Health Care Foundation of Greater Kansas City Finance and Investment Committee Minutes of Meeting Held Monday, July 20, 2015

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1 Health Care Foundation of Greater Kansas City Finance and Investment Committee Minutes of Meeting Held Monday, Location: 2700 East 18th Street, Jonas Board Room, Suite 211, Kansas City, Missouri Committee Members in attendance: Kenneth P. Stremming, Chair, Thomas C. Carignan (via teleconference), Tom Cranshaw, James F. Dockins, Ed.D., Albert P. Mauro, Sr., S. Marie McCarther, Ph.D., Peg VanWagoner, and Kimberly C. Young Committee Members unable to attend: Wayne Powell (notified prior to meeting of inability to attend) Health Care Foundation of Greater Kansas City Board Members and Associates in attendance: Mark Flaherty, General Counsel, Rhonda Holman, Vice President/COO, Bridget McCandless, M.D., President/CEO, Victoria Meeks, Administrative Assistant, Richard H. Zimmer, CFO/Assistant Treasurer, and Tracy Skidgel, Manager Administrative Services/Executive Assistant Guests in Attendance: Daniel M. Couch (Former HCF Board member), Kevin Hrad (AON Hewitt) (via teleconference), David Keil (AON Hewitt) (via teleconference), Landon Rowland (Former HCF Board member), and Al Tikwart, Jr. (Former CAC member) Ken Stremming, Chair, opened the meeting at 12:00 p.m. Messrs. Hrad and Keil participated via teleconference as their flight was cancelled. Review and Approve Finance & Investment Committee Minutes of May 18, 2015 Committee members reviewed the May 18, 2015 F&I Minutes. Albert P. Mauro, Jr. motion to approve, Tom Cranshaw seconded. Discussion followed. A second shortened set of sample minutes was also provided for review. Committee members were asked to provide Dr. McCandless with their comments on the shortened version as to the adequacy of the content. Following discussion, the preference of the Committee is to go forward with condensed meeting minutes. The motion was approved by unanimous voice vote. Review and Accept May & June 2015 Financial Statements Rick Zimmer, CFO, provided an overview of June Financial Statements. Areas highlighted were: 1. The Schedule of Investments was modified to include asset allocation ranges for each asset class. The change was made to facilitate more opportunistic rebalancing based on Medium Term Views (MTV) monitored by Aon Hewitt. Asset Allocation ranges are defined in the current Statement of Investment Policies and Guidelines. 2. A MTV column was added to reflect the current views of Aon Hewitt. The current views are reflected by symbols. For example, five upward arrows ( ) would reflect a recommended max overweight position for that asset class, while five downward arrows ( ) would represent a strong underweight recommenda on. An equal (=) symbol reflects a neutral position. Discussion and recommended procedures regarding the active use of MTV s followed later in the meeting. 3. Net Investment Value of $550 Million at the end of June declined ($4) Million from the previous month. However, for the first half of the year, Net Investment Value has increased $15 Million.

2 4. Aon Hewitt has been asked to review the Emerging Market Debt Managers, Ashmore and PIMCO due to the significant outperformance of one manager over another since initial purchases two years ago (August 2013). 5. Real Estate has been a significant contributor to HCF s positive investment performance through the first six months. RREEF s 7.3% year to date return has significantly outperformed the 5.3% six month return of UBS. 6. Turning to the Balance Sheet, HCF s cash burn rate through six months has been $15 Million. Almost half of our required liquidity has come from Private Equity cash distributions now totaling $7 Million. Other significant sources of year to date liquidity has come from Lawsuit settlement proceeds $5.5 Million, and Investment Sales $2 Million. 7. On the Statement of Changes in Net Assets, revenue from Investments through the first sixmonths was $15.3 Million compared to $21.3 Million this time last year. HCF investments earned only $5 Million more the second half of 2014 for $26 Million in total revenue and a 4.7% return. For 2015, HCF investments have earned 45% of their annual budgeted target of $33M through the first six months. We are currently trailing our budgeted 6.2% investment return through the first half of the year. 8. Net Assets have increased $21 Million since year end. $13.5 Million of the increase in due to legal settlement proceeds received in April and the remaining $8 Million increase from positive operational performance (i.e. investment revenue less expenses). 