Pension Investment Review as of September 30, 2015 December 1, 2015

Transcription

1 UNIVERSITY OF CALIFORNIA Office of the Chief Investment Officer ATTACHMENT 3 Pension Investment Review as of September 30, 2015 December 1, 2015 Growing Portfolios Building Partnerships UC Investments

2 The overall investment objective for all University of California Retirement Plan ( UCRP ) assets is to maximize real, long-term total returns (income plus capital appreciation adjusted for inflation), while assuming appropriate levels of risk. UCRP s specific objective is to maximize the probability of meeting the Plan s liabilities, subject to the Regents funding policy, and to preserve the real (inflation adjusted) purchasing power of assets.

3 Delivering value through values. OUR INVESTMENT BELIEFS

4 Our Products Pension: $51.7B 55% Retirement Savings: $19.2B 20% Working Capital: $14.2B 16% Total Return: $8.4B 9% Short Term: $5.8B 7% $93.5B Endowment: $8.4B 9% $93.5Billion 100%

5 Delivering value through values. Our Investment Beliefs 1 Invest for the long term. Where we can, we focus on investments over 10 years and beyond. This offers many more opportunities than those available to short- and intermediate- term investors. We aim to make the most of our scale and ability to be patient. 2 Invest in people. The contributions of talented people are among the most important drivers of success for any investment organization. So we ve made the recruitment and retention of exceptional staff a cornerstone of our strategy. 3 Build a high-performance culture. Every organization needs a clearly defined culture to make sure everyone is working towards the same ends and speaking the same language. Our culture is one of responsibility, accountability and high performance. We are proud of our achievements but try to be humble, as markets sometimes surge and fall without warning. 4 We are all risk managers. Our aim is simple: to earn the best risk-adjusted return that meets the objectives of our various portfolios. But achieving that aim is complex. An effective risk-management function is critical, enabling the leadership to delegate authority to the investment team. Everyone on the team is in the risk-management business. 5 Allocate wisely. The key to investing, and the most important driver of performance, is asset allocation. To make effective investment decisions and achieve the appropriate combination of risk and return, we have to maintain a clear and balanced understanding of stakeholders unique objectives, time horizon, risk tolerances, liquidity and other constraints. As a globally significant investor, we also aim to make the most of our scale and patience when we allocate assets. 6 Costs matter. High-quality advice comes at a cost. We get that. But we also believe fees and costs for external managers must be fully transparent and straightforward. Anything else creates potential problems opaque fees can mask risk. Plus, cost savings can be considered a risk-free return. If we can save money through efficient, well-executed strategies, then we must. We intend to capture every dollar of this risk-free return that we can.

6 Our Investment Beliefs 7 Diversify with care. Act with clarity. Diversification is invaluable, but it s not a cure-all. It allows us to spread risk and reduce the impact of any individual loss. But diversifying too broadly can draw investors into assets and products they don t fully understand. We prefer a more focused portfolio of assets and risks that we know extremely well. We also need to be keenly aware of our own strengths and weaknesses in the global context in order to act decisively when we believe markets are behaving irrationally or when we have a skill or knowledge advantage. That means keeping a constant, cleareyed check on our evolving capabilities. It s not always an easy or painless process, but it s an essential one. 8 Sustainability impacts investing. Sustainability is not a check box, but rather, a fundamental concern that we incorporate into decision making. We focus particularly on how sustainability can improve investment performance. Sustainable businesses are often more rooted in communities and resilient to future crises, which means investing in them makes good business sense. They are bound to affect portfolios in the future, and we need to consider them in our broader lens of investment decision making. 9 Collaborate widely. We are proud to be a part of the University of California, as well as the broader community of institutional investors. Through active collaboration, we aim to leverage the unique resources of the university. We also want to foster collaborative relationships with our peers to leverage our long-term competitive advantages. 10 Innovation counts. The best investors recognize that markets are constantly fluctuating and that no good idea lasts forever. We must always be innovating and identifying new opportunities. Getting in early brings rewards. Just as importantly, some of the best opportunities transcend asset-class silos. There are advantages in thinking differently and partnering with peers that are willing to work with us on innovative projects. Collaboration is one of the most powerful drivers of innovation.

