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 9:02 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 had no comments. Chris Prevatt arrived at 9:03 a.m. B. INDIVIDUAL MANAGER PRESENTATIONS BlueBay Asset Management Presentation by Rachel Basarab-Horwath, Anna Troup & Tom Heflin. Mr. Beeson briefly introduced BlueBay, one of OCERS two emerging market debt managers. Mr. Beeson stated that OCERS hired BlueBay in 2013 and despite the short track record, staff decided to bring BlueBay in to discuss the volatility in the emerging market debt space. Mr. Beeson stated that OCERS investment is in BlueBay s blended strategy of both local and hard (dollar nominated) currency debt. Mr. Beeson stated that OCERS total emerging markets debt portfolio is two-thirds weighted towards local currency and one-third towards hard currency, where Pictet, OCERS other emerging markets debt manager, only invests in local currency. Mr. Beeson stated that 2013 was a challenging environment for the emerging markets debt space, where some of the headwinds included currency depreciations, capital outflows, and rising inflation. Mr. Beeson stated that BlueBay underperformed the benchmark by 2.3% since the inception of the strategy in March, Mr. Eley: How do we avoid buying managers at the top and instead find managers that will excel? Mr. Miller: It is somewhat complicated selecting managers considering that one of the standard criteria is historical performance. In this particular case, the decision to move in to this area in early 2013 was a strategic asset allocation choice and not a market timing decision. Unanticipated, the emerging markets got trashed by the Federal Reserve s tapering announcements in May, 2013.

2 The key highlights of the presentation were: Firm update: BlueBay has $58.8 billion of assets under management, including $19.8 billion managed by the emerging market debt team. The emerging market debt team consists of 39 investment professionals all based in London and the team has an average investment experience of 14 years. The emerging market debt team is a stable team that keeps growing and currently, BlueBay is working on deepening the trade execution team. The team has had 2% turnover since the inception of the strategy and no departures over the last 6 years. Mark Poole, the founder and CIO, has begun to transition away from the day-to-day activities of the firm. The CIO role has been split into two co-cio roles between David Dowsett and Raphael Robelin, while Mr. Poole is the executive chairman of the asset allocation committee. Internally, it has not had an impact on the organization. Market Overview: The case for emerging markets remains intact and the higher yields provide an attractive opportunity to investors. Part of the emerging market s volatility in 2013 was caused by the Federal Reserves tapering announcement and it resulted in large sell-offs in the emerging markets. Following, the focus landed on current account deficit countries and the Fragile 5 (Brazil, India, Indonesia, Turkey, and South Africa), where the markets started to punish them for twin-deficits and as a result they experienced aggressive currency sell-offs. During the second half of 2013 Indonesia and India started to focus on orthodox monetary policy changes; raising their interest rates to aid the currency recovery. South Africa has stabilized, while Turkey is still sending mixed signals. Due to the volatile emerging markets, BlueBay emphasizes the importance of the focus on a country-by-country differentiated basis rather than the overall macro environment. The portfolio manager, Rodrigo De Fonseca, recently visited China and he came back with a bearish outlook on China, where his growth view is more muted than the 7.5% that markets are recording. BlueBay believes China has a balancing act to perform, where they need to simultaneously manage the growth dynamic and deleverage. The Chinese financial system is also starting to show signs of stress and it is having an increasing impact on markets tied to Chinese imports. Outlook for 2014: For the first time since 2008, BlueBay is expecting that net issuance of hard currency debt will be slightly negative given the large increase in repayments. On a forward looking basis, BlueBay believes the emerging countries will start issuing debt in their own currencies as they become more emerged, while hard currency issuance will slowly diminish. The emerging market universe is consisting of 62 countries and offers great alpha opportunities in comparison to the developed markets. Also, given that it is an investment grade asset class, emerging markets sovereign credit offers investors attractive spreads. Over the last 24 months, emerging markets local currencies experienced substantial sell-offs, but emerging markets still offers better yields than the developed markets. Currently, BlueBay is seeing an inflow of capital in emerging markets as the institutional investor base is looking for opportunities within emerging markets to obtain higher yields. Emerging markets re-priced last year in terms of the rising rates in the U.S. and BlueBay believes emerging markets could therefore be in better shape for a rising rate environment going forward. Overall, the emerging markets held-up well in regards to the political tumult in Crimea, which is reflecting the current momentum driven market. BlueBay expects that emerging markets will continue to experience volatility in the first half of 2014 due to elections in the Fragile 5 countries. In the second half of 2014, BlueBay expects that hard currency spreads will start to tighten, while some of the currency depreciations will start to reverse. BlueBay is uncertain about the emerging markets growth outlook and if the developed market s growth will start to transfer over. 2

