REGULAR MEETING OF THE MONTANA BOARD OF INVESTMENTS DEPARTMENT OF COMMERCE 2401 Colonial Drive, 3 rd Floor Helena, Montana October 2, 2018

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1 Control Home to Return to Top REGULAR MEETING OF THE MONTANA BOARD OF INVESTMENTS DEPARTMENT OF COMMERCE 2401 Colonial Drive, 3 rd Floor Helena, Montana October 2, 2018 COMMITTEE MEETINGS A. Audit Committee 8:30 AM 1. Public Comment Public Comment on issues with Committee Jurisdiction 2. Approval of August 2018 Committee Meeting Minutes 3. Comments from Chair and Reference to Checklist 4. Executive Director General Comments 5. FY18 Financial Statements Update and Comments 6. STIP a. Yellowstone County STIP Letter b. Web Portal Transition c. Resolution Status B. Human Resource Committee 9:30 AM BREAK Tab 1 CALL TO ORDER Mark Noennig, Chairman A. Roll Call B. Notice of Video Recording of Meeting C. Public Comment Public Comment on issues with Board Jurisdiction D. Introduce New Board Member Jim Edwards and New Executive Director Dan Villa E. Administrative Business 1. Audit Committee Report 2. Human Resource Committee Report F. Comments from TRS and PERS Board Members G. Comments from Board Legislative Liaisons Tab 2 EXECUTIVE DIRECTOR REPORTS Executive Director A. Member Requests or Follow up from Prior Meeting B. Monthly Snapshot Tab 3 BOARD MEMBER RVK TRAINING SESSION IN PORTLAND, OR 10:00 AM 10:15 AM 10:30 AM 10:45 AM Tab 4 NEW INVESTMENT COMMITMENTS Emily Kovarik, CPA & Thomas Winkler, CAIA 11:15 PM Tab 5 PROXY VOTING OF PUBLIC EQUITES Mike Pettit and Tim House LUNCH SERVED Tab 6 PRIVATE EQUITY ASSET CLASS REVIEW Michael Nguyen, Investment Officer & Thomas Winkler, CAIA, Investment Analyst 11:30 PM 12:00 PM 1:00 PM The Board of Investments makes reasonable accommodations for any known disability that may interfere with a person s ability to participate in public meetings. Persons needing an accommodation must notify the Board (call or write to P.O. Box , Helena, Montana 59620) no later than three days prior to the meeting to allow adequate time to make needed arrangements.

2 Tab 7 CASH MANAGEMENT OF STATE MONIES Julie Feldman, CPA, John Romasko, CFA & Department of Administration Staff BREAK Tab 8 RVK INC. A. Performance Report Tutorial B. Behavioral Biases and Decision Making Best Practices RECAP OF STAFF TO DO LIST AND ADJOURNMENT Mark Noennig, Chairman 2:00 PM 2:45 PM 3:00 PM 4:00 PM Appendix A Annual Board Meeting Schedule B. Systematic Work and Education Plan C. Acronym Index D. Terminology List The Board of Investments makes reasonable accommodations for any known disability that may interfere with a person s ability to participate in public meetings. Persons needing an accommodation must notify the Board (call or write to P.O. Box , Helena, Montana 59620) no later than three days prior to the meeting to allow adequate time to make needed arrangements.

3 MEMORANDUM Montana Board of Investments Department of Commerce 2401 Colonial Drive, 3 rd Floor Helena, MT (406) To: From: Members of the Board David Ewer, Executive Director Date: September 13, 2018 Subject: Executive Director Reports 1. Member Requests or Follow Up from Prior Meeting a. Guidance on the STIP web portal transition - verbal update to Audit Committee b. Deputy Director position - verbal update to Human Resource Committee c. Analysis of the four buildings, a cost benefit analysis for sales vs. continuing to lease them to state agencies - see comments below in 3. d. Management Discussion and Analysis (MD&A) letter follow-up - verbal update to Audit Committee e. Yellowstone County STIP matter - verbal update to Audit Committee f. Status of Executive Director Employment Contract - verbal update to Human Resource Committee 2. Monthly Snap Shot - included under this Tab 3. Board Montana Properties Senior staff has discussed this matter and offers this assessment. If the properties are sold in the near future, the sale amount should be close to the market assessment, as staff is unaware of any exceptional new market forces at work in the Helena area for such properties. The opportunity costs of holding the properties in the Board s Trust Funds Investment Pool, as authorized at the August meeting, are likely not an issue. The properties currently deliver significant cash flow and have achieved a better over-all return than the current average of Trust Funds Investment Pool. Regarding the impact on state agency tenants, while quantification is limited to professional judgement, senior staff believe that rents to state agencies would likely rise rather than fall if the properties were sold out-right. Regardless of where Board Montana properties are held, they remain a significant time commitment by Board staff. Deputy Executive Director Burton estimates that 10% of her time is spent administering these properties.

4 As of 7/31/2018 unaudited Total Fund Market Value % Pension by Plan Market Value % Pension Internal/External Pension Active/Passive Pensions $11,724,668, % PUBLIC EMPLOYEES' RETIREMENT $5,841,258, % Trust Funds $2,528,432, % TEACHERS' RETIREMENT $4,202,863, % State Operating Funds $1,620,663, % Internal 19.3% FIREFIGHTERS' RETIREMENT $422,228, % Insurance Reserves $1,617,077, % Passive POLICE RETIREMENT $406,609, % Local Government Funds $1,157,345, % 31.4% SHERRIF'S RETIREMENT $363,085, % Grand Total $18,648,187, % GAME WARDEN'S RETIREMENT $196,062, % HIGHWAY PATROL RETIREMENT $150,357, % Total Fund Local Government Funds JUDGES' RETIREMENT $103,457, % Insurance Reserves 6.2% VOL. FIREMANS' RETIREMENT $38,746, % 8.7% Total $11,724,668, % Retirement Plan Cash $ 233,305, % Retirement Plan CAPP $ 11,491,362, % Active 68.6% State Operating Funds 8.7% Trust Funds 13.6% Pensions 62.9% Top Ten Non-Pension Accounts Market Value % STATE FUND INSURANCE $1,461,162, % TREASURERS $960,841, % TRUST AND LEGACY ACCOUNT $695,820, % PERMANENT COAL TRUST FUND $564,271, % STATE OF MONTANA $430,774, % TREASURE STATE ENDOWMENT $277,640, % TOBACCO TRUST FUND $226,905, % MONTANA STATE UNIVERSITY $120,139, % RESOURCE INDEMNITY TRUST $108,588, % UCFRB RESTORATION FUND $106,771, % Total $4,952,915, % External 80.7% MBOI Snapshot Internal External Active Passive $ 2,260,516,031 $ 9,464,152,179 $ 8,045,467,326 $ 3,679,200, % 80.7% 68.6% 31.4% $ 11,724,668,210 $ 11,724,668,210 MBOI Internal/External Coal Tax Trust Market Value % BIG SKY ECON DEV FD $103,466, % TRUST FUNDS INVESTMENT POOL $100,458, % Active 82.0% SHORT TERM INVESTMENT POOL $3,007, % External 50.8% PERMANENT COAL TRUST FUND $564,271, % TRUST FUNDS INVESTMENT POOL $371,946, % IN STATE LOANS $144,028, % Internal External Active Passive VHLM Mortgage $37,504, % $ 9,178,638,041 $ 9,469,549,771 $ 15,295,243,643 $ 3,352,944, SHORT TERM INVESTMENT POOL $10,792, % 49.2% 50.8% 82.0% 18.0% TREASURE ST. REG. WATER SYSTEM $96,207, % $ 18,648,187,812 18,648,187,812 Intercap Statistics SHORT TERM INVESTMENT POOL $1,191, % Loans Outstanding 79,538,879 Internal 49.2% $ Row Labels Market Value % TRUST FUNDS INVESTMENT POOL $95,015, % DOMESTIC EQUITY PAC $4,161,036, % $ INTERNATIONAL EQUITY PAC $2,063,612, % TREASURE STATE ENDOWMENT $277,640, % Bonds Outstanding $ 105,110,000 PRIVATE EQUITY PAC $1,248,673, % TRUST FUNDS INVESTMENT POOL $274,293, % Number of Borrowers 183 US TREASURY AGENCY PAC $949,467, % SHORT TERM INVESTMENT POOL $3,169, % Loan Rate 3.15% REAL ESTATE PAC $819,121, % IN STATE LOANS $177, % MORTGAGE BACKED PAC $459,554, % SCHOOL FACILITIES FUND $16,691, % Short Term Investment Pool INVESTMENT GRADE CREDIT PAC $396,613, % TRUST FUNDS INVESTMENT POOL $15,641, % Account # Accounts Total Market Value % TIPS PAC $383,733, % SHORT TERM INVESTMENT POOL $1,050, % Total State 312 $ 2,078,601, % HIGH YIELD PAC $321,268, % Total $1,058,277, % Total Local 153 $ 1,157,345, % NATURAL RESOURCES PAC $261,243, % Total STIP 465 $ 3,235,947, % CASH EQUIVALENTS PAC $255,948, % STIP Reserve $ 33,356,940 BROAD FIXED INCOME PAC $145,212, % Trust Funds Investment Pool Market Value STIP NAV with Reserve DIVERSIFYING STRATEGIES PAC $25,878, % TRUST FUNDS INVESTMENT POOL $2,341,704,874 Average Current Month STIP Yield % Grand Total $11,491,362, % Passive 18.0% MBOI Active/Passive TIPS PAC INVESTMENT 3.3% GRADE CREDIT PAC 3.5% MORTGAGE BACKED PAC 4.0% REAL ESTATE PAC 7.1% US TREASURY AGENCY PAC 8.3% PRIVATE EQUITY PAC 10.9% CONSOLIDATED ASSET PENSION POOL BY ASSET CLASS CASH NATURAL EQUIVALENTS RESOURCES PAC 2.3% HIGH YIELD PAC 2.8% PAC 2.2% BROAD FIXED INCOME PAC 1.3% DIVERSIFYING STRATEGIES PAC 0.2% DOMESTIC EQUITY PAC 36.2% INTERNATIONAL EQUITY PAC 18.0%

5 MEMORANDUM Montana Board of Investments Department of Commerce 2401 Colonial Drive, 3 rd Floor Helena, MT (406) To: From: Members of the Board Michael Pettit, Director of Investment Operations Tim House, Investment Analyst Date: October 2, 2018 Subject: Staff Review of Proxy Voting Overview This memorandum addresses stock proxy voting as part of the Board s 24-month systematic work/education plan by reviewing and updating how the Board s public equity proxies are voted. Role of Stock Proxies Some key decisions involving public corporations typically require an affirmative majority vote of the shareholders in a process set out in each corporation s by-laws. The vote is carried out by a proxy mechanism not requiring actual attendance at the corporation s annual meeting. Common Proxy Ballot Measures Corporate Governance Elections of Directors Appointment of Auditors Changes in Legal and Capital Structure Corporate Restructurings, Mergers and Acquisitions Proposals Affecting Shareholder Rights Anti-Takeover Measures Executive Compensation Board s Proxy Policies The Board addresses proxy voting in the Retirement Plans investment policy. Proxy Voting...Active voting of proxies is an important part of the Board s investment program. Under the contractual arrangements between the Board and its investment managers, the responsibility for voting proxies on the investments is delegated to the managers. They are contractually required to establish a proxy voting program in coordination with Board Staff and are required to vote proxies, excluding shares on loan under the Board s securities lending program, in the interest of the Plans beneficiaries. Records of proxy votes shall be maintained by the Managers, and/or its third-party designee, and submitted to Staff and/or an external service provider annually. Staff will monitor the proxy voting practices of the Board s external investment managers. External service providers may be retained by either the board or the managers to assist in monitoring efforts. This monitoring will be coordinated with each manager to reasonably assure the Staff that managers are fulfilling their fiduciary responsibilities with respect to proxy voting.

