Alternatives Investments: Striking the Balance Between Growth Tomorrow and Liquidity Today

Transcription

1 Alternatives Investments: Striking the Balance Between Growth Tomorrow and Liquidity Today NCPERS Annual Conference Session Dr. Ben Meng Senior Portfolio Manager and Head of Asset Allocation, California Public Employees Retirement System (CalPERS) Rafael Silveira Portfolio Strategist, Asset Management Solutions J.P. Morgan Asset Management Hank Kim Executive Director and Counsel, National Conference on Public Employee Retirement Systems Bob Parise Co-Head, Americas Defined Benefit Business J.P. Morgan Asset Management, Moderator FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

2 Agenda Introduction Review of survey results - Explores public plans interest in illiquid assets - Challenges and opportunities public pensions face when investing in illiquid assets Introducing the liquidity case study - Proposes a framework to measure public plan s capacity to hold alternative assets - Indicates which portfolios are better suited to deliver returns while controlling plan sponsor s contribution and liquidity risks Conclusions 1 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

3 A joint study A JOINT STUDY BETWEEN THE NATIONAL CONFERENCE ON PUBLIC EMPLOYEE RETIREMENT SYSTEMS (NCPERS) AND J.P. MORGAN ASSET MANAGEMENT EXPLORING PUBLIC PENSION PLANS AND LIQUIDITY ABOUT NCPERS: Largest trade association for public sector pension funds, representing more than 500 funds throughout the US and Canada Manage nearly $4 trillion in pension assets Principal trade association working to promote and protect pensions by focusing on Advocacy, Research and Education for the benefit of public sector pension stakeholders MOTIVATION BEHIND THE RESEARCH: OUR QUESTIONS What is the current perception of public pension fund towards illiquid assets and liquidity risk? How can managers measure plan s capacity to hold illiquid assets? Should public pension fund allocate more of its assets to alternatives? If so, how much? How to find a balance between long term liquidity issue and short term obligations? 2 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

4 Overview Main findings from the survey: Liquidity matters up to a certain degree and is not critical concern during crisis 72% of the respondents considering an increase in their alternatives allocation sometimes in the next three years Contrary to our view, >50% of the respondents believed that plan s allocation to alternatives should not be affected by funded status Our case study indicates that the average public pension plan is not facing an immediate liquidity threat, in which plan assets converge to zero and benefits cannot be paid Plans should focus on solvency issues rather than possible short term liquidity stress. To overcome solvency issues, portfolios should have higher allocation to alternatives, which in turn generates higher expected return 3 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

5 Survey Results 4 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

6 Survey results Respondents profile 40 public pension plans 29 local government pension plans 11 state pension plans 2.3 million active and retired members Liquidity: An important factor but not a paramount consideration Percentage of responses on a 1-5 scale on liquidity in selecting asset allocation strategy 7.5% Extremely important 5.0% Not important 22.5% Somewhat important Over $400 billion in total plan assets 66% median funded status 25.0% Very important 40.0% Important A significant portion of plans rebalance a couple of times a year Fraction of respondents indicating frequency of rebalancing 7.9% Less frequently than annually 18.4% Yearly 15.8% More frequently than quarterly 15.8% Quarterly 42.1% A couple times a year Liquid alts have aroused interest but so far little commitment Fraction of respondents indicating interest in liquid alternatives 12.5% I am already invested in such funds. 22.5% I need a better understanding of this fund category. 17.5% At this point, I am considering investing in them. 7.5% I am not aware of such strategies. 40.0% At this point, I am not planning to invest in them. Source: 2014 NCPERS/ J.P. Morgan Liquidity Survey. For illustrative purpose only. 5 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

7 Reviewing liquidity status and appetite for alternative assets Liquidity shortages were not a critical concern during Liquidity challenges faced by plans, % 90% 85% Respondents appetite for alternatives assets is significant Fraction of respondents considering higher allocation of illiquid asset in the next one to three years* 60% 53% Below median funded status Above median funded status 80% 70% 50% 47% 45% 60% 40% 35% 50% 40% 30% 20% 10% 0% Facing temporary asset allocation imbalances 31% Worrying about liquidity position 8% 8% Having to exit illiquid positions 23% Having to Facing contribute to the redemption gates plan 30% 20% 10% 0% 30% 26% 26% 25% 21% 15% Hedge Funds Real Estate Private Equity Private Debt Infrastructure 43% of the plans have 20% or more allocated to alternatives reported liquidity problems Only 27% of the plans have less than 20% allocated to alternatives reported liquidity problems 72% of the respondents consider an increase in their alternatives allocation sometime in the next three years Apparently, underfunded plans favor real estate s steadier return profile Source: 2014 NCPERS/ J.P. Morgan Liquidity Survey. For illustrative purpose only. 6 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