9. Programmatic and Administrative expenses of $7.8 Million year to date are tracking to budget. S. Marie McCarther, Ed.D. motion to accept, Albert P. Mauro, Sr. seconded. Motion approved by unanimous voice vote. FFOG Investment Survey Final Summary Rick Zimmer provided an overview of the FFOG Survey Final Results. HCF s 2014 Investment Return of 4.7% landed in the 75 th percentile meaning 75% of the 171 reporting foundations performed better. The 2014 percentile range of returns was 1.6% to 11.7% with the 50 th percentile at 5.9%. HCF investment performance was much better over the more important 3 and 5 year time frames. The survey demonstrated the importance of timely and productive asset allocation decisions for those foundations consistently performing in the 25 th and 5 th percentiles. Fiduciary Focus: Asset Allocation Article entitled Importance of the Asset Allocation Study Rick Zimmer provided an overview of key discussion points from the article. Highlighted discussion points included: Asset allocation is a primary driver of variability of portfolio performance over a long term time horizon Fiduciaries should consider not only the organization s ability to assume risk (liquidity, desired spending targets, return targets) and also their willingness to assume risk (certain organizations and their fiduciaries may, by nature, be more risk adverse or risk seeking). Every asset class and investment within the portfolio should have a defined purpose, examples: risk reduction, return enhancement, inflation hedging, low cross correlation and others. The question is, what should we change in our process to be more effective and efficient in the decisions we make? The selected asset allocation mix should then be immortalized in the Investment Policy Statement, along with allowable ranges... setting allowable ranges around asset class targets allows... the opportunity to add value through tactical adjustments to the asset allocation. Aon Hewitt Medium Term Views (MTVs) Mr. Hrad shared that at the last meeting the committee reviewed medium term views and how the Foundation s portfolio reflects the views. The general idea is it is impossible to predict the market over the short term. There is less variability as time horizon Page 2

3 increases, and investors are rewarded for holding cheaper assets. Incorporating MTV s into the process assists in buying cheap and holding over an intermediate term. MTVs work because markets are rarely at fair value. MTVs seek to add value by taking a number of diversified positions within a given risk budget. MTVs should be primarily valuation driven but need to incorporate other market factors which matter and MTVs use should incorporate judgment. MTVs work in tandem with the strategic long term benchmarks and portfolio allocations as they are adjusted within appropriate target ranges for each asset class. There are two way in which HCF can implement a policy for acting on MTVs: 1) Discretionary rebalancing on a more timely basis. This would permit actions to be taken between meetings with a F&I subcommittee consisting of Aon Hewitt, HCF staff, and designated F&I Committee member(s). 2) Tactical rebalancing decisions made at HCF F&I meetings only Would fit within the current governance model MTVs would be highlighted and recommendations provided at F&I meeting Either approach would entail the following: movement within widened policy ranges for more flexibility to take advantage of opportunities. Following procedure #1 above, decisions made between meetings would be brought to the F&I Committee at the next meeting. Discussion followed, including: How does the movement impact transaction fees related to turnover? AON Hewitt has a 12 person team that develops and monitors the medium term views for their OCIO (Outsourced Chief Investment Officer) clients. AON Hewitt does not move money often unless the MTV s are compelling and does not place a trade unless the value of the view beats the transaction costs. An efficient way to incorporate MTV s in asset allocation is through normal selling of investments for liquidity needs. What does this do to the risk profile of the HCF considering both risk to the investment program and fiduciary risk? 5 10 years ago, one would not find many institutions making medium term decisions, however fast forward and the growth and explosion of outsourcing has made this approach more common. As HCF would not be an outlier from a peer perspective, Aon Hewitt does not believe that fiduciary risk would increase. Regarding risk to the investment program, only small and infrequent tweaks are anticipated within approved ranges. Aon Hewitt recommended widening the current approved ranges (an additional + or 3%) for certain asset classes. Widening the ranges for public equities, fixed income and alternative investments would give the opportunity using MTV s. The new recommended proposed ranges are detailed on Page 12. A member clarified 1) do we want to move to a model that will allow for more flexibility in how asset allocation and rebalancing is done including new procedural steps? And 2) should we expand the targeted ranges in order to be more effective and flexible going forward? Discussion followed regarding implementation of MTVs. Peg VanWagoner commented that shifts within our asset allocation could take place between meetings and reported back to the Committee via or at the next meeting. Perhaps a subcommittee of the F&I committee could be created for approval of inter meeting asset allocation decisions. Chair Stremming reminded that the Investment Policy allows for rebalancing within a plus or minus 3% range of our longterm Policy targets. In practice however, the inter meeting rebalancing has been to rebalance to the longterm target without consideration for MTV s. Incorporating MTV s into our investment process is simply a more proactive way of rebalancing. Kimberly Young inquired how this change would affect decision making of the full committee? Rick Zimmer and Dave Keil believes minimally. Page 3

