Public Pension Funding Forum

Transcription

1 Public Pension Funding Forum September 12, 2017 Presented By Biagio Manieri, PhD, CFA PFM Asset Management PFM 1

2 Historical Plan Performance vs. Index Median Plan Performance Index BSB (1991) 13.4% 13.5% BHB (1995) 9.0% 10.1% PFMAM (2015) 9.1% 10.1% Brinson, Hood & Beebower,1995; Brinson, Singer & Beebower, 1991; PFMAM 2015 white paper study PFM 2

3 US Large-cap Equities Index places above median Index Active Source: PARis Investment Metrics, Returns are gross of manager fees, Index is net of fees PFM 3

4 US Small-Cap Equities Index places in top quartile Index Active Source: PARis Investment Metrics, Returns are gross of manager fees, Index is net of fees PFM 4

5 Active and Passive Management Most active managers do not consistently add value Passive management helps reduce overall investment costs Percentage of Active Funds Outperformed by Index One Year Three Years Five Years Ten Years Fifteen Years U.S. Equity 60.49% 92.91% 85.82% 82.87% 82.23% Non-U.S. Equity 84.94% 71.09% 66.95% 83.89% 89.36% EM Equities 63.90% 83.56% 74.73% 85.71% 89.89% High Yield 94.17% 90.91% 88.04% 96.60% 95.92% EM Debt 39.19% 82.54% 86.44% 76.19% 76.00% Source: S&P; as of December 31, 2016 PFM 5

6 Passive Can Outperform in Down Markets Also Percentage of Active Funds Beaten by Index During Prior Two Bear Markets Fund Category Benchmark to 2002 All Cap Funds S&P All Mid-cap Funds S&P Mid-cap All Small-cap Funds S&P Small-cap Source: S&P Indices and CRSP Database PFM 6

7 Active Manager Persistence is Weak Percentage of Top Quartile Active Managers that Remain in Top Quartile # of Funds % of Funds Remaining Sep Year 2-Years 3-Years 4-Years All Domestic Equity Large-Cap Equity Mid-Cap Equity Small-Cap Equity Multi-Cap Equity Source: S&P, December PFM 7

8 Endowment Model Has Not Outperformed Despite rising Alternatives allocation, endowments have not outperformed a simple 60% S&P 500 Index/40% Aggregate Bond Index. Trailing Returns 1 Year 3 Year 5 Year 10 Year 15 Year 20 Year Endowments -1.9% 5.1% 5.3% 4.8% 5.2% 6.7% 60/40 4.8% 8.7% 8.9% 6.9% 5.9% 7.4% Relative -6.7% -3.6% -3.6% -2.1% -0.6% -0.7% Returns as of June Source for endowments: NACUBO, endowment performance rounded to first decimal and trailing PFM periods calculated by geometric mean of each Fiscal Year, Endowment performance is expressed net of fees. 60/40 8 Represented by 60% S&P 500 Index and 40% Barclays Aggregate Bond Index, Index returns sourced from Bloomberg.

9 Hedge Funds: Underperforming a Traditional Portfolio Hedge Funds Benchmarks vs. 60/40 Portfolio 1 Year 3 Years 5 Years 7 Years 10 Years 15 Years HFRI Fund Weighted Composite Index * 7.98% 2.56% 4.89% 4.42% 2.98% 5.66% HFRI Fund of Funds Composite Index * 6.29% 1.49% 3.83% 3.00% 0.85% 3.40% 60/40 Benchmark ** 12.36% 4.87% 8.56% 9.08% 4.87% 6.78% Relative Performance (HFRI FoF Composite vs. 60/40 Benchmark) -6.07% -3.38% -4.72% -6.09% -4.02% -3.35% *Source: HFRI, indices are net of fees, as of 6/30/17. PFM **Source: PARis Investment Metrics, as of 6/30/17; 60/40 Benchmark consists of 39% Russell 3000, 21% MSCI ACWI ex 9 US, 40% Bloomberg Barclays Aggregate.

