the Plan's Principal Protection strategy, and as of March 31, 2016, the market values of the RF and the RHBF accounts were $790.5 million, and $137.5 million, respectively. In September of 2015, JP Morgan notified staff that Douglas Swanson, head portfolio manager responsible for overseeing U.S. Value Driven fixed income platform, who has been with JP Morgan for 30 years was taking a leave of absence for an indefinite amount of time. The announcement was unexpected, but due to his long tenure at JP Morgan his retirement was foreseeable. Subsequently, Barb Miller, a 20-year employee who until then was managing a different group, was selected to succeed Mr. Swanson. A couple of months before Mr. Swanson's leave of absence, three other members of his team had left the U.S. Value Driven group to either take a position in another area of the firm or explore opportunities outside the firm. Two of the analysts covered corporate credit, which is not part of the Plan's Principal Protection strategy. Although this high number of departures in a short period was abnormal, staff considered it to be coincidental. Additionally, most of these employees were not directly involved in managing the Plan's new strategy. Rick Figuly, the lead portfolio manager for the Plan's mandate and an employee of JP Morgan since 1993, and Tim Eisel who 6.1

2 is Mr. Figuly's back-up, continue to oversee the strategy without any indication of their intention to leave. In April, however, staff was informed that three additional senior portfolio managers were departing. Mark Jackson, an employee of the firm for 20 years who along with Mr. Figuly was a potential candidate in the past to succeed as the head of U.S. Value Driven team, unexpectedly left the firm. Henry Song, an eleven-year member of the team, also resigned to explore other opportunities. The third portfolio manager, Chris Nauseda, announced his retirement effective end of June after 35 years of service at JP Morgan. Furthermore, Brett Cambern, the Plan's client portfolio manager since inception, notified staff that he was retiring in May after 24 years of employment at JP Morgan. The organizational changes at JP Morgan's U.S. Value Driven Investment team over the past ten months are concerning. The abnormally high turnover of senior employees along with a sudden departure of the head of the team seems to indicate that the team may be experiencing structural changes which are not welcomed by all employees. Staff and RVK, Inc. (RVK), the Plan's general consultant, will continue to monitor the situation and do not anticipate any material impact on the Plan's portfolio at this time. Based on discussions with JP Morgan, staff and RVK expect the firm to retain key professionals and stop the recent high rate of attrition. Furthermore, it is expected that Mr. Figuly will continue to manage the Plan's portfolio, and over time, the firm will strengthen its bench of professional staff by hiring and promoting internally. Regardless, the recent departures are significant and warrant close monitoring of the firm under an organization watch status. As a result, staff and RVK recommend that the Retirement Board place JP Morgan on organizational watch status. Both staff and RVK will continue to closely monitor JP Morgan's performance and investment process. The following documents are attached: Resolution No Correspondence from RVK Jeremy Wolfson Chief Investment Officer LPL/JW/CM/FH:mea 6.2

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5 Memorandum RVK To From Water & Power Employees' Retirement Plan ("The Plan") RVK, Inc. ("RVK") Subject J.P. Morgan Principal Protection Watch Status Recommendation Date May 11, 2016 Recommendation According to Section IV, 4.5, 4 of the Board-approved Investment Policy Statement: "An investment manager/portfolio attains watch status if at least one of two events occurs: (i) the portfolio's investment performance does not meet one of the criteria found in Schedule 1, or (ii) after the Portfolio Review is conducted, staff anq/or the investment consultant recommends to the Board that an investment manager is a candidate for watch status. The Board then approves or disapproves the recommendation. If the Board approves the recommendation to place a specific investment manager on watch status, staff will issue a formal notification to the investment manager." Due to recent personnel departures RVK has conducted a formal review of the J.P. Morgan Principal Protection mandate. After conducting this review, RVK recommends J.P. Morgan Principal Protection be placed on watch status for a period no less than six months. Background The J.P. Morgan U.S. Value Driven Strategies team oversees a variety of investment grade fixed income portfolios across its platform including the Principal Protection strategy held by The Plan. The team is also responsible for Core Plus, Short Duration, Intermediate Duration, Long Duration, Mortgage-Backed Securities, and Government Bond portfolios. The Plan's total exposure to the J.P. Morgan Principal Protection strategy was approximately $928 million as of March.31, The Plan initially retained J.P. Morgan in the second quarter of 2010 as a Core Fixed Income manager. With the recently implemented changes to the fixed income structure, J.P. Morgan's mandate was changed during the third quarter of They now manage a Principal Protection portfolio that excludes exposure to credit. In March 2016, J.P. Morgan announced that three portfolio managers would be leaving its U.S. Value Driven Strategies team. Chris Nauseda announced that he would be retiring on July 1, and later in the month, Mark Jackson and Henry Song announced that they would be leaving the firm. These departures follow the indefinite leave of absence taken by Doug Swanson, the former head of U.S. Value Driven Strategies, in September. While the departing portfolio managers are not the primary portfolio managers assigned to the Principal Protection mandate, due to the multiple prominent departures, RVK recommends 6.5