6 Board s Delegation to Investment Managers Proxy The BOI has delegated proxy responsibility to its investment managers who may choose to vote proxies completely independently or may use the service of a proxy advice firm. The Board s external managers are required to provide us with their proxy voting policies. Staff obtains a compilation of proxy votes through the services of Broadridge. All current BOI investment managers have submitted their proxy voting guidelines to the BOI. The more common traits are: They generally acknowledge that special care and prudence when voting proxies is required with the fiduciary standards required by ERISA plans Many acknowledge using outside vendors, but generally do not bind themselves absolutely to the outside recommendation Most guidelines explicitly list what types of proxy issues will be voted against, for example o Excessive compensation o Poison pills and other harmful limitations to full value o Deleterious changes to the capital structure o Lack of board member independence, auditors, or poor governance choices Investment Managers Often Use External Proxy Service Providers for Proxy Voting Many external managers use outside proxy service providers to vote, or at least advise managers, in proxy voting. Two of the more prominent proxy services are Institutional Shareholder Services (ISS) and Glass Lewis. Institutional Shareholder Services (ISS), founded in 1985, is a subsidiary of MSCI Inc., well-known for its benchmark services. ISS states that it tracks over 42,000 meetings in 115 countries. Glass, Lewis & Co., founded in 2003, also provides proxy advisory service and states that it tracks more than 20,000 meetings in 100 countries Managers can make blanket adjustments at any time to the voting guidelines template provided by the proxy service provider. For instance, if the provider has a default of voting for all poison pill proposals, the manager can change the default vote for their clients to against all poison pill proposals. The managers reserve the right to override the default recommendation and almost all have language that allows the portfolio manager to have input in the voting process if the request is documented in writing. Examples of Proxy Policies and Practices from Select BOI Investment Managers Below are considerations routinely arising with proxy voting and specific examples how a firm addresses them. ERISA It is standard practice for the investment manager to acknowledge the importance of fiduciary care as required by ERISA (the federal Employee Retirement Income Security Act). For example, the language below is taken directly from one of the Board s managers, Acadian Asset Management: When voting proxies on behalf of our clients, Acadian assumes a fiduciary responsibility to vote in our clients' best interests. In addition, with respect to benefit plans under the Employee Retirement Income Securities Act (ERISA), Acadian acknowledges its responsibility as a fiduciary to vote proxies prudently and solely in the best interest of plan participants and beneficiaries. So that it may fulfill these fiduciary responsibilities to clients, 2

7 Acadian has adopted and implemented these written policies and procedures reasonably designed to ensure that it votes proxies in the best interest of clients. Client Direction or Withholding a Vote There may be occasions when Acadian determines that not voting a proxy may be in the best interests of clients; for example, when the cost of voting the proxy exceeds the expected benefit to the client. There may also be times when clients have instructed Acadian not to vote proxies or direct Acadian to vote proxies in a certain manner. Acadian will maintain written instructions from clients with respect to directing proxy votes. Investment Managers Generally reserve the Right to Vote outside of the Proxy Service Providers Recommendations Acadian also reserves the right to override ISS vote recommendations under certain circumstances. Acadian will only do so if they believe that changing the vote is in the best interest of clients. All overrides will be approved by an Executive Officer of Acadian and will be documented with the reasons for voting against the ISS recommendation. Investment Managers establish Proxy Oversight Committee It is common for the investment manager to form an internal proxy oversight committee in addition to outside Proxy Service Providers. From T. Rowe Price: The T. Rowe Price Proxy Committee develops our firm s positions on all major proxy voting issues, creates guidelines, and oversees the voting process. The Proxy Committee, comprised of portfolio managers, investment analysts, operations managers and internal legal counsel, analyzes proxy policies based on whether they would adversely affect shareholders interests and make a company less attractive to own. In establishing our proxy policies each year, the Proxy Committee relies upon our own fundamental research, independent research provided by an outside proxy advisor, and information presented by company managements and shareholder groups. Once the Proxy Committee establishes its recommendations, they are distributed to the firm s portfolio managers as voting guidelines. Ultimately, the portfolio managers decide how to vote on the proxy proposals of companies in their portfolios. Because portfolio managers may have differences of opinion on portfolio companies and their unique governance issues, the Price Funds may cast different votes at the same shareholder meeting. When portfolio managers cast votes that are counter to the Proxy Committee s guidelines, they are required to document their reasons in writing to the Proxy Committee. Annually, the Proxy Committee reviews T. Rowe Price s proxy voting process, policies, and voting records. Investment Managers Utilize Outside Proxy Service Providers to avoid Conflicts of Interest It is also common for investment managers to protect themselves from conflicts of interest. Again, from Acadian: Relying on ISS to vote proxies ensures that Acadian votes in the best interest of its clients and insulates Acadian s voting decisions from any potential conflicts of interest. There may also be times when clients have instructed Acadian not to vote proxies or direct Acadian to vote proxies in a certain manner. 3

8 Acadian will maintain written instructions from clients with respect to directing proxy votes. Acadian also reserves the right to override ISS vote recommendations under certain circumstances. BOI s Investment Managers and their Proxy Service Provider The list below identifies who uses which proxy service company and any other qualifier. Acadian ISS Alliance Bernstein Dom. Small cap Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors and for conflict of interest) American Century Internal Investment managers vote proxies (will use independent board in case of conflict of interest) Analytic ISS Artisan ISS Baillie Gifford Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors and for conflict of interest) Franklin Templeton Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors and for conflict of interest) Intech ISS Invesco Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors and for conflict of interest) Iridian Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors for conflict of interest) JP Morgan Internal Investment managers vote proxies (will use outside Proxy Service Providers for conflict of interest) Lazard Internal Investment managers vote proxies (will use outside Proxy Service Providers as advisors for conflict of interest) T Rowe Price ISS maintains and implements a custom voting policy for the Price Funds and other client accounts. TimesSquare ISS Vaughan Nelson ISS Voya ISS 4

9 Proxy voting summary for Calendar Year 2017 The table below lists proxy votes recorded for meeting dates from January 1, 2017 to December 31, * There were a total of 2,240 proxies and over 100 million shares voted. The data below is obtained through Broadridge s Proxy Edge product. We have access to this service at no charge based on our relationship with State Street and we can view all our managers votes parsed by company or manager for custom time periods. Most of the shares are voted in the second quarter. Account Name Ballot Shares Voted Shares Shares On Loan Shares not Voted ACADIAN 31,076,507 30,727, , ,344 ALLIANCE BERNSTEIN 984, , ,173 - AMERICAN CENTURY 12,840,217 12,790,467 1,564,578 49,750 ANALYTIC 4,156,709 4,156, ,107 - ARTISAN 3,429,926 3,429, ,013 - BAILLIE GIFFORD 5,473,303 5,473,303 1,325,575 - FRANKLIN TEMPLETON 15,932,281 15,901,466 2,351,143 30,815 INTECH 1,655,642 1,655,642 90,562 - INVESCO 9,925,596 9,878, ,115 47,150 IRIDIAN ASSET MGMT 1,612,776 1,612, ,546 - J.P. MORGAN 5,084,890 5,084, ,187 - LAZARD 5,807,748 5,420, , ,225 T. ROWE PRICE 4,165,105 4,165, ,658 - TIMESSQUARE 2,200,420 2,200, ,680 - VAUGHAN NELSON 2,366,514 2,366, ,134 - VOYA 784, ,607 97,307 - Grand Total 107,496, ,632,016 8,625, ,284 Proxies occasionally cannot be voted or are purposely not voted. If a stock is loaned** via securities lending, which the Board allows, the voting rights go to the borrower, who becomes the technical owner. Some countries, also known as share-blocking markets, forbid an equity owner from both trading a company s stock and exercising proxy rights during a proxy time period. It is not unusual for a manager to waive proxy voting so as not to limit possible trading. Countries having a no trade period are: Argentina, Belgium, Egypt., Lebanon, Luxembourg, Mauritius, Morocco, Norway, Slovak Republic, Switzerland and Turkey. In some markets, the fact that a manager is voting a proxy can become public information, and, given the nature of those markets, may impact the price of the securities involved. *The report does not include comingled managers. **Shares on loan must be recalled for the manager to direct a vote. Managers weigh the impact of removing the shares from loan with the desire to vote the shares. Conclusion Retaining proxy control internally would require delegating proxy voting to a proxy service company such as ISS, at a new additional expense to the Board. Having in-house BOI staff solely voting proxies is unrealistic due to the extensive amount of due-diligence required. Therefore, staff believes the current delegation of proxy voting to its outside investment managers is justified and reasonable. 5

10 Private Equity Asset Class Review October 2018

11 Table of Contents Private Equity and Its Role Within CAPP 3 Strategies of Private Equity Investing 4 Private Equity Objectives, Benefits, and Risks 5 Private Equity Portfolio Overview 7 Investment Pacing & Portfolio Implementation 18 Private Equity Market Environment, Strategy & Rationale 29 Private Equity Investment Process 34 Private Equity Asset Class Schedule of Investments 37 2

12 Private Equity Asset Class and Its Role Within CAPP Provide the consolidated asset pension plan (CAPP) with exposure to a diverse spectrum of private investment opportunities across different industries, both within and outside the United States. Diversify across a number of funds, vintage years, investment opportunities, and geographies. Approved Ranges Total Private Equity 9% to 15% of CAPP Benchmark No individual private equity investment > 7.5% of asset class No individual private equity manager > 15% of asset class No more than 30% of the Private Equity Asset Class can be Non-U.S. Cash held at asset class level is < 5% of the Private Equity Asset Class market value MSCI USA Small Cap Index (since April 2017) 3

13 Strategies of PE Investing - Summary Buyout Large/Mega Buyout Middle-Market Buyout Lower Middle-Market Buyout Venture Capital Early Stage Late Stage Debt Related Direct Lending Mezzanine Distressed Distressed for Control Distressed for Non Control 4

14 Objectives and Benefits Direct investment in private companies not publicly listed or traded Objectives Pursuit of higher returns on investment Diversification to reduce risk by allocating outside of public markets Private equity investment returns have been higher over time Benefits Different risks and rewards than public equities or bonds 5

15 Private Equity - Risks What Strategy, Sector, and Country exposure How managed Monitor concentration (p. 9-12) Vintage Year Serial commitments & diversification (p. 13) Manager, Operations, Business Due diligence, onsite visits, monitor concentration (p ) Cash flows, liquidity, and timing Monitor approved IPS range (p. 17), Pacing study (p. 18) 6

16 Private Equity Portfolio Overview 7

17 Performance and Market Value Performance as of 6/30/2018 (Time Weighted Rate of Return) Since inception 12.3% 1 year 15.6% 5 year 11.8% 10 year 9.0% Sizing as of 6/30/2018 $1.252 billion 11.2% of CAPP Performance is based on prior quarter s fair market value adjusted for cash flows during the most recent quarterly period. Time weighted rate of return net of all manager fees and expenses. 8

18 Composition by Strategy Market Value 6/30/18 Distressed 10% Debt Related 7% Venture Capital 14% Buyout 69% Buyout $ Venture Capital $ Distressed $ Debt Related $ 85.3 Total Private Equity $ 1,252.0 Source: State Street. 9

19 Composition by Geography - Global Market Value 6/30/18 United Kingdom, 4% Canada, 3% Australia, 2% Germany, 2% Malaysia, 1% Singapore, 1% China, 5% Other, 6% USA, 78% Source: State Street. 10

20 Composition by Geography - US Market Value 6/30/18 Other (States <1%), 8% New York, 6% Texas, 9% California, 11% Washington, 1% Kansas, 1% Indiana, 1% Oklahoma, 1% Oregon, 1% Minnesota, 2% Missouri, 2% Georgia, 2% South Carolina, 2% Colorado, 6% Tennessee, 2% Pennsylvania, 3% Michigan, 6% New Jersey, 3% Florida, 5% Ohio, 5% Massachusetts, 4% Source: State Street. U.S. Direct fund exposures only. Arizona, 4% Virginia, 4% Illinois, 4% North Carolina, 4% 11

21 Composition by Sector Market Value 6/30/18 Industrials Information Technology Consumer Discretionary Health Care Financials Materials Energy Consumer Staples Real Estate Telecommunication Services Cash Equivalent Utilities Other 0% 5% 10% 15% 20% 25% 30% MBOI PE Index Index: MSCI USA Small Cap 12

22 Composition by Vintage Year Market Value 6/30/18 Millions $160 $140 $120 $100 $80 $60 $40 $20 $0 Fund of Funds + Secondaries Vintage Year Direct Debt + Distressed+ Special Situations Direct Buyout + Venture Source: State Street. 13

23 Top 10 Private Equity Managers Market Value 6/30/18 Axiom Asia $69 Northgate Capital HCI Equity Partners Veritas Capital OCP Asia $57 $54 $51 $45 Adams Street Partners, LLC HarbourVest Centerbridge Siguler Guff Advisers, LLC Audax Group $32 $39 $38 $34 $33 $13 $0 $20 $40 $60 $80 Buyout Debt Related Distressed Venture Capital Millions Source: State Street. 14

24 Top 10 Private Equity Fund Investments Market Value 6/30/18 Northgate V, L.P. HCI Equity Partners IV, LP Orchard Landmark II, LP BDCM Opportunity Fund III, L.P. Axiom Asia Private Capital III, LP Pine Brook Fund II, L.P. Veritas Capital Fund V Performance Venture Capital II Vida Insurance Credit Opportunity Fund II, LP GI Partners IV $41 $38 $33 $32 $30 $28 $27 $27 $27 $23 $0 $10 $20 $30 $40 Millions Buyout Debt Related Distressed Venture Capital Source: State Street. 15

25 Historical Commitments by Strategy Commitments 8/31/18 Millions $400 $350 $300 $250 $200 $150 $100 $50 $ Direct Buyout + Venture Direct Debt + Distressed + Special Situations Fund of Funds + Secondaries Source: State Street. 16

26 History of MBOI Private Equity Program Market Value 6/30/18 16% 14% 12% 10% 8% 6% 4% 2% 0% $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Millions Private Equity MV (RHS) PE as % of Pension (LHS) IPS Min (LHS) IPS Max (LHS) May RHS Right Hand Scale, LHS Left Hand Scale

