The new asset allocation took effect on July 1, 2014 coinciding with the beginning of the 2015 fiscal year and involved the following changes:

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1 This memo is intended to memorialize the decision made by the SDCERA Board of Trustees to change the SDCERA Policy Asset Allocation effective July 1, Beginning in 2009, the SDCERA Board of Trustees revised its asset allocation strategy to increase the expected return per unit of risk while also diversifying the portfolio in order to help assure consistent returns across a wide range of economic outcomes. This decision was largely driven by the investment performance during the financial crisis where the plan lost 38.29%. The premise of the investment approach is to allocate across different asset classes in such a way that each of them matter but none of them matters too much. Said another way, in order to diversify, a multitude of asset classes is needed; however, no individual asset class should have any outsized influence on the portfolio s return. This concept, often called Risk- Based Investing, focuses on using risk contribution as the primary allocation tool rather than the more conventional method of allocating dollars. In early 2014, SDCERA completed an asset-liability and asset allocation study to examine the effectiveness of the Fund s investment strategy and use of leverage. While this allocation proved to be beneficial to the County (net returns since 10/1/09 of 9.66% versus the blended actuarial rate of return of 7.90%), the Board still thought it was prudent to conduct a review of its investment policy. Over the last several years, the Board has found the merits of a risk-based asset allocation policy to be appealing, and on April 17, 2014, the SDCERA Board of Trustees unanimously approved a recommendation for a new asset allocation that was derived from the input of the Portfolio Strategist, General Consultant and Specialty Consultants along with SDCERA s CEO, Director of Private Markets, Investment Officers and other staff. The new investment approach involved adding a dynamic, risk-based component that recognizes the impact of outside forces on asset class volatility and correlations. In actuality, the new asset allocation is a minor adjustment versus what was previously in place, and under most economic conditions, the two approaches are expected to produce similar results. However, while the previous allocation offered diversification across a wide range of economic scenarios, it lacked a dynamic component with the ability to adapt to changing economic environments or regimes where the relative impact of surprise growth, inflation or changing sentiment can dominate other return drivers. The Board considers a more dynamic, risk-based approach to be particularly relevant in today s environment of historically low interest rates, high equity multiples and the transition from extraordinary monetary stimulus to more normal monetary policy. Furthermore, within this

2 structure the use of leverage becomes a more flexible tool that will be more easily identifiable within one component of the portfolio and will vary considerably based upon expected economic conditions. In addition to the changes mentioned above, the implementation framework behind the new asset allocation strategy could potentially yield over $19 million in fee savings annually, primarily due to a reduced allocation to higher fee hedge funds from to 5% and via the direct implementation of Risk Parity and Trend by Salient at no marginal cost to participants. New Allocation Overview The new asset allocation took effect on July 1, 2014 coinciding with the beginning of the 2015 fiscal year and involved the following changes: Elimination of the allocation to US TIPS Reduction in the allocation to Reduction in the allocation to US Reduction in the allocation to Alternatives - Hedge Funds Increase in the allocation to Managed Futures Strategies - Trend Creation of an allocation to Private Credit Creation of an allocation to Dynamic Strategies - Risk Parity The reduction in both the Equity and US Bond allocations should be interpreted in conjunction with the exposure to these asset classes within the Risk Parity component, which invests in both equities and bonds. Moreover, the addition of Risk Parity and the reduction of the Equity and US Bond allocations effectively removes the explicit leverage target (total exposure of 135%) and instead isolates the leverage in a more focused and diversified manner within the Risk Parity sleeve. The Board understands that the plan must take some amount of market risk to achieve its target return and that its primary objectives are to establish the risk target for the investment program and determine the asset allocation strategy that maximizes the expected return at that level of risk. The Board also understands that different asset classes behave differently in different economic and geopolitical scenarios; therefore, the portfolio must be diversified across multiple asset classes to minimize the probability of experiencing large drawdowns (losses).