6 RVK placing the Principal Protection strategy on watch status for a period no less than six months. We believe that J.P. Morgan's team-based approach allows it to withstand this level of turnover without a significant impact to the competitiveness of the strategy. Therefore, we are not recommending termination at this time. Following multiple calls with J.P. Morgan, RVK believes the departures represent a loss of talent and raise concerns about J.P. Morgan's ability to retain talented portfolio managers. We will continue to closely monitor the U.S. Value Driven Strategies team and investigate our concerns. Further turnover at the portfoljo manager level or a notable deterioration in performance will likely lead to a termination recommendation. RVK may further recommend termination across the U.S. Value Driven Strategies platform if we discover dysfunction at the team level. If no issues persist, RVK will recommend removing the Principal Protection strategy off watch status. Team The Principal Protection strategy is managed by the Columbus, Ohio based team led by Barb Miller, head of US Value-Driven Strategies. The lead portfolio manager for this strategy is Richard Figuly. Figuly is a member of the Global Fixed Income, Currency & Commodities group, and is also part of the short duration and core plus bond fund management team. Miller and Figuly have been working together to manage the core strategy for over 20 years. Previously the team was part of Banc One before being acquired by J.P. Morgan in The core bond team remained in place and is still located in Columbus. The U.S. Value Driven Strategies platform uses the same process across all strategies. Swanson and Nauseda had been portfolio managers that focused on the Core Bond Fund. Jackson focused on investment grade credit and Song focused on MBS strategies. After discussions with Bob Michele, Head of Global Fixed Income, Currency, and Commodities, and Barb Miller, Head of U.S. Value Driven Strategies, we believe it is likely that Jackson and Song jointly received a competitive offer from another firm. However, both have been careful not to disclose the details of any offer that they may have received. Michele and. Miller expressed both departures had been a surprise and that they had recently increased their commitment to the portfolio managers through increased responsibility, compensation, and visibility. Their departure appears to be unrelated to Swanson's leave of absence and Nauseda's retirement. Jackson and Song are currently on garden leave for the next three months and two months, respectively, and are no longer managing portfolios. Nauseda continued as a manager on the Core Bond Fund until April 15. He will be transitioning off of his separate account portfolios in the c~ming months before his July retirement. RVK 2 6.6

7 RVK The U.S. Value Driven Fixed Income Team has remained relatively stable prior to this recent wave of departures and, thus, has developed a deep, experienced team of portfolio managers. There are currently 23 portfolio managers on the U.S. Value Drive Strategies team with 10 specifically focused on investment grade credit, Jackson's area of expertise, and 9 focused on MBS, Song's area of expertise. Furthermore, the portfolio construction process is a team-based approach in which portfolio managers are constantly sharing ideas and trades across the platform. This collaborative process also ensures a transfer of expertise across the team and reduces key person risk. Miller expressed that the team currently has sufficient portfolio management coverage and that many senior and intermediate-level portfolio managers will be taking on additional responsibility. Miller has been given the freedom to add as many portfolio managers as necessary. She intends to make any additions gradually with a preference toward internal promotions. Biographies: Richard Figuly, managing director, is a member of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Rick is a portfolio manager for the U.S. Value Driven team and is responsible for managing institutional taxable bond portfolios. An employee since 1993, Rick previously served as a fixed income trader trading all taxable fixed income securities while specializing in structured products. Prior to joining the firm, Rick was a fiduciary tax accountant at the Bank One Ohio Trust Company. Rick is also a retired Major of the Ohio Army National Guard. He holds a B.S. in finance from The Ohio State University. Mark M. Jackson, managing director, was a member of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Mark is a portfolio manager for the U.S. Value Driven team and is responsible for managing institutional taxable bond portfolios. Prior to joining the firm in 1996, he served as a portfolio manager for Alexander Hamilton Life Insurance Company and was also with the Public Employees Retirement System of Ohio as a portfolio manager. Mark holds a B.S. in finance from Miami University and is a CFA charterholder. Barbara E. Miller, managing director, is a portfolio manager and Head of the U.S. Value Driven platform within our Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Barb is responsible for portfolio construction, market strategy, allocation decisions, and security selection for value-driven strategies. In addition to her investment role, Barb is also senior location officer in Columbus for our GFICC group. An employee since 1994, she was previously an investment manager for Central Benefits Mutual Insurance Co., a portfolio manager for fixed income and equities at Midland Mutual Life Insurance Company, and a portfolio manager and trader for trust portfolios at National City Bank. Barb holds a B.S. in finance and banking from Franklin University. RVK

8 RVK Christopher Nauseda, executive director, is a member of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Chris is a portfolio manager for the U.S. Value Driven team and is responsible for managing institutional taxable bond portfolios. An employee since 1982, Chris previously served as vice president at First Chicago NBD Corporation (predecessor firm). Before this, he worked as a trader and managed various money market pooled funds and also served as a quantitative analyst. Chris holds a B.S. in finance from Wayne State University and an M.B.A. from Wayne State University. Henry Song, executive director, was a member of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Henry is a portfolio manager for the U.S. Value Driven team and is responsible for managing institutional taxable bond portfolios. An employee since 2005, Henry previously supported Columbus taxable client portfolio managers in reporting as well as client communications. Before joining the firm, he interned at LaSalle Bank's treasury department, assisting the risk management process for the mortgage and mortgage servicing rights portfolios. Henry holds a B.B.A. from the Ross School of. Business at the University of Michigan and is a CFA charterholder. Douglas S. Swanson, managing director, was a member of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in Columbus, Doug is the team leader and head portfolio manager responsible for overseeing U.S. fixed in~ome strategies including core, intermediate, short duration, long duration, MBS, inflation managed and stable value. In addition to his investment role, Doug also is the Location Head for all Columbus-based employees. An employee since 1983, he previously worked as managing director of the Taxable Bond team for Banc One Investment Advisors. Prior to this, Doug was first vice president and portfolio manager at First Chicago NBD Corporation, where he managed the government/corporate desk and large institutional portfolios. Prior to that position, Doug was a fixed income quantitative research analyst. He holds a B.S. in chemistry from the Massachusetts Institute of Technology and an M.S. in management from the Sloan School at the Massachusetts Institute of Technology. RVK 4 6.8