27 Investment Pacing & Portfolio Implementation 18

28 Pacing Evaluates current private equity exposure and commitment plan relative to total plan assets Considers the following factors: Paid in Capital (Contributed Funds/Cash In) Distributed Capital (Distributed Funds/Cash Out) Valuation Allocation within the range Takes into account the annualized growth rate for the total plan assets Provides flexibility to explore various scenarios 19

29 Life Cycle of a Private Equity Fund J-Curve and Net Exposure Millions $40 $30 $20 $10 $0 -$10 -$20 -$ Years Contributions Distributions Fund I Net Cash 20

30 Life Cycle of a Private Equity Funds Millions $40 $30 $20 $10 $0 -$10 -$20 -$ Years Fund I Net Cash Fund II Net Cash Fund III Net Cash 21

31 Life Cycle of a Private Equity Portfolio $1,400 $1,200 $1,000 $800 Millions $600 $400 $200 $0 -$200 -$400 -$ Years Commitments Yr. 1 Commitments Yr. 2 Commitments Yr. 3 Commitments Yr. 4 Commitments Yr. 5 Commitments Yr. 6 Commitments Yr. 7 Commitments Yr. 8 Commitments Yr. 9 Commitments Yr

32 Pacing 10 year actual/forecast 18% Private Equity as % of CAAP 16% 14% 12% 10% 8% 6% 4% 2% 0% Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24 Dec-25 Dec-26 Dec-27 Dec-28 Actual Allocation Current Pacing No New Commitments "Target" Actual allocation: MBOI Private Equity as % of CAAP. Current Pacing assumption average $350M/Year. Target of 12%, focus on approved range of 9-15% per IPS. 23

33 Pacing Commitments Past 5 Years Millions $400 $350 $300 $365 $250 $200 $150 $145 $190 $145 $200 $190 $100 $50 $ YTD YTD: as of 8/31/

34 Pacing Decisions Starting in 2018 Pacing $ Expected Long-term Annual Allocation Goal - $350M # Expected Funds per Year $ Expected Commitment size - $25-75M 25

35 2018 Implementation Private Equity Buyout Debt Related Distressed Venture Capital Total OCP Asia Fund III 75,000,000 75,000,000 Deerpath Capital Advantage IV 60,000,000 60,000,000 Builders VC Fund I 20,000,000 20,000,000 Crescent Asia Consumer and Deep Value Fund II 50,000,000 50,000,000 Blue Sage Capital III 40,000,000 40,000,000 Axiom Asia V 40,000,000 40,000,000 HKW Capital Partners V 40,000,000 40,000,000 Pangaea Three 40,000,000 40,000,000 Totals 210,000, ,000,000-20,000, ,000, Portfolio Composition by Strategy (Commitment) 58% 37% 0% 5% 100% MBOI Private Equity Portfolio by Strategy (Market Value) 69% 7% 10% 14% 100% 26

36 Commitment Pacing Moving Forward Millions $400 $350 $330 $330 $330 $350 $350 $350 $370 $370 $370 $300 $250 $200 $150 $100 $50 $

37 Private Equity Market Environment, Strategy & Rationale 28

38 Purchase Price Multiples Leveraged Buyout 12 Purchase Price Multiples Period (Observations) May Source: S&P Global Market Intelligence, Leveraged Buyout Review 2Q 2018

39 Debt Multiples Leveraged Buyout Debt Multiples May Source: Leveraged Buyout $50M or more of EBITDA; S&P Global Market Intelligence, Leveraged Buyout Review 2Q 2018

40 Private Capital Funds in Market $1,600 4,000 $1,263 $1,200 3,000 $ Billion $800 $705 $888 $699 $607 $758 $797 $733 $793 $946 $1,008 2,000 # of Funds $400 1,000 $ Aggregate Capital Targeted (LHS) No. of Funds in Market (RHS) 0 May 2017 Source: Preqin Private Capital Fundraising Q Data Pack 31 LHS: Left Hand Scale. RHS: Right Hand Scale.

41 Strategy and Rationale What Why Focus on North America Well understood, resource constraints, deepest, most liquid, rules of the game Selectively add international and emerging market managers, focus on Asia Growth story, augment asset class exposure Move the program toward smaller market cap strategies Be selective with larger market cap focused manager re-ups More value creation levers, greater alignment of interest, lower leverage/entry multiples Fewer value creation levers, do not totally disregard but focus on our key relationships, best managers 32

42 Strategy and Rationale cont. What Increase emphasis on noncorrelated strategies Opportunistically add venture exposure Why Diversification, downside protection, durability and predictability of returns Focus on access, appealing long-term return profile for top quartile performance Direct Lending Focus on small to medium size enterprises with limited capital solutions, special situations, no access to high yield, adds diversification, current yield Deemphasize fund-of-funds generally in favor of direct fund commitments Opportunistically sell in the secondaries market If comparable to a fund-of-funds, a direct strategy should outperform due to a reduced fee burden Active portfolio management, divest of non-strategic relationships 33

43 Private Equity Investment Process 34

44 Private Equity Investment Process Deal Sourcing Fund Monitoring Due Diligence Legal Review Investment Decision 35

45 Private Equity Deal Flow Last 18 Months 36

46 Private Equity Asset Class Schedule of Investments 37

47 Private Equity Asset Class 6/30/18 Strategy Buyout Large/Mega Middle-Market Investment Manager Investment Name Vintage Year Original Commitment Market Value ITD IRR Investment Multiple Lexington Partners Lexington Capital Partners V, L.P $50,000,000 $1,803, Oak Hill Capital Partners Oak Hill Capital Partners II, L.P $25,000,000 $1,073, Carlyle Group Carlyle Partners IV, L.P $35,000,000 $907, Lexington Partners Lexington Capital Partners VI-B, L.P $50,000,000 $6,189, Terra Firma Capital Partners Terra Firma Capital Partners III, L.P $27,458,352 $5,393, Welsh, Carson, Anderson & Stowe Welsh, Carson, Anderson & Stowe X, L.P $25,000,000 $16, J.C. Flowers & Co. LLC J.C. Flowers II, L.P $25,000,000 $5,106, Oak Hill Capital Partners Oak Hill Capital Partners III, L.P $20,000,000 $9,951, Lexington Partners Lexington Capital Partners VII, L.P $45,000,000 $14,917, American Securities American Securities Partners VI, L.P $35,000,000 $16,919, American Securities American Securities Partners VII, L.P $20,000,000 $12,639, Adams Street Partners, LLC Brinson Partners Primary Fund 1998 $7,161,019 $182, Adams Street Partners, LLC Brinson Non-U.S. Trust-1999 Primary Fund 1999 $1,524,853 $28, Adams Street Partners, LLC Brinson Partners Primary Fund 1999 $8,346,761 $115, Adams Street Partners, LLC Brinson Partners Primary Fund 1999 $20,064,960 $695, Adams Street Partners, LLC Brinson Non-U.S. Trust-2000 Primary Fund 2000 $1,815,207 $180, Adams Street Partners, LLC Brinson Partners Primary Fund 2001 $15,496,322 $1,355, Adams Street Partners, LLC Brinson Non-U.S. Trust-2002 Primary Fund 2002 $1,696,452 $37, Adams Street Partners, LLC Brinson Partners Primary Fund 2002 $16,297,079 $449, Adams Street Partners, LLC Adams Street Non-U.S. Fund 2002 $6,000,000 $489, Adams Street Partners, LLC Adams Street U.S. Fund 2002 $34,000,000 $4,102, Adams Street Partners, LLC Brinson Non-U.S. Trust-2003 Primary Fund 2003 $1,896,438 $83, Adams Street Partners, LLC Brinson Partners Secondary Fund 2003 $2,608,820 $344, Adams Street Partners, LLC Brinson Partners Primary Fund 2003 $15,589,100 $1,562, Adams Street Partners, LLC Adams Street U.S. Fund 2003 $20,000,000 $3,766, Adams Street Partners, LLC Brinson Non-U.S. Trust-2004 Primary Fund 2004 $897,613 $102, Adams Street Partners, LLC Brinson Partners Secondary Fund 2004 $1,151,151 $128, Adams Street Partners, LLC Adams Street Non-U.S. Fund 2004 $5,000,000 $944, Adams Street Partners, LLC Brinson Partners Primary Fund 2004 $8,832,269 $1,195, Adams Street Partners, LLC Adams Street U.S. Fund 2004 $15,000,000 $2,932, Adams Street Partners, LLC Adams Street Global Oppty Secondary Fund 2004 $25,000,000 $4,817, Strategies in italics: Fund of Fund and Secondary investments. 38

48 Private Equity Asset Class 6/30/18 Strategy Buyout Middle-Market Investment Manager Investment Name Vintage Year Original Commitment Market Value ITD IRR Investment Multiple JLL Partners JLL Partners Fund V, L.P $25,000,000 $2,537, Adams Street Partners, LLC Adams Street Non-U.S. Fund 2005 $5,000,000 $1,389, Adams Street Partners, LLC Adams Street U.S. Fund 2005 $25,000,000 $7,151, Neuberger Berman LLC NB Co-Investment Partners LP 2005 $35,000,000 $1,425, Affinity Ventures Affinity Asia Pacific Fund III, L.P $15,000,000 $4,249, CCMP Capital Advisors CCMP Capital Investors II, L.P $30,000,000 $304, Portfolio Advisors LLC Port. Advisors Fund IV (E), L.P $15,000,000 $3,337, Trilantic Trilantic Capital Partners IV L.P $11,098,351 $1,528, HarbourVest HarbourVest Direct 2007 Fund 2007 $20,000,000 $1,457, HarbourVest Dover Street VII L.P $20,000,000 $3,573, HarbourVest HarbourVest Intl Private Equity Fund VI 2008 $19,321,774 $16,006, Lexington Partners Lexington Middle Market Investors II, LP 2008 $10,000,000 $4,282, Odyssey Investment Partners Odyssey Investment Partners Fund IV, LP 2008 $20,000,000 $2,830, Portfolio Advisors LLC Portfolio Advisors Secondary Fund, L.P $15,000,000 $3,577, Veritas Capital Veritas Capital Fund IV, L.P $25,000,000 $20,744, Sterling Partners Sterling Capital Partners IV 2011 $20,000,000 $12,966, HarbourVest Dover Street VIII LP 2012 $25,000,000 $11,037, Neuberger Berman LLC NB Strategic Co - Invest II, LP 2012 $20,000,000 $13,938, Affinity Ventures Affinity Asia Pacific Fund IV L.P $20,000,000 $18,041, Odyssey Investment Partners Odyssey Investment Partners Fund V, LP 2013 $25,000,000 $12,486, Trilantic Trilantic Capital Partners V L.P $20,000,000 $13,435, CCMP Capital Advisors CCMP Capital Investors III, L.P $25,000,000 $22,319, GI Partners GI Partners IV 2014 $20,000,000 $22,919, Veritas Capital Veritas Capital Fund V 2014 $20,000,000 $27,112, JLL Partners JLL Partners Fund VII, LP 2015 $25,000,000 $16,618, Neuberger Berman LLC NB Strategic Co-Investment Partners III, LP 2015 $20,000,000 $10,955, HarbourVest Dover Street IX L.P $20,000,000 $6,623, Levine Leichtman Capital Levine Leichtman Capital Partners VI, L.P $40,000,000 $7,068, Veritas Capital Veritas Capital Fund VI 2017 $25,000,000 $2,717, Strategies in italics: Fund of Fund and Secondary investments. 39

49 Private Equity Asset Class 6/30/18 Strategy Buyout Investment Manager Investment Name Vintage Year Original Commitment Market Value ITD IRR Investment Multiple Lower Middle-Market Carlyle Group Carlyle U.S. Growth Fund III, L.P $25,000,000 $416, Siguler Guff Advisers, LLC Siguler Guff Small Buyout Opportunities 2006 $25,000,000 $11,014, Axiom Asia Axiom Asia Private Capital II, LP 2008 $25,000,000 $18,349, Tenex Capital Management Tenex Capital Partners SG, L.P $20,000,000 $9,982, HCI Equity Partners HCI Equity Partners III, LP 2010 $20,000,000 $15,358, Cartesian Capital Group Pangaea Two, LP 2011 $20,000,000 $20,939, Gridiron Capital LLC Gridiron Capital Fund II 2011 $15,000,000 $11,492, Siguler Guff Advisers, LLC Siguler Guff Small Buyout Opps Fund II 2011 $25,000,000 $22,678, Audax Group Audax Private Equity Fund IV, L.P $25,000,000 $21,277, Axiom Asia Axiom Asia Private Capital III, LP 2012 $25,000,000 $30,057, Eureka Growth Capital Eureka III, L.P $20,000,000 $11,382, HCI Equity Partners HCI Equity Partners IV, LP 2013 $25,000,000 $38,338, Pine Brook Pine Brook Fund II, L.P $25,000,000 $28,008, Southern Capital Group Southern Capital Fund III L.P $15,000,000 $15,851, Spire Capital Spire Capital Partners III, L.P $15,000,000 $11,489, Guardian Capital Partners Guardian Capital Partners Fund II, L.P $20,000,000 $13,494, HKW Capital Partners HKW Capital Partners IV, L.P $20,000,000 $16,846, Kinderhook Industries LLC Kinderhook Capital Fund IV, L.P $20,000,000 $21,481, Angeles Equity Partners Angeles Equity Partners I, L.P $20,000,000 $1,473, Audax Group Audax Private Equity Fund V, L.P $20,000,000 $11,484, Axiom Asia Axiom Asia Private Capital IV, LP 2015 $40,000,000 $20,651, Gridiron Capital LLC Gridiron Capital Fund III, L.P $20,000,000 $10,708, DFW Capital Partners DFW Capital Partners V, L.P $20,000,000 $9,359, Kinderhook Industries LLC Kinderhook Capital Fund V, L.P $35,000,000 $9,577, McCarthy Capital McCarthy Capital Fund VI, L.P $25,000,000 $8,111, Tenex Capital Management Tenex Capital Partners II, L.P $35,000,000 $13,898, RiverGlade Capital RiverGlade Capital, L.P $25,000,000 $4,656, Vida Capital Management Vida Insurance Credit Opportunity Fund II, LP 2017 $40,000,000 $26,730, Axiom Asia Axiom Asia V, L.P $40,000,000 $ Bluesage Blue Sage Capital III 2018 $40,000,000 $ Cartesian Capital Group Pangaea Three, LP 2018 $40,000,000 $ Cresent Point Cresent Asia Consumer & Deep Value Fund II 2018 $50,000,000 $ HKW Capital Partners HKW Capital Partners V, L.P $40,000,000 $ Strategies in italics: Fund of Fund and Secondary investments. 40

