TEACHERS RETIREMENT BOARD. INVESTMENT COMMITTEE Item Number: 16 CONSENT: ATTACHMENT(S): 5. DATE OF MEETING: November 1, 2017 / 20 mins

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1 TEACHERS RETIREMENT BOARD INVESTMENT COMMITTEE Item Number: 16 SUBJECT: Annual Investment Cost Report for 2016 CONSENT: ATTACHMENT(S): 5 ACTION: DATE OF MEETING: / 20 mins INFORMATION: X PRESENTER(S): Debra M. Smith, April Wilcox, Shifat Hasan, Raelan Lambert, Pavilion Alternatives Group, LLC POLICY Investment cost reporting and monitoring requirements are governed by the CalSTRS Investment Policy and Management Plan, IPMP, Teachers Retirement Board Policy Manual, Section 1000, page A-1. As the controlling policy document for the investment branch, the IPMP establishes the framework for meeting CalSTRS objectives. CalSTRS Defined Benefit, Defined Benefit Supplement, and Cash Balance investment portfolios are all governed by the IPMP. The third objective after return and risk for the investment portfolio is to minimize the cost of investments. The investment branch takes this objective very seriously and strives to operate the plan in the most effective, low cost manner. HISTORY AND BACKGROUND OF THE ITEM During the investment cost presentation at the November 2015 meeting, the Investment Committee (Committee) requested staff to track all expenses and fees including those that are capitalized or netted from the investments (e.g. limited partnerships). In response to the Committee s request, staff developed a project plan that included outsourcing part of the work to an existing CalSTRS investment project consultant. A motion was passed to confirm and implement the project plan as recommended by staff. Pavilion Alternatives Group, LLC ( Pavilion ) was engaged as the project consultant to obtain paid management fees, partnership expenses, other fees and expenses, and carried interest associated with CalSTRS' invested capital. While each partnership has an audited annual financial statement, which is closely reviewed by staff, the netted costs and expenses are not uniformly disclosed nor are they delineated by each respective limited partner. As a result, the information must be carefully obtained one investment at a time through direct engagement. At the November 2016 meeting, staff presented the most comprehensive investment cost report in its history. For the first time, per the Committee s direction, the cost report delineated the costs and carried interest associated with managing investments in private markets such as limited partnerships and joint ventures. This report established a baseline, allowing us to move closer to developing trend lines over time and present more meaningful cost measurement information to the Committee. INV318

2 Investment Committee Item 16 Page 2 PURPOSE The purpose of this informational report is twofold: (1) To provide the Committee our calendar year 2016 Annual Cost Report; enhanced with a point in time, year-over-year (YoY) comparison and a comprehensive view into costs and carried interest associated with the various investments across our asset classes and investment strategies (Attachments 2 & 3); (2) To provide the Committee peer comparisons of investment cost data prepared by an external cost measurement provider. Their analysis compares us to our peers and reports our cost effectiveness based on their methodology (Attachment 4). DISCUSSION Our Approach to Investment Cost Management Over the past year, the Committee has adopted and approved seven Investment Belief Statements to be included in the IPMP; the third one is regarding the management of investment costs as outlined below: Belief 3 Long-term Benefits of Managing Investment Costs. We Believe: Investment costs, if not managed appropriately, can have a significant (rather than frictional) impact upon overall portfolio performance. Therefore: CalSTRS, as a large-scale investor, should focus on measuring, monitoring, and minimizing all relevant investment costs. CalSTRS has always believed that investment costs are an important determinant of fund performance and require close oversight and active monitoring. In recent years, we have witnessed an increasing weight placed on fees and expenses by a range of market analysts and commentators. In many cases, their discussions omit the fact that fees and expenses (costs) are one of the two broad components of NET returns; the other component being gross returns. Net Returns = Gross Returns Fees & Expenses CalSTRS investment staff understands that our members depend on their retirement from our net returns and not from our gross returns. As a crucial component of net returns, fees and expenses are consistently monitored and factored into staff s decision making process every day. CalSTRS investment staff engage in rigorous negotiations and due diligence to reduce investment costs across all asset classes. We utilize a combination of studies, analysis and expert opinions to ensure that negotiated fees are superior to market averages. Oftentimes, we are able to leverage our size and stability to obtain better cost structures than would otherwise be available to investors. We take advantage of every opportunity to renegotiate expenses with our partners. In addition, several asset classes are exploring innovative investment vehicles with low cost structures and lucrative INV319

