CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE

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1 Date: September 17, 2015 CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE To: From: Subject: Retirement Board Members Linda P. Le, Retirement Plan Manager J V Board Agenda Item No. 7: Report on Dimensional Fund Advisors - On-Site Due Diligence Visit (September 23, 2015, Regular Retirement Board Meeting) Recommendation That the Board of Administration (Retirement Board) of the Water and Power Employees' Retirement Plan (Plan) receive and file this report on the on-site due diligence visit to Dimensional Fund Advisors (Dimensional) in Santa Monica, California. Summary Investment Officer Melissa Soo Hoo (staff) met with representatives from Dimensional on July 29, 2015, in Santa Monica to review and discuss the organizational and operational processes relating to the investment portfolios it manages on behalf of the Plan. This was the first on-site due diligence visit to Dimensional's offices since its hire. The Retirement Board selected Dimensional in 2012 to manage a global real estate securities mandate of $20 million for the Retirement Fund (RF) and $5 million for the Retiree Health Benefits Fund (RHBF). The Plan initially funded its accounts with 40% of the mandate in March 2013, with the remaining funding paced over the following six quarters until reaching its full mandate in October Due to the smaller size of the mandate, the Plan invests in the strategy through a mutual fund structure. As of June 30, 2014, Dimensional manages $20.4 million for the RF and $5.1 million for the RHBF. Staff interviewed the personnel directly responsible for managing the Plan's assets and observed and confirmed the capabilities of the management team and available resources to manage the Plan's portfolios. Staff met and interviewed key members of the firm overseeing its various operating departments, including: Joseph Chi, Co-Head of Portfolio Management Christopher Crossan, Global Chief Compliance Officer Henry Gray, Head of Global Equity Trading David Martin, Chief Financial Officer Bruce Simmons, Vice President, Operations 7.1

2 Jeff Batas, Senior Associate, Operations Joseph Young, Vice President, Institutional Services Key functional areas of discussion included the overview of the company, investment process and risk controls, portfolio operations, portfolio performance, compliance, and disaster recovery and business continuity. Dimensional is not currently on watch status. Company Overview Dimensional is a global investment management firm founded in 1981, which currently manages over $406 billion in assets in equity, fixed income, and real estate securities. Dimensional is privately held, primarily by its co-founders, board members, and current and former employees; approximately 50% is held by its two co-founders, including current Chairman and Co-Chief Executive Officer Mr. David Booth. The firm did not report any anticipated or planned ownership changes, other than its commitment to broadening employee ownership over time through its long-term incentive plan. Dimensional primarily operates two business lines - institutional business and financial advisory services. The firm's current business initiative is rolling out its Target Retirement Solutions product for defined contribution plans, which it reports will not require significant additional resources. However, the firm remains committed to continually adding resources across the firm to support all products and strategies. The firm has over 900 employees and is headquartered in Austin, Texas, with fullservice portfolio management and trading offices located in Santa Monica, London, Sydney, Tokyo, and Singapore, in addition to five global client service offices. In July 2015, Dimensional announced plans to open a full-service office in Charlotte, North Carolina, anticipated to house as many as 300 employees over time, staffed by a combination of new hires and transfers from other offices. Dimensional observes equal employment opportunity policies that encompass all aspects of employment, including but not limited to recruitment, hiring, training, job assignment, promotion, compensation, benefits, transfer, discipline, and termination. The firm regularly recruits from top undergraduate and graduate colleges, and operates an internship program globally. Dimensional also actively participates in recruiting and professional development initiatives to reach a diverse talent pool and enhance the career success of its employees, including the Forte Foundation and Robert S. Toigo Foundation. As of June 30, 2015, Dimensional manages $6.5 billion in assets in the global real estate securities strategy in which the Plan is invested, of which $5.5 billion is held in omnibus accounts, representing holdings by multiple investors. Of the omnibus accounts, Dimensional estimates that approximately 10% are institutional assets, and 90% is held by retail investors through Dimensional's financial advisory services business. The remaining $1 billion in strategy assets is managed directly with various corporate pension, foundation, endowment, high net worth, and subadvisor accounts, 7.2