3 Portfolio Strategy: BlueBay s investment process is driven by fundamental bottom-up analysis. The process is designed to identify value in each separate section of a country s fixed income capital markets. BlueBay focuses on global economic conditions and market technicals and the investment style is rewarded when the bottom-up research identifies market mis-pricings. In recognition of idiosyncratic market drivers and to preserve capital, BlueBay focuses on liquid portfolios to obtain greater flexibility at times of market dislocation. BlueBay has a blended long-only approach to emerging markets investing, where they invest across local and hard currency sovereigns and local and hard currency corporates. BlueBay has a preference for investing in mainstream emerging markets rather than frontier markets for the majority of the asset classes. BlueBay tends to underperform in a momentum driven market. Cash is always in the portfolio to back the derivatives. Performance: BlueBay has underperformed the benchmark by 2.32% since the inception of the portfolio in March, In 2013, May, June, and August were very large negative months for BlueBay and emerging markets local currencies imposed a large negative drag on performance in 2013, while hard currencies performed much better. Country selection detracted 1.66% from performance and the local/hard currency allocation detracted 0.66%. BlueBay s positions in Poland and Slovenia were positive contributors to performance, while Brazil and Indonesia were detractors. Local currency in Turkey, South Africa, and Brazil hurt performance in In terms of Brazil, BlueBay still holds the position and believes the investment will payoff in the long-run. BlueBay s probability-weighted 12 month return is 3.2% for hard currency debt and 4.1% for local currency debt. Mr. Hilton: How do you see China resolving their issues? Ms. Troup: People s Bank of China will have to resolve China s financial issues in the same way that U.S. will have to unwind the continuous use of monetary easing. These are two very different drivers hitting the market and both scenarios are new to investors and no one knows how they will get played out. BlueBay is constantly monitoring the situation and trying to understand how it will be dealt with. Mr. Prevatt: What impact does the volatile political situation have on Venezuela s currency? Ms. Troup: There is a lot of noise about Venezuela, but the government has taken steps to liberalize the exchange rate process and in order to take the black market exchange rate out. Venezuela was downgraded, but BlueBay had incorporated the risk. Political unrest and noise is a common theme across many of the emerging markets and BlueBay explores the risk-reward characteristics while incorporating the liquidity of a currency when determining the appropriate price for a currency. Mr. Delaney: What is there to invest in El Salvador? Ms. Troup: It is BlueBay s underweight position in comparison to the benchmark that resulted in a positive performance attribution. Mr. Miller: How come you missed the Fragile 5 to such great extent? Ms. Troup: Brazil is a Fragile 5 country, but it is an investment grade credit and BlueBay believes its Brazil trade was too early but will catch-up going forward. In terms of Indonesia, BlueBay took a deep dive into the country and it seemed as they were moving in the right direction in terms of managing their twin deficits. As a lesson from 2013, BlueBay is very cautious in owning sovereign credit while being underweight local currency. South Africa had a Rand sell-off, but BlueBay feels positive about their economy and some of the positions have been positive since the sell-off. Ms. Freidenrich: What are your portfolio allocations this year in comparison to last year and is the outlook moving towards value rather than momentum? 3