50 Private Equity Asset Class 6/30/18 Strategy Debt Related Direct Lending Distressed For Control Non Control Investment Manager Investment Name Vintage Year Original Commitment Market Value ITD IRR Investment Multiple Welsh, Carson, Anderson & Stowe WCAS Capital Partners IV, L.P $25,000,000 $1,724, OCP Asia Orchard Landmark II, LP 2016 $30,000,000 $33,456, CapitalSpring Investment Partners CapitalSpring Investment Partners V, LP 2017 $40,000,000 $18,840, Deerpath Capital Management Deerpath Capital Advantage IV (US), L.P $30,000,000 $14,261, OCP Asia OCP Asia Fund III, LP 2018 $75,000,000 $11,340, MHR Institutional Partners MHR Institutional Partners III L.P $25,000,000 $11,178, MatlinPatterson MatlinPatterson Global Opps. Ptnrs. III 2007 $30,000,000 $12,406, Black Diamond BDCM Opportunity Fund III, L.P $25,000,000 $32,451, Centerbridge Centerbridge Capital Partners II, LP 2010 $25,000,000 $13,071, Catalyst Investments Catalyst Fund Limited Partnership IV 2012 $15,000,000 $9,869, Catalyst Investments Catalyst Fund IV Parallel, L.P $15,000,000 $9,548, Centerbridge Centerbridge Capital Partners III, L.P $20,000,000 $10,805, Oaktree Capital Group OCM Opportunities Fund VIIb, L.P $35,000,000 $2,535, Centerbridge Centerbridge Special Credit Partners, LP 2009 $12,500,000 $555, Oaktree Capital Group Oaktree Opportunities Fund VIII, L.P $10,000,000 $1,421, Centerbridge Centerbridge Special Credit Partners II, L.P $20,000,000 $6,304, Centerbridge Centerbridge Special Credit Partners III, L.P $35,000,000 $7,065,

51 Private Equity Asset Class 6/30/18 Strategy Venture Capital Early Stage Late Stage Investment Manager Investment Name Vintage Year Original Commitment Market Value ITD IRR Investment Multiple Adams Street Partners, LLC Brinson Non-U.S. Trust-2001 Primary Fund 2001 $1,341,612 $69, Adams Street Partners, LLC Adams Street V 2002 $40,000,000 $10,622, Industry Ventures Industry Ventures Fund IV, L.P $10,000,000 $1,504, Highway 12 Ventures Highway 12 Venture Fund II, L.P $10,000,000 $11,340, Portfolio Advisors LLC Port. Advisors Fund IV (B), L.P $30,000,000 $14,130, Portfolio Advisors LLC Port. Advisors Fund V (B), L.P $10,000,000 $5,901, Performance Equity Management Performance Venture Capital II 2008 $25,000,000 $26,904, Northgate Capital Northgate V, L.P $30,000,000 $40,832, Opus Capital Opus Capital Venture Partners VI, LP 2011 $10,000,000 $4,777, Northgate Capital Northgate Venture Partners VI, L.P $15,000,000 $16,549, Tenaya Capital LLC Tenaya Capital VI, L.P $20,000,000 $18,704, Tenaya Capital LLC Tenaya Capital VII, L.P $15,000,000 $6,430, BRV Opportunites Fund, LP BRV VI, L.P $20,000,000 $3,737, Builders VC Builders VC Fund I, L.P $15,000,000 $1,603, Builders VC Builders VC Entreprenuers Fund I, L.P $5,000,000 $ Adams Street Partners, LLC BVCF IV, L.P $15,000,000 $2,007, Strategies in italics: Fund of Fund and Secondary investments. 42

52 MEMORANDUM Montana Board of Investments Department of Commerce 2401 Colonial Drive, 3 rd Floor Helena, MT (406) To: From: Members of the Board David Ewer, Executive Director (With input from MBOI and Department of Administration staff) Date: September 20, 2018 Subject: Cash Management of State Monies Background For over forty years, the Board of Investments (the Board ) has been responsible for administering the Unified Investment Program, which is constitutionally-mandated. With only a few exceptions, this program mandates that all state money, regardless of source or use, flows into or out of the Board of Investments. The yearly velocity is in the billions of dollars, the number of transactions is in the tens of thousands. The Board serves as a vital utility, but rather than delivering gas or electricity, the Board delivers cash for the entire campus of state government. Along with the Board of Investments, there are three other key entities at the highest level that are responsible for the state s cash movement: the Department of Administration s Daily Operations Section within the State Accounting Bureau, the state s depository bank, US Bank in Helena, and the state s custodial bank, State Street Bank, in Boston. The chart below shows the daily cash flow possibilities among the various entities: 1

53 Montana s State Treasurer, ex officio, is John Lewis, Director of the Department of Administration (Department). The Department s State Accounting Bureau assists the Board of Investments in administering the treasury function and overall cash management. The Department s Director s Office of Finance and Budget annually prepares General Fund cash projections which estimate monthly cash availability and potential cash deficits possibly necessitating the State to issue Tax and Revenue Anticipation Notes (TRANS). The Daily Operations Section deposits the agency collections not deposited directly at US Bank, reconciles all bank accounts, prepares a monthly collateralization report, reconciles all Electronic Funds Transfer, provides prior notification to the Board of Investments of large outgoing wires, and reports all payment and receipt activity to the Board. Additionally the Department works with US Bank on all payment and collection issues and works with the Board in establishing and maintaining all external depository bank accounts and reviewing and approving deposit exceptions as allowed under State law. The Board s involvement with cash management is closely related to managing the Short Term Investment Pool (STIP) portfolio. In general, STIP provides the liquidity for all aspects of the cash management function, including the pension funds, various state agencies, the State s General Fund, and local governments choosing to participate in STIP. Cash Flow Types Occurring Throughout the Year Inflows: Income from income and property taxes, oil and gas taxes, investment earnings and US government payments. Outflows: Vendor payments, pension benefits, State of Montana payroll, FICA, school payments (OPI). Settlements: Security purchases, sales and maturities for STIP, Trust Funds Investment Pool (TFIP), State Fund, Consolidated Asset Pension Pool (CAPP), All Other Funds and pool participant unit purchases and sales. These transactions are included in the State Street/US Bank daily net wire. Daily Cash Flow Types to US Bank, the Depository Bank Deposits by the Department of Revenue and Treasury Unit ACH (Automated Clearing House) deposits/withdrawals Wires in/out including State Street Bank net wire Warrants cashed Appendix A As a reference tool, Appendix A accompanying this memo includes specific Board policy, governance or orientation material directly relating to cash management and the general duties of the State Treasurer. Senior Staff Involving Cash Management While literally scores of state and private sector employees are part of the State s cash management, three state employees have principal responsibilities and will make brief presentations during the Board s October 2018 meeting relating to their respective areas. 2

54 Kyndra Cozzie, Daily Operations Section Manager State Accounting Bureau Kyndra is responsible for the Treasury and Warrant Writer functions within the Department of Administration. Kyndra will provide an overview of the functions of the Treasury and Warrant Writer, as they relate to the cash management process, along with updates to the state s disaster recovery plans. John Romasko, CFA, Investment Officer - John is the Board s principal staff person who oversees bulk cash movement to and from the depository bank, in Helena and the custodial bank, State Street Bank in Boston. John monitors and assures sufficient liquidity, and invests idle monies. Julie Feldman, CPA, Financial Manager - Julie is the principal overseer of specific cash movement from the customer perspective, i.e., all the STIP customers, primarily state agencies, but many Montana local governments as well, who may use STIP. She and BOI accounting staff are responsible for accounting for the bulk cash transactions with respect to the STIP money pool; hers is a dual role. Questions and Answers (Q and A) In anticipation of some likely questions, Staff has compiled our responses in the following Q and A: 1. How does the state pay its bills? Bills are paid through the Department of Administration by issuing checks (called warrants ) or Electronic Funds Transfers drawn against funds at US Bank in Helena. The Board of Investments administers the daily movement of cash between US Bank (the Depository bank ) and State Street Bank (the Custodial bank ). 2. How does the state track, account, and invest or expend its monies? State agencies remit the cash they collect to the Daily Operations Section Treasury Unit. Agencies must use SABHRS (Statewide Accounting Budgeting and Human Resource System) to track their cash and other funds. The Unified Investment Program mandates that the Board of Investments is in charge of where and how the money is invested. State agency cash is primarily held in either separate STIP accounts at the agencies discretion or held within the State Treasurer s Fund. The Treasurer s Fund has its own STIP account, which is managed at the discretion of the MBOI. 3. What is STIP? How big is it? Who governs it? STIP operates similarly to a money market fund. For the year ended June 30, 2018, the STIP portfolio was approximately $3.3 billion. Its governance is entirely under the Board of Investments. 4. Who earns the income on the STIP portfolio? State agencies that are allowed to maintain their own interest may use STIP and their pro rata share of the portfolio earnings are distributed or reinvestment at their discretion. Per statute, interest earned on the Treasurer s fund is deposited in the general fund. 5. How much available cash does STIP maintain? STIP maintains at least 10% in daily liquidity and 15% weekly liquidity. 6. How many STIP customers are there? As of June 30, 2018, there were a total of 488accounts: 331state accounts and 157local government accounts. 7. Can anyone use STIP? No. State agencies must be authorized by law to have their own STIP account; otherwise they must use the Treasurer s Fund. Montana local governments may choose to invest in STIP. 3

55 8. What is the difference between the State s Depository bank and its Custodial bank? Who is responsible for hiring them? The Depository bank, US Bank, assigns a bank account in the State of Montana s name. This account is used to deposit daily cash receipts and pay the State s warrants. The Department of Administration is responsible for hiring the Depository bank. The Custodial bank, as the name implies, holds (has custody of) the securities within the Board s investment pools and the All Other Funds investments. The Custodial bank provides an investment accounting system. The Custodial bank is hired by the Board of Investments and the Department of Administration. 9. How are these banks paid? Both banks are paid by a permanent law (a statutory appropriation) rather than the biennial appropriation process. Both vendor functions must be bid out under the State s procurement laws. 10. What safeguards are in place to protect the state s money? a. Compartmentalization with separate functions between the Treasury Unit and the BOI. No single individual has the authority to direct the entire cash management process. b. User access and dollar limitations are controlled by US Bank s security module and Board internal control policies. c. Daily reconciliation of STIP and Treasurer s cash. d. There are numerous internal controls. e. Audits are done annually. 4