3 Investment Committee Item 16 Page 3 performance potential. When appropriate, we opt for performance-based fees and expenses over fixed asset-based fees because this structure may enhance the alignment of our basic interests with those of our partners. We are constantly looking for ways to optimize all aspects of cost management and monitoring without compromising the quality of our investment returns. We are no longer alone in this pursuit. Over the past year, we have observed that managing fees and expenses are an increasingly dominant theme among our local and global peers. According to an article on Top1000Funds.com, a low return environment has prompted investors across the globe to put more pressure on fund managers fees and expenses. In addition to investment cost monitoring and reporting, we utilize benchmarks to measure the relative performance of the investment portfolio in relation to our costs. The overarching criterion is to focus on optimal cost, which may not always be the lowest cost, but has the highest net payoff. We understand that there is an opportunity cost associated with low cost investments and often times that cost can be substantial. We diligently strive to obtain the optimal balance of lower cost and higher quality investments that would generate the best results for our members. Our approach to investment cost management is holistic, with the prime focus on the highest overall payoff. There is no industry standard for investment cost reporting. Comparability is strenuous and in many cases not possible because every pension plan is unique. They are limited by their respective mandates, funding objectives and cash flow constraints. Additionally, private assets have characteristics such as non-standard reporting format and variability in deal structures, making cost reporting exceptionally complex; therefore, performance measurement and cost extraction is intricate and not always directly comparable to our peers. Our annual cost reporting initiative is a helpful exercise for us; we are more conscious of the inconsistent expense classifications across the industry. We continue to improve and enhance this cost reporting to provide more transparent information across all asset classes and build best practices. The sections below provide a synopsis of our cost reporting enhancements and methodology. Reporting Enhancements In our efforts to enhance and improve the cost report, we have made a few changes this year compared to our report last year (2015 Cost Report). This year, we provided a total fund and asset class/investment strategy level YoY comparison of the results (Attachment 2). The following are other enhancements we made to the report: 1) Change in the methodology of the Net Asset Value determination, a crucial component in the basis point (bps) calculations. We used a smoothing factor to account for new and exited/liquidated investments throughout the year, which results in more reasonable and unbiased calculations. 2) We allocated the cost of Custodial, Audit and Branch Support across all asset classes to reflect each asset classes costs more accurately; previously, this was reported under one line item. INV320

4 Investment Committee Item 16 Page 4 3) The report reflects all new and reorganized asset classes/investment strategies approved by the Committee over the year. 4) We made some extensive format changes to provide more meaningful information and enhance simplicity. For example, we are now providing a view into the Public Market Costs and Private Market Costs along with the previously reported External Management Costs and Internal Management Costs. Reporting Methodology For the public market investments, fees and expenses, such as broker commissions, were obtained from our global master custodian and soft dollar expenditures were retrieved by staff and included in the report. The trading spread for certain fixed income and currency instruments are not included in this report because there is an extensive effort required to capture these spreads and the uniqueness of each transaction results in the inability to produce estimation with a high degree of confidence. For our Securities Lending Program, we pay lending agent fees one of two ways: directly to the lending agent or by netting the fee against our contractual share of the income. These expenses are not outlined in this report; however, they are included in CalSTRS comprehensive annual financial report. The Securities Lending Program, managed by the Fixed Income unit, is a supplemental low-risk strategy that allows CalSTRS to use its existing asset base (the costs of which, we have included in this report) and lending expertise to generate additional income. For the private market investments, Pavilion was contracted to capture on a cash basis, the 2016 calendar year costs and carried interest including fees and expenses that are capitalized and netted from cash flows. There are over 600 partnership investments, separately managed accounts, joint ventures and co-investments within CalSTRS complex global investment portfolio. The majority of the capitalized and netted costs are from partnership structures, primarily within the Private Equity and Real Estate asset classes. The individual limited partner s (i.e. CalSTRS) expenses are not separately recorded nor provided in a consistent format that allow for simple extraction, comparison and aggregation. Each partnership has an audited annual financial statement, which is closely reviewed by staff; however, as previously noted, information must be carefully obtained one investment at a time through direct engagement. To obtain the cost information of our private assets, Pavilion utilized the reporting template ( Fee Template ) developed by the Institutional Limited Partners Association ( ILPA ) for private equity. Data was obtained through a combination of the Fee Template and other sources, which included financial statements and supplemental schedules provided by the general partners and managers. All data was thoroughly checked for reasonableness and completeness, representing numerous validation protocols for every investment. Pavilion will be available to discuss their process and answer any questions. Within this report, we have presented two views of our cost information: 1) External Management Costs vs. Internal Management Costs (Chart 1) 2) Public Market Costs vs. Private Market Costs (Chart 2) INV321