8 2015 NCPERS Annual Conference 1. What were CalPERS (liquidity) experience in and how relevant is liquidity when choosing an investment of vehicle? 7

9 2015 NCPERS Annual Conference CalPERS Liquidity Experience in Reduced Demands Security Lending On-loan Balances 2008 $ 33.9 B 2013 $ 10.8 B Committed (Undrawn) Capital 2008 $ 42.5 B 2013 $ 18.7 B Source: Liquidity Allocation Recommendation and Introduction to Treasury Management, CalPERS Asset Liability Management Workshop November

10 2015 NCPERS Annual Conference CalPERS Liquidity Experience in (Cont.) Management Changes Establishment of Investment Strategy Group Enhanced Communication Explicit liquidity management Collateral Management Internalized Radical risk reduction 2008: 23% matures < 30 days 2013: 90% matures < 30 days Source: Liquidity Allocation Recommendation and Introduction to Treasury Management, CalPERS Asset Liability Management Workshop November

11 2015 NCPERS Annual Conference Historic & Projected PERF Cash Flow Analysis Potential Shortfall Source: Liquidity Allocation Recommendation and Introduction to Treasury Management, CalPERS Asset Liability Management Workshop November

12 Liquidity Case Study 11 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

13 Introduction of the liquidity case study Profile of the typical plan 8% US Direct Real Estate (unlevered) 2% US Cash 2% US High Yield 4% US Private Equity 1% 2% World Ex-US Gov Bond 22% US Aggregate 8% Hedge Fund- Diversified Commodities 35% US Large Cap 17% Global Equity (unhedged) CASE STUDY ASSUMPTIONS Assets returns are stochastic Each asset class has a liquidity profile (availability) under normal market conditions and under stressed market conditions (i.e., after observing a 2009-like event) Each quarter the plan needs cash to make benefit payments and fulfill capital calls. It can raise cash from contributions, investment distributions and assets withdrawn from investments A liquidity stress occurs when available liquidity is less than needed liquidity, defined as the total of The payout Private market capital calls Severity is defined as the amount by which the liquidity needed exceeds the liquidity available Liquidity crises are assessed on a quarterly basis and the portfolio is rebalanced on a quarterly basis back to the Strategic Asset Allocation Asset size of $6.2 billion Annual combined participant/sponsor contribution of $373 million Benefit payments of $500 million Expected compound return 6.6% 1 Annualized volatility of 9.8% 1 Total allocation to alternatives of 20.5% Source: J.P. Morgan Asset Management. NCPERS survey. 1 Expected return on assets is compounded yearly. Both expected return on asset and annualized volatility are calculated based on 2014 J.P. Morgan Long Term Capital Market Assumptions. 12 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

14 Asset classes projected risk, return and liquidity profile 9% Exp Return 8% 7% 6% 5% 4% Full liquidity under all market conditions Average liquidity under normal markets and little liquidity under stressed markets US Direct Real Estate (unlevered) Hedge Fund-Diversified US High Yield US Private Equity Global Equity (unhedged) US Large Cap Normal Market Liq Little to minimal liquidity under all market conditions <20% Stressed Market Liq <20% 50% 50% 3% 2% US Aggregate World Ex-US Gov Bond (unhedged) US Long Treasury Commodities Asset Class 100% 100% 1% US Cash Fixed Income Equity Alternatives 0% -1% 4% 9% 14% 19% 24% 29% Exp Volatility Source: J.P. Morgan Asset Management. For illustrative purpose only. Return and volatility assumptions come from J.P. Morgan s 2014 Long-Term Capital Market Return Assumptions. The relative size of each bubble represents our estimate of the portion of assets that can be cashed out under normal scenarios. The shaded portion of each bubble represents the portion of assets that can be cashed out under stress scenarios- the closer the shading comes to a circle s outline, the more liquid asset class is under stress scenarios. To illustrate, in a normal quarter, based on the experience of the firm s senior portfolio managers, a plan could redeem 20% of its investment in the typical real estate fund. In the two-deviation event, the redemption value could fall to 10%. 13 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