4 Dave Keil further clarified that if you believe that markets get mispriced once in a while and the F&I Committee only meets once a year, you would not be able to take advantage of MTV s. If you had an outsourced CIO relationship or if you had a 10 person internal investment team you could use MTVs easily. The question is whether our current meeting schedule of every other month frequent enough for effectively incorporating MTV s? Mr. Keil believes it would be better if you use MTVs not to have to wait 2 months and it would be nice if there was a subset of management and board authorized to approve MTV changes between meetings. AON Hewitt would still be that of a non discretionary advisor requiring HCF governance to provide direction and approval. It would not be the type of arrangement where AON has trading ability. Mark Flaherty commented since the Real Estate and Private Equity asset classes are inherently less liquid do you factor that in to the new recommended ranges? These asset classes are 25% of our portfolio that you cannot move money in and out daily. Mr. Keil responded the recommended widening of ranges does not include Real Estate and Private Equity due to their illiquidity. These types of investments are longterm strategic decisions and not tactical in nature. Question and discussion continued regarding the following questions: (1) how frequently are tactical adjustment typically made? (2) How do our current targeted ranges compare to other clients? (3) How do we effectively and efficiently implement these ranges and MTV s? (4) Do we delegate this process to a subcommittee? (5)How do other organizations do that? After much discussion, Dave Keil shared the recommended most preferred method is to have a sub group of the Committee with authority to make inter meeting decisions when MTV s are compelling to make an adjustment within approved ranges. This would also allow for the Committee subgroup to be tactical if a large amount of cash becomes available to the Foundation inter meeting. Dave Keil believes the frequency of inter meeting decisions maybe three or four times a year on average. If implemented today we don t have any tactical recommendations at this time. Landon Rowland expressed concern as to whether we have inadequate infrastructure? What do funds our size do how many people look and decide also considering the burden that this fiduciary decision puts on this committee? Dave Keil shared that organizations HCF s size rely heavily on investment consultants. Larger organizations rely less on investment consultants but also a person investment internal team. F&I is HCF s investment team. A subcommittee structure between F&I meetings has benefit of making decisions faster, and can report back to the committee as to what has taken place. This would not take the final asset allocations choices and review of asset allocation decisions away from full committee. It is the step in between going to full Internal CIO model, which is not recommended at this time. Mark Flaherty suggested a sub committee structure that included Bridget McCandless, Rick Zimmer, Peg VanWagoner (F&I member) and Ken Stremming (F&I Chair). The committee is rethinking the original premise that allows the CFO upon consultation with AON Hewitt to rebalance independently within our current approved ranges. With greater latitude comes greater responsibility. Need to make sure we are following F&I committee s intent. Committee requested written description of a newly proposed process. Al Mauro made a motion to recommend to the Board the adoption of the proposed ranges and establish a sub committee to work with management regarding AON Hewitt s mid term views and authority to Page 4

5 make investment decisions between F&I committee meetings. Tom Cranshaw seconded. Motion approved by unanimous voice vote. Chair Stremming will appoint members to the MTVs sub committee. Aon Hewitt Global Asset Allocation Updates Greece Resolution; Chinese Market; and Outlook Mr. Hrad commented that the information was provided in the Supplemental Materials. In a time saving effort no additional discussion was held. HCF Performance Update Second Quarter 2015 Flash Report Kevin Hrad provided the report and stated that the change of market value to $551.9 Million for an increase of approximately $9 Million was due to the Parametric Clifton contribution and investment gains. Quarter performance of 0.6% return and 2.9% for year to date as compared to the benchmark of 2.5. Equity market has been choppy but squeaked out a positive return. Non U.S Equity market has declined after a strong first quarter. Fixed income market was negative for first two quarters. Aon Hewitt attributes the Foundation s investment return to diversification. We do not have peer ranks available but safe bet to assume that HCF is in top 20 30% percentile for first half of the year. The first of July was a tough period with Greece/China hitting peaks. Portfolio is up 80 bps. in July. Close to being on track for return. Fixed income is down but what