7 Table of Contents Market Review 8 Investment Highlights 15 Investment Performance 16 Asset Allocation 19 Performance Attribution 21 Risk Measures 22 Asset Class Summary 26 Public Equity 27 Fixed Income 33 Private Equity 39 Absolute Return 45 Real Estate 49 Real Assets 54 Policy Benchmark 58 7

8 Market Review

9 Equity Markets Performance Highlights A sustained collapse in commodity prices, China's market rout, followed by an unexpected currency devaluation, as well as fears of a Greek default and a September U.S. interest rate hike were some of the numerous factors that made the past three months one to remember. U.S. stocks broke a 10-quarter winning streak as the S&P 500 Index dove into negative territory in August Healthy stock market gains in July gave way to steep declines in August and September, leaving the broad U.S. stock market benchmark with a total return of -6.44% for the three months ending September 30, The decline pushed the S&P 500 Index well into the red for the 9 months ending September. Non-U.S. stocks generally suffered steeper declines than their U.S. counterparts, as weaker economic fundamentals exacerbated the effects of global market unrest. The quarter s "risk-off" sentiment affected emerging markets stocks the most (for instance, China's benchmark Shanghai Composite was one of the world's worst performers with a 25 percent loss, its weakest performance since 2008) and developing markets sharply underperformed developed market benchmarks. Compared with a broad mix of currencies, the U.S. dollar advanced modestly, which slightly reduced overall non-u.s. stock returns for U.S.-based investors. 9

10 Equity Markets Volatility Highlights Equity values remain elevated above historic averages at the same time the business cycle continues to mature and vulnerabilities and risks are rising. Many of the drivers of global growth appear to be slowing as stimulus in the form of low interest rates, QE and currency devaluation becomes less and less effective and China s economy continues to transition. In general, we expect a lower return and higher volatility environment for equities. Markets are likely to remain volatile while they adjust for the (slow) removal of crisis-era policies. In other words, central banks might migrate from being a source of stability to a source of instability. Above average valuations coupled with expectation for only moderate growth should lead to much lower returns than that of the past six years. In addition, events this summer, from Greece to failing oil prices to the slowdown in China and concerns about its impact on global growth, underscore that in a fully valued market, unfavorable macro or earnings news can generate volatility. 10

11 Yields US Treasury Bond Curve Highlights Treasury yields fell during the quarter and the yield curve flattened in response to slower growth and soft inflation data. Gross Domestic Product growth of 1.5% and falling retail prices due to lower energy costs and a stronger dollar were the main drivers. 10-year Treasury fell 31 basis points to 2.04% during the quarter while 10 year break even Inflation rate fell 47 basis points to 1.43%. 11

12 Spreads Credit Spreads by Ratings Highlights Spreads widened as a risk-off environment developed over the course of the quarter. Lower quality credit fared the worst and high yield outflows led to selling into a liquidity constrained market. Companies continued to engage in shareholder enhancing activity M&A, share buybacks, and general re-leveraging of balance sheets. 12

13 Currency US Dollar Index Highlights The US dollar has been the main channel to express investors views as they react in anticipation to a rate hike. 13

14 Crude Oil Crude Oil Price Highlights The slowdown in China might be secular, not cyclical, which raises concerns about global output as well as long-term demand for commodities. 14

15 Investment Highlights

16 Investment Performance Annualized Returns (%) 3 Month 1 Year 3 Year 5 Year 7 Year 10 Year 20 Year UC Pension (5.7) (0.9) UC Pension Benchmark (5.4) (2.5) Value Added (0.3)

17 Investment Performance 12 Months Contribution to Return Percentage (%) Highlights Over the past year the Pension lost -0.89%. Real Estate, Private Equity, Fixed Income, Absolute Return, and Cash contributed 2.47% but was offset by the combined losses of -3.35% from Equity and Real Assets. 17

18 Investment Performance Assets Under Management Attribution 12 Months Contribution to Return Millions ($) Assets Under Management September 30, 2014 Market Gains Value Added Net Cash Flow Assets Under Management September 30, 2015 $52.1 billion ($1.3 billion) $0.8 billion $0.1 billion $51.7 billion 18