10 Growth of $1 (Starting 3/31/1986) Private Equity: Higher Fees and Lower Liquidity Private equity has outperformed public equity likely due to higher leverage When adjusted for leverage, we do not believe the private equity industry will outperform the public equity market 70 Public vs Private Equity Private Equity Small-Cap Value Levered Small-Cap Value Source: PARis Investment Metrics; as of 3/31/2017 PFM 10

11 Value of $1 Invested (Starting 1/1/1928), Log-Scale Long-term Real Returns: Equities vs Fixed Income Equity vs Fixed Income Real Returns S&P 500 US Govt/Corp LT $200 $180 Annualized Real Return: S&P % US LT Govt/Corp 2.58% $190 $160 $140 $120 $100 $80 $60 $40 $20 $10 $ Source: Morningstar, Bloomberg, Federal Reserve Bank of St.Louis, as of 6/30/17. Tracks growth of $1 Invested starting PFM 01/01/1928. Fixed Income comprised of 50% IA SBBI US LT Government (USD) and 50% IA SBBI US LT Corporate (USD). 11

12 YoY Change (%) Example of Tactical Asset Allocation: Emerging Markets GDP (percent change, constant prices) World Advanced economies Emerging market and developing economies $120 $100 WTI Crude WTI Oil Price $80 $60 $40 $20 $0 Dec '13 Mar '14 Jun '14 Sep '14 Dec '14 Mar '15 Jun '15 Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17 PFM Source: World Economic Outlook Database, April 2017; Bloomberg 12

13 Value of $1 Invested (Starting 1/1/2010) Example of Tactical Asset Allocation: Equities Equity Market Performance - Growth of a Dollar $3.0 S&P 500 MSCI EM MSCI EAFE $2.5 $2.0 $1.5 $1.0 $0.5 Dec '09 Dec '10 Dec '11 Dec '12 Dec '13 Dec '14 Dec '15 Dec '16 Source: Bloomberg, as of 6/30/17. Tracks growth of $1 Invested Starting 1/1/2010. PFM 13

14 Dec '13 Jan '14 Feb '14 Mar '14 Apr '14 May '14 Jun '14 Jul '14 Aug '14 Sep '14 Oct '14 Nov '14 Dec '14 Jan '15 Feb '15 Mar '15 Apr '15 May '15 Jun '15 Jul '15 Aug '15 Sep '15 Oct '15 Nov '15 Dec '15 Jan '16 Feb '16 Mar '16 Apr '16 May '16 Jun '16 Jul '16 Aug '16 Sep '16 Oct '16 Nov '16 Dec '16 Jan '17 Feb '17 Mar '17 Apr '17 May '17 Jun '17 High Yield OAS Example of Tactical Asset Allocation: High Yield Option Adjusted Spreads 9.0% High Yield (LHS) 7.0% 5.0% 3.0% PFM 14 Source: Bloomberg, as of 6/30/17.

15 Example of Tactical Asset Allocation: Commodities We do not share in the belief that commodities hedge inflation $100 invested in commodities 100 years ago would be worth ~$1100 in mid-2017 Adjusted for inflation, $ years ago is worth ~$2600 in mid $3,000 CPI PPI-Commodities $2,500 $2,000 $1,500 $1,000 $500 $ Source: Bureau of Labor Statistics; producer price index- all commodities; consumer price index- All urban consumers PFM 15

16 Demographic-Based Investing for Public Pension Plans 2017 Public Pension Funding Forum Presented by: September 12, 2017 David R. Wilson, CFA NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION.

17 Pension Risk Concepts FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 2

18 Pension Risk Overview Higher risk investments OK Lower risk investments advised Growth assets like equities may help assets keep up with inflation-sensitive liability Investment time horizon for retirees shorter; retiree payments are easily matched or hedged with bonds Large plan relative to tax base means investment shortfalls have bigger impact on government finances High benefits payment as percent of assets indicates mature plan with shorter time horizon Increasing payroll means contributions are increasing and new cash flow will mitigate impact of volatility Inflation-sensitive Retiree Liability Size of Plan Total Cash Outflow Increase in Payroll Active & Retiree Active Only None X < 40% 40 60% > 60% X < 150% 150% - 250% > 250% X < 5% 5% - 8% > 8% X Steady Slow None X Forward-looking statements are provided for illustrative purposes only and do not reflect actual performance results of a single product currently or previously managed, and should not be relied upon as investment advice. Data is provided for illustrative purposes only and has been obtained from sources believed to be reliable, but is not guaranteed for accuracy or completeness and should not be relied upon for investment advice. The reader should not be assume that an investment and/or the strategies identified were or will be profitable or will meet its investment objectives. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 3