3 as well as one other public pension plan account aside from the Plan's accounts. Since the Plan's initial investment on March 31, 2013, assets in the strategy have grown by $3.2 billion, most significantly in the firm's financial advisory accounts. Investment Process As a firm, Dimensional integrates extensive empirical and academic research into its quantitative investment process. Dimensional's investment philosophy is underpinned by its beliefs in integrating academic research to define the real estate asset class; using information in market prices to define its desired, investible universe of securities; managing risk through broad diversification; and minimizing costs through efficient management of portfolio turnover and trading costs. Mr. Joseph Chi, co-head of Portfolio Management, is located in the Santa Monica office and helps oversee over 1 00 portfolio managers across Dimensional's global offices and various strategies. Approximately ten portfolio managers work on the strategy in which the Plan is invested, with the team spread out across the United States, London and Sydney to provide global coverage. Dimensional's global real estate securities strategy is managed as a fund of funds, which invests its assets in Dimensional's Real Estate Securities strategy (U.S.) and Dimensional's International Real Estate Securities strategy (non-u.s.). In the global strategy and its underlying funds, Dimensional excludes real estate operating companies (REOCs), property companies, mortgage REITs, and specialized REITs from its investible universe, and continually evaluates event-driven and other ongoing considerations to further refine its universe of eligible securities. The portfolio is broadly diversified by country, REIT sector, and REIT size. The portfolio is currently invested in 21 countries, both developed and emerging; Dimensional's portfolio management team and Investment Committee continually evaluate the eligibility of different countries for inclusion in its universe. The portfolio's free-float adjusted market capitalization floor of $50 million lends itself to a slight small-cap bias. The portfolio currently holds 380 positions, versus 326 in the Plan's benchmark, which reflects Dimensional's philosophy of maintaining a diversified portfolio, and bias toward including companies with a smaller capitalization than are included in the index. The portfolio management team manages various risks to maintain a broadly diversified portfolio, while monitoring the characteristics of individual securities and the overall strategy to prevent style drift. The guidelines for Dimensional's global real estate securities fund target a maximum of 10% per issue at time of purchase; sector weights are capped at 10% of their approximate weight and industry groups are generally capped at 25%. Mr. Chi did not identify any significant revisions to the portfolio's investment process or guidelines since the Plan's initial investment in March 31,

4 Portfolio and Performance Staff reviewed the current portfolio with Mr. Chi, who discussed the positioning of the portfolio versus the Plan's benchmark, including country allocation, sector allocation and attribution, as well as overall risk management. While Dimensional uses the S&P Global REIT index as its prospectus benchmark for the fund, the Plan uses the FTSE EPRAINAREIT Developed Index as its REIT policy benchmark. Mr. Chi and staff discussed significant variations in country and sector alloccltions between Dimensional's portfolio and the Plan's benchmark. Mr. Chi attributed these differences to the level of exposure to REOCs; whereas Dimensional excludes REOCs from its portfolio as part of its investment philosophy, REOCs comprised 21% of the Plan's benchmark as of June 30, Mr. Chi requested that staff review the appropriateness of the Plan's benchmark; subsequent to the on-site visit, staff reviewed Dimensional's request following further research and consideration, and affirmed the Plan's current benchmark. As of June 30, 2015, the portfolio outperformed the FTSE EPRAINAREIT Developed Index net of fees on a one-year basis by 1.2% and since inception on March 31, 2013 by 0.63%. Trading and Portfolio Operations Review Staff met with Henry Gray, Head of Global Equity Trading, who provided an overview of the firri1's trading processes and philosophy. Dimensional's investment philosophy, which emphasizes highly diversified portfolios with modest to low turnover, underpins the firm's flexible, patient approach to trading. Dimensional uses Charles River Investment Management System (CRIMS), an industry-standard order management system, to place and execute trades. The portfolio managers create order lists of candidate securities, which include substitutable securities with similar expected return characteristics. The portfolio managers provide the list to the traders with a total dollar amount goal, giving traders the flexibility choose the trades for most efficient execution. The trading team seeks favorable price execution through its patient trading philosophy. Dimensional employs approximately 19 trading personnel throughout its global offices, whose work stations are physically located amongst its equity and fixed income portfolio management teams. The order list is routed to the corresponding desk, whereupon the traders wait for opportunities to purchase at the bid side of the spread, and sell at the ask. Ultimately, they will execute those orders where they see the greatest opportunity, while leaving other orders only partially filled or even unfulfilled if they cannot achieve favorable pricing. Dimensional's Investment Committee reviews and formally approves a concentrated list of brokerage firms before they are approved to trade, and reaffirms the approvals 7.4