19 Asset Allocation Cash Other Investments Highlights Given higher valuations, maturity of the business cycle and rising risks, we expect both lower returns and higher volatility. 10 year Treasury, at 2.3%, has anchored risk premiums lower across asset classes, making it difficult to achieve returns at or above the discount rate for the foreseeable future. Public Equity $51.7 Billion Fixed Income We used the past year to reposition the portfolio, taking profits on robust valuations in private equity, real estate and REITs. The portfolio is positioned to weather and take advantage of some volatility: 1) 3% cash; 2) below target allocations to growth assets (Public and Private Equity) and slightly higher allocation to Fixed Income; 3) Beta.55 and volatility at 7.2%. Compared to our Endowment, the Pension allocation is much more sensitive to Equity (and to a much lesser extent, Fixed Income). While this is not uncommon, it raises questions about potential drawdowns in times of stress. Public Equity: 54% Fixed Income: 23% $27.7B $12.0B Other Investments: 20% Cash: 3% $10.4B $1.6B Performance and results need to be taken in context: o Risk: One measurement system, agent-based risk framework, and risk factor approaches o Public equity: Rationalize manager base, maximize active management and increase risk efficiency/eliminate excess diversification o Absolute return: Construct a non-directional absolute return portfolio, which can opportunistically take advantage of structural shifts such as private lending. Eliminate duplicative risks by shifting long/short equity to Public equity. o Private equity and real estate: Highly selective approach to identify 8-10 of the best private transactions each 19

20 Asset Allocation Public Equity Market Value in $ Billions Percentage Over/Underweight Relative to Policy U.S. Equity % +0.1 Non-U.S. Developed % -1.9 Emerging Markets % +0.5 Total % -1.3% Fixed Income Core % +1.0 High Yield % +0.3 Emerging Markets % -0.2 TIPS % -0.2 Total % 0.9% Other Investments Absolute Return % +0.0 Private Equity % -2.2 Real Estate % +0.5 Real Assets % -1.0 Total % -2.7% Cash % 3.1% Total % 0.0% 20

21 Performance Attribution 1 Year Public Equity Weight Active Weight Allocation Attribution Selection Attribution Total Attribution U.S. Equity Non-U.S. Developed Emerging Markets Fixed Income Core High Yield Emerging Markets TIPS Other Investments Absolute Return Private Equity Real Estate Real Assets Cash TOTAL 100% +0.0% -0.1% +1.7% +1.6% 21

22 Risk Measures Total Risk Highlights Total Risk ( Volatility) is measured by standard deviation of monthly total returns; each point shows a 12 month measurement period. A standard deviation of 7% means that roughly two-thirds of the time, the realized return will be within 7% from the average return. Total Risk was 7.2% at the end of the quarter; much lower compared to recent years. The reduction of risk is due to the general lower volatility environment in the equity markets. Active Risk Active risk is measured by standard deviation of monthly active returns; each point or bar shows a 12 month measurement period. A standard deviation of 3% means that roughly two-thirds of the time, the realized active return will be within 3% from the average active return. Most of the active risk is attributed to security and manager selection decisions that differ from the benchmark. The Active Risk was 1.1% at the end of September and has been trending upward as we have increased our tilts from the benchmark. 22

23 Risk Measures Beta to S&P 500 Highlights Beta is a measure of the sensitivity of the total portfolio to the S&P 500 Index. Beta was 0.55 at the end of the quarter; which means that if the S&P 500 went down 10%, we would expect the portfolio to go down by 5.5%. Information Ratio is a ratio of Active Return over Tracking Error; Tracking Error is the standard deviation of the active return over time. The higher the information ratio, the better the portfolio is able to achieve active return against the relative risk to the policy benchmark taken. Information Ratio was 1.8 at the end of September, given our outperformance of 1.6% above the benchmark and tracking error (active risk) of 1.1%. Information Ratio 23

24 Risk Measures Risk vs Return 5 Years 9/30/2015 Return Risk Ratio UCRP UCRP Benchmark S&P MSCI ACWI Barclay US Aggregate Highlights The Risk Return chart shows return and the amount of volatility taken to achieve it. The return to risk ratio reflects the reward per unit of risk we are achieving. For the past 5 years, for every unit of risk we took we were rewarded Our total risk is primarily related to our allocation between equity and bonds. At the end of September our allocation was underweight to public and private equity and overweight to fixed income relative to the policy benchmark. Our total risk is similar to the benchmark but with a higher total return. Over the past 5 years the portfolio has earned more than the global stock portfolio as measured by the MSCI ACWI and taken on less risk. 24

25 Risk Measures Risk vs Return 10 Years 9/30/2015 Return Risk Ratio UCRP UCRP Benchmark S&P MSCI ACWI Barclay US Aggregate Highlights Risk Return chart shows return and the amount of volatility taken to achieve it. The return to risk ratio reflects the reward per unit of risk we are achieving. For the past 10 years, for every unit of risk we took we were rewarded Over the past 10 years the portfolio has earned more than the global stock portfolio as measured by the MSCI ACWI and taken on less risk. 25