56 From the Board s Governance Manual: Appendix A Cash Management Authorization The Unified Investment Program The Montana Constitution requires that the Legislature provide for a Unified Investment Program for public funds. Section , MCA, established the Unified Investment Program, created the Montana Board of Investments (the Board ) and gave the Board sole authority to invest state funds in accordance with state law and the state constitution. State law requires that the Board operate under the "prudent expert principle," defined as: 1) discharging its duties with the care, skill, prudence, and diligence that a prudent person acting in a like capacity with the same resources and familiar with like matters exercises in the conduct of an enterprise of a like character with like aims; 2) diversifying the holdings of each fund to minimize the risk of loss and maximize the rate of return; and 3) discharging its duties solely in the interest of and for the beneficiaries of the funds managed. Selection of Custodial Bank and Investment Consultant While this Governance Policy delegates general contracting authority to the Executive Director, the Board reserves the right and the authority to make the final selection of the Custodial Bank and the Investment Consultant after which the Executive Director shall negotiate a contract. The Board s powers are specifically circumscribed under for custodial/depository banking services, and et. seq. pertaining to the State s procurement laws. From Montana Code Annotated: Deposit of funds in hands of state treasurer. (1) Under the direction of the board of investments, the state treasurer shall deposit public money in the treasurer's possession and under the treasurer's control in solvent banks, building and loan associations, savings and loan associations, and credit unions located in the state, except as otherwise provided by law, subject to national supervision or state examination. (2) If needed financial services are not available through solvent banks, building and loan associations, savings and loan associations, and credit unions located in the state, the state treasurer may deposit public money in out-of-state financial institutions subject to national supervision. (3) The state treasurer shall deposit funds in banks, building and loan associations, savings and loan associations, and credit unions in amounts that may be designated by the board of investments and shall withdraw deposits when instructed to by the board of investments. (4) When money has been deposited under the board of investments and in accordance with the law, the state treasurer is not liable for loss on account of any deposit occurring from any cause other than the treasurer's own neglect or fraud. (5) The state treasurer shall withdraw all deposits or any part of the deposits from time to time to pay and discharge the legal obligations of the state presented to the treasurer in accordance with the law. (6) The state treasurer may contract with a financial institution to provide general depository banking services. The cost of contracting for banking services is statutorily appropriated, as provided in , from the general fund General fiscal duties of state treasurer. (1) The state treasurer is the custodian of all money and securities of the state unless otherwise expressly provided by law. (2) It is the duty of the state treasurer to: (a) receive and account for all money belonging to the state, not expressly required by law to be received and kept by some other person; (b) pay warrants out of the funds upon which they are drawn; 5

57 (c) upon payment of any warrant, record the receipt of the person to whom it is paid; (d) keep an account of all money received and disbursed; (e) at the request of either house of the legislature or of any legislative committee, give information in writing as to the condition of the treasury or on any subject relating to the duties of the office of state treasurer; (f) superintend the fiscal concerns of the state; (g) suggest plans for the improvement and management of the public revenue; (h) keep an account of all warrants drawn upon the treasury and of other appropriation records that the treasurer determines to be essential for the support of the accounting records maintained in the department; (i) keep a register of warrants, showing the fund upon which each warrant is drawn, each warrant's number, who received the warrant, and the date issued; (j) require all persons who have received money belonging to the state but who have not accounted for it to settle their accounts; (k) draw warrants on the state treasury for the payment of money directed by law to be paid out of the treasury, except that a warrant may not be drawn unless authorized by law; (l) authenticate with the official seal of the state all warrants drawn and all copies of papers issued from the office of state treasurer; (m) collect and pay into the state treasury all fees received; (n) discharge other duties as may be imposed upon the state treasurer by law; and (o) provide information through the state's official internet website detailing how donations can be made to the state general fund or to any function of state government. 6

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60 RVK Education Session Montana Board of Investments ( MBOI ) October 2, 2018

61 Table of Contents Performance Reporting Basics 3 Board Member Challenges and Effective Practices 11 Introduction to Behavioral Biases 19 Appendix: Key Investment Formulas 24 2

62 Why is performance reporting needed? Every line is the perfect length if you don't measure it. Marty Rubin 3

63 Key Investment Terms Term Annualized Return Gross of Fees Net of Fees Total Fund Peer Rankings Standard Deviation (σ) Description The geometric average return that an investment has earned over a multi-year period. The annualized return represents the return that a plan has received on average during the period if there was no return volatility. 1 The return of an investment BEFORE deducting investment management fees. Gross of fees performance is primarily used to benchmark returns against peer groups, as databases providing peer group data only collect gross of fees performance data. The return of an investment AFTER deducting investment management fees. The net of fees return is the actual return received by investors before deducting other administrative costs (e.g., custody fees, staffing, consultant, etc.). Peer groups are groups of other investment plans that have similar attributes to the MBOI pension plans. For MBOI performance reports, RVK uses a peer group that consists of all public plans with greater than $3 billion in assets. Data for this subset is drawn from the Mellon Analytical Solutions Trust Universe along with the Investment Metrics Plan Sponsor Universe. Peer rankings provide a rough benchmark to evaluate the aggregate investment results of the MBOI relative to public plans of similar size. A statistic that measures the dispersion of a dataset relative to its mean. In the investment profession, the standard deviation is used to indicate the degree to which annual returns tend to vary over time. The greater the standard deviation, the greater the variance of annual returns from the average return. All else being equal, investors generally seek to minimize the standard deviation for any given level of target return. 2 1 RVK performance reports use time-weighted returns, which do not factor in the timing of cash flows. Money-weighted returns (also referred to as internal rate of return), factor in the timing of cash flows. Money-weighted returns are typically used to gauge returns in private asset cases, such as private equity and real estate. 2 See Appendix for formulas to calculate key statistics. 4

64 Key Investment Terms (continued) Term Downside Risk Correlation (ρ) Beta (β) Tracking Error Sharpe Ratio Description A measure similar to standard deviation, but focused only on negative movements of a return series. It is calculated by taking the standard deviation of the negative monthly returns. Lower downside risks indicate that returns have offered greater protection in declining markets. A statistical measure that describes the relationship of asset class returns. Correlations range between -1.0 and 1.0. A value of 1.00 indicates that returns move perfectly in unison. A value of indicates that returns move perfectly in opposition. A value of 0 indicates there is no relationship between the returns of two asset classes. Correlations are useful to describe the relative diversification power of different asset classes in a portfolio. Beta measures the sensitivity of a portfolio relative to a chosen market index. For the MBOI, the Beta of the portfolio is measured against the returns of the S&P 500 index. In simple terms, the Beta of the portfolio captures the extent to which the portfolio return mirrors the S&P 500 return. For example, if the Beta = 1.0, a 10% S&P 500 return would translate to a 10% portfolio return. If the Beta = 0.5, a 10% S&P 500 return would translate to a 5% portfolio return. The tracking error measures the standard deviation of an investment manager (or portfolio of managers) relative to a chosen index. The higher the tracking error, the greater the expected deviation of the portfolio from the reference index. Captures the absolute rate of return earned by an investment per unit of risk. The higher the value, the better the product's historical risk-adjusted performance. The ratio is calculated by taking the excess rate of return over the risk-free return and dividing it by the standard deviation of the excess return relative to the risk free asset. 5

65 What are MBOI s Core Investment Objectives? Objective Match the Actuarially Required Return Maintain Appropriate Diversification to Achieve Fund Objectives Description Generating a return that matches the actuarially required return (7.50% or 7.65% depending on plan) is the most important objective for the MBOI. However, achievement of the goal cannot be pursued without considering other return, risk, and liquidity related goals. Diversify fund assets by asset class, sub-asset class, and investment manager in order to dampen overall portfolio volatility and reduce the potential negative impact of any single type of investment. Strategic Asset Allocation Value Added Generate incremental value through the use of strategic asset allocation based on fundamental return and risk expectations for each asset class. Active Manager Value- Added Generate incremental value via targeted use of internal management resources and actively, managed external managers. Maintain Adequate Liquidity to Fund Distributions Maintain adequate liquidity to ensure that distributions are paid in a timely manner and that sales of assets are not forced at inopportune moments. 6

66 Performance Reporting and MBOI Objectives Performance reports measure the progress of investment plans relative to their specific return and risk objectives. For the Montana Board of Investments, performance reports provide insight into the following objectives: Objective Match the Actuarially Required Return Primary Performance Metrics Total Fund Annualized Return (Net of Fees) Maintain Appropriate Diversification to Achieve Fund Objectives Strategic Asset Allocation Value Added Active Manager Value-Added Maintain Adequate Liquidity to Meet Distribution Requirements Beta Total Fund Peer Rankings - Annualized Return - Downside Risk - Standard Deviation - Sharpe Ratio (risk-adj. return) Asset Class Composite Returns vs. Broad Market Indices Asset Class Composite Returns vs. Peers Individual Investment Manager Returns vs. Strategy- Appropriate Benchmarks and Peers Cash Allocation 7

67 Performance Reporting Explained in Three Quotes Not everything that can be counted counts, and not everything that counts can be counted. Albert Einstein You do not need to understand everything in a performance report in order to gauge performance there is a lot of noise. We tend to overvalue the things we can measure and undervalue the things we cannot. John Hayes Do not underestimate the importance of qualitative information. If something seems off, ask questions regardless of whether it is quantifiable. If you can't explain it simply, you don't understand it well enough. Albert Einstein If you do not understand something in a performance report, it is our responsibility to explain it more effectively. 8

68 Important Performance Reporting Limitations to Remember Limitation Explanation Time Horizon Tracking Error Variance in Peer Investment Objectives and Fee Levels Plan-Specific Investment Constraints Institutional investors (including the MBOI) invest in asset classes that produce variable returns over short investment horizons. While it is important to report short term performance, Boards must exercise discipline and not overact to short term trends. Tracking error relative to benchmarks (both at the manager and composite level) can be significant, especially over short time horizons and/or within alternative asset classes (e.g., private equity, real estate, and natural resources). Boards must be careful not to over-react to dramatic underperformance or celebrate excessively in response to dramatic outperformance. While useful as a rough benchmark for plan performance, two important limitations are: 1. Comparability of Plan Objectives & Constraints The MBOI investment objectives (and resulting investment strategy) may differ materially from those of the plans included in the peer group database. 2. Fee Structure Uncertainty Peer group data is reported on a gross of fees basis. If MBOI s fee levels are below those of most peers, peer rankings will be understated. Various plan-specific constraints can impact the relative performance of investments over all time periods. These constraints can be critical to the Plan s strategy, but can lead to misleading performance results. Boards must be careful to consider their specific investment objectives and be cognizant of how this impacts performance. 9

69 Key Insights 1. Performance Reports provide a critical check on the effectiveness of an investment strategy. 2. Effective Performance Reporting strives to: A. Link performance metrics directly toall core plan objectives B. Explain the most important metrics clearly and succinctly such that any Board Member can understand the implications 3. Performance Reports are NOT the only source of information that Board Members should use to evaluate the effectiveness of an investment program. 4. Clarity is the responsibility of the creator of a performance report not the reader. 10

70 Board Member Challenges and Effective Practices

71 Scope of MBOI Responsibilities for Management of the Unified Investment Program Abbreviated Summary of MBOI Board Responsibilities Created by the Montana legislature in 1972, the Board is administratively attached to the Department of Commerce but functions as an independent, quasi-judicial board with full and final authority over its two major responsibilities: the Unified Investment Program and the In-State Investment Program. 1. The Unified Investment Program was established by the legislature to create a single agency vested with the authority to invest and manage state funds in accordance with state law and the Montana constitution. The Board also invests local government funds at their discretion. Both the Unified Investment Program and the In-State Investment Program are required by law to operate under the "prudent expert principle", defined as: a. Discharging its duties with the care, skill, prudence, and diligence that a prudent person acting in a like capacity with the same resources and familiar with like matters exercises in the conduct of an enterprise of like character and like aims. b. Diversifying the holdings of each fund to minimize the risk of loss and maximize the rate of return; and c. Discharging its duties solely in the interest of and for the benefit of the funds managed. MBOI hired RVK to assist the Board with the oversight and implementation of the investment strategy. Source: 12

72 Role of MBOI Board Members Key Oversight Responsibilities Approve Investment Policies for Each Account Sample policies include Retirement Plans, Trust Funds Investment Pool, STIP, and State Fund Insurance. Approve Asset Allocation The Board approves the target asset allocation range for the investment pools. Review Investment Activity of the Board Staff The Board meets approximately 6 times per year to review the investment activities of the investment staff. Sample agenda items include, but are not limited to: investment performance, asset class reviews, investment fee reviews, and selection and review of 3 rd party providers (e.g., custodian, consultant, etc.). Source: 13

73 RVK Best Practices Research Key Elements of RVK s Investment Committee/Board Best Practices Study Project Description Objective Literature Review Interviews with Investment Committee Chairs, Members & Staff Investment Professional Surveys Included an exhaustive review of professional journals, editorials, and proprietary publications produced by other investment firms. Included more than 30 interviews with investment committee chairs, members, and staff. Organizations in which these individuals were affiliated represented well over $100 billion in institutional assets. Administered two surveys of investment professionals (primarily RVK consultants). Survey #1: Investment Committee Task Prioritization Survey #2: Investment Committee Member Qualifications Gain an understanding of existing literature on investment committee best practices and identify research gaps. Identify common investment committee challenges and potential best practice case studies. Generate insight regarding: a. Task prioritization by investment committees b. Attributes and skills that enable effective investment committee management Source: Investment Committee Best Practices. RVK, Inc. (2017). 14