19 Example Pension Risk Assessment Metric City of ABC High Risk Public Fund Survey Funding Metrics Funded ratio (market) 80% < 70% 74.7% Unfunded liability % of revenue 36% > 50% Unfunded liability % of payroll 113% > 250% 220% Contribution % of revenue 6.7% > 7.0% Plan Maturity Metrics Active to retiree ratio 0.95 < Plan liability % of revenue 180% > 200% Retiree liability % of total 63% > 60% Net cash flow % of assets -2.8% < -3.0% -2.3% Other Metrics Discount rate Inflation Assumption 4.5% > 4.0% 4.5% Fixed income coverage of retiree liability 38% < 50% 50% Source: Nuveen Asset Management calculations based on data from City of ABC, National Association of State Retirement Administrators Public Plan Survey from FY 2015 Data is provided for illustrative purposes only and has been obtained from sources believed to be reliable, but is not guaranteed for accuracy or completeness and should not be relied upon for investment advice. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 4

20 Observations on Retirement Plan for City of ABC Level of plan risk is moderate since the plan liability is of manageable size No cost-of-living adjustments (COLA) allows for close asset-liability match Investment time horizon is relatively short, as indicated by number of retirees, negative cash flow and low anticipated payroll growth FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 5

21 Pension Time Horizon May Be Frontloaded Time Period % of Pension Liability 0-10 years 43% years 30% years 17% years 8% 40+ years 2% Sample plan based on 7.50% discounting. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 6

22 Millions 10-Year Potential Funded Ratio Scenarios Assuming future contributions equal the normal cost, the hypothetical plan has a 70% probability of a declining funded ratio and a 50% probability of a decline greater than 20%. 160% $ % $ % 100% $200 80% $150 60% $100 40% 20% $50 0% Time (year) $0 Source: Nuveen Asset Management, City of ABC Liability Payments 10th Percentile Funded Ratio 20th Percentile Funded Ratio 30th Percentile Funded Ratio 40th Percentile Funded Ratio 50th Percentile Funded Ratio 60th Percentile Funded Ratio 70th Percentile Funded Ratio 80th Percentile Funded Ratio 90th Percentile Funded Ratio The hypothetical black hole scenario was constructed using return and volatility assumptions for ABC s target asset allocation, assumed future liability values, assumed future contributions, and assumed benefit payments. Changes in the assumptions may change the results. Different examples and market conditions will result in different outcomes. Data is provided for illustrative purposes only and has been obtained from sources believed to be reliable, but is not guaranteed for accuracy or completeness and should not be relied upon for investment advice. The reader should not assume that an investment and/or the strategies identified were or will be profitable or will meet its investment objectives. Data reflects hypothetical, or simulated, performance results of a fictional account managed in part by a proprietary quantitative model. It does not reflect the results of an actual client account. Hypothetical results are no guarantee of future results. This presentation contains no recommendations to buy or sell any specific securities and should not be considered investment advice of any kind. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 7

23 Demographic-Based Investing for Public Plans FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 8

24 Benefits of Demographic-Based Investing (DBI) Focuses on creating the cash flow to pay benefits Brings assets & liabilities together in a single risk framework Adapts level of risk to plan demographics Risk is reduced as plan population ages because: Investment time horizon decreases Impact of negative returns increases with negative cash flow Plan assets & liability are larger relative to revenue base demographic leveraging Liquidity becomes more important FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 9

25 PV of Payments ($MM) Payment Obligation Profile 35,000 30,000 25,000 Annual Benefit Payments These payments are long-term, uncertain, related to economic growth, allow more time for funding 20,000 15,000 10,000 5, Years These payments are fixed and paid in the short-term Retired & Terminated Active Source: Nuveen Asset Management, City of ABC FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 10

26 PV (Payments) Potential DBI Solution Including Contributions Funded Ratio at 80%: Allocation 70% Diversified Growth/ 30% Matching Fixed Income 41% of net payment obligations matched; 69% of net retiree payment obligations matched 18,000 16,000 14,000 contribution fixed income diversified growth unfunded liability 12,000 10,000 8,000 6,000 4,000 2, Note: PVB cash flows; only contributions attributable to current members are included. Source: Calculations by Nuveen Asset Management based on data from City of ABC. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 11

