TEACHERS RETIREMENT BOARD. INVESTMENT COMMITTEE Item Number: 7 CONSENT: ATTACHMENT(S): 2. DATE OF MEETING: February 3, 2016 / 30 mins.

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1 TEACHERS RETIREMENT BOARD INVESTMENT COMMITTEE Item Number: 7 SUBJECT: Chief Investment Officer s Report Open Session CONSENT: ATTACHMENT(S): 2 ACTION: INFORMATION: X DATE OF MEETING: / 30 mins. PRESENTER(S): Christopher J. Ailman POLICY The Chief Investment Officer s Report Open Session is covered under the reporting and monitoring requirements of the overall CalSTRS Investment Policy and Management Plan, Teachers Retirement Board Policy Manual, Section 1000, page A-16. HISTORY OF THE ITEM This item has been included in the Investment Committee agenda at each meeting to provide the committee with critical market and asset allocation information to assist in their oversight of the CalSTRS Investment Portfolio. The most current information on the CalSTRS Investment Portfolio can be found on the web at CalSTRS.com under Investments. PURPOSE The purpose of this report is to provide the committee key bits of information regarding the asset allocation and performance or activities of the investment portfolio. Investment portfolio asset allocation as of December 31, 2015 (un-audited) Pension Consulting Alliance s December 2015 Risk Overview REPORTS ON THE WEB Annual and Quarterly investment reports are now available on CalSTRS.com web site in the Investments tab under Reports & Surveys. CONCLUSION In addition to this information, at the Investment Committee meeting, the CIO will present a PowerPoint presentation on current market conditions and global risks on the horizon. Prior to the meeting, the PowerPoint presentation will be posted on the CalSTRS.com website. INV18

2 Attachment 1 Investment Portfolio & Risk Dashboard Chief Investment Officer s Report As of December 31, 2015 Assets of $ est. Billion Fixed Income 16.2% Real Estate 13.9% Cash 2.3% Inflation Sens. 0.9% Abslt Rtn. 1.8% Global Equity 55.7% Private Equity 9.2% FYTD Asset Allocation over the past three years (Monthly data) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% INV19 Page 1 of 3

3 Pension Consulting Alliance Risk Overview as of December 2015 INV20 Page 2 of 3

4 PCA risk dashboard December 2015 Three asset classes remain at unfavorable pricing levels. These two risks are outside their historic levels, one high and one low. INV21 Page 3 of 3

5 Investment Committee Risk Report As of November 30, 2015 INNOVATION & RISK INV22

6 Overview This report is a regular attachment to the CIO Report. The purpose of this report is to provide the Investment Committee with useful information about the investment risk exposures in the total portfolio. Included in this report are analyses of two special topics: one analysis on the relationship between climate change, demographics and political instability; and another on the relationship between acts of terrorism and the economy. CalSTRS Total Fund Risk The Innovation & Risk team utilizes the BlackRock Aladdin risk management system for the total plan portfolio. This comprehensive view makes it possible to view common risks across the portfolio, including traditional metrics like sector and geography, along with exposures to risk factors such as global equity markets and volatility. According to the BlackRock risk model, approximately 66 percent of the total risk in the portfolio comes from public equity market risk, versus an approximately 56 percent asset weight. Public equity risk and private equity risk combined comprise about 79 percent of portfolio risk, a small decrease from 81 percent in August. Total Portfolio Risk Weights as of November 30, 2015 Total Portfolio Asset Weights as of November 30, 2015 INV23

7 CalSTRS Geographic Exposure Across all asset classes, the fund has significant exposure to the U.S. with approximately 75 percent of the portfolio invested in the U.S.; a decrease from 78 percent in August. The next-largest exposure is nearly 4 percent in the U.K. Economic growth and equity performance, particularly in the U.S., are the largest sources of risk in the portfolio. Total Portfolio Geographic Exposure as of November 30, 2015 CalSTRS Top 10 Exposures Exposure Market Value (000s) % Total Fund U.S. Government* 17,398, % Apple 2,027, % Alphabet (Google) 1,344, % Microsoft 1,301, % General Electric 1,052, % Exxon Mobil 970, % JP Morgan 845, % Johnson and Johnson 878, % Berkshire Hathaway 821, % Verizon 812, % Total Top 10 27,453, % *includes US Treasuries, Agency MBS and other government agency debt INV24

8 Public Equity Exposure Mkt Val % Public (000s) Equity Apple 1,995, % Alphabet (Google) 1,337, % Microsoft 1,262, % Exxon Mobil 964, % General Electric 938, % Johnson and Johnson 863, % Amazon 759, % Wells Fargo 725, % JP Morgan 696, % Facebook 688, % Total Top 10 10,231, % Fixed Income Exposure Mkt Val (000s) % FI U.S. Government* 16,716, % Bank of America 227, % Verizon 201, % Goldman Sachs 189, % Morgan Stanley 185, % Mexico Government** 168, % Citigroup 162, % Wells Fargo 158, % JPMorgan 144, % Comcast 132, % Total Top 10 18,288, % *US Treasuries, Agency MBS and other govt Agency debt ** PEMEX and Mexico Govt debt Private Equity Fund Mkt Val (000s) % of PE Blackstone Capital Partners V 1,054, % TPG Partners V 649, % Permira IV 458, % Providence Equity Partners VI 426, % First Reserve Fund XII 418, % TPG Partners VI 413, % Carlyle Partners V 369, % Apax Europe VII 348, % Advent International GPE VI 310, % Carlyle Europe Partners III 285, % Total Top 10 4,735, % Real Estate Manager Mkt Val (000s) % of RE Principal 3,076, % CBRE 3,016, % BlackRock 1,647, % Fortress 1,476, % Fairfield 1,280, % GI Partners 1,244, % Clarion 893, % PCCP 818, % Lionstone 788, % Waterton 679, % Total Top 10 14,922, % *as of 6/30/2015 INV25