26 Asset Class Summary

27 Public Equity Public Equity Pension Emerging Markets Cash Other Investments Non-U.S. Developed $27.7 Billion U.S. Equity Public Equity $51.7 Billion Fixed Income U.S. Equity: 54% Non-U.S. Developed: 31% Public Equity: 54% Fixed Income: 23% $14.9B $8.5B $27.7B $12.0B Emerging Markets: 16% Other Investments: 20% Cash: 3% $4.3B $10.4B $1.6B 27

28 Public Equity Investment Performance As of September 30,2015 Market Value ($ Million) Annualized Returns (%) % Allocation 3 Month 1 Year 3 Year 5 Year 7 Year 10 Year 20 Year Public Equity 27, % U.S. Equity 14,885 54% Russell 3000 Tobacco Free Index Value Added Non-U.S. Developed 8,502 31% MSCI World ex-u.s Value Added Emerging Markets 4,320 16% MSCI Emerging Market Value Added

29 Public Equity Highlights Major markets were all negative for the year as the quarter pushed markets into negative territory. Correlated move down across regions and low cross-sectional volatility created a difficult environment for active management. Stock selection in the US was the largest detractor, particularly in healthcare. Some profit taking and higher volatility in our portfolio and the markets, after run-up and low volatility in performance over the past several years, is not unusual. Our top allocations performed relatively better than our lower conviction allocations. Overweight and underweight positions across regions and sectors were approximately neutral to performance. 29

30 Public Equity Sectors Sector Exposures 25.0% Public Equity 20.0% 15.0% MSCI ACWI Highlights Overweight to healthcare was a detractor, but mainly due to poor stock selection. 10.0% 5.0% Underweight to utilities was a detractor as market flows moved to safety, but values do not look compelling. 0.0% Cons Disc Cons Staples Energy Financials Health Care Industrials Info Tech Materials Telecom Utilities Public Equity 14.0% 8.9% 4.7% 19.8% 17.5% 11.0% 14.3% 5.3% 2.4% 2.1% MSCI ACWI 13.0% 10.3% 6.6% 21.6% 12.3% 10.3% 14.2% 4.7% 3.8% 3.3% Active 1.0% -1.3% -1.9% -1.8% 5.2% 0.7% 0.1% 0.6% -1.3% -1.2% 25.0% Sector Contribution to Risk Public Equity MSCI ACWI Underweight to energy was a contributor. Removed some of the underweight to financials during the quarter as better balance sheets, affordable valuations, and the prospect of rising rates may create tailwinds. 20.0% 15.0% 10.0% 5.0% 0.0% Cons Disc Cons Staples Energy Financials Health Care Industrials Info Tech Materials Telecom Utilities Public Equity 13.8% 7.1% 6.3% 20.2% 17.7% 11.2% 14.0% 6.1% 2.0% 1.6% MSCI ACWI 13.0% 8.2% 8.9% 22.4% 11.4% 10.5% 13.8% 5.8% 3.4% 2.6% Active 0.7% -1.0% -2.6% -2.1% 6.3% 0.7% 0.1% 0.3% -1.3% -1.0% 30

31 Public Equity Regions 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Regional Exposures 0.0% Canada Asia ex-jp Europe ex-uk Emerg Asia Emerg EU Japan Latin Amer UK US Rest Of World Public Equity 1.4% 2.5% 15.3% 11.5% 1.8% 5.9% 1.7% 6.3% 53.4% 0.1% MSCI ACWI 3.0% 3.7% 16.0% 6.7% 1.7% 7.8% 1.3% 7.0% 52.8% 0.0% Active -1.6% -1.2% -0.7% 4.8% 0.1% -1.9% 0.5% -0.7% 0.7% 0.1% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Public Equity MSCI ACWI Regional Contribution to Risk Public Equity MSCI ACWI Highlights The overweight to China was a detractor. While we anticipated that the bifurcation in values among certain segments of the local Chinese market would deflate, we did not expect a stock market crash (MSCI China down 23% during the quarter) due to margin fuelled leverage, nor the extent of liquidation to our portfolio which was primarily positioned in cheaper securities such as H-shares. At slightly over 2% of the MSCI ACWI, the index does not adequately reflect China as the second largest stock market in the world. We believe the recent crisis has created stock specific opportunities with active managers. While the underweight to Japan was a slight positive contributor, we removed the underweight as the market sold off during the quarter. The focus on corporate governance has strong potential to create value given large cash balances and ample free cash flow generation. 0.0% Canada Asia ex-jp Europe ex-uk Emerg Asia Emerg EU Japan Latin Amer UK US Public Equity 1.1% 2.4% 17.8% 11.8% 2.0% 5.1% 2.1% 6.4% 51.2% MSCI ACWI 3.2% 4.2% 20.0% 6.5% 1.9% 5.9% 1.7% 8.0% 48.7% Active -2.1% -1.7% -2.2% 5.3% 0.1% -0.8% 0.5% -1.6% 2.5% 31