3 The following table highlights the asset classes and sub-asset classes along with a description of the role and investment rationale of each of the portfolio components. Asset Class Sub-Class Investment Rationale Equity Credit Diversifying Assets Real Assets Dynamic Strategies Public Equity Private Equity High Yield Credit Private Credit US Treasuries Local Emerging Market Debt Managed Futures/Trend Hedge Funds and Relative Value Private Real Estate Other Private Real Assets Risk Parity (15% Volatility) Assets that are expected to do well when GDP is positive and inflation remains within expectations. The ideal environment is one in which valuations are reasonable and corporate earnings have positive momentum. Assets that are expected to generate a positive carry in most markets, enhancing and diversifying returns at lower expected volatilities. Assets that are expected to generate a modest return in most markets but will provide safety during periods of equity market stress. Intended to take advantage of inflation risk premia embedded in both fixed income and foreign exchange markets associated with developing economies. Seeks to extract cross-market momentum as a behavioral factor that has a positive expected return with low to negative correlations with traditional risk factors. Strategies that are utilized to access uncorrelated return streams via active managers who are perceived to have skill in navigating any market environment. Financial assets and real assets that are expected to respond positively to either the current level of inflation or changes in the rate of inflation. Investment strategies that are rules-based and are designed to adapt risk exposure to, Credit, Rates and Commodities as market risk evolves over time. SDCERA s current long-term investment objective is to achieve an annualized compound growth rate of 7.75% over a multi-year market cycle. As stated above, the portfolio will be diversified across many asset classes in an attempt to minimize the probability of large losses. It is important to avoid these losses for two reasons. First, the return required to maintain and/or improve the funded status of the Trust remains 7.75% regardless of whether the market is down. Second, the return required to make up a loss is always bigger than the loss itself. By way of illustration, if the portfolio experienced a 10% loss in any given year, it would require a corresponding gain of 29% the next year to be back on target with the 7.75% assumed rate of return. Scenario 1 Scenario 2 Beginning Value Year 1 Year 2 Period Return 7.75% 7.75% Portfolio Value $100 $ $ Period Return -10% 29% Portfolio Value $100 $90 $116.10

4 The Board believes that a balanced portfolio requires both breadth (large number of independent return streams) and diversification (each return stream contributes proportionately to total portfolio risk). In order to achieve these concepts, an investment portfolio must have a dynamic component that can adapt to varying market environments over time. The new asset allocation is expected to achieve these objectives by combining traditional asset classes with a dynamic risk-based allocation approach (Risk Parity) that will balance risks across major asset classes and will maximize the return per unit of risk over a full market cycle. The table below illustrates the prior and new asset allocation along with a brief explanation of rationale for any changes. Asset Class Sub-Class Prior Allocation New Allocation Rationale for Allocation Change Global Equity - The constraint between an explicit allocation to Global Developed and Emerging Market 20.0% was removed allowing investment discretion to tactically vary across these markets as market trends Global Developed Equity 20.0% - dictate. The 5% reduction in equities will be offset by the allocation to both Risk Parity and Trend. Risk Equity Emerging Market Equity 5.0% - Parity could have -10% to 1 of its allocation in equities, and Trend could have -80% to 200%, which Private Equity 10.0% when combined with the long-only allocations, can result in greater tactical changes to the total portfolio 10.0% exposures. Total Equity 35.0% 30.0% High Yield Credit 5.0% 5.0% The addition of Private Credit is intended to participate in credit-related instruments that are often characterized by higher yield, greater seniority, enhanced loan covenants or a combination of those Credit Private Credit - 5.0% characteristics vis-à-vis public market alternatives. Total Credit 5.0% 10.0% US Treasuries 40.0% 5.0% The reduction in Diversifying Assets was primarily driven by the addition of Risk Parity along with the desire to invest Fund assets in a more fee efficient manner. The reduction in both US Treasuries and Local Local Emerging Market Debt 10.0% 5.0% Emerging Market Debt will be offset by the allocation to Risk Parity that will have significant exposure to Relative Value Strategies 10.0% - both of these return streams. The reduction in Macro Strategies and Relative Value Strategies (often Diversifying referred to as hedge funds ) is expected to reduce annual fees by ~$10 million. The new allocation Assets Macro Strategies 10.0% - combines the two previous categories and lowers the explicit exposure from to 5% of Fund assets. Hedge Funds & Relative Value - 5.0% Additionally, a new category Managed Futures/Trend was created to increase exposure to these Managed Futures/Tend - 5.0% systematic strategies that have desirable and unique diversification benefits. Total Diversifying Assets 70.0% 20.0% Private Real Estate 10.0% 10.0% The Real Assets portion of the Fund has remained largely unchanged. US TIPS have been eliminated in favor of other asset classes we view to possess more productive inflation protection. Real Assets Other Private Real Assets 10.0% 10.0% US TIPS 5.0% - Total Real Assets 25.0% 20.0% Dynamic Risk Parity (15% Volatility) Risk Parity is not an "asset class" but rather a strategy that invests across the asset class spectrum in % proportions that vary depending on risk measures. This risk-based strategy targets a constant volatility, Strategies Total Dynamic Strategies % which we expect to generate more consistent returns over time % 100.0% Dynamic Asset Allocation Strategies The new asset allocation will have allocated to Dynamic Strategies. These strategies use an alternative approach to asset allocation by allocating on the basis of risk versus dollars. Under a traditional dollar weighting scheme, the distribution of total risk is highly skewed in favor of equities. Market environments change, and as a result the correlation among the asset