15 Liquidity case study results Plan s asset value over the next 20 years Probability of solvency crisis and liquidity stress Projections for the plan s asset value over the next 20 years Yearly probability th 1.0% 0.9% 0.90% % $ Billion 10 75th 0.7% 5 50th 25th 0.6% 0.5% 0.52% th 0.4% Probability of Solvency Crisis Probabilty of Liquidity Stress The average public pension plan is not facing an immediate liquidity threat, in which plan assets converge to zero and benefits cannot be paid The lowest 5% of scenario returns of model plan could become insolvent by 2032 Plans should focus on solvency issues rather than possible short term liquidity stress To overcome solvency issues, portfolios should have higher allocation to alternatives, which in turn generates higher expected return Source: J.P. Morgan Asset Management. For illustrative purpose only. This framework projects a typical defined benefit pension plan s assets over the next 20 years (from 2015 to 2034) and across 10,000 asset return scenarios using J.P. Morgan s 2014 Capital Market Return Assumptions as inputs. We define a liquidity stress as the situation in which a plan while still technically solvent, faces an increased likelihood of insufficient liquidity to meet its quarterly obligations. This model calculates the possibility that a typical plan would find itself in any one quarter without enough cash to meet the next two years worth if benefit obligations. 14 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

16 Optimal portfolio allocation 100% 3.0 US Private Equity Original portfolio Asset Allocation 90% 80% 70% 60% 50% 40% 30% Investment Utility US Direct Real Estate (unlevered) Hedge Fund Diversified Global Equity (unhedged) Commodities US Large Cap World Ex US Gov Bond 20.5% Alternatives 27.5% Fixed Income 52.0% Equity 20% 10% 0.5 US High Yield US Aggregate Optimal portfolio 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% Total Allocation to Alternative Assets 0.0 US Cash Investment Utility (RHS) 35.0% Alternatives Accounting for tail liquidity risk, 35% allocation to alternatives would optimize average plan portfolio. The suggested public pension benefits from having a higher allocation to alternatives because the benefit of a higher asset return and lower long-term solvency risk exceeds the short-term risk of a liquidity crisis THE BENEFIT OF A HIGHER ASSET RETURN AND LOWER LONG-TERM SOLVENCY RISK EXCEEDS THE SHORT-TERM RISK OF A LIQUIDITY CRISIS The optimal allocation of 35% to alternatives reduces the risk of liquidity and solvency stress scenario by 9% 22.2% Fixed Income Source: J.P. Morgan Asset Management. For illustrative purpose only. To arrive at the optimal allocation, portfolios ranging from 0% to 100% alternatives allocations were run through Monte Carlo simulations, deriving return, volatility and liquidity risk for each calendar quarter over the next 20 years. We maintained the proportions constant within each asset class, so as we grew the alternatives allocation of the portfolio, we shrank the conventional allocations proportionately. Following the spirit of the original mean-variance optimization suggested by Harry Markowitz (Portfolio Selection, Journal of Finance, 1952), we maintain a linear functional form and extended it by introducing the liquidity risk factor. We defined investment utility as normalized return minus normalized volatility and liquidity risk. For simplicity we decided to have equal weights on each factor. These parameters can obviously vary given a plan sponsor s preferences or views. 42.8% Equity 15 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

17 2015 NCPERS Annual Conference 2. What do you think about the approach and does it make sense to measure liquidity risk in this way? 16

18 2015 NCPERS Annual Conference Step 1: Demands for Liquidity For a public pension fund, we identified the following six demands for liquidity: 1. Member benefits payment 2. Administrative expense 3. Payment to service providers 4. Capital calls 5. Margin calls 6. Dry powder to deploy during times of market dislocation Source: Ben Meng, (2013, Fall). Volatility and Beyond An Introduction to Liquidity at Risk, JOIM Conference. 17

19 2015 NCPERS Annual Conference Differentiating Demands for Liquidity 12 More Predictable 10 Members Benefit Payment Payments to Service Providers Demands for Liquidity Members Benefits Time Aspect (how advance) Months 8 Administrative Expense Administrative Expense Months Predictability 6 Capital Calls Payment of Service Providers Capital Calls Months 5 to 10 days 4 Margin calls 1 day 2 Less Predictable 0 Margin Calls Dry Powder to deploy during market dislocations 0 Less Negotiable More Negotiable12 Negotiability Dry Powder Depends on how long market dislocation lasts (months) Source: Ben Meng, (2013, Fall). Volatility and Beyond An Introduction to Liquidity at Risk, JOIM Conference. 18

