OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OH PERS (7377)

Transcription

1 OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OH PERS (7377) MEMORANDUM DATE: July 5, 2007 TO: FROM: CC: RE: OPERS Retirement Board Members Chris DeRose - Executive Director Greg Uebele, Senior Investment Officer - External Management Tom Sherman, Government Relations Officer Julie Becker, General Counsel Jennifer Hom, Director - Investments Cal Hamrick, Assistant Director - Communications Anti-Terrorism Policy Purpose The Board directed staff to draft a policy addressing investments with ties to terrorism, including the countries of Iran and Sudan. This memo describes the background, considerations and next steps for completing this policy effort. Staff will discuss this at the July Investment Committee meeting and welcomes feedback from the Investment Committee. Background Staff has been working with legislators and the other Ohio retirement systems regarding Substitute House Bill 151 ( Bill - see Attachment A) for several weeks. The Bill would have mandated that OPERS divest certain investments in companies identified with business ties to Iran and Sudan ( scrutinized companies ). Through extensive deliberations, the Executive Directors of the five Ohio retirement systems delivered a letter ( Letter - see Attachment B) to the Speaker of the Ohio House of Representatives. This Letter established that OPERS would:... commit to work with their Retirement Boards to expeditiously develop an investment policy consistent with the boards fiduciary duties, and with the intent of: divesting fifty percent of active, direct holdings in certain non-u.s. publicly traded companies doing business in Iran and Sudan, based on Sub. H.B. 151, by Dec. 31, 2007, and with the ultimate goal of full divesture from such holdings. During the June 20 Board meeting, the Board approved the following actions:

2 1. OPERS is opposed to any mandatory divestiture of holdings in companies as provided in the current version of Substitute House Bill 151, or any similar legislation, as such mandatory divestment is inconsistent with the Board s fiduciary duties to the membership. 2. The Board directed staff to draft a policy addressing investments in companies doing business in the countries of Iran and Sudan and any other countries that might be involved in terrorist activities for the board s consideration. In order to effectively coordinate the development and implementation of the policy, staff has created a working group consisting of members from the Legal, Government Relations, Investments and Communications divisions. Policy Considerations There are many facets to a policy regarding investments in companies with ties to terrorism and staff has identified several for consideration as we work toward creating an associated policy. At the August Investment Committee meeting, staff will present additional information on how these considerations may be addressed through a policy. Substitute House Bill Sponsor Objectives Through the discourse over the last several weeks, the Bill sponsors have presented many arguments for the Bill. The Board has approved two actions as noted above and this memo will not revisit the merits of the Bill. It may prove useful as we consider a policy however, to reflect on what staff perceived are the two main sponsor objectives. 1. The Bill sponsors have argued that the retirement systems are unaware of the significant risks that investments in companies with business ties to regimes supporting terrorism pose and that the retirement systems are not managing these risks effectively. 2. The Bill sponsors believe that by divesting of these assets, the companies will restrict their activities with these regimes thereby pressuring the leaders in these countries to refrain from supporting terrorism. Laws and Fiduciary Duty At the August Investment Committee meeting, staff will provide an overview of applicable U.S. and international laws regarding investments in countries identified as sponsors of terrorism. Staff will also provide information on the process for compliance with these laws. Through the noted actions, the Board has reaffirmed the commitment to maintaining the integrity of the fiduciary duty standard. Staff will include appropriate fiduciary duty requirements in the policy. Scope The Letter applies to the Defined Benefit and Health Care funds, but not the Defined Contribution Fund. The Letter further states that the scope of our policy includes active, direct holdings in certain non-u.s. publicly traded companies doing business in Iran and Sudan. This corresponds to any non-u.s. public stocks and bonds held through our enhanced index or active internal and external separate accounts as shown in Table 1. This list is subject to the final policy and associated screening criteria, but it shows that the scope may encompass screening 23 Page 2 of 5