4 Ms. Troup: BlueBay went from being structurally long the local rates markets last year to holding relative value, on both the rate side and the foreign exchange rate side. BlueBay believes there is value over time to be overweight local currency versus hard currency and hold a 60/40 (local/hard currency) position. Mr. Miller: Please discuss the cash position. Ms. Troup: The cash position is in place to back forwards and swaps. BlueBay runs an allocation of 5-15% in tactical cash in order to preserve capital in volatile markets. Mr. Eley: Please discuss how diversified your counterparties are. Ms. Troup: BlueBay will follow-up on the counterparty risk. The Committee recessed at 10:08 a.m. The Committee reconvened at 10:18 a.m. BTG Pactual Presentation by Jim McBride, Gerrity Lansing, Joyce Niggley & Fernando Lamas Mr. Beeson stated that BTG Pactual acquired RMK Timberland in 2013 and manages OCERS Valencia Tree, LLC separate account. Mr. Beeson also stated that OCERS placed RMK Timberland on watch in April of 2012 when they announced that the advisory firm was going to be sold. Mr. Beeson stated that staff will be reviewing the transition and expects to eventually recommend removing BTG Pactual from the watch list at an upcoming Investment Committee meeting. OCERS invested in RMK Timberland in 2008 and through the recession OCERS properties initially lost value, but they continue to recover and OCERS has received $3 million in distributions thus far. The key highlights of the presentation were: Firm update: BTG Pactual acquired the RMK Timberland Group in BTG Pactual has 2,700 employees and 181 partners with offices around the globe. BTG Pactual Merchant Banking Group has $13.4 billion of assets under management, including $2.9 billion managed in timberland strategies. BTG Pactual Timberland Merchant Group has nearly 1.9 million acres under management across a globally diversified platform of which 1.2 million are located in the United States. BTG Pactual is one of the largest timberland managers globally. BTG Pactual manages OCERS $40 million separate timberland account, Valencia Tree, LLC. Market Overview: Historically, timberland investments have had unique growth drivers, and investments have been concentrated in mature markets. Timberland is a unique asset class and historically, timberland investments have had low correlation with other asset classes and positive riskadjusted returns. To date, there has been approximately $50 billion of institutional timberland investment worldwide with close to $40 billion of this capital concentrated in the United States. U.S. Timberland returns have decreased from 18.9% (avg ) to 6.3% (avg ). Outlook for 2014: The timberland market is still weak as a result of the last recession, but exports and rising housing markets have potential for a significant comeback. BTG sees a large opportunity for 4

5 mature timber as the U.S. housing market continuous to recover. The strong demand for pulp and paper from China stabilized the market during the recession and BTG still sees a firm demand. BTG believes sawtimber prices could dramatically escalate if the current economic recovery follows historical patterns. Portfolio Strategy: BTG s timber investments have a broad regional diversification with nearly 750 million acres of U.S. timberland in 7 different regions. BTG diversifies the timberland investments geographically and by type/species of sawtimber and pulpwood. On behalf of Valencia Tree, LLC, BTG has budgeted 2.2 million of timber sales for 2014 with $1.5 million currently under contract and actively being harvested. BTG manages OCERS timberland assets on the ground and constantly monitors the wellbeing of the properties. BTG emphasizes their use of best practices and their environmental program to ensure no harm to the environment in their practices. BTG does not use leverage because it takes away from optionality in the timing of selling timber. Performance: BTG expects the performance to improve over time as the market recovers. Since inception, the performance has been slightly better than the NCREIF Timberland Index, 3.4% vs. 3.1%. The income component was lower for the 1-year and 3-year time periods in comparison to the index, but with the current sales under contract Valencia Tree should outperform going forward. Timberland is a long-term investment and returns will improve over time as strategies are implemented and market conditions improve. BTG s strategic plan for Valencia Tree is showing a projected 8.3% nominal gross internal rate of return (IRR) over the next 5 years. Valencia Tree has up to this point distributed $3 million and most of the distributions thus far have been from timber sales. Ms. Freidenrich: Why do you have so many timberland employees compared to other asset classes? Mr. McBride: Timberland is a special asset class which requires field offices and on the ground asset management by investment professionals at the various locations. Ms. Freidenrich: Has the forest service sold most of their land in the Oregon area? Ms. Niggley: Most public owned land was taken out of production in the 1990s to save the spotted owl. The U.S. forest service was initially harvesting much of U.S. timber, but they are more recreational these days. It is a rare occasion that you see sales by the U.S. forest service. As a result, it puts more pressure and demand on private foresters sales. Mr. Delaney: Please discuss the risk of disease and fire. Ms. Niggley: Geographic and species/type diversification is important. BTG has foresters on the ground inspecting the properties for diseases. In each region, the plants are divided and planted in different tracts where a fire would not impact the entire region. Also, OCERS properties have casualty insurance. The Committee recessed at 11:07 a.m. The Committee reconvened at 11:17 a.m. Ms. Freidenrich left at 11:17 a.m. 5