32 Public Equity Characteristics Dividend Yield (%) Dividend per Share EPS P/B P/CE P/E P/S Payout Ratio (%) ROE (%) Public Equity U.S. Equity Non-U.S. Developed Emerging Markets MSCI ACWI S&P MSCI EM MSCI ACWI ex U.S

33 Fixed Income Fixed Income Pension TIPS Cash Other Investments Emerging Markets Debt $12.0 Billion Core Public Equity $51.7 Billion High Yield Fixed Income Core: 58% High Yield: 12% Public Equity: 54% Fixed Income: 23% $7.0B $1.5B $27.7B $12.0B Emerging Markets Debt: 10% TIPS: 19% Other Investments: 20% Cash: 3% $1.2B $2.3B $10.4B $1.6B 33

34 Fixed Income Investment Performance As of September 30,2015 Market Value ($ Million) Annualized Returns (%) % Allocation 3 Month 1 Year 3 Year 5 Year 7 Year 10 Year Fixed Income 11, % Core 6,949 58% Barclays U.S. Aggregate Bond Index Value Added High Yield 1,477 12% Merrill Lynch High Yield Cash Pay Value Added Emerging Markets Debt 1,246 10% JP Morgan Emerging Markets Bond Value Added TIPS 2,320 19% Barclay U.S. TIPS Value Added

35 Fixed Income Highlights We continue to have a bias to higher rates, although we expect the Fed to be very gradual in the normalization of rates. We believe that an environment of slowly rising rates and 1.5% to 2% US GDP growth will lead to spread product outperforming Treasuries. High Yield will continue to benefit from a growing US economy and the additional carry offered in a rising rate environment. Real yields rose during the quarter leading to TIPS underperforming nominal Treasuries. Value added was a result of the portfolio s short real yield duration exposure. 35

36 Fixed Income Core Summary of Duration Buckets 50.0% 40.0% 30.0% 20.0% Core Fixed Income Benchmark Highlights Core Fixed Income is positioned short of benchmark duration. Curve exposure is weighted to the front end of the curve and underweight the long-end of the curve. 10.0% 0.0% 0 to 3 3 to 5 5 to 7 7 to to +INF Core Fixed Income 39.3% 27.8% 18.2% 6.2% 8.5% Benchmark 27.1% 35.0% 16.9% 8.4% 12.6% Active 12.2% -7.2% 1.3% -2.2% -4.1% Summary of Credit Rating 80.0% 60.0% Core Fixed Income Benchmark The portfolio is underweight Treasury securities and overweight spread product investment grade credit and structured product. The spread product overweight leaves the portfolio underweight high quality AAA government and Agency securities and overweight lower credit quality. The underweight to Treasuries hurt performance as the Treasury component had the highest returns in the benchmark. 40.0% 20.0% 0.0% AAA AA A BBB BB or lower Core Fixed Income 47.0% 3.2% 7.8% 16.3% 25.7% Benchmark 69.3% 3.6% 10.1% 12.6% 4.4% Active -22.2% -0.5% -2.3% 3.7% 21.3% Duration and curve exposure hurt performance as rates rallied, with the long end of the curve outperforming. The Credit and Treasury sectors underperformed their respective benchmarks while Collateral sector outperformed. The unconstrained allocation detracted from performance due to very short duration and long credit exposure. 36