27 Fixed Income Traditional v. DBI Change in perspective on fixed income with demographic-based approach A matching bond cash flow eliminates asset and liability risk Traditional Fixed Income DBI Fixed Income Objective Diversification Align with payment obligation Key risk Interest rate sensitivity Reinvestment risk Risk Metric Return volatility Shortfall relative to payment obligation Low risk fixed income Short maturity Maturity = payment time horizon Impact of rate rise Price loss Higher yield FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 12

28 How Can We Keep Public Pension Plans Alive and Well? Align risk with size of plan and plan maturity Adapt investments to plan demographics and sponsor s ability to take risk Tailor investment strategy relative to pension liability payouts Regularly assess risk at a strategic level FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 13

29 Endnotes This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Financial professionals should independently evaluate the risks associated with products or services and exercise independent judgment with respect to their clients. This information has been prepared by Nuveen Asset Management, LLC for informational purposes only. The information contained herein is neither investment advice nor a legal opinion. It is presented only to provide information on our investment strategies and investment process. Nuveen Asset Management cannot assure that the type of investments discussed herein will outperform any other investment strategy in the future, nor can it guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. The exact characteristics and security selection of a portfolio designed to meet a client s specific investment objectives will change and could be materially different depending on prevailing economic or market conditions and availability of individual securities at the time of implementation. The data used for this presentation was obtained from publicly available reports, including internally derived databases and information as referenced herein. Nuveen Asset Management believes the data to be reliable but does not make any representations as to its accuracy or completeness. The views expressed are as of the date of publication of this piece, and are subject to change without further notice. Forecasts, estimates, and certain information contained herein are based upon internal views and research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product and should not be construed or interpreted as an offer or solicitation for the purchase or sale of any financial instrument. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. The Nuveen Asset Management Frozen Corporate Pension Plan is hypothetical and provided for discussion purposes only and should not be relied upon for investment advice. Nuveen Asset Management (NAM) has not previously managed these products and there is no guarantee the they will meet their investment objectives. The reader should not assume that an investment in these hypothetical products/strategies will be profitable. This report contains no recommendation to buy or sell any specific securities and should not be considered investment advice of any kind. All investments carry a certain degree of risk, including possible loss of principal. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager. Nuveen Hypothetical Plan comparisons are provided for illustrative purposes only and should not be relied upon for investment advise. Investing in securities involves risk of loss that investors should be prepared to bear. There is no assurance that any investment will provide positive performance over any period of time. Past performance is no guarantee of future results and different periods and market conditions may result in significantly different outcomes. CFA and Chartered Financial Analyst are registered trademarks owned by CFA Institute. Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen, LLC INST-AN-06/17 FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR PUBLIC DISTRIBUTION. 14

30 Wells Capital Management Analytic Investors Factor Based Investing September 12, 2017 NCPERS Public Pension Funding Forum Ryan Shelby, CAIA - Head of Factor Solutions, Analytic Investors Wells Fargo Asset Management is a trade name used by the asset management businesses of Wells Fargo & Company.

31 Factor-based investing What is factor-based investing? Like DNA, a factor is a primary characteristic of a portfolio that explains its behavior over long periods of time. Factor-based strategies target exposure to intuitive, well understood, well researched investment ideas such as: Small Size Value Momentum Quality Low Volatility Smaller companies Inexpensive stocks Trending stocks Financially healthy firms Lower risk stocks WELLS CAPITAL MANAGEMENT 2

32 Decomposing portfolio returns Investors increasingly recognize factors as key building blocks of return Manager Skill (active return) Quality Manager Skill (active return) Momentum Manager Skill (active return) Factor Exposure Value Interest Rates Low Volatility Small Size Market Exposure Market (passive Exposure return) (passive return) Market Exposure (passive return) Past Present and future WELLS CAPITAL MANAGEMENT 3

33 Why factor-based investing? Exposures to factors can improve portfolio results U.S. Equity market Source: Analytic Investors. As described in Clarke, Roger, Harindra de Silva, and Steven Thorley., 2017, Pure Factor Portfolios and Multivariate Regression Analysis Spring 2017 edition of the Journal of Portfolio Management. WELLS CAPITAL MANAGEMENT 4

