2016 Fixed Income Asset Class Review September 22-23, Jason Weiner, Director of Fixed Income Germán Gaymer, Fixed Income Investment Analyst

Transcription

1 2016 Fixed Income Asset Class Review September 22-23, 2016 Jason Weiner, Director of Fixed Income Germán Gaymer, Fixed Income Investment Analyst

2 Agenda I. Fixed Income Market Environment & Performance II. Fixed Income Asset Class Overview III. Fixed Income Manager Review IV. Conclusion 2

3 I. Fixed Income Market Environment & Performance

4 Fixed Income Environment & Performance % U.S. Treasury Yields Maturity Yield Record Lows 10yr yr yr 30yr Treasury yields are near record lows as a result of global central bank policies. As of 8/29/2016 Source: Bloomberg 4

5 Fixed Income Environment & Performance Japanese and European Central Banks continue to expand their balance sheets causing interest rates to reach unprecedented levels. As of 8/29/2016 Source: Bianco Research 5

6 Fixed Income Environment & Performance Approximately 1/3 of total developed market sovereign debt trades with negative interest rates. Source: Bloomberg & Bianco Research As of 08/31/2016 6

7 Fixed Income Environment & Performance Record low interest rates have caused a contraction in risk premiums as investors reach for yield. IG Spreads HY Spreads bps bps IG Average HY Average Last Avg.* IG HY *Average as of 01/01/2006 Barclays Agg BofA ML IG BofA ML HY CS Leveraged Loan Index JP Morgan EMBI GD JP Morgan GBI-EM GD JP Morgan CEMBI GD Last 12 mo. 5.56% 9.37% 9.28% 3.72% 14.45% 11.55% 10.02% YTD 5.52% 9.52% 14.54% 6.44% 14.46% 15.49% 10.94% As of 8/29/2016 Source: Bloomberg 7

8 Fixed Income Environment & Performance The bond markets are currently pricing in only a modest probability of a rate hike in Source: Bloomberg & Bianco Research As of 08/29/2016 8

9 Fixed Income Environment & Performance Summary Interest rates may remain lower for longer given central bank policies. Investors continue to search for attractive yields in other asset classes because of this persistently low interest rate environment. Market reactions are making it difficult for the Federal Reserve to increase rates given tepid economic growth and very low inflation expectations. Current monetary policy combined with effective fiscal policy could have a significant impact on the future level of interest rates. Market Value YTD 1 YR 3 YR 5 YR Total Core $6,114,420, % 5.77% 4.03% 3.87% Total Non-Core $1,644,318, % 0.04% n/a n/a As of 6/30/2015, Net Performance 9

10 II. Fixed Income Asset Class Overview

11 Year Pacing Plan Update Core Fixed Income Pacing Plan Information 2010 February Board education piece on Derivatives presented Core Fixed Income continues to fund Equities 2011 Core Fixed Income continues to fund diversification of total plan including Equities, Real Return and Real Estate 2012 August Board approved changing the target allocation from 35% to 30% in conjunction with the Asset Allocation Study Core Fixed Income continues to fund diversification of the total plan 2013 September Board approved Non-Core Fixed Income managers (Loan/CLO) $750M to be funded from Core Fixed Income Core Fixed Income continues to fund diversification of the total plan 2014 June Board approved Non-Core Fixed Income managers (RMBS/CMBS) $750M to be funded from Core Fixed Income September December- ongoing funding of Loan/CLO portfolios December $500M RMBS/CMBS portfolios fully funded Core Fixed Income continues to fund diversification of the total plan 2015 February - $500M CLO/Loan portfolios fully funded March Board approved reallocating previously approved allocation of $250M each for Bank Loan/CLO and RMBS/CMBS strategies to existing managers to be funded from Core Fixed Income April May reallocation of RMBS/CMBS fully funded August Bank Loan/CLO portfolios fully funded Core Fixed Income continues to fund diversification of the total plan 2016 February New Fixed Income Director joined TMRS February The Board decided to discontinue securities lending program due to a credit rating agency downgrade of the lending agent. April Securities Lending Legacy Assets were sold and the program was completely terminated Core Fixed Income continues to fund diversification of the total plan 11

12 As of June 30, 2016 Core Fixed Income Allocation Mandate Market Value % of Total Fund Core Weighting vs. Target CORE FIXED INCOME 30.0% BlackRock $4,090,752, % PIMCO $2,023,668, % 25.0% 25.2% TOTAL $6,114,420, % 20.0% 10.0% 15.2% 15.0% 10.0% 5.0% 0.0% Actual Target Difference NOTE: Percentages may not be exact due to rounding; State Street Analytics as of 6/30/16. 12

13 Non-Core Fixed Income Pacing Plan Information Year Pacing Plan Update 2012 August Board approved segregating Non-Core Fixed Income from Core Fixed Income and making it a separate asset classes for better transparency and control. Board also approved 10% target allocation to Non-Core in conjunction with the Asset Allocation study March Educational session presented to Board (Intro to Non Core) June Board approved Non-Core Fixed Income allocation and authorized manager search for the Bank Loan/CLO strategy September Board approved Manager selections for Bank Loan/CLO strategy December Board approved 2014 Pacing Plan, including a manager search for the RMBS/CMBS strategy 2014 May Board approved increasing the sector allocation limit from 25% to 40% of the Non-Core Fixed Income asset class. Board also approved manager selections for RMBS/CMBS strategy. December Board approved Pacing Plan, including a manager search for Emerging Market Debt (EMD) Managers 2015 February Emerging Market Debt Manager search completed March Board approved reallocating previously approved allocation of $250M each for Bank Loan/CLO and RMBS/CMBS strategies to existing managers May Board approved Emerging Market Debt Manager recommendations December Board approved 4 Direct Lending Manager recommendation for a total of $950 M 2016 June 1 st recommendation: Opportunistic Credit Managers for $700 million September Expected to make 2 nd search process recommendation December Expected to make 3 rd search process recommendation 13

14 Non-Core Fixed Income Allocation As of June 30, 2016 Mandate Market Value % of Total Fund Non-Core Weighting vs. Target NON-CORE FIXED INCOME Guggenheim $386,830, % Highland $369,715, % Voya $385,517, % Ellington $384,751, % Golub $38,045, % White Oak $79,458, % TOTAL $1,644,318, % 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% 20.0% 6.8% Actual Target Difference -13.2% NOTE: Percentages may not be exact due to rounding; State Street Analytics as of 6/30/16. 14

15 BlackRock PORTFOLIO MANAGEMENT STRUCTURE Fixed Income MANAGER STRATEGY PORTFOLIO BENCHMARK Core US Core (enhanced index) Barclays US Aggregate Bond Index PIMCO Active Core Plus Barclays US Aggregate Bond Index Highland Capital Non-Core Bank Loan/CLO Debt Credit Suisse Leveraged Loan Index Guggenheim Bank Loan/CLO Debt Credit Suisse Leveraged Loan Index Voya Investment Management (formerly ING Investment Mgmt) RMBS/CMBS Ellington Management Group RMBS/CMBS Golub Direct Lending N/A White Oak Direct Lending N/A Deutsche Bank Securities Lending* N/A 33% Barclays US Agg Corp Index and 67% Barclays US Corp High Yield Index 33% Barclays US Agg Corp Index and 67% Barclays US Corp High Yield Index * Program terminated

16 III. Fixed Income Manager Review

17 US Core Fixed Income Objective Core Fixed Income Asset Class Overview Purpose is to diversify the risk of the overall investment portfolio with a secondary goal of capital preservation. Performance objective is to exceed the Barclay s US Aggregate Bond Index net of fees over rolling five-year periods and within tracking errors as specified in the Manager contracts, determined according to the specific strategies employed. Investment Philosophy- BlackRock Top down determination of investment themes are based on bottom-up inputs. Investment themes establish parameters for sector, sub-sector and security selection. Macro overlays for duration and volatility are viewed as a separate sector and used opportunistically. Investment Philosophy- PIMCO PIMCO s investment philosophy is driven by diversifying strategies and focuses on longer term secular (3-5 year) trends. Seek to add value through top down strategies including interest rate exposures, duration, volatility, yield curve positioning and sector rotation. Employ bottom-up strategies through in depth credit analysis and specific security selection. 17

18 Annual Manager Report Card for: BlackRock Strategy: Core Bond Assessment Area Grade Update & Comments Organization People No recent material organizational or structural changes. No additional disclosures made since last review. Philosophy/Strategy/Process Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other YTD 5.31%. Performance in line with benchmark. ITD 4.27% (8 bps over benchmark). Client service and portfolio management teams are very accessible and responsive N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 18

19 Annual Manager Report Card for: PIMCO Strategy: Core Bond Assessment Area Grade Update & Comments Organization People PIMCO has transitioned effectively after the CEO departure. PIMCO has maintained a strong and experienced management team and performance has been in line with expectations. TMRS staff is removing PIMCO from its watchlist. No personnel changes regarding TMRS portfolio. Philosophy/Strategy/Process Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other PIMCO has continued to add key advisors to its Board of Experts. YTD: 5.17% slight underperformance. ITD 4.31% (18 bps overperformance) Client service is extremely responsive and proactive. N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 19

20 Objective Non Core Fixed Income Asset Class Overview The purpose is to enhance total return through income and capital appreciation and provide diversification to the total investment portfolio. This allocation may be managed actively and/or passively through multiple managers in consideration of manager concentration risk. The Performance Objectives is to exceed the returns of a blended benchmark comprised of the Barclays US Corporate High Yield Index 50%, the JPM GBI-EM Global Diversified Index (USD Unhedged) 25%, and JPM CEMBI Broad Diversified Index 25%, net of fees over rolling five-year periods and within tracking errors as specified in the manager contracts or otherwise agreed to in writing, determined according to the specific strategies employed. 20

21 Annual Manager Report Card for: Ellington Management Group Strategy: RMBS/CMBS Assessment Area Grade Update & Comments Organization People Philosophy/Strategy/Process No material changes since last review. No departures related to TMRS. Strong portfolio management team. Strategy focuses on security selection and scenario analysis. Firm utilizes proprietary models to uncover value in the securitized credit market. Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other YTD: 1.44% underperformance versus benchmark, mainly due to benchmark mismatch. ITD: 2.01% In discussions to expand mandate and benchmark. N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 21

22 Annual Manager Report Card for: Voya Investment Management Strategy: RMBS/CMBS Assessment Area Grade Update & Comments Organization People On August 31, 2016 Voya announced that its CEO was stepping down. The CEO will be replaced by current CIO, who at the same time will be replaced by current Head of Public Fixed Income. The transition shows staff that Voya was prepared for this kind of event. Staff believes there is no immediate impact to TMRS portfolio. Staff will continue to monitor the situation. Philosophy/Strategy/Process Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other Micro-level collateral analysis. Macro themes expressed through asset allocation. YTD: 0.68% underperformance versus benchmark, mainly due to benchmark mismatch. ITD: 2.12% Client service and portfolio management teams are very accessible and responsive. N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 22

23 Annual Manager Report Card for: Highland Capital Strategy: Bank Loans/CLO Assessment Area Grade Update & Comments Organization People Philosophy/Strategy/Process Independent. 100% employee-owned. In 2015, formed Highland Alternative Investors a liquid alternatives platform. CLO Portfolio Manager was terminated and replaced. Strategy includes fundamental analysis, proactive due diligence and exploiting price inefficiencies. Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other YTD:1.82% underperformance due to higher CLO exposure and industry selection. ITD: -0.05% N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 23

24 Annual Manager Report Card for: Guggenheim Partners Strategy: Bank Loans/CLO Assessment Area Grade Update & Comments Organization People No additional disclosures made since last review. Guggenheim has undertaken some organizational restructuring. Staff believes there are no material changes regarding TMRS portfolio. No material changes regarding TMRS portfolio. Philosophy/Strategy/Process Portfolio(s) Performance Compliance Guideline Changes Risk Management Operations Client Service Other Strategy relies on fundamental analysis and proactive relative value security selection. YTD: 2.79% underperformance due to CLO exposure. ITD: 2.39% Restriction on non-rated securities miscoded on compliance program. Error corrected. New team in place. Global restructuring of client service area. N/A Excellent In Good Standing Fair (working with manager) Unsatisfactory (remedial action being taken) Comprehensive Review 24

25 Securities Lending At the February 2016 Board Meeting, the TMRS Board of Trustees decided to terminate the Securities Lending Program due to a credit downgrade of Deutsche Bank and consequent breach of TMRS IPS. Deutsche Bank was notified immediately and the Securities Lending program was significantly downsized. The remaining portfolio was kept in place to fund the legacy assets portfolio until they could be sold. The chart below depicts the unrealized losses for the legacy portfolio from 2007 until the program was terminated. The largest unrealized loss occurred on January 2009 when TMRS legacy portfolio has a total unrealized loss of $185,848,083. $50,000,000 TMRS Legacy Portfolio Loss $- $(50,000,000) $(100,000,000) $(150,000,000) $(200,000,000) All legacy assets were sold by April 21 st 2016 and the final loss for TMRS was approximately $3,810,879. Staff will re-evaluate the securities lending program during the custodial search in

26 IV. Conclusion

27 Conclusion and Recommendations TMRS Investment Staff and RVK concur that no structural changes are needed/recommended at this time PIMCO Recommendation Staff is removing PIMCO from the watch list after continued monitoring and extensive review. Staff is comfortable with the current organization. Continue to monitor managers and address any highlighted issues Continue expansion of the non-core fixed income allocation Reduce core fixed income according to recent asset allocation study 27

28 DISCLOSURE TMRS periodically discloses public information that is not excepted from disclosure under Section (b) of the Texas Public Information Act. Information provided by a manager, a general partner or other data provider to TMRS or a TMRS service provider, and contained in these materials, may have been independently produced or modified by TMRS or the TMRS service provider. 28