really helped HCF in this quarter was Shenkman Floating Rate Fund where interest rates rose. Aetos and Maverick performed pretty well. We have the markup for Private Equities through first quarter but no detailed report. Real Estate had some strength up 6.5%. Peg VanWagoner reminded AON Hewitt that they were to update the manager descriptions at the conclusion of the Flash Report to include the Private Equity and Real Estate managers. Dave Keil confirmed that he would take care of it. HCF Liquidity Analysis Dave Keil provided an overview regarding the ability of investment program to bear some liquidity risks and attempt to earn higher rates of return. AON Hewitt has a model approach for a liquidity process. Looked at HCF s liquidity in all the different scenarios to assess how our portfolio would respond. This included modeling parameters based on degree of Illiquidity. 1) Liquid; 2) Quasi Liquid; 3) Illiquid: Potential lockup of 5 10 years; and 4) Illiquid: Potential lock up of 10+ years. Page 5 details placement of HCF s portfolio in the buckets. No problems with liquidity. Even during Black Skies scenarios, HCF could still fund grants and operating expenses. Dave Keil then directed Committee members to an opposite scenario of receipt of additional funds and how Aon Hewitt would recommend investing it. If that happened, asset allocation recommendation wouldn t change. The following would be re evaluated Underlying manager vehicles being used (would a more cost effective vehicle be available?); ways of implementing in alternatives (Private Equities, Hedge Funds, Private Real Estate); consider more direct private equity placements and conduct updated pacing. No further questions. Chair Stremming thanked Dave and Kevin for attending and their efforts and said goodbye to them. Dan Couch departed. Non Director Investment Advisor Roles & Responsibilities Dr. McCandless began discussions regarding Bylaws review and non director participation in committee meetings. Dr. McCandless read the Bylaws verbiage, which states In addition, the Chairperson of the Board may appoint up to two prior members of the Board who are no longer Directors to serve as voting members of the F&I Committee for terms of one year, for up to three terms. Previously we discussed the possibility of considering advisors that were not previous members of the F&I committee and the Bylaws do not currently allow. Dr. McCandless stated that she wanted to know what she should bring to Bylaws Sub Committee for review. Other organizations use other advisors without voting rights with special expertise but don t want all the obligations and time Page 5

6 required of a Board member. Currently, we could invite as a guest but the individuals would have no ability to be ongoing members of the committee. Does the committee want the latitude? It would be a volunteer situation. Would we need to take measures to protect them under the D&O policy? Is the attorney client communication in place if we give legal advice and non board member has no privilege? Or as in the past, we have made them officers to solve the problem, asst. treasurer, asst. secretary, etc. If no voting role the volunteer s risk is less. We can make them voting members without being board members. Members of the committee felt, with the size of our board, we should be able to select individuals to serve on the Board. Concern that Board is large enough and adding more people could confuse things. Marie McCarther clarified that under present Bylaws we can invite people in as guest with special expertise on a specific topic. Would have to monitor any legal advice while they are sitting at the table. An additional concern in the current Bylaws is that the budgeting process is not discussed as a responsibility of the F&I Committee and needs to be included. Additional discussion was held. Recommended Change in F&I Charter Responsibilities related to Annual Board Communication of Investment Risk Profile and Projected Returns Rick Zimmer provided the overview. Under Responsibilities, page 2 second bullet, the proposed language was as follows: Determine the Foundation s risk tolerance, investment horizon and probabilities of reaching the stated long term investment objectives under multiple asset allocation scenarios. Annually communicate to the Board, HCF s investment risk profile and projected returns to assure programmatic and investment goals are annually aligned. Inform the full Board regarding asset allocation discussion verbiage enhances the communication. Anticipate performing the update at the April Board meeting present to Board the discussion regarding asset allocation. Roy Robinson made a motion to approve the revised changes under responsibilities bullet 2. S. Marie McCarther, Ed.D. seconded the motion. The motion was approved by unanimous voice vote. Upon motion made and seconded the meeting adjourned at 2:35 p.m. Discussion was held regarding receipt of information from Aon Hewitt. Should be noted that not all committee members had hard copies of the materials presented today. Normally Aon Hewitt would have brought the information to the meeting. Committee members concurred that review of the information in advance of the meeting was very helpful. Page 6