20 2015 NCPERS Annual Conference Step 2: Supply of Liquidity For a public pension fund, we identified the following six liquidity supplies: 1. U.S. Treasury 2. Synthetizing equity exposure 3. Security lending 4. Line of credit 5. Issuing debt 6. Liquidating assets Source: Ben Meng, (2013, Fall). Volatility and Beyond An Introduction to Liquidity at Risk, JOIM Conference. 19

21 2015 NCPERS Annual Conference Differentiating Supplies of Liquidity 10 More Reliable 9 8 US Treasury Securities Synthetic Equity Exposure Supply for Liquidity Risks Time to Source US Treasury Low return T+1 day Synthetic Equity Exposure Leverage Basis Risk T+3 day Reliability 7 Liquidating Assets Security Lending Security Lending Line of Credit Leverage counter-party risk Leverage counter-party risk T+1 to T+3 days T+5 to T+10 days 6 Line of Credit Issuing Debt Leverage Months Less Reliable 5 4 Issuing Debt 0 More Time to Less Time to 12 Source Liquidity Timeliness Source Liquidity Liquidating Assets valuation Days to Months Source: Ben Meng, (2013, Fall). Volatility and Beyond An Introduction to Liquidity at Risk, JOIM Conference. 20

22 Conclusions 21 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

23 Conclusion: Handle alternatives potential with care Survey indicates that a significant portion of the plans have large appetite towards alternatives investment Our case study has shown that the average public pension portfolio may well benefit from a higher commitment to alternatives Increasing allocation to alternatives would reduce the risk of liquidity stress scenario as the enhance long term return from alternatives balance out reduced short term liquidity However, several things need to be considered regarding alternatives investment: Effective alternative investing demand more vigilant rebalancing Performance distribution among alternative managers embraces a wide dispersion of returns 22 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

24 Appendix 23 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

25 J.P. Morgan s asset class assumptions Asset Expected Arithmetic Return (%) Expected Compound Return (%) Vol % Available as immediate liquidity in regular period % Available as immediate liquidity in turbulent periods US Cash 2.0% 2.0% 0.5% 100% 100% US Long Treasury 4.1% 3.3% 13.5% 100% 100% US Aggregate 4.4% 4.3% 4.5% 100% 50% US High Yield 6.8% 6.0% 12.8% 75% 40% World Ex-US Gov Bond (unhedged) 3.6% 3.3% 8.3% 75% 50% US Large Cap 8.5% 7.5% 14.8% 100% 100% Commodities 5.3% 3.8% 18.5% 100% 100% Global Equity (unhedged) 9.0% 7.8% 16.8% 100% 100% Hedge Fund-Diversified 5.5% 5.3% 6.5% 50% 5% US Direct Real Estate (unlevered) 6.7% 6.0% 12.0% 20% 10% US Private Equity 10.1% 8.0% 22.0% 10% 1% Source: J.P. Morgan Asset Management. For illustrative purpose only. 24 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