3 portfolios consisting of $25.4 billion. This represents approximately 30.7% of the total $82.8 billion in assets in the Defined Benefit and Health Care Funds as of May 31, Table 1. Active, Direct Portfolios of Non-U.S. Public, Stocks and Bonds Subject to Company Screening ($ millions - unaudited as of May 31, 2007) Non-U.S. Equity Global Bonds # External Managers Assets # Internal Managers Assets 1 Acadian ACWIF $432 1 Internal Core $11,808 2 Acadian Emerging Market $204 2 Long Duration Bond $3,552 3 Acadian Small Cap $633 Sub-Total $15,360 4 Alliance Bernstein $1,567 5 Boston Company $275 # External Managers Assets 6 Brandes $1,628 1 AFL CIO $97 7 JP Morgan Fleming $743 2 Cap Guardian Emerging Market $291 8 LSV $382 3 Fort Washington Investment Advisors $111 9 QMA $297 4 Goldman Sachs High Yield $ T. Rowe Price $208 5 Post Advisory Group $ TT International $749 6 Pyramis Core Bond $ Walter Scott Partners $806 7 Shenkman High Yield $290 Sub-Total $7,924 8 Smith Breeden $341 9 Stone Harbor Emerging Market $240 Sub-Total $2,131 Total = $25,415 While the discussion about the Bill has largely focused on terrorism, it contains other specific screening criteria including government contracts, genocide, capital expenditures, and revenues from oil, mineral extraction, military equipment and power generation. The scope of the screening criteria will be addressed as we develop the policy. During the last several weeks, staff has been presented with many different lists of scrutinized companies. Most recently, staff reviewed a list of 74 scrutinized companies and identified holdings in 28 of those companies with a value of $369 million as of December 31, 2006 as shown in Table 2. This information was reported to the Ohio Retirement Study Council on June 20. It is important to note that this list of holdings was not generated from screening criteria developed by OPERS and is only indicative. The OPERS holdings also vary with time and may be different at this time or in the future. Table 2. OPERS Direct Holdings on a Scrutinized Companied List as Reported to the Ohio Retirement Study Council Market Value (USD) Market Value (USD) # Company Name As of December 31, 2006 # Company Name As of December 31, ABB Ltd. $31,845, Norsk Hydro ASA $19,925,557 2 Acs, Actividades de Construccion y Servicios S.A $340, Oil & Natural Gas Corporation Ltd. $3,812,184 3 Aggreko PLC $1,309, OMV AG $5,935,316 4 Alcatel Lucent $40,575, Petrochina Company Limited $4,911,160 5 BASF AG $9,063, Petronas Dagangan Bhd $65,638 6 CHC Helicopter Corp. $674, Petronas Gas Bhd $102,235 7 China Petroleum & Chemical Corp. $11,896, Reliance Industries Ltd. $2,736,943 8 Credit Agricole SA $28,982, Repsol Ypf SA (Formerly Repsol, S.A.) $12,839,935 9 Electricity Generating Public Company (EGCO) $505, Rio Tinto plc $22,517, ENI Spa $52,918, Rolls-Royce Group plc $10,484, Linde AG $278, Royal Dutch Shell PLC $19,192, Lukoil Oao $8,206, Sasol Ltd. $2,393, Mitsubishi Heavy Industry Ltd. $86, Sembcorp Industries Limited $1,984, Mitsui & Co. $22,123, Total SA (Formerly Total Fina Elf S.A ) $53,496,540 Total $369,203,521 Page 3 of 5