37 Fixed Income High Yield Summary of Duration Buckets 40.0% 30.0% 20.0% 10.0% High Yield Benchmark Highlights High yield is positioned in-line with the benchmark on overall duration with slightly less exposure to the longer end of the high yield curve. The portfolio has an underweight to BB credits offset by a higher exposure to CCC credits. 0.0% 0 to 3 3 to 5 5 to 7 7 to to +INF High Yield 28.8% 32.8% 34.6% 2.9% 0.8% Benchmark 26.9% 37.0% 29.5% 5.0% 1.6% Active 1.9% -4.1% 5.1% -2.1% -0.8% Management is split approximately 55% external and 45% internal. Internal performance added significant value through security selection as well as a focus on higher quality B/BB which outperformed CCC s. Summary of Credit Rating 60.0% 40.0% 20.0% High Yield Benchmark External management on the whole underperformed, with one manager outperforming due to overall higher quality and conservative positioning in energy and the other two managers underperforming the benchmark. Internal funds are positioned in stronger credits with less overall yield than the benchmark. This positioning helped during the quarter as better quality outperformed lower quality. 0.0% AAA to A BBB BB B CCC lower High Yield 1.1% 1.6% 28.7% 42.8% 25.7% Benchmark 0.1% 0.3% 43.3% 41.7% 14.6% Active 1.1% 1.3% -14.6% 1.1% 11.1% While we continue to think high yield will perform well in the coming quarters, we believe the market will be very selective, focused on better balance sheets, and have bouts of volatility driven by ETF and Fund flows. 37

38 Fixed Income Emerging Debt Top 10 Country Exposures United States 6.4% Mexico 4.1% Indonesia 2.0% Hungary 1.4% Colombia 1.4% Brazil 1.1% Slovenia 1.0% Romania 0.8% Dominican Republic 0.8% Croatia 0.8% Bottom 10 Country Exposures Azerbaijan -0.7% Pakistan -0.7% India -0.9% Jamaica -0.9% Argentina -1.8% China -1.9% Malaysia -2.1% Ukraine -2.3% Lebanon -3.1% Russia -3.2% Highlights The Emerging Market portfolio is positioned close to benchmark duration and is somewhat higher in credit quality. The portfolio is overweight to Mexico, Indonesia, and the United States. The portfolio s US exposure is through domestic High Yield as a substitute for EM sovereigns. Significant underweights include Russia, Lebanon, and Ukraine. Ukraine was up over 50% during the quarter due to a better than expected debt restructuring with bondholders. We believe that emerging markets will continue to be volatile and struggle to adjust to a strong US dollar and a drawdown of liquidity. 38

39 Private Equity Private Equity Pension Coinvestment Cash Other Investments Venture Capital $3.0 Billion Buyout Public Equity $51.7 Billion Fixed Income Buyout: 59% Venture Capital: 29% Public Equity: 54% Fixed Income: 23% $1.8B $0.9B $27.7B $12.0B Co-investment: 12% Other Investments: 20% Cash: 3% $0.3B $10.4B $1.6B 39

40 Private Equity Investment Performance Market Value ($ Million) Annualized Returns (%) % Allocation 3 Month 1 Year 3 Year 5 Year 7 Year 10 Year Private Equity 2, % Actual Private Equity Return Value Added Buyout 1,763 59% Venture Capital % Co-investment %

41 Private Equity Performance and Attribution Major Risk Exposures and Positioning at Beginning of the Period Structurally biased toward growth Individual companies drove risk with 20 companies accounting for 20% of the portfolio Key sector exposures are Healthcare, IT and Consumer Major Events During the Period Sold $341 million of funds in late Q2 Early Q3 with focus on Venture and China exposure Funded co-investment increasing exposure to telecom infrastructure Generated $169 million dollars of distributions during the quarter and contributed $187 million dollars to new investments Main Performance Contribution During the Period Co-investments are the strongest contributor with a 31.5% return for the year Venture Capital was also a strong contributor at 12.9% Buyouts contributed 10.5% for the year Current Risk Exposures and Positioning Structural bias towards growth Single company risk continues to be important and will grow in importance in the future Signed direct investment creating risk exposure to financial services and increases idiosyncratic risk Reallocated portfolio in November shrinking the number of managers and line items 41

42 Private Equity Buyout Highlights Buyout returns were 10.5% for the year. Buyout exposure of $1,763 million represents approximately 59% of Private Equity and 3.3% of the overall portfolio. The buyout market benefitted from robust M&A activity and numerous indicators signal that we are in a frothy market environment: Debt/EBITDA multiples average 5.7x, down slightly from with 5.9x in 2014 Purchase price multiples now average 10.3x, up from 9.7x in