5 Investment Committee Item 16 Page 5 External management costs are expenses that are associated with external asset management. Generally, these are management fees of private and public market investments, partnership expenses and support and oversight of the externally managed portfolios. Internal management costs are expenses that are incurred for internal asset management and include associated staff salaries, and operational and administration costs for the management of those investments. Public market costs are expenses associated with the management of the publicly traded equity investments and fixed income securities. These include external management costs such as management fees, broker commissions and applicable internal costs. Private market costs are the expenses associated with private assets including the costs that have been capitalized and deducted from the gross value of the investment, such as management fees for limited partnerships, portfolio company fees and other types of expenses paid to the general partner and/or its affiliates. Within our report, private market costs also include relevant staff salaries and administration costs to manage the private assets. Carried interest, typically applicable to limited partnerships, is a profit sharing agreement between the general partner and the limited partners (i.e. CalSTRS). It is positively correlated to investment returns and is paid to the general partner upon the profitable exit from an investment and only after specific performance thresholds have been achieved (e.g. a preferred rate of return). Typically, carried interest is not paid on any particular portfolio investment until limited partners receive back all contributions (including fees and expenses) and a preferred return hurdle is met. Additionally, we report carried interest separate from the costs mentioned above (for detailed definitions, please see Attachment 5 - Glossary). Summary of Cost Reports All costs and carried interest within this report are for calendar year 2016 and on a cash basis. It is important to note that information in this cost report is one point on the trend line we intend to develop over years. Costs can fluctuate significantly each year depending on the life cycle of the underlying individual investments. CalSTRS is a long term investor and as such, when comparing to returns, cost data is more meaningful over several years. TABLE 1 OVERALL COSTS ($ in millions) Change ($Absolute) NAV* Cost Bps NAV Cost Bps NAV Cost Total Portfolio $ 194,698 $ $ 186,100 $ % 4.6% Total Portfolio w/carried Interest $ 194,698 $ 1, $ 186,100 $ 1, % *Smoothed to account for new and exited investments over the year Total investment costs were 50.0 basis points (bps) in 2016 compared to 51.8 bps in Average net asset value (NAV) grew approximately 4.6% yoy; yet fees, in absolute dollar terms, only increased by 1% excluding carried interest and 3.3% including carried interest. With the break points and fee structures we negotiate, we can expect that fees will continue to track less than the NAV growth over time. Paid carried interest, which is not just a cost comparison number, was higher in 2016 compared to 2015 and is reflective of higher overall profits (and thus returns) shared with partners over INV322

6 Investment Committee Item 16 Page 6 several years. For detailed total fund and asset class/investment strategy level YoY comparison, please refer to Attachment 2. Charts 1 and 2 in the subsequent pages contain summarized cost information and should be read in conjunction with the attachments. Chart 1 (page 6) illustrates our view of how the overall costs are broken out by external management costs, internal management costs and carried interest. For CalSTRS, it generally costs more to manage investments externally than internally. Internal investment management allows us to focus on strategies where we can leverage our internal knowledge and skills and, more importantly, add value by generating meaningful cost savings. However, there are strategies that require either significant infrastructure or specialized expertise that economically justify managing externally. For such strategies, we utilize external investment managers and partners, overseen and monitored by internal staff. Internally managed investments represent 45% of the total portfolio (see Attachment 3); however they represent only 3% of the total costs (see Chart 1). In 2016, external management costs were approximately $946 million compared to $27 million for internal management costs. For asset class and investment strategy level details, please refer to Attachment 3. CHART 1 CalSTRS Investment Portfolio - External & Internal Management Costs and Carried Interest Chart 2 (page 7) illustrates our view of how the overall costs are broken out by public market costs, private market costs and carried interest. Private market investments (private assets) are complex and require a higher degree of expertise, resulting in higher costs. A Public Market Equivalent (PME) analysis conducted by Meketa Investment Group in 2016 disclosed that the private equity program added significant value to CalSTRS, relative to having invested the same capital in public markets. The PME analysis has demonstrated that so far, the higher costs of these types of investments are offset by the greater risk and return benefit they provide to CalSTRS. There were 603 private assets in 2016; the costs associated with 98% of the private assets were obtained and reported compared to 91% for General partners/managers of the remaining 2% INV323