26 J.P. Morgan s long-term capital market return assumptions Expected year annualized compound returns (%) 1,2 Rationale Inflation 2.25 Significant slack in the economy overall, elevated levels of unemployment, ongoing deleveraging, and firmly anchored market expectations will keep inflation low overall, Reflationary central bank policies create the risk for higher inflation Core Inflation 2.25 for the outer years of the projection horizon Real GDP 2.50 The cyclical picture continues to improve and economic momentum is improving, as secular challenges from an ageing population and rising entitlement costs become more pressing U.S. Cash 2.00 The Federal Reserve to keep policy rates on hold for an extended period and raise them only gradually thereafter. Real rates to remain low by historical standards. U.S. Intermediate Treasury Yield levels to stay contained in the near term before rising towards their higher equilibrium levels as monetary policy is eventually normalized. Dampened total returns due to both low income from the low level of yield and negative markto-market U.S. Long Treasury returns from rising rates. U.S. TIPS 4.75 TIPS to outperform nominal treasuries as longer-term expected inflation rises only moderately from current levels. U.S. Aggregate 4.25 U.S. Short Duration Gov t/credit 2.50 U.S. Short Duration Gov t/credit 4.75 Spreads are expected to narrow somewhat, but total returns should remain exposed to rising overall yields broadly in line with treasury rates; intermediate maturity securities benefit most from the curve roll-down. U.S. Investment Grade Corporate 5.00 U.S. Long Corporate 5.00 U.S. High Yield 6.00 U.S. Leveraged Loan (BB or better) 4.50 Any further reduction in default rates and spread narrowing will provide only limited protection to offset the mark-to-market pressure from rising Treasury rates. Income is expected to be the driver of returns. haircut World Government Bond (local) 2.75 Government bond yields to rise globally from current levels, leading to negative mark-to-market returns during the period where rates converge to equilibrium. Outside the U.S., countries are likely to experience a prolonged period of lower World ex-u.s. Government Bond (local) 2.50 rates and normalization due to slower economic growth World ex-u.s. Government Bond (hedged) 3.25 Higher U.S. cash yields compared to weighted average WGBI cash yields are expected to boost returns to U.S. investors. Emerging Markets Sovereign Debt (hedged) 6.75 Spreads have room to narrow, but total returns are at risk from rising U.S. Treasury yields given the long index duration. Emerging Markets Local Currency Sovereign Debt (unhedged) 7.00 Spreads are expected to narrow further, but total returns are expected to be constrained as overall yields rise with U.S, Treasury rates. Emerging Markets Corporate Debt (hedged) 6.25 Yields are expected to rise as inflation and real rates in emerging economies increase to their higher equilibrium levels over time. Total returns to largely driven by income. U.S. Municipal (1-15 Blend) 3.75 Spreads are expected to narrow further, but total returns are expected to be constrained as overall yields rise with U.S. Treasury rates. U.S. Large Cap 7.50 Sum of below building blocks (nominal earnings per share growth + dividend yield + price-to-earnings return impact). Total returns are expected to recover over the long term as the corporate sector out performs the domestic economy. U.S. Large Cap EPS Growth 4.50 Real corporate earnings growth remains robust as companies maintain cost discipline, while margins to drift gradually lower. U.S. Large Cap Dividend Yield 3.00 Dividend yield is expected to rise as companies favor payouts over new investment U.S. Large Cap P/E Return Impact zero Valuation multiples approach more recent historical averages. But upside is limited due to secular pressures and limited headline growth. U.S. Mid Cap 7.75 U.S. Small Cap 7.50 Mid Cap companies in particular are likely to benefit from acquisition activity by larger firms, especially given the significant cash build- up on large cap corporate balance sheets. U.S. Large Cap Value 7.75 U.S. Large Cap Growth 7.25 Value is expected to outperform growth given starting valuations and more favorable sector concentrations. Europe ex-u.k. Large Cap (local) 8.00 An earnings premium to nominal GDP is expected due to the large share of globally sourced revenues. Valuation to improve from depressed levels and dividend yields to rise moderately. Japan Large Cap (local) 4.75 Earnings to outperform the domestic economy given exposure to fast-growing overseas markets. Japan to remain a global underperformer given demographic challenges and the ongoing battle with deflation U.K. Large Cap (local) 8.25 An earnings premium to nominal GDP is expected given support from foreign-sourced revenues. Tolerance for higher inflation to keep valuations in check, but dividend yields are expected to rise moderately. EAFE Equity (local) 7.50 Market Capitalization weighted average of expectations for regional equity returns. EAFE Equity (unhedged) 7.75 Slight dollar depreciation against the weighted average of EAFE currencies is expected to boost returns to U.S. investors. Emerging Markets Equity (unhedged) 9.00 Asia ex-japan Equity (unhedged) 9.25 Overall more favorable demographics, policy flexibility and improved corporate governance should support long-run growth even with weaker economic fundamentals. Global Equity (unhedged) 7.75 Market capitalization weighted average of expectations for regional equity returns. U.S. Private Equity 5, Median manager returns assumed to be in line with mid cap equity. Sizeable divergence expected across private investments. U.S. Direct Real Estate (unlevered) 5, Appreciation of real estate assets lower initial property yields and low nominal GDP expectations reduce return expectation by 0.50% per annum from 2013 estimates. U.S. Value Added Real Estate (unlevered) 5, A real estate rick assumption between core and opportunistic, seeking to enhance cash flows, occupancy, and building renovation; historically has given a higher yield compared to core. European Real Estate (unlevered, local) 5, European real estate, with low nominal GDP growth, to produce muted return expectations. U.S. REITs 6.75 Solid REIT performance and a slight NAV premium to direct unlevered real estate results in REIT returns that are broadly in line with the real asset return. Global Infrastructure 5, Expectations for returns are based on continued interest in infrastructure cash flows with good visibility and the benefit of leverage for low rick bondable assets. Hedge Fund Diversified 5, Expected hedge fun returns are based on multi-variate regressions to public markets. A blend of emerging market, commodities, small cap and U.S. aggregate bond betas to be the main drive of median manager expected returns. Sizeable divergences are expected among managers. Hedge Fund Event Driven 5, Blend of emerging market, commodities, mid cap. Small cap, U.S. high yield and cash betas to be the main driver of median manager expected returns. Sizable divergences are expected among managers. Hedge Fund Long Bias 5, Blend of commodities, emerging market equity, and large and small cap betas to be the main driver of median manager expected returns. Sizeable divergences are expected among managers. Hedge Fund Relative Value 5, Blend of emerging market credit, commodities, U.S. and investment grade bond betas to be the main driver of median manager expected returns. Sizeable divergences are expected among managers. Hedge Fund Macro 5, Blend of commodities, emerging market equity, and cash betas to be the main driver of median manager expected among managers. Commodities (spot) Return expectation is based on the growth of nominal global GDP. Returns to be less robust, reflecting large supply/demand challenges. Gold (spot) 4.25 Expected return is based on the historical relationship with inflation expectations, the U.S. dollar and emerging markets. ALTERNATIVE/OTHER 2 EQUITY 2 U.S. ECONOMIC FIXED INCOME 2 INDICATORS * Data as of September 30, 2013, except hedge funds (diversified, event driven, long bias, and relative value) as of June 30, 2013 and hedge fund (macro) as of May 31, Return estimates are on a compound or internal rate of return (IRR) basis. Equivalent arithmetic averages, as well as further information, are shown on the following page. 2 All asset class assumptions are in total return terms, including equity return assumptions. All returns are in U.S. dollar terms unless otherwise indicated. 3 U.S. Intermediate Treasury returns based on Barclays Capital U.S. Treasury: 7-10 yr Index. 4 U.S. Long Treasury returns based on Barclays Capital U.S. Treasury: 20+ yr Index. 5 Private equity, hedge funds, real estate, infrastructure and commodities are unlike other asset classes shown above in that there is no underlying investible index. Hedge fund returns are shown net of manager fees. 6 The return estimates shown for these asset classes are our estimates of industry medians the dispersion of returns among managers in these asset classes is typically far wider than for traditional asset classes. See additional notes on the following page. 25 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