5 annually. Senior traders have the ability to approve a new broker for a trade same day through the Compliance team, to be formally ratified by the Investment Committee at the next feasible opportunity. As of December , Dimensional discontinued usage of soft dollars and no longer uses brokerage commission to purchase research or other services. Mr. Bruce Simmons, Vice President, and Mr. Jeff Batas, Senior Associate, of the Investment Operations group discussed Dimensional's middle office and back office support functions. Dimensional's middle office functions are performed by third party service provider Citigroup, which is responsible for transaction management, reconciliation, recordkeeping, performance analytics, and client reporting. Dimensional's operations group is responsible for monitoring these services, reviewing trends and metrics, resolving key issues, and overall maintaining communications to ensure that issues are properly escalated. Mr. Simmons and Mr. Batas discussed middle office's workflow in the trade settlement cycle and reconciliation processes, as well as Dimensional's role in overseeing Citigroup's services and the key performance indicators that the operations group reviews. Dimensional also contracts with third party vendors for its back office functions, which include custody, fund accounting and administration, and shareholder servicing. Since 2013, Dimensional has contracted with State Street as custodian and fund accountant for the firm's mutual funds registered in the United States. Compliance Mr. Christopher Crossan, Global Chief Compliance Officer, discussed the various functions and programs of Dimensional's compliance group, from portfolio management and trading controls to the firm's various regulatory and internal controls. The compliance group is comprised of 28 employees globally, with regional heads of compliance located in London and Sydney to administer programs in compliance with the various foreign securities regulatory entities. Dimensional monitors daily portfolio compliance through both pre-trade and post-trade compliance checks. Pre-trade compliance checks are automated through CRIMS. After an order is entered by the portfolio management time and before it is routed to the trading desk for execution, CRIMS checks for compliance with the investment guidelines and generates an alert if it detects a potential breach. The order is escalated to the compliance team, which determines the most appropriate course of action. Any orders approved through the pre-trade check are then routed to the trading desk for execution. Compliance monitors post-trade compliance following a nightly scheduled batch process. Any identified trade issues are communicated with the portfolio management team and are resolved in accordance with Dimensional's Error Correction Policy, which includes making the client whole for losses incurred as a result of error events. The firm has not discovered any active breaches of portfolio compliance. 7.5

6 Dimensional has also adopted and implemented formalized Code of Ethics and Standard of Conduct policies to maintain internal compliance standards on personal trading, insider trading, political contributions and gifts and entertainment for employees. The compliance group regularly performs reviews of commission payments made to brokers, trading counterparties, execution prices, trade aggregations and allocations, employee personal trading files, and other ongoing surveillance to look for unusual patterns or deficiencies. In addition, the compliance team conducts an annual review of its policies to reevaluate compliance risks and assess the effectiveness of its program. The findings of the annual review and any material compliance matters are reported to the Dimensional Funds' Board of Directors. The financial statements of the U.S. mutual funds are externally audited by PricewaterhouseCoopers annually and reviewed semiannually. Disaster Recoverv and Business Continuity Mr. David Martin, Chief Financial Officer, discussed Dimensional's business continuity plan, which provides processes and guidelines to sustain critical functions in event of disaster or other business disruption. Dimensional's six trading and operations offices, spread throughout the United States, Europe and Asia, are equipped to provide assume coverage for each other in the event that business is disrupted in one location. Data is routinely mirrored and backed up in its offices, as well as an off-site data center in Austin hosted by third party vendor Sungard. Time critical systems and data are copied real-time to a Disaster Recovery data center, also in Austin. Key staff in each office has the ability to log into the network remotely and work from home if necessary. The business continuity plan is tested regularly, and reviewed formally on an annual basis and updated as n~eded; employee contact information updated quarterly. Summarv and Findings Staff covered a comprehensive agenda with various representatives from Dimensional, and discussed and observed various areas and functions of the firm. From staff's perspective, Dimensional adequately addressed management and operational topics of discussion relating to the Plan's portfolios. Staff did not observe any areas of concern. during this visit. Jeremy Wolfson Chief Investment Officer LPUJW/SV/MS:mea 7.6

CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE

Date: May 4, 2016 CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE To: From: Subject: Retirement Board Members Linda P. Le, Retirement Plan Manager Board Agenda Item No.