7 Investment Committee Item 16 Page 7 of private assets were non-responsive. They are primarily composed of co-investments and investments at the end of their life, which typically have low costs. In 2016, public market costs approximated $181 million compared to approximately $792 million for private market costs. As a proportion of net assets, both private and public market costs were lower in 2016 compared to For asset class and investment strategy level details, please refer to Attachment 3. CHART 2 CalSTRS Investment Portfolio - Private & Public Market Costs and Carried Interest Peer Comparison Data for peer comparisons were compiled and prepared by one third party cost measurement service provider utilizing various customized methodologies. The peer comparison is strictly for benchmarking purposes and differs from CalSTRS reported costs primarily due to the exclusion of broker commissions, partnership expenses and carried interest within the peer comparison. Based on a comparison of 14 global peers from $88 billion to $524 billion in AUM, CalSTRS investments was a low cost fund. 1 CalSTRS investment cost of 37.5 bps was below its expected cost of 48.3 bps and peer median of 41.5 bps, demonstrating our fund was low cost compared to peers, given an identical asset mix. 1 CalSTRS saved 10.8 bps over the expected investment costs, which equates to approximately $211 million saved compared to its peers. 1 For further details on peer comparison, please refer to Attachment 4. 1 Data collected and compiled by CEM Benchmarking, Inc. for calendar year INV324

8 Investment Committee Item 16 Page 8 CONCLUSION We have been reporting investment fees and expenses for well over a decade. As reflected on our investment beliefs statements, we acknowledge the long-term benefits of managing investment costs. Reducing costs is an integral part of our investment decision making process and we understand the importance of monitoring and measuring all costs to meet our policy objectives. We believe this report to be comprehensive; we scrutinize and report the costs across all asset classes. Our thoroughness and dedication to transparency, even prior to legislation requiring detailed cost reporting for California pension plans, continues to make us the front-runners amongst our peers in reporting investment costs. We cannot stress enough that there are challenges to comparability of costs with our peers due to the lack of standard practices across our industry for reporting these costs. We anticipate setting these standards in the form of best practices and building cost trend lines over several years, as we build on this information and continue our annual cost reporting. We will work closely with Pavilion starting early 2018 to gather relevant 2017 calendar year costs for our private assets. Separately, we will work with third party cost measurement service providers to monitor our effectiveness in managing costs for 2017 compared to our peers. We will continue to partner together with other institutional investors and organizations (e.g. ILPA) to develop standardized cost reporting practices across all the asset classes to enhance accuracy and transparency, and improve benchmarking. These efforts and the continued enhancements of our annual investment cost report will strive to provide the Committee the most meaningful investment cost information. Staff and Pavilion are available to answer any questions you may have. ATTACHMENTS/POWERPOINT Attachment 1 Investment Cost Report Outline Outline of the investment costs which are included in this report. Attachment 2 YoY Comprehensive Costs and Carried Interest A YoY comparison for the total fund and each asset class/investment strategy. Shows the total costs and paid carried interest across all asset classes and investment strategies. Attachment 3 Internal/External Management Costs & Private/Public Market Costs A view of the investment portfolio s internal and external management costs as well as the expenses associated with private and public markets. Attachment 4 Peer Comparison An overview of how CalSTRS investment costs compare to its peers. Data is based on a third party cost measurement service provider. Attachment 5 Glossary PowerPoint 2016 Investment Cost Report INV325

9 Investment Committee Item 16 Page 9 Prepared and Recommended by: Shifat Hasan, Associate Portfolio Manager Melissa DaRonco, Associate Portfolio Manager April Uyematsu, Investment Officer Reviewed by: June Kim, Director of Global Equity Steven Tong, Director of Innovation & Risk Glenn Hosokawa, Director of Fixed Income Mike DiRé, Director of Real Estate Margot Wirth, Director of Private Equity Paul Shantic, Director of Inflation Sensitive Anne Sheehan, Director of Corporate Governance April Wilcox, Investments Operations Director Debra Smith, Chief Operating Investment Officer Michelle Cunningham, Deputy Chief Investment Officer Christopher J. Ailman, Chief Investment Officer INV326