43 Private Equity Venture Highlights Venture returned 12.9% for the year. Venture exposure of $870 million represents approximately 29% of Private Equity and 1.7% of the overall retirement plan. We significantly reduced exposure to China and Techfocused managers. 43

44 Private Equity Co-Investment Highlights Co-investments returned 31.5% for the year. Co-investment exposure of $343 million represents approximately 12% of Private Equity and 1% of the overall retirement plan. Co-Investment portfolio consists of 23 investments with an average age of 2.3 years since investment. 44

45 Absolute Return Multi- Strategy Absolute Return Relative Value Arbitrage Distressed $3.2 Billion Global Macro Emerging Market Equity Hedge Event-Driven Public Equity Pension Cash $51.7 Billion Other Investments Fixed Income Distressed: 4% Emerging Market: 7% Public Equity: 54% Fixed Income: 23% $0.1B $0.2B $27.7B $12.0B Equity Hedge: 18% Event-Driven: 18% Other Investments: 20% Cash: 3% $0.6B $0.6B $10.4B $1.6B Global Macro: 13% Multi-Strategy: 18% $0.4B $0.6B Relative Value Arbitrage: 22% $0.7B 45

46 Absolute Return Investment Performance Market Value ($ Million) Annualized Returns (%) % Allocation 3 Month 1 Year 3 Year 5 Year 7 Year Absolute Return 3, % % HRFX Absolute Return + 50% HRFX Market Directional Value Add Distressed 142 4% Emerging Market 220 7% Equity Hedge % Event-Driven % Global Macro % Multi-Strategy % Relative Value Arbitrage %

47 Absolute Return Highlights The first quarter of the fiscal year was a notable period for markets; scores of assets registered outsized moves and a number of anomalous events were observed. Hedge funds were challenged in this environment. Risk positioning, crowding, exogenous and idiosyncratic events all culminated in a perfect storm. For the trailing 3 years, the Absolute Return portfolio returned 7.3%, outpacing its benchmark by 440 basis points despite the recent challenging quarter. Nonetheless, the team will take this opportunity to reposition the portfolio and reduce its vulnerability to risk-off market environments: o o Evaluating integrating equity-related hedge fund strategies with Public Equity portfolio. Focusing on strategies with modest correlations to stocks and bonds. 47

48 Absolute Return Investment Strategies Highlights After beginning the quarter with relatively aggressive positioning, equity hedge and event driven strategies dramatically de-risked, reducing both leverage and net exposures. Crowded sectors and trades bore the brunt of this unwind. Relative value managers took advantage of technical dislocations in structured credit to add to risk. Macro managers benefitted from being short select commodities within the energy and metals complexes. Most continue to play for looser monetary policy in Europe and Japan and thus there is a bias to be long European and Japanese equities (on a currency hedged basis). Divergent policies driving managers to be long USD against many currencies, including in emerging markets. Consensus is for path of US rate rise to be lower than expected. Distressed investors beginning to find opportunities on both the short and long side of the ledger. 48

49 Real Estate Real Estate Pension Opportunisti c Opportunistic Cash Other Investments $3.1 Billion Core Public Equity $51.7 Billion Value-Added Fixed Income Core: 39% Value-Added: 38% Public Equity: 54% Fixed Income: 23% $1.2B $1.2B $27.7B $12.0B Opportunistic: 23% Other Investments: 20% Cash: 3% $0.7B $10.4B $1.6B 49

50 Real Estate Investment Performance Market Value ($ Million) Annualized Annualized Performance Returns (%) (%) % Allocation 3 Month 1 Year 3 Year 5 Year 7 Year 10 Year Real Estate 3, % NCREIF ODCE Index Value Added Core 1,207 39% Value-Added 1,162 38% Opportunistic %

51 Real Estate Highlights Market conditions are favorable for successful completion of individual asset business plans. Robust investor demand for stabilized yield created a very favorable sales environment realized gains on sale of assets delivered above projected returns. Separate account portfolio was the best performing vehicle due to strong sale of properties, investor demand for core assets and healthy fundamentals on remaining assets. 51