27 J.P. Morgan s long-term capital market return assumptions (cont d.) FIXED INCOME EQUITY ALTERNATIVE/OTHER EXPECTED ANNUALIZED VOLATILITY (%) 2 EXPECTED COMPOUND RETURN (%) 2 EXPECTED ARITHMETIC RETURN (%) 2 U.S. Inflation U.S. Cash U.S. Intermediate Treasury U.S. Long Treasury U.S. Tips U.S. Aggregate U.S. Short Duration Gov t/credit U.S. Long Duration Gov t/credit U.S. Investment Grade Corporate U.S. Long Corporate U.S. High Yield U.S. Leveraged Loan (BB or better) World Government Bond (local) World Government Bond (unhedged) World ex-u.s. Government Bond (local) World ex-u.s. Government Bond (hedged) Emerging Markets Sovereign Debt (hedged) Emerging Markets Local Currency Sovereign Debt (unhedged) Emerging Markets Corporate Debt (hedged) U.S. Municipal (1-15 Blend) U.S. Municipal High Yield U.S. Large Cap U.S. Mid Cap U.S. Small Cap U.S. Large Cap Value U.S. Large Cap Growth Europe ex-u.k. Large Cap (local) Japan Large Cap (local) U.K. Large Cap (local) EAFE Equity (local) EAFE Equity (unhedged) Emerging Markets Equity (unhedged) Asia ex-japan Equity (unhedged) Global Equity (unhedged) U.S. Private Equity 5, U.S. Direct Real Estate (unlevered) 5, U.S. Value Added Real Estate (unlevered) 5, European Real Estate (unlevered, local) 5, U.S. REITs Global Infrastructure 5, Hedge Fund-Diversified 5, Hedge Fund-Event Driven 5, Hedge Fund-Long Bias 5, Hedge Fund-Relative Value 5, Hedge Fund-Macro 5, Commodities (spot) Gold (spot) U.S. Inflation U.S. Cash U.S. Intermediate Treasury 3 U.S.LongTreasury 4 U.S. TIPS U.S. Aggregate U.S. Short Duration Gov t/credit U.S. Long Duration Gov t/credit U.S. Investment Grade Corporate U.S. Long Corporate U.S. High Yield U.S. Leveraged Loan World Government Bond (hedged) World Government Bond (unhedged) World ex-u.s. Government Bond (hedged) World ex-u.s. Government Bond (unhedged) Emerging Markets Sovereign Debt (unhedged) Emerging Markets Local Currency Sovereign Debt (unhedged) Emerging Markets Corporate Debt (unhedged) U.S. Municipal (1-15 Blend) U.S. Municipal High Yield U.S. Large Cap U.S. Mid Cap U.S. Small Cap U.S. Large Cap Value U.S. Large Cap Growth Europe ex-u.k. Large Cap (unhedged) Japan Large Cap (unhedged) U.K. Large Cap (unhedged) EAFE Equity (hedged) EAFE Equity (unhedged) Emerging Markets Equity (unhedged) Asia ex-japan Equity (unhedged) Global Equity (unhedged) CORRELATION MATRIX As of September 30, 2013* U.S. Private Equity (unhedged) 5,6 U.S. Direct Real Estate (unlevered) 5,6 U.S. Value Added Real Estate (unlevered) 5,6 European Direct Real Estate (unlevered) 5,6 U.S. REITs Global Infrastructure 5,6 Hedge Fund-Diversified 5,6 Hedge Fund-Event Driven 5,6 Hedge Fund-Long Bias 5,6 Hedge Fund-Relative Value 5,6 Hedge Fund-Macro 5,6 Commodities (spot) 6 Gold (spot) All returns on this page are in U.S. dollar terms. Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations to all the above asset classes. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or as a promise of future performance. Note that these asset class assumptions are passive only they do not consider the impact of active management. References to future returns for either asset allocation strategies or asset classes are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. See footnotes on the prior page. 26 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