6 Hancock Timber Resource Group Presentation by Katie AmRhein & Logan Roise Mr. Beeson briefly introduced Hancock Timber who manages OCERS Valencia Forest, LLC portfolio. Mr. Beeson stated that OCERS initial investment was $100 million and the portfolio is currently valued at $94.8 million. Valencia Forest s property values declined during the recent recession and it is on the path to make its way back up. The portfolio has made $7.7 million in distributions thus far. Mr. Beeson stated that Tom Sarno, the portfolio manager for Valencia Forest, has been promoted to Director of Global Operations and Katie AmRhein is OCERS new portfolio manager. Mr. Beeson also stated that Katie AmRhein is a senior portfolio manager at Hancock Timber and she has previous experience managing three out of OCERS four properties through other investors. Mr. Delaney: What was the strategic reason of giving $100 million to Hancock and $40 million to RMK? Ms. Chary: The staff s recommendation was to hire a single manager for $140 million, but the Investment Committee decided to hire both managers with a greater weight to Hancock, the more established team and firm. The key highlights of the presentation were: Firm update: As of December 31, 2013, the Hancock Timber Resource Group had $11.5 billion assets under management across 6.3 million acres. Valencia Forest s portfolio manager, Tom Sarno, has been promoted to Director of Global Operations upon the retirement of Bruce McKnight. Katie AmRhein has assumed the portfolio manager responsibilities of Valencia Forest, but Mr. Sarno will be overseeing the transitions, at least in the near term. Ms. AmRhein is a senior portfolio manager and has been a portfolio manager at Hancock for 15 years. Market Overview: Wood producer prices experienced pronounced volatility in The slow recovery of U.S. housing has not resulted in a pick-up in sawtimber pricing, but it is driving demand. A price pickup is expected as inventory from the recession is being worked through. Despite a slow-down in China s overall economy, construction remained strong in 2013 and overall exports to China increased. China s imports of both softwood lumber and softwood logs reached new peak volumes in New Zealand s timber harvest has more than doubled over the past 20 years and exports primarily to China have accounted for all the growth. Outlook for 2014: Hancock has a mildly positive outlook for the North American economy in 2014, with housing continuing to slowly recover. The North American timber markets are driven by the recovery in U.S. residential construction and lumber demand will continue to gain forward momentum. Expanding biomass-energy production is beginning to bolster pulpwood markets. The development of biomassenergy and pellet manufacturing will benefit the loss in the pulp and paper industry leading to strong pricing for the market. Portfolio Strategy: The fund objective is to achieve long-term capital appreciation and moderate cash income through an actively managed and diversified timber portfolio. Hancock seeks to diversify the portfolio by geographic allocation, tree species/product, and maturity/merchantability, with a target of 75% in at least two of the three primary U.S. timberland regions. In terms of leverage, total borrowings shall not exceed 35% of the portfolio s market value or 70% of an investment. Timberland has strong risk-return features with a standard deviation around 10%. Timberland also acts as an inflation hedge and has low correlations with other asset classes. 6

7 Performance: The Valencia Forest portfolio has underperformed the benchmark by 3.4% since the inception in April, All four properties are on the path of recovery after the last recession and in 2013, the total value increased by 5.5%. The IRR is still slightly underwater, but it is continuously improving and the projected performance is a nominal IRR of 9.6%. The Red River property is most at fault for the negative 0.3% since inception performance of the portfolio. Mr. Miller: Where are the opportunities for deploying new capital? Ms. AmRhein: Presently, the demand for Timberland properties is very strong. The U.S. south region is experiencing strong markets. Globally, there is less deal flow, but there are opportunities in South America. Mr. Miller: Please state if the expected return is real or nominal. Ms. AmRhein: It is real, CPI adjusted. C. CIO COMMENTS Mr. Miller asked for the Committee member s preference in terms of a domestic small-cap equity review. Mr. Hilton stated that he prefers to include it on the same day as the regular manager monitoring meeting. PUBLIC COMMENTS: None COMMITTEE MEMBER COMMENTS: None CHIEF EXECUTIVE OFFICER/STAFF COMMENTS: None COUNSEL COMMENTS: None 7

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