9 Special Analysis: Climate change, demographics and political instability The effect of climate change on economic, social and political factors is complex. A recent paper suggests that climate change could lead to greater political instability and violence from social/political disruption 1. The key connection between climate change and political instability is based on climate change disruption of agriculture, which triggers rapid and disruptive rural-to-urban migration. There is a considerable body of "conflict research" exploring the causes and circumstances of state violence and political instability. In addition, climate change is not the first environmental issue presented as a possible source of political disruption 2. Combining some of the findings from these areas of research allow us to identify regions and countries that may be at a heightened risk of climate change-induced disruption. There are three key factors to consider when identifying higher risk areas: Demographics: A "youth bulge", or population that is disproportionately young relative to average. Historically, countries with a youth bugle are at greater risk of revolution and violence. It's important to note that a youth bulge alone is not a sufficient condition for violence. The presence of a youth bulge doesn't, ipso facto, lead to instability. Reliance on agriculture: The core assumption is that climate change will disrupt (negatively) agricultural production and lead to large rural-to-urban migratory flows. In order for such an urban migration to be meaningful, the country must have a greater-than-average reliance on agriculture in the economy Weak political institutions: Prior research found countries with relatively weak governance and political institutions, along with a poor economy, are at greater risk of political violence. This is particularly true in the presence of a catalyst such as urban migration (the risk is even further magnified if there's a youth bulge). The maps below highlight countries at greater risk of climate change-induced political disruption and violence. These countries have all of the key risk factors identified above: a youth bulge, a significant economic reliance on agriculture, plus relatively weaker governance and economic growth. Not surprisingly, much of Africa and portions of the Middle East are at greater risk. Perhaps more surprising is India, which has relatively better governance than the rest, but a high reliance on agriculture and a young population. We've also included a link to an interactive version below the map INV26

10 Special Analysis: Terrorism and risk of recession In light of recent attacks, we looked at the connection between terrorism and the economy to estimate the probability that a terror attack could negatively affect retail sales enough to cause a recession. To address this question, we used a large database of historical global attacks dating back to 1970 and the behavior of retail sales in the aftermath of attacks. The result is that we estimate a three to five percent chance that a terrorist attack will cause a recession. Our analysis focused on retail sales following nine events in the U.S., U.K., Spain, Norway and Japan. None of the nine attacks had a measurable effect on retail sales in the year following an attack. In September 2001, the month of the largest attack in our sample, retail sales were down considerably. However, sales rebounded strongly in October 2001, with no measurable effect within three months of the attack. The historical evidence suggests that the economy is robust to moderate to large attacks. Some of the reasons for a lack of effect are likely: the localized nature of previous attacks; the overall size and scope of the U.S. and global economy; and the fact that retail sales account for a relatively small 10 percent of U.S. GDP. INV27

11 Despite a lack of relationship between historical attacks and retail sales, it's important to account for the possibility that a future attack could significantly affect the economy. In order to estimate the probability that a terror attack will cause a recession, we need two key assumptions: The probability of different magnitude attacks The probability that a particular magnitude attack will cause a recession As a simple numerical example, suppose there is a 10 percent chance of a terrorist attack and a 25 percent chance that an attack, if/when it happens, will cause a recession. The probability that an attack will cause a recession is then 10 percent x 25 percent = 2.5 percent. In reality, different magnitude attacks probably have different likelihoods of causing a recession. The chart below shows a summary of our assumptions about the probability of different magnitude attacks and the probability that such an attack will cause a recession. When we combine these assumptions, we estimate a three to five percent chance of an attack causing a recession. Probability of Different Magnitude Attacks Probability of Recession After Attack INV28

12 Making small to modest adjustments to our assumptions about the probability of an attack or its effect on the economy change our estimate from three to five percent to about 7 percent. Our analysis focused on historical events and the likelihood they might cause a recession, but didn't address more detailed questions such as "what type of attack or scale of attack might be more likely to cause a recession?" The type of attack, number of victims, geographic dispersion, and scope of attack are all likely to be important factors in determining whether a particular event causes a recession. Market Volatility The volatility index presented in the two charts below is an indicator of general market turbulence. The red lines provide a threshold by which to judge whether a day is an "outlier" or not. The longer-term chart shows that, historically, periods of higher turbulence tend to cluster in time. The clustering of turbulent periods means that if a particular day is an outlier, the following day is much more likely to be an outlier. Several days in a row of outliers are a strong indicator that market turbulence could persist for many weeks or months. Since a burst of volatility surrounding the Chinese equity market, the past few months have seen very little turbulence. The second chart shows only one outlier since the "China volatility" in mid-late August. During normal periods, we would expect to see about five or six such outliers in a 90 day period. Despite tragic events in different parts of the globe, coupled with news headlines and increased volatility across markets, market turbulence is largely in the "normal" range. Market Turbulence - Long Term Market Turbulence - Recent INV29