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11 Global Equity Corporate Governance Fixed Income Cash Real Estate Private Equity Inflation Sensitive Innovative Strategies Strategic Overlay Operating Expense within this Attachment and throughout this report includes staff salaries, travel, supplies, training and other Investment Branch support and administrative expenses. Includes advisor, consultant, risk and trade management system expenses. 2 Other Expenses within this Attachment and throughout this report include portfolio company fees that the General Partner/Manager or its related parties receive from the portfolio companies for consultancy services, broken deal fees, transaction and deal fees, board of director fees, ongoing monitoring fees and capital markets fees, as well as property management fees, construction management fees, project marketing fees, and other fees for real estate partnerships; also includes fund of fund fees. It includes private asset related partnership expenses inclusive of accounting, IT, administration, audit & tax, bank fees, custody fees, due diligence, legal, organizational, travel and entertainment, insurance, partnership level taxes and other expenses charged to the partnership. Includes brokerage commissions charged to CalSTRS for trades in the public markets. Excludes trading spread for fixed income and currency instruments. INV327 Investment Cost Report Outline 1 2 Management Fees Operating Expense 1 Other Expenses 2 Attachment 1 Investment Committee - Item 16 Asset Class/ Investment Strategy Base Management Fees Performance Fees CalSTRS Internal Salary CalSTRS Operating Expense CalSTRS Other Expenses Partnership/ Fund Expenses Brokerage/ Commission Transaction Fee Soft Dollar Services Carried Interest Risk Mitigating Strategies included in reports -- not applicable

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13 $ Bps $ Bps $ Bps Net Asset Value* 194, ,100 8, Management Fees Operating Expense Other Expenses (33) (2.6) Total (Excluding Carried Interest) (1.8) Carried Interest Total (Including Carried Interest) $ 1, $ 1, $ 52 (1.1) INV328 YoY Comprehensive Costs and Carried Interest 1 Total Fund CY 2016 & 2015 Costs ($ in millions) Attachment 2 Investment Committee - Item Change * Net Asset Value for 2016 smoothed for new and exited investments. In proportion to net assets, total investment costs slightly decreased in 2016 compared to 2015; this is reflected in the change in bps before and after paid carried interest. In 2016, investment costs increased in absolute dollar terms, due to: Increased assets under management A CalSTRS organization wide cost allocation initiative, which caused an increase in the allocation of administrative expenses outside of the Investment Branch to be allocated to the Investment Branch. Carried interest increased by $42 million, reflective of the higher performance thresholds met by the limited partnerships. The increase can be attributed to profits shared for a single high profit investment in the Real Estate asset class. 1 Tables on this page and subsequent pages may not foot due to rounding.

14 Change Change Change Change Net Asset Value* 106, ,135 5, ,067 4,337 (269.5) 31,214 30, ,774 4, Management Fees (3.6) (0.1) Operating Expense Other Expenses (0.3) 9 16 (7.5) (0.1) Total (Excluding Carried Interest) (10.6) Carried Interest (7.2) Total (Including Carried Interest) $ 147 $ 130 $ 16.7 $ 67 $ 84 $ (17.7) $ 21 $ 20 $ 1.0 $ 2 $ 1 $ Change Change Change Change Net Asset Value (621.6) ,275.0 Management Fees (1.3) (0.1) Operating Expense Other Expenses (0.2) (15.9) (0.0) Total (Excluding Carried Interest) (15.7) Carried Interest (15.1) Total (Including Carried Interest) (30.7) INV329 Asset Class/ Investment Strategy Attachment 2 Attachment 2 YoY Comprehensive Costs and Carried Interest Investment Committee - Item 16 Asset Class/Investment Strategy $ in millions Global Equity Corporate Governance Fixed Income Cash/Liquidity * Net Asset Value for 2016 smoothed for new and exited investments. Basis Points (Bps) Asset Class/ Investment Strategy Global Equity Corporate Governance Fixed Income Cash/Liquidity