74 Common Challenges Common Challenges of Institutional Investment Committees I II III IV Defining the Scope of Authority Selecting Committee Members Maintaining Strategic Continuity Optimizing Decision Making and Execution Determining the optimal scope of delegated committee authority Identifying responsibilities to delegate to staff or third parties Establishing an optimal Board size Identifying key member roles Identifying value-added member attributes Recruiting qualified committee members Evaluating committee member performance Educating new and existing committee members Creating comprehensive and practical documentation Establishing a continuous, disciplined strategic review process Prioritizing issues appropriately Creating impactful meeting materials Ensuring consistent meeting attendance Ensuring adequate meeting preparation Executing meeting facilitation that balances efficiency and thoroughness Enforcing accountability Common Obstacles Stakeholder time availability Organizational influence of committee members (e.g., major donors) Candidate pool constraints, such as: Current committee membership, Legally required representation Committee member turnover Infrequency of committee meetings Pre-existing investment biases of committee members Meeting time constraints Committee member availability and engagement Research Results and Case Studies Case Study #1: Authority-Based Committee Charter Investment Committee Member Selection Survey Case Study #2 Volunteer Advisor Program Case Study #3 Trustee Reviews Case Study #4 Committee Member Orientation Compendium of Effective Tactics to Promote Strategic Continuity Annual Investment Strategy Reviews Rolling Work Plans Strategic Objective Statements Compendium of Effective Decision- Making Tactics Pre-Meeting Conference Calls Executive Summaries Decision Prioritization Frameworks Source: Investment Committee Best Practices. RVK, Inc. (2017). 15

75 Obstacles to Effective Decision Making Attributes of Investment Decisions 1. Highly-complex concepts with multiple decision inputs. 2. High degree of uncertainty regarding cause and effect even for the most experienced investors. 3. Variable levels of engagement among Board members. 4. Influence of human instincts (behavioral biases) that often lead to undesirable outcomes. Board Member Attributes and Constraints 1. Variable levels of investment experience and training. 2. Significant competing demands on time available for self-education and meeting preparation. 3. Instinctual desire to take action in order to contribute positively to investment outcomes. 4. Limited knowledge of the rationale driving past investment decisions. 5. Limited knowledge of common behavioral traps that can impair decision making. Resulting Risks and Challenges 1. Temptation to alter the investment strategy in a manner inconsistent with long term objectives 2. Insufficient investment in self-education and preparation for Board meetings. 3. Susceptibility to unconscious behavioral biases that impair decision-making. 4. Continuous erosion of institutional knowledge 16

76 Other Useful Tactics to Improve Decision Making & Execution Pre-Meeting Conference Calls RVK consultants find that a simple 30-minute call in advance of meetings can save hours of unnecessary discussion and debate. Typically, the chairperson, CIO, and occasionally a few committee members attend the call. The purpose of the call is to review major agenda items and the required decisions, as well as discuss potential changes or additions to the meeting materials. Pre-meeting calls are particularly valuable for committees with severe time constraints. Meeting Executive Summaries Recognizing that committee members lack the required time to read all of the materials, RVK consultants help many of our clients prepare by drafting a short one to three page document summarizing all of the key issues and decisions that will be covered at the upcoming meeting. In short, preparing an executive summary takes a relatively modest amount of time for the consultant or investment committee chairperson, but saves substantial time for committee members both in terms of meeting preparation and subsequent meeting discussions. Decision Prioritization Frameworks In order to determine an appropriate time allocation for meeting agenda items, it is often helpful to employ prioritization frameworks. In Investment Committee Best Practices, we present two prioritization frameworks: one that addresses strategic issues and one that helps isolate issues most appropriate for committee-based decision making. We encourage committees to consider such frameworks in order to better prioritize and execute decisions. Source: Investment Committee Best Practices. RVK, Inc. (2017). 17

77 Key Insights 1. Acknowledge the significant time and educational constraints that impact Board decision making. 2. Thorough meeting preparation is often more important than subsequent deliberation. 3. Continuously assess whether meeting time allocation matches the materiality of the decision at hand. 18

78 Introduction to Behavioral Biases

79 What are Behavioral Biases? Behavioral biases (also referred to as cognitive biases) are systemic (nonrandom) errors in thinking in the sense that a judgement deviates from what would be considered desirable from the perspective of accepted norms or correct in terms of formal logic. Source: Ariely, D. (2008). Predictably Irrational. New York: Harper Collins. 20

80 Common Behavioral Biases Impacting Investment Decisions 1. Herd Behavior Tendency to favor investments that demonstrate successful outcomes in the recent past regardless of whether future prospects are attractive. Example: Investing in dotcom stocks at the market peak in Loss Aversion Systemic bias toward risk taking when faced with a choice between certain loss or the pursuit of a risky, but uncertain attempt to achieve a gain (even if the expected value is worse than the certain loss). Example: Hiring active managers in efficient asset classes rather than accepting a slightly negative return from an index fund. 3. Hindsight Bias Using current information to judge the quality of a decision despite the fact that this information was unknowable when the decision was made. Example: Terminating staff or an investment manager due to underperformance that was driven by factors that could not have been known at the time of the investment. 4. Optimism Bias Tendency to overestimate the probability of positive events and underestimate the probability of negative events. Example: Tendency to overestimate one s ability to successfully time the market. 21

81 Common Behavioral Biases (Continued) 5. Framing Bias Tendency to make a different choice depending upon how the relevant data impacting the choice is framed. Example: Tendency to prefer an investment with a 90% chance of success over an identical investment with a 10% chance of failure. 6. Confirmation Bias Tendency to seek only information that confirms pre-existing beliefs. Example: Disproportionate inclusion of research suggesting a high risk of increasing inflation when testing a belief that higher inflation is on the horizon. 7. Sunk Cost Fallacy Bias toward remaining in an investment in order to recoup losses regardless of the relative attractiveness on a forward-looking basis. Example: Refusal to sell a stock despite permanent impairment of financial prospects. 22

82 Key Take Aways 1. Our fundamental instincts as human beings often betray us when making investment decisions. 2. Awareness of our systemic biases and manually making adjustments to correct for them typically constitutes the only effective defense. 23

83 24 Appendix A: Key Investment Formulas

84 Investment Formulas Statistic Formula Variables Variance s 2 = X i X n 1 X i X n = term in data set = mean of data set = sample size Standard Deviation σ = s 2 = X i X n 1 S 2 X i X n = variance of data set = term in data set = mean of data set = sample size Covariance COV X, Y = in X i X Y i Y n 1 X i X Y i Y n = term in data set X = mean of data set X = term in data set Y = mean of data set Y = sample size Correlation ρ x,y = Cov r x, r y σ x σ y r x r y σ x σ y = return of investment x = return of investment y = standard deviation of investment x = standard deviation of investment y Beta β = Covariance r i, r m Variance r m r i r m = return of investment = return of reference index (e.g., S&P 500) 25

85 Investment Formulas (continued) Statistic Formula Variables Tracking Error TE = n i=1 R m R 2 b n 1 R m R b n = manager return in period i = benchmark return in period i = number of periods Sharpe Ratio Sharpe Ratio = r p r f σ p R p R f σ p = portfolio return = risk free rate = portfolio standard deviation 26

86

87 2018 CALENDAR Board Dates Board Packet Mailing Federal Holidays 01 New Year s Day 15 M.L. King Day JANUARY S M T W Th F S FEBRUARY S M T W Th F S 19 Presidents Day Good Friday MARCH S M T W Th F S APRIL S M T W Th F S Easter Sunday 13 Mother s Day 28 Memorial Day MAY S M T W Th F S JUNE S M T W Th F S 17 Father s Day Independence Day JULY S M T W Th F S AUGUST S M T W Th F S Labor Day SEPTEMBER S M T W Th F S OCTOBER S M T W Th F S Columbus Day 31 Halloween 6 Election Day 12 Veterans Day 22 Thanksgiving Day NOVEMBER S M T W Th F S DECEMBER S M T W Th F S 1 25 Christmas Day

88 BOI WORK & EDUCATION PLAN FEBRUARY Ethics Policy Disaster Recovery and Emergency Preparedness Outreach Efforts for Board - Loan and Municipal Programs Domestic Equities Asset Class Review STIP Review Quarterly Reports Committee Meetings: Audit: Financial Audit FEBRUARY Ethics Policy Outreach Efforts for Board - Loan and Municipal Programs In-State Loan Program INTERCAP / Board Rated Credit, Bond Issuer, Credit Enhancer International Equities Asset Class Review STIP Review Treasurers Fund Review Quarterly Reports Committee Meetings: Audit: Financial Audit APRIL Custodial Bank Relationship, Performance, Continuity Website Policy Statements Review Capital Market/Asset Allocation - Consultant Consultant Board Member Education MAY MT Buildings (Board as Landlord/Tenant Holdings) Fixed Income Asset Classes Review Budget Status FYTD Quarterly Reports Committee Meetings: Audit: Accounting Review HR: Staffing Level Review HR: Exempt Staff Compensation Review APRIL Custodial Bank Relationship, Performance, Continuity Website Policy Statements Review Benchmarks used by Board Natural Resources Asset Class Review Capital Market/Asset Allocation - Consultant Consultant Board Member Education MAY MT Buildings (Board as Landlord/Tenant Holdings) Budget Status FYTD Fixed Income Asset Classes Review State Fund as Principal Investment Client State Government Customer Relationships Separate Accounts Review Quarterly Reports Committee Meetings: Audit: Accounting Review HR: Staffing Level Review HR: Exempt Staff Compensation Review AUGUST AUGUST Cost Reporting including CEM, Inc. Analysis Cost Reporting including CEM, Inc. Analysis Budget Status Prior FY Budget Status Prior FY High Yield Asset Class Review Real Estate Asset Class Review Real Estate Asset Class Review Coal Severance Tax Trust Review Quarterly Reports Quarterly Reports Committee Meetings: Committee Meetings: Audit: SOC Report Audit: SOC Report OCTOBER Proxy Voting Public Equities Review Cash Management of State Monies Private Equity Asset Class Review Consultant Board Member Education OCTOBER Securities Lending Review Private Equity Asset Class Review Diversifing Strategies Asset Class Review Consultant Board Member Education NOVEMBER NOVEMBER 2019 Legislative Session 2019 Legislative Session Budget Proposed FY '20-'21 Resolution 217 Authorization of Investment Vendors Resolution 217 Authorization of Investment Vendors PERS and TRS Relationship PERS and TRS Relationship Asset Allocation Range Approval Asset Allocation Range Approval Quarterly Reports Diversifing Strategies Asset Class Review Committee Meetings: Quarterly Reports Audit: Securities Litigation Status Committee Meetings: Audit: Annual Report and Financial Statements Audit: SOC Report HR: Exempt Staff Performance Review Audit: Annual Report and Financial Statements HR: Exempt Staff Performance Review

89 PORTRAIT format WORK PLAN 2018 and 2019 REV.xlsx Completed In-Process Expected Expected X X Accounting Review X X X X Annual Report and Financial Statements X X X X Asset Allocation Range Approval (Board Must Review/Approve Annually as per Policy) X X X X Audit (Financial) X X Benchmarks used by Board X X Board as a Rated Investment Credit, a Bond Issuer and a Credit Enhancer X X X X Board Member Education X X X X Board s Budget X X X X Capital Market/Asset Allocation - Consultant X X Cash Management of State Monies X X X X Cost Reporting including CEM, Inc. Analysis X X Custodial Bank Relationship, Performance, Continuity X X Disaster Recovery and Emergency Preparedness X X X X Domestic Equities Asset Class Review X X X X Exempt Staff Performance and Compensation Review (HR Policy Requires Annual Consideration) X X X X Ethics Policy (Board Policy Requires Annual Affirmations) X X X Fixed Income Asset Classes Review X X In-State Loan Program X X INTERCAP Program X X X X Internal Controls X X X International Equities Asset Class Review X X X X Investment Counsultant Independent Presentations (Board Requries at Least Two Annually) X X X X Legislative Session and Interim Matters X X MT Buildings (Board as Landlord/Tenant Holdings) X X X X Outreach Efforts for Board - Loan and Municipal Programs X X X X PERS and TRS Relationship X X X X Policy Statements Review (Governance Policy Requires Annual Investment Policy Review) X X X Private Equity Asset Class Review X X Proxy Voting Public Equities X X X Real Estate Asset Class Review X X X X Resolution 217 Authorization of Investment Vendors (Board Policy Requires Annual Update) X X X X Resolution 218 Continuity of Executive Director X X X X Resolution 234 Continuity of Chief Investment Officer X X Securities Lending X X X X Securities Litigation X X X X Staffing Level Review (Required Biannually in Board Policy) X X State Fund as Principal Investment Client X X State Government Customer Relationships X X Website X X STIP Review X X Trust Fund Investment Pool Review X Coal Severance Tax Trust Review X Treasurers Fund Review X Separate Accounts Review X X Natural Resources Asset Class Review X X High Yield Asset Class Review X X Diversified Strategies Asset Class Review

90 Board of Investment s Commonly Used Acronyms ABCP... Asset Backed Commercial Paper ABS... Asset Backed Securities ACH... Automated Clearing House ADR... American Depository Receipts AUM...Assets Under Management BOI... Board of Investments CAFR... Comprehensive Annual Financial Report CAIA... Chartered Alternative Investment Analyst CAPP... Consolidated Asset Pension Pool CFA... Chartered Financial Analyst CGT... Capital Gains Tax CIPM... Certified in Investment Performance Measurement CMBS... Commercial Mortgage-Backed Securities CP... Commercial Paper CPA... Certified Public Accountant CPI... Consumer Price Index CRP Loan... Conservation Reserve Enhancement Program Loan DOA... Department of Administration DPI... Distributions to Paid-In EBITDA... Earnings Before Interest, Taxes, Depreciation, and Amortization EM... Emerging Markets EMEA Europe, Middle East, Africa ESG... Environmental, Social, Governance ETF... Exchange Traded Funds FCA... Financial Conduct Authority FMV... Fair Market Value FOIA... Freedom of Information Act FRM... Financial Risk Manager