28 J.P. Morgan s long-term capital market return assumptions disclaimers The information and analysis contained herein are based on data provided by you to J.P. Morgan Asset Management or data from public sources and may be used for discussion purposes only and are not intended as an offer or solicitation with respect to the purchase or sale of any security. Nothing contained herein is intended to create a fiduciary relationship between you and JPMAM with respect to the analysis presented herein and exclusive reliance on the analysis is not advised. This presentation is not intended as a recommendation to invest in any particular asset class or as a promise of future performance. References to future returns are based on the information that you have provided and are not promises of actual returns in any particular product or account. The information and analysis contained herein are not intended to provide, and should not be relied upon for, accounting, asset allocation or tax advice. Any opinions, estimates forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. All returns on this page are in U.S. dollar terms. Note: Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations to all the above asset classes. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or as a promise of future performance. Note that these asset class assumptions are passive only they do not consider the impact of active management. References to future returns for either asset allocation strategies or asset classes are not promises or even estimates of actual returns a client portfolio may achieve. See footnotes on the prior page. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. 27 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

29 Disclaimer Important Disclaimer This material is intended to report solely on the investment strategies and opportunities identified by J.P. Morgan Asset Management. Additional information is available upon request. Information herein is believed to be reliable but J.P. Morgan Asset Management does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. Past performance is not indicative of future results. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Asset Management and/or its affiliates and employees may hold a position or act as market maker in the financial instruments of any issuer discussed herein or act as underwriter, placement agent, advisor or lender to such issuer. The investments and strategies discussed herein may not be suitable for all investors. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Changes in rates of exchange may have an adverse effect on the value, price or income of investments. All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. Results shown are not meant to be representative of actual investment results. Any securities mentioned throughout the presentation are shown for illustrative purposes only and should not be interpreted as recommendations to buy or sell. A full list of firm recommendations for the past year is available upon request. Derisking is a general term referring to strategies that aim at reducing the risk exposure of plan sponsors to their pension fund; however the term in no way implies the removal of risk. J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc. 270 Park Avenue, New York, NY JPMorgan Chase & Co. 28 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION