Report to Investment Committee

Transcription

1 Report to Investment Committee Agenda of: SEPTEMBER 12, 2017 From: Thomas Moutes, General Manager ITEM: VI SUBJECT: INVESTMENT MANAGER CONTRACT WITH PANAGORA ASSET MANAGEMENT, INC. REGARDING THE MANAGEMENT OF AN ACTIVE DOMESTIC SMALL CAP VALUE EQUITY PORTFOLIO AND POSSIBLE COMMITTEE ACTION Recommendation: That the Committee recommend to the Board a three-year contract renewal with PanAgora Asset Management, Inc. for management of an active domestic small cap value equity portfolio. Discussion: Background The Board hired PanAgora Asset Management, Inc. (PanAgora) in November 2005 to manage an active domestic small cap value equity portfolio benchmarked against the Russell 2000 Value Index. The small cap value equity strategy is part of PanAgora s Dynamic Equity suite of strategies, which use a quantitative investment model to exploit market inefficiencies. The Dynamic Equity investment philosophy consists of three components: 1) purchasing reasonably priced stocks; 2) purchasing companies that are managed well and operate efficiently; and 3) exploiting stock price momentum by considering market sentiments. The Dynamic Equity team consists of 10 investment professionals led by Jaime Lee, Ph.D. LACERS portfolio was valued at $117 million as of July 31, The Board previously approved a three-year contract renewal in The current contract expires on January 31, Organization PanAgora has 129 employees and is headquartered in Boston. The firm is 66% owned by Power Financial Corporation (directly and through various subsidiaries); 14% owned by Nippon Life Insurance; and 20% owned by employees. As of July 31, 2017, PanAgora managed $50 billion of total firm assets, with $130 million of assets in the small cap value equity strategy. 1

2 Due Diligence In August 2016, Jane Zhao, a senior portfolio manager on the Dynamic Equity team left the firm to pursue other opportunities. In December 2016, Jaime Lee, Ph.D. joined the firm and assumed leadership of the Dynamic Equity team from George Mussalli, Chief Investment Officer, who now oversees all equity teams at PanAgora. In addition, two portfolio managers and an analyst joined the team last year. These organizational changes have not adversely impacted PanAgora s quantitative model-driven investment process. Performance As of July 31, 2017, PanAgora outperformed its benchmark, net-of-fees, over the 3-year, 4-year, 5- year, 7-year, and 10-year periods. PanAgora underperformed the benchmark over the 3-month, 1- year, 2-year, and since inception periods as presented in the table below. PanAgora is in compliance with the LACERS Manager Monitoring Policy. Annualized Performance as of 7/31/17 (Net-of-Fees) 3-Month 1-Year 2-Year 3-Year 4-Year 5-Year 7-Year 10-Year Since Inception 1 PanAgora Russell 2000 Value Index % of Excess Return Inception date 2/28/06 On a calendar year basis, PanAgora has outperformed its benchmark, net-of-fees, in seven of 10 periods as presented in the table below. Calendar Year Performance (Net-of-Fees) PanAgora Russell 2000 Value Index % of Excess Return Fees LACERS pays PanAgora an effective fee of 66 basis points (0.66%), which is approximately $772,200 annually based on the value of LACERS assets as of July 31, General Fund Consultant Opinion NEPC, LLC concurs with this recommendation. Strategic Plan Impact Statement A contract renewal with PanAgora will allow the fund to maintain a diversified exposure to the domestic small cap value equity markets, which is expected to help achieve satisfactory long-term risk adjusted investment returns (Goal IV). The discussion of the investment manager s profile, strategy, performance, and management fee structure are consistent with Goal V (uphold good governance practices which affirm transparency, accountability, and fiduciary duty). This report was prepared by Eduardo Park, Investment Officer I, Investment Division. 2

3 RJ:BF:EP:ag Attachments: 1) Consultant Recommendation NEPC, LLC 2) Workforce Composition 3

4 ATTACHMENT A To: From: Los Angeles City Employees Retirement System Investment Committee NEPC, LLC Date: September 12, 2017 Subject: PanAgora Dynamic Small Cap Value Recommendation NEPC recommends Los Angeles City Employees Retirement System (LACERS) extend the contract that is currently in place with PanAgora Asset Management, Inc. ( PanAgora ) for a period of 3 years from the date of contract expiry. Background PanAgora has been an active equity manager for LACERS since February As of June 30, 2017 PanAgora managed $117.1 million, or 2.8% of Plan assets, with an asset-based fee of 0.66% annually. The performance objective is to outperform the Russell 2000 Value Index by at least 200 basis points, net of fees, annualized over a full market cycle (normally three-to-five years). Performance of the Dynamic Small Cap Value strategy is currently compliant with LACERS manager monitoring policy. The firm is owned by a combination of 3 distinct parties: Power Financial Corporation ( Power ), Nippon Life Insurance Company ( Nippon ) and PanAgora employees. The largest share is owned by Power while PanAgora employees are permitted to own up to 20% of the firm. Over the past couple of years, PanAgora has made a concerted effort to build out their Dynamic Equity Management Team. In 2015 Jaime Lee, Ph.D., Director, Equity joined the team and now leads the Dynamic Equity strategy. Jaime replaced George Mussalli, Chief Investment Officer and Head of Equity Research, who currently oversees PanAgora s broader equity group. More recently, the Dynamic Equity Management Team welcomed two new additions, Sevinc Cukurova, Ph.D., Analyst and Rohit Shrivastava, Portfolio Manager, who joined in May 2016 and August 2016, respectively. There was, however, one Senior Portfolio Manager departure last year, Jane Zhao. PanAgora s strategy is very much quantitatively driven and so the turnover mentioned above has not adversely impacted the team s resources or investment process. 900 Veterans Boulevard Ste. 340 Redwood City, CA TEL: CAMBRIDGE ATLANTA CHARLOTTE CHICAGO DETROIT LAS VEGAS SAN FRANCISCO

5 ATTACHMENT A The firm manages approximately $47 billion on behalf of over 150 clients with 135 employees, all located in Boston. The firm s Dynamic US Small Cap Value product has approximately $136 million in total AUM with one other U.S. based corporate pension client invested in the product. NEPC is comfortable with both the value of total assets and number of investors in the product. The firm has the economic base to support the research and management of the strategy because it is quantitatively managed and shares the same investment process with many of PanAgora s other products. From a client concentration perspective, LACERS does represent a significant portion of the strategy s assets, however, this has always been the case based on historical AUM. The philosophy underpinning the Dynamic Small Cap Value portfolio is that behavioral biases of investors create pricing inefficiencies. PanAgora s quantitative approach is based on the premise that predictors of return vary for each individual stock, largely due to the fact that the 2000 companies in the universe evolve at various paces through their life cycles. This fact necessitates a unique model be applied to each individual stock for analysis. The firm s proprietary Contextual Alpha Modeling process seeks to address this inconsistency in a systematic and repeatable process. Every stock in the universe is ranked based on PanAgora s unique alpha score and the highest ranking stocks will form the basis for consideration to be included in the portfolio. The strategy s performance is expected to be driven primarily by stock selection, as is confirmed in the commentary below. Performance Since inception, the PanAgora portfolio has matched the Russell 2000 Value Index, returning 6.8%, net of fees, through June 30, In the five year period ended June 30, 2017, the portfolio outperformed the index by 2.0% (15.4% vs. 13.4%), ranking in the 18 th percentile of the evestment US Small Cap Value Equity peer group of investment managers (please refer to Exhibit 1). The portfolio has an information ratio of 0.84 and ranks in the 5 th percentile among its peers over the past five years. Since inception, the information ratio is and ranks in the 80 th percentile for the period ended June 30, The five year information ratio turned positive during 2012 and remains in positive territory as of June 30, 2017 (refer to Exhibit 3). Active risk, as measured by tracking error versus the index, since inception has been 3.38%. The portfolio has underperformed the Russell 2000 Value Index in each of the past 5 quarters (refer to Exhibit 2), which has significantly hindered PanAgora s near-term results (1 Year: 18.9% vs. 24.9%). During this time, stock selection proved to be the biggest drag on relative performance. Specifically, stock selection in industrials, consumer discretionary, information technology and energy were the largest detractors. The portfolio s sector allocation actually had a net positive impact on results versus the benchmark. It is also worth noting that active management in general has struggled in the small cap value space, as evidenced by the Russell 2000 Value Index ranking in the 30 th percentile versus the universe. Despite near-term performance struggles, PanAgora has performed favorably compared to their benchmark and peers over longer periods. As detailed in Exhibit 1, for the three year period ending June 30, 2017, the portfolio outperformed the benchmark by 0.5% (7.5% vs. 7.0%) and ranked in the 38 th percentile. Looking out even further, the portfolio added 2.0% and 3.0% of value above the Russell 2000 Value Index over the trailing five and

6 ATTACHMENT A seven year periods, respectively. These results are in line with the stated portfolio performance objective. During these periods PanAgora ranked in the top quartile in a universe of small cap value peers. The portfolio does rank below median over 10 years and since inception, however, it did manage to meet or exceed its stated benchmark on a net of fee basis. Referring to Exhibit 2, on a cumulative basis the portfolio has added value on a rolling quarterly basis against its benchmark since the start of Investment gains from periods of outperformance have not been eroded by the recent periods of underperformance on a cumulative basis relative to the benchmark. With respect to investment management fees, when compared to other small cap value managers in its peer group, evestment U.S. Small Cap Value, PanAgora ranks in the 13 th percentile, or in other words, 87% of the universe charges higher investment management fees. Conclusion While PanAgora has struggled to outperform the index over the near-term, their quantitative, repeatable process which is reliant on stock selection has led to positive cumulative performance over longer periods. There have been minimal changes to the team responsible for the strategy over the past couple of years. While we cannot anticipate future changes to the team, the quantitative process supporting the strategy limits the adverse impact that any one departure may have. The following tables provide specific performance information, net of fees referenced above.

7 ATTACHMENT A Exhibit 1

8 ATTACHMENT A Exhibit 2

9 ATTACHMENT A Exhibit 3

10 Exhibit 4 ATTACHMENT A

11 Exhibit 5 ATTACHMENT A

12 ATTACHMENT B Vendor Address PanAgora Asset Management, Inc. 470 Atlantic Ave., 8th Floor Boston, MA Date Completed: August 30, 2017 Category U.S. Small Cap Value Equities TOTAL COMPOSITION OF WORK FORCE African Asian or American Indian/ Caucasian Total Percent (%) Gender American Hispanic Pacific Islander Alaskan Native (Non Hispanic) Employees Minority Male Female Occupation Full Time Full Time Full Time Full Time Full Time Full Time Full Time Full Time Officials & Managers % 27 6 Professionals % Technicians % 0 0 Sales Workers % 0 0 Office/Clerical % 0 0 Semi-Skilled % 0 0 Unskilled % 0 0 Service Workers % 0 0 Other % 0 0 Total % 85 27