91 FTE... Full Time Equivalent position (State personnel) FX... Foreign Exchange GAAP... Generally Accepted Accounting Principles GASB... Governmental Accounting Standards Board GP... General Partner GTAA... Global Tactical Asset Allocation IG... Investment Grade IPS... Investment Policy Statement IRP... Intermediary Relending Program IRR... Internal Rate of Return LAD... Legislative Audit Division LBO... Leverage Buyout LP... Limited Partner/Partnership LPAC... Limited Partner Advisory Committee LTV... Loan to Value MBOH... Montana Board of Housing MBOI... Montana Board of Investments MBS... Mortgage Backed Securities MFFA...Montana Facility Finance Authority MLP... Master Limited Partnership MMbbl/D... One Million Barrels per Day (Oil) MOIC... Multiple of Invested Capital MOM... Montana Operations Manual MPERA... Montana Public Employee Retirement Administration MPT... Modern Portfolio Theory MSCI... Morgan Stanley Capital International MSCI ACWI...MSCI All Country World Index MSCI EAFE... MCSI Europe, Australasia, and Far East MSCI EM... MSCI Emerging Markets MSTA... Montana Science and Technology Alliance MTSBA... Montana School Boards Association

92 MVO... Mean-Variance Optimization NAV... Net Asset Value NCREIF... National Council of Real Estate Investment Fiduciaries NOI... Net Operating Income (Real Estate) ODCE... Open-End Diversified Core Equity (Core Real Estate Funds) PE... Price-to-Earnings Ratio PERS... Public Employees Retirement System QSCB... Qualified School Construction Bonds QZAB... Qualified Zone Academy Bonds REIT... Real Estate Investment Trust RFP... Request for Proposal Russell... Russell Indices RVPI... Residual Vale to Paid-in SABHRS... Statewide Accounting Budgeting and Human Resource System SFBP... State Fund Bond Portfolio SFIP... State Fund Investment Portfolio SITSD... State Information Technology Services Division SMAs... Separately Managed Accounts SOC... Service Organization Controls (Audit Report) SPX... Standard & Poor s 500 Total Market Index SSBCI... State Small Business Credit Initiative STIP... Short Term Investment Pool TFBP... Trust Funds Bond Portfolio TFIP... Trust Funds Investment Pool TIF... Tax Increment Financing TIFD... Tax Increment Financing District TIPS... Treasury Inflation Protected Securities TRS... Teachers Retirement System TVPI... Total Value to Paid-in TWR... Time-Weighted Return VC... Venture Capital

93 Board of Investment s Terminology List 130/30 Public Markets A form of Long-Shorting where the long exposure is 130% and the short exposure is 30%. See Partial Long/Short Active Management An investment method which involves hiring a manager to research securities and actively invest and trade securities to outperform an assigned index. Compare to Passive Management. Actuarial Assumed Rate of Return Accounting The investment rate of return used by actuaries that enables them to project the investment growth of retirement system assets into the future. An individual rate is determined and adopted by each Pension System. Actuarial Funding Status Accounting A measurement made by actuaries to measure a pension system s financial soundness. Shows the actuarial assets available to fund liabilities. Agency Bonds Fixed Income Agency bonds are issued by official US Government bodies. Compare to GSE Bonds All Other Funds (AOF) Holds all uncategorized accounts and funds. Alpha The measure of active return on an investment compared to the market. A measure of 1 means that an investment returned 1% in excess of the benchmark over a specified time period. Alternative Investments An all-encompassing range of investments, other than traditional assets such as publicly traded stocks and bonds. The most common alternative investments are private equity, real estate, commodities, and hedge funds. Annualize To annualize is to convert a short-term calculation or rate into an annual rate. Appreciation An increase in the value of an asset over time. The increase can occur for several reasons, including changes in supply or demand, or because of changes in inflation or interest rates. Compare to Depreciation. Asset Backed Securities (ABS) Fixed Income A security whose income payments and overall value are collateralized by a specific pool of underlying assets (i.e. mortgage backed loans, auto loans, credit card loans). Pooling together a group of similar assets into financial instruments allows investors to mitigate the risk of individual default. Average Credit Quality Fixed Income The average credit rating for each bond in the portfolio adjusted for its relative weight in the portfolio. See Credit Rating. Basis Points (bps) A basis point is 1/100th of a percentage and is regularly used when discussing the market (100 bps = 1.00%) Beta The measure of volatility or systematic risk of a security or portfolio compared to the market. Example: If a company has a beta of 1.5, it implies that its more volatile than the overall index because it is greater than 1. Because of this, if the market moves 1% the company is expected to move 1.5% in the same direction. < 1 = less risk than market 1 = same risk as market > 1 = more risk than market Blind Pool Private Investments A fund or portfolio where the investors are not aware of what the specific investments will be at the time of the initial commitment. Bloomberg Barclay s US Aggregate Index Fixed Income A broad bond index covering most U.S. traded bonds and some dollar denominated foreign bonds traded in the U.S. Broad Fixed Income Fixed Income A broad investment class including Investment Grade, structured bonds, Government and Agency bonds, international bonds, and High Yield.

94 Buyout Private Investments A fund strategy that acquires a controlling interest in a company. Under a buyout, the previous ownership loses control over the company in exchange for compensation. If borrowed funds are used to acquire the company, the deal is called a leveraged buyout. Large/Mega buyout Target companies have revenues >$1B, EBITDA of >$300M Typically, private equity fund sizes of $2B and up Middle market buyout Target companies have revenues <$1B, EBITDA of $25M - $300M Typically, private equity fund sizes of $750M to $2B Lower middle market buyout Target companies have revenues of $10M - $300M, EBITDA of $3M - $25M Typically, private equity fund sizes of <$750M Capital Call (Drawdown) Private Investments When the GP s investment team is ready to purchase an asset, they will issue a capital call or drawdown for a portion of the capital committed by the LPs. Capital Commitment Private Investments The amount of capital an LP is contractually obligated to pay into a blind pool fund or portfolio to finance underlying investments and their associated fees and expenses. Cap Rate Real Estate The ratio of NOI compared to the current market value. The cap rate is often used to value and compare real estate investments. Carried Interest Private Investments A share of the profits of an investment fund that is paid to the GP. Cash Equivalents Assets that retain value and have a high degree of liquidity and are generally short-term commitments with minimal risk of loss. Clawback Private Investments A payment from the GP to the LPs as the result of the GP receiving excess distributions above what was contractually agreed upon. Commingled Fund Represents a pool of assets for multiple clients and are managed in a similar fashion by the same entity. Each client has a pro-rata share of the overall portfolio. Custody of the underlying securities are at the investment manager s custodian. Consolidated Asset Pension Pool (CAPP) The Consolidated Asset Pension Pool invests directly in the 13 Asset Classes. Correlation A measure of how investments or asset classes move relative to each other during the same period. To increase diversity, managers look for assets with lower correlations with other assets = perfectly negative correlation 0.0 = no correlation +1.0 perfectly positive correlation Coupon Fixed Income The interest rate paid on a bond. This can either be a fixed or floating rate. A floating interest rate is typically tied to a benchmark such as U.S. Treasury Bills. Payments can be monthly, semi-annual, or annual. Covenant Fixed Income A legally binding term of agreement between a bond issuer and a bond holder which are designed to protect both parties. Can potentially restrict an issuer from undertaking certain activities or ensure they meet certain requirements. 2

95 Credit Rating Fixed Income An assessment of creditworthiness of a borrower. A credit rating (between AAA and BBB) given by one of the three main credit rating agencies indicates a relatively low risk of default and hence an Investment Grade security. Investment Grade High-Yield In Default Moody s S&P Fitch Aaa AAA AAA Aa AA AA A A A Baa BBB BBB Ba BB BB B B B Caa CCC CCC D C CC D DDD Currency Risk Risk Management A risk variable that comes from investments in currencies, currency futures contracts, forward currency exchanges, etc. These investments are subject to the risk that the value of a currency will change at a fundamental level. Custodian BOI/Gov t Specific A financial institution responsible for safeguarding BOI s financial assets by holding assets on behalf of BOI, thus forming a fiduciary relationship. Debt Multiple Private Investments A company s debt divided by EBITDA Debt Related Private Investments A fund strategy that provides debt financing in the form of a secured or unsecured loan for working capital or capital expenditures. Also called term loans, which often requires the borrower to adhere to certain rules regarding financial performance called covenants. Depreciation A decrease in the value of an asset over time. The decrease can occur for several reasons, including changes in demand or supply, or because of changes in inflation or interest rates. Compare to Appreciation. Discount Fixed Income Describes the discrepancies in the paid amount against its par value. A discount means the purchasers bought the security for less than the asset s par value. Compare to Premium Distressed Private Investments An investment strategy whereby the private investment manager purchases a distressed asset at a significant discount with the intention of turning around or improving the asset prior to selling. Distributions Either cash or equity returned to investors after a fund or portfolio exits an investment. Private Investments Diversification Risk Management Investing in different asset classes, industries, securities, and/or countries to protect against extreme losses and to expand the possibilities of gains from multiple asset types. Domestic Equity Equity from the United State including stocks, or other public equity-related investments. Downside Capture Ratio During a down market, the downside capture ratio shows how a portfolio compared to its benchmark. It is shown as a ratio with a value below 1 being preferred as it indicates that the portfolio had good downside protection and didn t lose as much as its benchmark. Compare to Upside Capture Ratio. 3

96 Downside Risk Risk Management Downside risk describes the potential downfall and unintended negative consequences of an investment. Dry Powder Refers to fund s uninvested capital available to fund future investments. Duration Fixed Income A measure of a bond or portfolio s sensitivity to changes in interest rates. As duration increases, the bond or portfolio s sensitivity to interest rates increases. Example: if current interest rates increase by 1% and a bond has a duration of 4, the bond price will decrease by about 4%. However, if interest rates decrease by 1% the bond price will increase by about 4% EBITDA Stands for: Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a non-gaap measurement that shows as an organization s earnings before interest, taxes, depreciation, and amortization can be subtracted out. This allows for a greater understanding of a company s current operating profitability EBITDAX Private Investments Stands for: Earnings Before Interest, Taxes, Depreciation, Depletion, Amortization, and Exploration Expenses. This is a valuation metric used for oil and gas companies which shows their ability to produce income from operations in a given year. Enterprise Fund Financial Statements Accounting Used to account for the recovery of costs for goods or services primarily provided to users outside of the primary government. Used by BOI to report the programs created under the Municipal Finance Consolidation Act and the Economic Development Bond Act. Equity Styles Public Markets Categorization of investment approaches or objectives that a fund manager uses Core: Core holdings are a central investment of a long-term portfolio that exhibit common traits such as strong market share and promising growth prospects. Considered a blend of growth and value investing. Growth: An investment style that focuses on earnings that are expected to grow at a desirable and above average rate. Value: An investment strategy where assets are chosen because they are trading below their intrinsic value or fundamentals making them undervalued. Exchange Traded Fund (ETF) Public Markets An investment fund traded on stock exchanges, much like stocks. Most ETFs track an index, such as a stock index or bond index. Face (Par) Value Fixed Income The stated value of an investment at maturity. Fixed Income Fixed Income An investment, generally in bonds and loans, that returns payments on a regular schedule (coupon) as well as the original investment (principal) at the end of investment period. Foreign Markets Risk Risk Management Risks that are not typically associated with domestic markets including changes in currency exchange rates, less government supervision of exchanges, brokers, and issuer; increased social economic, political uncertainty, and greater for price volatility. These risks may be greater in emerging and frontier markets. Forms of Economic Markets Public Markets Economic markets are divided based on several measurements including economic development, size and liquidity requirements, and market accessibility criteria. Developed Market: A country that is developed in terms of its economy and capital markets like the US, Japan, Germany, or Canada. Emerging Market: A country that has built an adequate infrastructure to facilitate a developed economy and capital market but is still working towards other characteristics of a developed market. Frontier Market: A market from a developing country that does not have a developed stock market or infrastructure and generally has higher returns to compensate investors. 4