15 Change Change Change Net Asset Value* 25,805 25, ,541 17,178 (637.7) 1,922 1, Management Fees Operating Expense Other Expenses (8.0) (23.1) Total (Excluding Carried Interest) (12.8) Carried Interest (127.0) Change Change Change Net Asset Value 5.9 (371.2) 1,553.8 Management Fees Operating Expense Other Expenses (3.1) (10.9) Total (Excluding Carried Interest) Carried Interest (65.2) Total (Including Carried Interest) (65.2) INV330 Asset Class/ Investment Strategy Attachment 2 Attachment 2 YoY Comprehensive Costs and Carried Interest Investment Committee - Item 16 Asset Class/Investment Strategy $ in millions Real Estate Private Equity Inflation Sensitive Total (Including Carried Interest) $ 589 $ $ $ 724 $ $ (139.8) $ 25 $ 18.7 $ 6.7 * Net Asset Value for 2016 smoothed for new and exited investments. Asset Class/ Investment Strategy Basis Points (Bps) Real Estate Private Equity Inflation Sensitive

16 Change Change Change Net Asset Value* 3,769 1,852 1, (69.3) Management Fees (3.3) Operating Expense (0.0) Other Expenses Total (Excluding Carried Interest) (3.2) Carried Interest 8 15 (6.7) Change Change Change Net Asset Value 10,351 1,267.7 (4,427) Management Fees (40.8) (1.7) Operating Expense (1.6) (0.0) Other Expenses (25.1) (0.0) Total (Excluding Carried Interest) (64.9) (1.8) Carried Interest (58.4) Total (Including Carried Interest) (123.3) (1.8) INV331 Asset Class/ Investment Strategy Attachment 2 Attachment 2 YoY Comprehensive Costs and Carried Interest Investment Committee - Item 16 Asset Class/Investment Strategy $ in millions Risk Mitigating Strategies Innovative Strategies Strategic Overlay Total (Including Carried Interest) $ 45 $ 44.9 $ (0.0) $ 8 $ 5.9 $ 2.2 $ 10 $ 13.5 $ (3.2) * Net Asset Value for 2016 is smoothed for new and exited investments. Reflects gains/(losses) on notional value for currency management. Asset Class/ Investment Strategy Basis Points (Bps) Risk Mitigating Strategies Innovative Strategies Strategic Overlay** ** For currency management, notional value is used for calculating basis points.

17 INV332 Asset Class/ Investment Strategy Public Market Costs Internal Salary Other Operating Global Equity 51,984 27% Fixed Income 5,328 3% Strategic Overlay* 11 0% Total $ 57,323 29% $ 115 $ 7 $ 9 $ 23 $ Private Market Costs Attachment 3 Investment Committee - Item 16 Internal/External Management Costs & Private/Public Market Costs ($ in millions) 1 External Management Costs Net Asset Value Ending Market Allocation Management Fee Operating Expense Other Expenses Total Expense 2016 Basis Points 2015 Basis Points*** Corporate Governance** 4,067 2% Real Estate 25,805 13% Private Equity 16,541 8% Inflation Sensitive 1,350 1% Risk Mitigating Strategies 2,402 1% Innovative Strategies 505 0% Total Private Market $ 50,669 26% $ 464 $ 15 $ 18 $ 294 $ Total External Mgt. $ 107,992 55% $ 579 $ 22 $ 27 $ 317 $ Asset Class/ Investment Strategy Public Market Costs Net Asset Value Ending Market Allocation Internal Management Costs Manager Fee Operating Expense Internal Salary Other Operating Global Equity 54,031 28% Fixed Income 25,886 13% Inflation Sensitive 572 0% Risk Mitigating Strategies 1,367 1% N/A Strategic Overlay* 76 0% Cash/Liquidity 4,774 2% Total Internal Mgt. $ 86,706 45% $ - $ 11 $ 15 $ 1 $ Total Public Market (internal & external from above) $ 144,030 74% $ 115 $ 18 $ 24 $ 24 $ Grand Total $ 194, % $ 579 $75 $ 318 $ * Net Asset Value reflects gains/ (losses) on notional values and uses notional values for calculating basis points for Currency Management. **Includes Net Asset Value of $852 million in Sustainability Managers for Corporate Governance. ***Adjustments made to 2015 data for comparison purposes 1 Table may not foot due to rounding. Other Expenses Total Expense 2016 Basis Points 2015 Basis Points***

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19 *Consists of 120 U.S. pension funds. **Starting in 2014 hedge fund performance fees are being included for all participants. This is one reason for the uptick in costs relative to INV333 Attachment 4 Investment Committee - Item 16 Peer Comparison (Developed by third party cost measurement service provider 1 ) Our total investment cost, excluding transaction costs and carried interest decreased from 46.8 bps in 2012 to 37.5 bps in Trend analysis includes 14 global peer funds with 5 or more consecutive years of data. Trend in Total Investment Cost 2 (excluding transaction costs and carried interest) 1 Data collected and compiled by CEM Benchmarking, Inc. for calendar year For data prior to 2016, underlying fund of fund fees based on peer median data with a default rate applied to CalSTRS. To the extent that peers adjust prior years' data and/or there is a change in peer group, CalSTRS prior years' costs may be different from what was previously reported by CEM.