52 Real Estate Type Highlights The portfolio is well diversified by property type. Real estate fundamentals are strong - vacancy rates continue to decline as strong demand outpaces supply. Debt on all separate account assets are fixed or floating swapped to fixed to hedge against anticipated interest rate increases The Industrial sector was the best performing driven by the ongoing strength of the bulk warehouse segment from e- commerce; now smaller multi-tenant and flex segments are seeing gains. Apartment rents continued to climb to record levels across most major markets, with higher growth in cities and suburbs near major technology employment centers and amenity-rich neighborhoods. Office sector newly renovated, premier office assets continue to report vacancy declines, with dense, urban markets attractive to millennial talent. Office sector is approaching its strongest years of growth. Retail occupancy remains highest at regional malls and lifestyle centers. E-commerce resistant formats, mainly perishable goods (grocery-anchored) and essential services, report the strongest leasing trends. Hotel occupancy levels across many major submarkets rose to all-time highs. More frequent travel by Millennials and retired Baby Boomers is likely to further lift overall revenue per available room. 52

53 Real Estate Region Highlights The portfolio is well diversified in gateway cities in the US high quality assets in top primary and secondary markets continue to report robust rent growth. Strong domestic capital flows, as well as record high foreign investment in commercial real estate, are driving asset values up and cap rates to new historical lows in many markets. Pricing has remained highly competitive for core or stabilized real estate in top-tier markets, tightening cap rates further. Strategic investments in the Pacific region (California) have delivered strong returns with realized gains on sale plus strong occupancy and rent growth on remaining assets. Apartments located in Houston remain well occupied but are now starting to offer increased concessions. 53

54 Real Assets Real Assets Pension Opportunisti c Timber Energy Cash Other Investments Opportunistic $1.1 Billion Public Equity $51.7 Billion Fixed Income Infrastructure Infrastructur e Energy: 29% Infrastructure: 30% Public Equity: 54% Fixed Income: 23% $0.3B $0.3B $27.7B $12.0B Opportunistic: 26% Timber: 15% Other Investments: 20% Cash: 3% $0.3B $0.2B $0.3B $10.4B $1.6B 54

55 Real Assets Investment Performance Market Value ($ Million) Annualized Returns (%) % Allocation 3 Month 1 Year 3 Year 5 Year Real Assets 1, % S&P GSCI Reduced Energy + Actual Real Assets Return Value Added Energy % Infrastructure % Opportunistic % Timber %

56 Real Assets Highlights The Real Assets portfolio returned 2% annualized over the past 3 years, outpacing the benchmark by 2.4%. Infrastructure and Opportunistic positive returns offset by weakness in Energy. Oil prices down significantly during the quarter. 56

57 Real Assets Investment Strategies Highlights The portfolio continues to be heavily weighted towards natural resources which includes oil & gas exploration and production, energy midstream and certain opportunistic mining investments. Energy and energy midstream exposure represents around 50% of the portfolio being most impacted by falling oil prices over the last twelve months. Oil prices have fallen 50% year on year from 9/30/14 and approximately 24% from the last quarter ended 6/30/15, depressing market value on lower projected cash flows and devaluing reserves. Geographically, 75% of co-investments and funds are targeting North American opportunities or have North American exposure, partially driven by the energy focus. Opportunistic strategies focused on energy and agricultural credit have shown resilience and downside protection in the current low commodity environment. 57

58 Policy Benchmark

59 Endowment Policy Benchmark Asset Class Benchmark Component Target Ranges Total Public Equity 54.92% U.S. Equity Russell 3000 Tobacco Free Index 24.09% +/-5% Developed Equity MSCI World ex-u.s. (net dividends) Tobacco Free 15.03% +/-5% Emerging Market Equity MSCI Emerging Market (net dividends) 6.99% +/-2% Opportunistic Equity MSCI All Country World Index (net dividends) 8.81% +/-3% Total Fixed Income 22.28% U.S. Core Fixed Income Barclays U.S. Aggregate Bond Index 12.44% +/-3% High Yield Debt Merrill Lynch High Yield Cash Pay Index 2.59% +/-1% Emerging Market Debt JP Morgan Emerging Markets Bond Index Global Diversified 2.59% +/-1% TIPS Barclays U.S. TIPS 4.66% +/-2% Total Other Investments 22.80% Absolute Return 50% HFRX Absolute Return Index + 50% HFRX Market Directional Index 6.22% +/-5% Private Equity Actual Private Equity Returns 8.03% +/-3% Real Estate (Private) Real Assets NCREIF Funds Index-Open End Diversified Core Equity Index (lagged 3 months) Commodities: S&P GSCI Reduced Energy Index; All other: Actual Real Assets Portfolio Returns 5.44% +/-3% 3.11% +/-1% 59