97 Forward Contract Public Markets A contract between parties to buy or sell an asset at a future date and predetermined price regardless of future market conditions. Can be used for hedging or speculation. Forward Rate Public Markets An interest rate that will be applicable to a future financial transaction. Fund-of-Funds Private Investments A fund that invests in multiple managers/funds, who then invest that capital directly. GAAP/GASB Accounting The Governmental Accounting Standards Board (GASB) is the author of the generally accepted accounting principles (GAAP) used by state and local governments in the US along with various corporations. General Partner (GP) Private Investments The team/firm that oversees the investment of a specific private fund. Global Industry Classification Standard (GICS) A common global classification standard used by thousands of market participants including MSCI (the BOI s preferred index provider). Through GICS there are 11 sectors, 24 industry groups, and 68 industries. GSE Bonds Fixed Income Stands for Government Sponsored Entity (GSE) bonds which are offered by lenders created by an act of congress to assist groups of borrowers. GSE bonds are backed but not guaranteed by the U.S. government. Compare to Agency Bonds Hedge Funds Public Markets Like mutual funds, hedge funds pool investors money and invest that money to make a positive return. Hedge funds typically have more flexible investment strategies than mutual funds. Hedging Public Markets An investment position taken to offset potential losses that may be incurred by another investment. Compare to Speculation. High-Yield Bond Public Markets A non-investment grade bond that is at a higher risk of default or some other adverse event. However, these pay higher yields than better quality bonds to make them attractive to investors. Indenture Fixed Income A contract that explains the various terms, options, and intricacies of a bond. Index A hypothetical portfolio of securities representing a market segment and are commonly used as a benchmark for the stock and bond markets (S&P 500, Barclay s Aggregate, or the MSCI USA IMI). Inflation The rate at which the general level of prices for goods and services is increasing. As inflation increases, the purchasing power of money falls. In-State Loan Program BOI/Gov t Specific Statutory authorized program that directs the Board to provide financial lending using Coal Tax Trust fund money to borrowers who meet program requirements set in law. Intermediary Relending Program (IRP) A loan to an Economic Development organization that has three years to loan the money to local businesses that need equity capital to obtain a bank loan. Funds are matched through a program with the United States Department of Agriculture (USDA). Internal Controls The plan of an organization that has the methods and measures used to monitor assets, prevent fraud, minimize errors, verify the accuracy and reliability of accounting data, promote operational efficiency, and ensure that established managerial policies and procedures are complied with. Internal Rate of Return (IRR) The dollar-weighted return earned by investors. 5

98 Internal Service Fund Accounting Used to account for the recovery for costs of goods or services primarily provided by one department or agency to another department or agency. Used to report to the investment operations of the Board. International Equity Equity outside of the United States. Examples include stocks or equity investments in China, Germany, or Canada. Investment Grade Bond Fixed Income Bonds rated BBB/Baa and above. These bonds have lower yields than high-yield bonds because of the lower risk of default. Investment Period Private Investments The prespecified timeframe during the beginning of a fund s life when the investments of the fund will be made. Key Man Provision Private Investments A clause that prevents the GP from making new investments after a key executive(s) departs. Leverage (Financial leverage) The use of debt to acquire additional assets. Example: If we were to purchase a $1,000 asset using $750 of debt and $250 of cash to fund the purchase, the purchased would 75% leveraged. Limited Partnership Private Investments The common legal structure used for private equity funds. Liquidity The ability of an asset to be converted into cash quickly and without a meaningful price discount. LPAC Membership Private Investments The Limited Partnership Agreement Committee (LPAC) membership is occasionally available as a term of agreement. Being on the LPAC gives BOI a chance to voice concerns more directly and make decisions in conjuncture with other LPAC members during unexpected events including the loss of key investment team members, extending the investing or exiting time frame, etc. Mark-to-Market Recording the price of an asset on a regular basis to reflect its current market value. Can also be referred as fair value accounting. Market Capitalization Public Markets Measured by the total dollar market value of a company s outstanding shares and is generally used to compare companies in investment universes or sectors. The following classification are according to the MSCI and are variable between investors and indexes. (all below ranges come from MSCI World) Large (Big) Cap: Defined as companies with market caps that are $20 billion or larger. Less volatile than other, smaller firms Mid Cap: Defined as a company with a market cap between $2 - $20 billion. These tend to have more risk than larger companies but with room to grow their market cap. Small Cap: Defined as companies with market caps less than $2 billion. Generally younger companies with growing potential and added risk. Maturity Fixed Income The agreed date that the full amount of the bond or investment must be paid back to the lender plus interest if applicable. Mean The average of a data set. All data points are added together and then divided by the number of data points. Median The center or middle number in a range of data when data points are organized by value. Montana Operations Manual (MOM) Accounting Contains guidance for all state agencies. Among the topics included are accounting, travel, procurement, information technology, budget, and human resources. 6

99 MSCI The provider of investment decision support tools including indexes. ACWI All Country World Index ACWI ex US All Country World Index excluding US EAFE Europe, Australasia, and Far East EM Emerging Markets IMI Investible (all-cap) Market Index US the United States Multi-Asset Class A combination of asset classes (i.e. cash, equity or bonds) used in an investment creating a group or portfolio of assets. Multiple of Invested Capital (MOIC) Private Investments Performance metric which shows how much more or less an investment is worth compared to the total invested capital over time. A multiple greater than one indicates a gain, and a multiple less than one indicates a loss. TTTTTTTTTT VVVVVVVVVV /IIIIIIIIIIIIIIII CCCCCCCCTTTTTT Natural Resources Private Investments Natural Resource investments are investments managed by external advisors who invest in timber, gas and oil related companies, as well as other natural resources. Net Asset Value (NAV) Accounting The true value of a fund s investments based on the quoted prices of its components. NNNNNN = VVVVVVVVVV oooo NNIIIIVVTTII VVVVVVVVVV oooo LLLLLLLLCCTTCCTTCCVVII NCREIF Real Estate Stands for National Council of Real Estate Investment Fiduciaries. A property Index that is compiled quarterly and shows the composite total rate of return measure of investment performance of a pool of individual commercial real estate properties acquired in the private market for investment purposes. NFI-ODCE Real Estate Short for NCREIF Fund Index Open End Core Equity; an index of investment returns reporting on both a historical and current basis. This information comes from 33 open-end commingled funds pursuing a core investment strategy. NOI (Net Operating Income) A calculation used to analyze real estate investments. NOI equals the revenue from the property minus necessary operating expenses. Overweight Public Markets A security position that is in excess, or overweight when compared to the security s weight in the underlying benchmark or sector. Actively managed portfolios will overweight securities that have the potential to earn excess returns above the benchmark returns. Portfolios can also be overweight sectors, countries, or some other characteristic. Compare to alternative weighting schemes such as equal weight or underweight. Partial Long/Short Public Markets An investing strategy that takes long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. Passive Management An investment strategy where a manager purchases a portfolio of securities that they hope to replicate market index returns, (this strategy generally involves lower management fees). Placement Agent Private Investments A third-party group that assists the GP in fundraising for a new or existing fund. Policy Portfolio A fixed baseline or target mix of asset classes (stocks, bonds, cash, etc.) for a portfolio. Preferred Return Private Investments The threshold return that the LPs of a private equity fund must receive, prior to the GP receiving its carried interest. Premium Fixed Income Describes the discrepancies in the paid amount against its par value. A premium means the purchasers bought the security for more than its par value. Compare to Discount. 7

100 Present Value Accounting The value of a stream of future cashflows discounted at a specified interest rate to the present date. Shows what a dollar in the future is worth to an investor today. Price to Book (P/B) Ratio Price of an Asset divided by its Book Value. Price to Earnings (P/E) Ratio Price of an Asset divided by its Earnings. Principal Repayment Fixed Income The payment of the face value or principal of a security by the issuer, generally due on the maturity date unless the issuer redeems the security before it matures. Private Investments Private Investments Asset classes comprised primarily of equity and debt securities in private operating companies, real property and other types of investments that are not publicly traded on a stock exchange. At BOI it is an umbrella term that covers the private equity, real estate, and natural resources asset classes. Prudent Expert Principle A measure that requires the fiduciary (BOI) to properly discharge their duties by doing the following: a) discharge the duties with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent person acting in a like capacity with the same resources and familiar with like matters exercises in the conduct of an enterprise of a like character with like aims; b) diversify the holdings of each fund within the unified investment program to minimize the risk of loss and to maximize the rate of return unless, under the circumstances, it is clearly prudent not to do so; and c) discharge the duties solely in the interest of and for the benefit of the funds forming the unified investment program. Purchase Price Multiple Private Investments The enterprise value of a company divided by the company s EBITDA Real Estate Classes Real Estate Core: Lower risk; considered the best quality holdings such as prime commercial property in major metropolitan cities that have low leverage and low levels of vacancy. Value-Add: Moderate risk, non-core; property that generally already has some form of in-place cash flow which investors are seeking to increase by making improvements or repositioning the property. Opportunistic: Higher risk, non-core; these properties tend to need more significant alterations and rehabilitation to realize their full earning potential. These properties generally have a higher vacancy rate, include higher levels of leverage, and can include ground-up development. Rebalancing Risk Management The action of buying or selling assets to realign the asset weights to meet the target portfolio. Resolution BOI/Gov t Specific A formal and written action by an organizational body that has long-term significance and requires a vote from the governing body. BOI uses resolutions mainly for its most significant and long-term actions and/or policies. Risk Tolerance Risk Management An investor s ability to handle declines in the value of their portfolio. Russell US Indexes Public Equity A family of global equity indices from FTSE Russell that allow investors to track performance of market segments. S&P 500 Index The Standard & Poor s market index based on the market capitalizations of the 500 largest companies which have common stock listed on the NYSE or NASDAQ. The weightings are determined by S&P Dow Jones Indices. SABHRS Accounting Stands for the State Accounting, Budgeting and Human Resource System. By statute, BOI investment and other financial data must be reported through this system, which is the State s official accounting book of record. 8

101 Sector An area of the economy in which businesses share the same or related product or services, e.g. an economic sector. This can also refer to a group of securities that exhibit similar characteristics. See Global Industry Classification for examples. Separately Managed Account (SMA) Represents a portfolio of assets specifically constructed according to the client s investment policy. Short Position A negative share or market value indicates a short position or sale of a borrowed security. Short Term Investment Pool (STIP) Used by state and local agencies and the retirement systems as an alternative to idle cash. STIP investments are short, highly liquid and among the safest obtainable as it is structured like a money market fund. Speculation Public Markets Involves investors making bets on future market conditions or events and is used when an investor hopes to increase profits. Compare to Hedging. Spread (Yield Spread) Fixed Income A measurement of the difference between yields. A higher spread indicates greater uncertainty of repayment and can allow for increased gains or losses. Standard Deviation Measures the dispersion or spread of a dataset compared to its historic mean. In finance it can be applied to the annual rate of return of an investment. It sheds light on the historical volatility of that investment. The greater the standard deviation of a security, the greater the variance between each price and the mean. Tail Risk Risk Management Describes portfolio risk when the return is (generally) more than two standard deviations from the mean. The tail risk probability is towards the far left or far right of the normal distribution curve pictured above and has a small chance of occurring (the returns during the Great Recession was considered a five standard deviation event). Lefttail risk is associated with negative returns while right-tail risks are associated with positive returns. TED Spread Fixed Income The difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills"). TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract. TIPS Fixed Income Treasury Inflation Protected Securities (TIPS) are Treasury bonds that are indexed to the Consumer Price Index to protect investors from the negative effects of inflation. Total Return The return on an investment including appreciation or depreciation, interest, dividends, and fees in the price of a security over a given period. Tracking Error The divergence between the price change of a position or a portfolio and the price change of a benchmark. Trust Fund Investment Pool (TFIP) TFIP is managed with the primary focus of generating income. Underweight Public Markets A security s portfolio weight that is less than or underweight the security s weight in the underlying benchmark. Can also be used to describe the relative composition of a portfolio such as underweight a sector or industry. Compare to equal weight or overweight. Underwriter Fixed Income The agent who buys investments to be resold to the public. At BOI this would generally be the investment firm that buys the Board s bonds to be resold to the public. 9

102 Unified Investment Program Financial Statements Accounting The program in the State s constitution requiring a central investment program which the legislature has assigned to the BOI. Upside Capture Ratio During an up market, the upside capture ratio shows how well a portfolio performed compared to its benchmark. It is shown as a ratio with a value above 1 being preferred as it indicates the portfolio beat the market by outperforming. Compare to Downside Capture Ratio Venture Capital Private Investments Money that is provided to seed early-stage, emerging growth companies. Venture capital funds invest in companies in exchange for equity in the companies they invest in. Vintage Year Private Investments The first year in which capital is drawn to fund an investment. Volatility The degree of variation of a price series over time as measured by the standard deviation of returns. Historic volatility is derived from time series of past market prices. An implied volatility is derived from the market price of a market traded derivative (in particular an option). Waterfall Type Private Investments The waterfall type describes how a private equity fund will make distributions to its LPs and GP. European Waterfall: Payment schedule where distributions are based off of how well the fund as a whole has performed. Deal-by-Deal Waterfall: Payment schedule where distributions are made on a deal-by-deal basis instead of on performance of the whole fund. Weighted Average Maturity (Life) Fixed Income Measures of how quickly the outstanding principal will be repaid. The higher the number the longer it is expected to take for the debt to be paid. Yield Curve A curve that plots the prevailing yield for bonds at different maturities. Curves generally slope upward because longer maturities require a higher interest rates to compensate for the added risk of holding an asset for an extended period. The graph below is a representation and not up to date. Yield to Maturity The yield anticipated on a bond or portfolio if it is held until maturity and all coupon payments are reinvested at the YTM. Fixed Income 10