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21 Glossary Attachment 5 Investment Committee - Item 16 Asset Class/Investment Strategy Management Fee (Asset- Based and Performance- Based) Basis Point (Bps) Brokerage Commissions/Fees Capitalized Costs Carried Interest (Profit Sharing) Corporate Governance Currency Management Program (CMP) External Asset Management As outlined in the Investment Policy and Management Plan (IPMP); a group of securities that have similar financial characteristics, behave similarly in the market place, and are subject to the same laws and regulations. CalSTRS asset classes and investment strategies include Global Equity, Corporate Governance, Fixed Income, Private Equity, Real Estate, Inflation Sensitive, Innovative Strategies, Risk Mitigating Strategies, Strategic Overlay and Cash. A periodic payment made by an investment fund to the fund s investment advisor for investment and portfolio management services which is calculated as a percentage of assets under management. Performance-based fees are paid when the advisor generates positive returns above an agreed upon performance rate. As displayed in the cost tables, manager fees include both asset base and performance base manager fees for public markets and manager fees excluding performance for private markets. Management Fee excludes internal staff salaries. A unit of measure used in finance to describe the percentage change in value or rate of a financial instrument. One hundredth of the one percent or.0001 in decimal form. An agent or agent s company charges to conduct transactions between buyers and sellers. Fees are charged for services such as purchases, sales, and advice on the transaction, negotiations or delivery. Included as Other Expenses within the report. An accounting method used to delay the recognition of expenses by recording the expense as a long-term asset. Applicable to private assets only. A profit sharing mechanism by which general partners are compensated for their performance, usually after meeting a certain performance threshold and returning all previously paid management fees to limited partners. Carried interest is distributed to the general partner as part of the profit before profits are paid to the limited partners (CalSTRS). A program within the Global Equity asset class. Some investments are structured as limited partnerships or co-investments, focused on active management where managers take large individual positions and engage boards and management to undertake value driving change. Others are structured like traditional external asset management and integrates robust environmental, social, and governance criteria into the portfolio company selection process. A program within the Strategic Overlay which manages CalSTRS total exposure to foreign currencies. Generally uses notional values, not market value, when calculating basis points. The outsourcing to external companies of asset management of various securities and other assets in order to meet specified investments goals. INV334

22 External Management Costs Fixed Income General Partner Global Equity Global Master Custodian Inflation Sensitive Infrastructure Innovative Strategies Internal Asset Management Internal Management Costs Internal Salary Net Asset Value (NAV) Attachment 5 Investment Committee - Item 16 Costs that are associated with external management of investments. Generally these are management fees of private and public markets, partnership expenses and related salaries, support and oversight. An asset class comprised of investment grade and non-investment grade securities in both the U.S. and non-u.s. dollar base. Examples of Fixed Income securities include debt securities and derivatives (futures, options, swap agreements or forward agreements). A general partner is an owner of a partnership who has unlimited liability. A general partner can be an entity or individual who is also usually a managing partner and active in the day-to-day operations of the business or investment fund. An asset class comprised of U.S.; non-u.s. developed countries, and emerging markets securities. Examples of Global Equity securities include Exchange Traded Funds (ETF), stocks domiciled in the U.S., international securities traded on the exchanges of all countries contained in the MSCI All Country World Index ex U.S. and the MSCI Frontier Markets Index, units of participation in commingled index funds or trusts and derivatives (futures, options, swap agreements, structured notes, warrants, asset trusts or forward agreements). A bank servicing the Investment Branch that takes responsibility for reconciling its records with those of each investment manager, processing and recording trades, relieving CalSTRS of this administrative burden. An asset class currently comprised of Infrastructure and Treasury Inflation-Protected Securities (TIPS), this asset class should produce a relatively stable return stream, with a return level between equities and fixed income, and an overall higher correlation to inflation than equity or fixed income. A strategy within Inflation Sensitive asset class comprised of limited partnerships, co-investments, commingled funds and publicly listed investments; spanning various industries such as energy resources and utilities, transportation assets, ports, water and waste and communications. An program where the primary objective is to invest in strategies that do not fit any of CalSTRS existing asset classes and explore new concepts that are expected to improve diversification of the overall investment portfolio when fully implemented. Asset management of various securities and other assets in order to meet specified investment goals performed in-house by CalSTRS staff. Costs that are incurred for internal management of the investments and relevant operational support and administration. An Operating Expense that comprises of salary and benefits paid to CalSTRS staff within the Investment Branch. The dollar value of the fund based on the total value of all the securities in its portfolio, any liabilities the fund has and the number of fund shares outstanding. INV335