4 Risk and Returns OPERS manages investment risk through well defined policies and guidelines at four levels: asset allocation, asset class, portfolio and security selection. This framework is designed to manage investment risk relative to well established asset class benchmarks that encompass macro and microeconomic risks while allowing sufficient flexibility to manage the assets for optimal risk-return tradeoffs. Macroeconomic factors affect all securities and include aggregate supply and demand, interest rates, currencies, taxes, trade policies, geopolitics, demographics and regulations. Microeconomic factors affect specific investments and include sector trends, balance sheet risk and other company specific risks. These macro and microeconomic risks, including specific risks such as terrorism, are managed in the aggregate through the asset allocation, asset class, portfolio and security selection framework. If the policy leads to divestment of assets that are in benchmarks for our asset classes or portfolios, the associated tracking error, or volatility, of returns relative to the benchmarks will be higher. Additionally, we do not know at this point if there are comparable replacement holdings that offer the same quality, return and safety to those that may be subject to divestment. While some effort has been made to review historical returns of portfolios with and without scrutinized companies, there is no way of knowing the forward looking opportunity costs of divesting scrutinized companies. Thus, divesting scrutinized companies is expected to result in incrementally higher tracking error with the possibility of no additional return. The policy may compensate for this risk-return tradeoff by reviewing the benchmarks and tracking error. Additionally, the Bill included a stop-loss provision whereby a retirement system could cease all divestment activities if losses approached 0.50% of all assets under management. We may consider a similar stop-loss provision in a policy to mitigate risk. Transition Costs The round trip transition costs for divesting assets is estimated at basis points ( %) for large capitalization stocks and these costs may be higher for smaller or emerging market assets. Although the holdings in Table 2 are not confirmed as current scrutinized companies, applying the transition costs to the $369 million results in a cost of approximately $750,000 to $1,300,000. The transition cost is subject to a number of factors including timing, liquidity and market conditions and the cost might be slightly higher if divestment is required in a short time frame. Engagement vs. Divestment The Bill sponsors have argued for an active divestment approach to achieve their desired outcomes as noted above. However, a process of actively engaging companies with ties to terrorism, including Iran and Sudan, may prove equally effective while minimizing tracking error risk and transaction costs. If the Board pursues an engagement approach, Corporate Governance may have a role in the development and implementation of the policy. Page 4 of 5

5 Implementation The Bill identifies several criteria for consideration with regard to investments in companies with ties to terrorism in Iran and Sudan. Staff will discuss these criteria at the August Investment Committee meeting. At this time, staff expects to engage a vendor to provide company screening services to periodically evaluate our associated holdings for investments in companies with ties to terrorism. Staff is gathering quotes from company screening vendors and will provide an update at the July Investment Committee meeting. Once the list of scrutinized companies is established, staff expects to implement any associated divestment actions through investment management agreement amendments with external managers and amendments to portfolio guidelines for internal portfolios. Staff anticipates that periodic reports will be generated identifying the scrutinized companies and providing a status of associated engagement or divestment. These reports will likely be presented to the Investment Committee and/or Board, legislative leadership and the Ohio Retirement Study Council. Coordination with systems Staff is continuing to coordinate these activities with the other four retirement systems that signed the Letter. OPERS is not obliged to have the same policy as the other systems, but certain aspects may be standardized in order to facilitate consistent reporting to the Ohio Retirement Study Council. Communications The topic of divestment from scrutinized companies has already drawn widespread attention from legislators, press, members of OPERS and other interested parties. Staff will continue to coordinate these activities and further communications details may be provided through the Legislative and Executive Director reports to the Board. Next Steps Staff will incorporate feedback from the Investment Committee and continue to move forward with the effort to establish a policy regarding investments in ties to terrorism as shown in the timeline in Table 3. These efforts will continue to be coordinated within OPERS, with the other four retirement systems and Mercer Investment Consulting. Further information including a draft policy framework will be presented at the August Investment Committee meeting. Table 3. Timeline for Policy Completion July August September Item July Investment Committee Discussion Draft Policy August Investment Committee Discussion Select Company Screening Vendor Create List of Scrutinized Companies Prepare Manager Amendments Revise Draft Policy September Investment Committee Discussion Final Policy Prepare Procedures Implement Policy Subject to change. Page 5 of 5

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34 Attachment B