5 classes (how these assets interact) changes as well. This phenomenon is why traditional diversification can fail, often when investors need it most. Risk Parity addresses this problem by employing an approach that targets a constant risk contribution from the various portfolio components. In order to accomplish this, Risk Parity portfolios use a rules-based process that incorporates recent market data and then adjusts the dollar allocation to its individual components to keep the portfolio risk in balance. The graphic below illustrates how a Risk Parity portfolio that consists solely of stocks and bonds differs from the traditional 60% stock and 40% bond portfolio both in terms of risk and dollar weightings. Traditional 60% Stock & 40% Bond Portfolio Dollar and Risk Allocation Dollar Allocation Risk Allocation 40% 3% 60% Risk Parity Stock & Bond Portfolio Dollar and Risk Allocation Dollar Allocation 16% 16% Risk Allocation 97% 50% 50% 84% 84% 50% 50% As mentioned above, Risk Parity targets risk contribution instead of dollar allocation. Of the many asset classes that are part of risk parity, the interest rates component (i.e. bond exposure) has historically had the lowest volatility (risk). Therefore, in order for Risk Parity to achieve an equal risk contribution from the interest rates component, the strategy must employ leverage such that there is a much larger dollar allocation to interest rates versus equities and other

6 components in the portfolio. This means that the gross notional exposure to Risk Parity could be significantly higher than the dollar allocation to the strategy itself. Momentum/Trend Strategies Momentum or Trend strategies employ a rules-based approach that is responsive to market changes and invests across equities, commodities and interest rates via exchange-traded futures contracts. The strategies objective is to buy (buy long) or sell (sell short) these assets based on recently observed return momentum. The primary benefit of trend strategies is that they tend to exhibit low to negative correlation to equities and other components within the SDCERA portfolio, most notably when those components are falling in value. This has the benefit of potentially lowering the total risk of the SDCERA portfolio and reducing the depth of some types of drawdowns. These strategies utilize leverage, and similar to Risk Parity, the resulting gross notional exposure can be higher than the invested dollar allocation. Total Fund Risk Contribution Risk Parity allocates across equities, rates, credit and commodities and also incorporates a momentum sleeve. Risk Parity Dollar and Risk Allocation Dollar Allocation Risk Allocation Stocks Momentum 10.5% Commodities Momentum 9.8% 35.2% Stocks 26.6% Credit Commodities Credit 17.9% Rates Rates A dollar allocation to Risk Parity will potentially increase the positive risk contribution from equities, commodities and credit from their previous levels. In addition, it will potentially increase the negative (i.e. more diversifying) risk contribution of rates exposure. As displayed in the chart below, equity-related assets represent the largest risk exposures for the Fund but are significantly lower than more traditional allocation options (which are closer to 90%). The biggest increase in risk contribution for the new policy versus previous policy is to the Other Real Assets component of the portfolio, which increases from 13% to 23%. That increase is

7 offset with a decrease to the hedge fund risk allocation from 15% to 8% and a modest decrease in rate-sensitive fixed income, which falls from a -2% to -4% risk contribution. Risk Contribution 1 100% 80% 60% 40% - Previous Policy vs. New Policy - Risk Contribution Analysis 8% 15% 3% 3% 23% 13% 3% 24% 22% 10% 10% 37% 38% -2% -4% Hedge Funds Real Estate Other Real Assets Private Credit Public Credit Private Equity Rat es - Previous Policy New Policy * * Includes the risk contribution of the equity, rates, credit and commodity exposures within the Risk Parity allocation. The incorporation of a risk-based allocation also separates the asset allocation decision from the amount of risk employed in a portfolio. Under a traditional asset allocation framework, investors typically make an important tradeoff decision that centers on diversification versus risk and associated returns. Most investors reject more diversified asset allocation strategies because they operate with too little risk and expected return to achieve portfolio return objectives. Through the use of flexible leverage, an investor may maintain the desired level of diversification while separately determining the desired level of risk. Without this tool, investors must concentrate their portfolio in riskier asset classes to achieve return objectives associated with higher portfolio volatility levels. The chart below illustrates that, over the next 10 years, most asset classes are not forecasted to achieve SDCERA s actuarial rate of return assumption in their native, unlevered form. Applying leverage to equalize the risk of these asset classes has the effect of raising the expected return of most of these asset classes to a level that exceeds SDCERA s actuarial rate.

8 Wurts & JPM 10-Year Asset Class Return Forecasts US TIPS Natural Resources and ORA Private Real Estate US 3 Month Bills/Cash Asset Allocation Strategies Emerging Market Debt Private Equity High Yield Fixed Income/Credit Emerging Market Equity Public Developed Equity 0% 2% 4% 6% 8% 10% 12% Wurts JPM The combination of portfolio diversification and prudent use of leverage effectively increases the efficiency of the portfolio by increasing the expected rate of return while operating at the same level of portfolio volatility or risk. This improvement in risk-adjusted returns is one of the primary tools considered by the Board to maximize the probability of achieving the actuarial assumed rate of return.