34 Factor performance and the economic cycle Diversifying across factors may help increase the odds that a portfolio will perform well in a variety of market conditions Early cycle Mid cycle Late cycle Recession Market /X X Value Small Size Momentum Quality X Low Volatility X = tends to outperform X = tends to underperform Based on Analytic Investors research using 60 years of empirical data. WELLS CAPITAL MANAGEMENT 5

35 Why do factors work? Factor premiums arrive through a combination of risk compensation, structural impediments, or behavioral biases held by the average investor Risk Compensation Structural Impediment Behavioral Bias Sample Supporting Research Market Sharpe (1964) Value Fama and French (1996) Small Size Fama and French (1996) Momentum Jegadeesh and Titman (1993) Quality Novy-Marx (2013) Low Volatility Clarke, De Silva, Thorley (2006) WELLS CAPITAL MANAGEMENT 6

36 Factor-based strategies Active or passive? Factor-based strategies include many of the benefits of passive management, such as high transparency, low turnover, and low fees, while preserving the ability to add value over the market benchmark like more traditional active products Passive Active Traditional cap-weighted Index Factor-based Investing Traditional active management Transparency High High Low Performance attribution Simple Simple Complex Turnover and trading costs Low Low Moderate to high Capacity High High Low to moderate Fees Low Low Moderate to high Exposure to style factors None Moderate Moderate Potential for outperformance None Moderate Moderate to high WELLS CAPITAL MANAGEMENT 7

37 Case study Portfolio impact Investors can apply factor-based investing in various ways Replacement for passive management Exposure to proven sources of return increases the odds of outperforming the market Strategic allocation to a multifactor strategy Disciplined, targeted exposures to desired factors can improve returns and/or lower risk. For example, including the low volatility factor can help lower volatility and improve downside protection, which helps investors stick with their plans Replacement for active management Preserves the potential for outperformance, however offers a more disciplined, transparent, and less expensive option than traditional active management WELLS CAPITAL MANAGEMENT 8

38 Portfolio impact Multifactor Strategies can improve returns and lower risk Impact on $1M portfolio July 2000 December 2016 $506K Increase Passive Index 70% Russell % Barclays U.S. Aggregate Return 5.27% Risk 10.61% Return / Risk 0.50 Active Management 70% Median Manager 30% Barclays U.S. Aggregate 5.45% 10.04% 0.54 Factor Enhanced 70% Analytic Large Cap 30% Barclays U.S. Aggregate 6.67% 9.57% 0.70 WELLS CAPITAL MANAGEMENT 9

39 Factor investing summary Factor investing summary 1) Factors drive stock returns Factors help explain stock behavior and are important drivers of return 2) Factor-based strategies are a blend of active and passive Factor-based strategies include many of the benefits of passive management, such as high transparency, low turnover, and low fees, while preserving the ability to add value over the market benchmark like more traditional active products 3) All strategies are multi-factor Many factors portfolios include unintended exposures; it is critical to manage exposure holistically when building a multifactor portfolio 4) Factor-based strategies can improve portfolio results Multifactor portfolios can be used as a core allocation within equity portfolios to improve returns and/or lower risk WELLS CAPITAL MANAGEMENT 10

40 Simulated performance disclosure Simulated performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between simulated performance results and the actual performance results subsequently achieved by any particular trading program. One of the limitations of simulated performance results is that they are generally prepared with the benefit of hindsight. In addition, simulated trading does not involve financial risk, and no simulated trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of simulated performance results and all of which can adversely affect actual trading results. Performance does not include advisory fees, brokerage or other commissions, mutual fund exchange fees, and other expenses a client would have paid. Results do not include the reinvestment of dividends and other earnings. WELLS CAPITAL MANAGEMENT 11

41 Disclosure Wells Fargo Asset Management (WFAM) is a trade name used by the asset management businesses of Wells Fargo & Company. WFAM includes but is not limited to Analytic Investors, LLC; ECM Asset Management Ltd.; First International Advisors, LLC; Galliard Capital Management, Inc.; Golden Capital Management, LLC; The Rock Creek Group, LP; Wells Capital Management Inc.; Wells Fargo Asset Management Luxembourg S.A.; Wells Fargo Funds Distributor, LLC; and Wells Fargo Funds Management, LLC. Wells Capital Management does not serve as an independent advice fiduciary during the sales process to any investor. WELLS CAPITAL MANAGEMENT WELLS FARGO ASSET MANAGEMENT 12