23 Notional Amount Operating Expense Other Expenses Custodian, Audit & Branch Support Expenses Partnership Expenses Portfolio Company Fees Private Equity Asset Class Private Markets Private Market Costs Attachment 5 Investment Committee - Item 16 The U.S. Dollar amount of the underlying assets. Includes staff salaries, travel, supplies, training and other Investment Branch support and administrative expenses. Includes advisor, consultant, risk and trade management system expenses. Includes portfolio company fees that the General Partner/Manager or its related parties receive from the portfolio companies for consultancy services, broken deal fees, transaction and deal fees, board of director fees, ongoing monitoring fees and capital markets fees, as well as property management fees, construction management fees, project marketing fees, and other fees for real estate partnerships; also includes fund of fund fees. It includes private asset related partnership expenses inclusive of accounting, IT, administration, audit & tax, bank fees, custody fees, due diligence, legal, organizational, travel and entertainment, insurance, partnership level taxes and other expenses charged to the partnership. Includes brokerage commissions charged to CalSTRS for trades in the public markets. Excludes trading spread for fixed income and currency instruments. Includes investment expenses not allocated to an asset class such as custodian, audit and other organizational support budget expenses. Applicable to private assets. Reflected under "Other Expenses" and includes private asset related partnership expenses inclusive of accounting, IT, administration, audit & tax, bank fees, custody fees, due diligence, legal, organizational, travel and entertainment; may also include insurance, partnership level taxes and other expenses charged to the partnership. Applicable to private assets. Reflected under "Other Expenses" and includes fees the General Partner/Manager or its related parties receive from the portfolio companies for consultancy services, broken deal fees, transaction and deal fees, board of director fees, ongoing monitoring fees and capital markets fees, as well as property management fees, construction management fees, project marketing fees, and other fees for real estate partnerships; includes fund of fund fees. An asset class comprised of limited partnerships, direct investments, coinvestments and secondary interests in leverage buyout, venture capital, distressed debt, mezzanine financing, natural resources and proactive private equity. The objective of private equity assets is to provide an enhanced investment return over those available in the public market. Refers to the market of mostly illiquid investments that do not trade on an exchange. Investment structures can range from limited partnerships, limited liability companies and joint ventures. The expenses associated with private assets including the costs that have been capitalized and deducted from the gross value of the investment, such as management fees for limited partnerships, portfolio company fees and other types of expenses paid to the general partner and/or its affiliates. Within our report, private market costs also include relevant staff salaries and administration costs to manage the private assets. INV336

24 Public Markets Public Market Costs Real Estate Asset Class Risk Mitigating Strategies Soft Dollars Spread Treasury Inflation- Protected Securities (TIPS) Attachment 5 Investment Committee - Item 16 Refers to the market of securities that trade on an exchange and can be bought or sold by anyone in the general population. These securities typically trade in a systemized secondary market. Expenses associated with the management of the publicly traded investments and fixed income securities. These include external management costs such as management fees, broker commissions and applicable internal costs. An asset class comprised of direct real estate investments, joint venture and value added investments, and commingled funds in Office, Retail, Multifamily and Industrial sub categories. An asset class that invests in a number of investment strategies including long duration U.S. Treasuries, trend following, global macro, systematic risk premia, and other types of strategies. Soft dollars are the benefits provided to an asset manager by a brokerdealer as a result of commissions generated from financial transaction executed by the broker-dealer for client accounts or funds managed by the asset manager. Soft dollars, in turn might be used to pay for future commission expenses, research, advice etc. A spread is the difference between the bid and the ask price of a security or asset. A strategy within Inflation Sensitive asset class that aims to preserve the purchasing power or to compensate for inflation experienced over the life of the investment. INV337