Ohio Public Employees Retirement System 277 East Town Street, Columbus, Ohio

Transcription

1 Ohio Public Employees Retirement System 277 East Town Street, Columbus, Ohio OPERS 2016 INVESTMENT Defined Benefit Fund Health Care Fund Health Care 115 Trust Fund PLAN

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3 TABLE OF CONTENTS Contents CHIEF INVESTMENT OFFICER S LETTER 1 EXECUTIVE SUMMARY 1 FUND STRATEGIES 6 TACTICAL OUTLOOK 18 ASSET CLASS STRATEGIES 24 POLICIES, COMMITTEES, AND RESOURCES 31 INVESTMENT ORGANIZATION STRUCTURE 40 STAFF DIRECTORY 41

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5 CHIEF INVESTMENT OFFICER S LETTER CHIEF INVESTMENT OFFICER S LETTER The Investments Division s long-term goal is sustained performance to help secure retirement benefits for our members. On behalf of OPERS Investments Division, I am presenting the Annual Investment Plan ( AIP ) for the year ending December 31, The AIP lays out goals against which our performance is measured, and the resources we have available to achieve these goals. Preliminary results for calendar year 2015 were a return of 0.33% for the Defined Benefit Fund and -2.18% for the Health Care Fund (1), both of which fell short of base return targets described in last year s AIP of 7.24% and 6.24%, respectively. The value added by Staff through implementation of the asset allocation after all fees and transactions costs for the Defined Benefit Fund and the Health Care Fund were excess returns of 8 and 30 basis points, respectively, for the year. As discussed in more detail below, the outperformance was excellent and almost universal across asset classes, but then was unfortunately heavily offset by the commodity exposure within the Risk Parity portion of the Fund. The underperformance of Risk Parity was muted to some extent in the Defined Benefit Fund by the strong relative performance of the allocations to illiquid asset classes (Private Equity, and Private Real Estate), but the Health Care Fund does not have those allocations, and so there was no such offset for Health Care. As of December 31, 2015, net assets of the Defined Benefit Fund and the Health Care Fund were $74.5 billion and $10.8 billion, respectively, reaching a combined $85.3 billion. Brief Retrospective Last year s letter detailed the Board s transformation of OPERS Defined Benefit asset allocation over a seven-year period from an allocation dominated by public global equities (traditional asset classes) to one that is more diversified and has an improved risk balance, but also a significant weighting to illiquid alternatives that is return-seeking. Last year s all-but-complete asset class transformation is now fully complete. While the asset allocation is reviewed in detail each year with a view to finding opportunities to add value through dynamic adjustments to the Board s long-term strategic allocation, no changes were recommended to the Board for this year. Many ideas were considered, but none met all of the hurdles. While we perceive that there are many areas of heightened risk that could eventually result in investment opportunities if re-priced by the market, none stand out to us presently. The Fund is already tactically overweight in its allocations to Private Equity and Private Real Estate (versus Public Equity and Fixed Income, respectively), and has modest strategic over-weights in emerging markets (both debt and equity). Staff also has a two-percent opportunistic allocation available which can be used with discretion. OPERS 2016 INVESTMENT PLAN Page 1

6 CHIEF INVESTMENT OFFICER S LETTER Standing Still So if you visit the Investments Division, you should expect to see a lot of folks hanging around with not much to do, right? I have a friend in this business (one, anyway) who is a very longserving state pension plan CIO, and he goes so far as to say that doing nothing is actually the hardest work investment professionals do. But not working that hard has us actually still very busy managing assets internally, identifying the best external managers, and hiring the best internal managers to implement the individual allocations. For example, we have been working toward managing a portion of the high yield allocation in-house. It saves money, adds investment perspective to our daily interactions, is complementary to our in-house core bond allocation and reduces agency risks, but it also adds to key person risk, not to mention the basic risk of creating and executing a complex strategy in volatile markets against highly competitive and knowledgeable market participants. (If this were easy, everyone would do it.) Approximately two-thirds of our Investment Staff positions are professionals dedicated exclusively to managing OPERS bond and stock assets in-house here in Columbus. All of these folks have some role in actively managed portfolios where we are competing against the rest of the world trying to beat standard bond and stock benchmarks while also showing strong performance versus peers. Competing every day on a global scale is certainly not a definition for standing still. For the Investments Division s Forum, held in October, Staff worked many hours to prepare a thoughtful discussion on the trade-offs between risk and return. We reviewed over a century of market data. Stated simplistically, financial theory holds that taking greater investment risk is rewarded by higher returns albeit with higher volatility of outcomes at least until a limit is reached. So what keeps us from reaching for the stars, so to speak? We have a noble mission. Our current return goal of 8% returns earned over time is in doubt, at least for investment horizons as far out as 10 or more years. Why not take more allocation risk on behalf of members? One of the many lessons of the recent crisis (2008) is that while it is very appropriate to seek the returns that the markets serve up (and to use our wisdom, research and insights to identify opportunities), it is possible and almost too easy in an environment of plentiful capital to turn otherwise safe assets into very risky investments. This was done through poor underwriting, illusory risk transfers, excessive leverage, carving asset pools up into have and have-not slices, and the like, or by simply having too much imagination about what returns assets or markets can or will provide. Safe assets that became very risky included such basic assets as houses, toll roads, and consumer loans. I would call this the limits of asset allocation allocation will only take us so far until we just start making it up into something it is not. Too many financial OPERS 2016 INVESTMENT PLAN Page 2

7 CHIEF INVESTMENT OFFICER S LETTER innovations seem to ignore basic financial market precepts. After all, the factors to which we can allocate funds to earn a return are limited, not plentiful. The limit to asset allocation at the other end of the spectrum is that it is not a kaleidoscope that should look different every time the markets shift. One of the few always right tools that disciplined investors have is the ability (and obligation) to re-balance right back into the assets in our allocation that are causing the most short-term indigestion. After re-balancing, the allocation looks just like it did before the short-term dislocation, once again giving the impression that Staff is doing nothing. But rebalancing is often hard work; requiring careful planning to identify in the detail that is within asset classes just what style of asset (e.g., value versus growth) is underperforming and what other specific assets are outperforming; and using research and skilled trading to source the liquidity in bad markets to sell one and buy another at reasonable transaction costs. Even when markets appear calm and we are amidst an apparently static allocation, buildings come for sale, loans are being paid off, companies are merging, new commitments are being negotiated, managers are being underwritten and due diligenced, Staff is being hired, crosstrained and evaluated, and events like falling oil prices are turning companies into winners or losers depending almost entirely on whether they either produce or else consume the commodity. There seems to be a lot of work involved in apparently standing still. All of this is meant to say, Investments Staff will spend the next year apparently standing still amid our static allocation. In closing, Staff would like to acknowledge the assistance and advice of OPERS Investment Advisors, and give recognition to the invaluable assistance of Enterprise Risk, Finance, Human Resources, Information Technology, Internal Audit, Investment Accounting and Operations, and Legal Services, all of which is greatly appreciated. Finally, we would like to thank the Executive Director and the OPERS Retirement Board members for their confidence in Staff, for the resources they make available to us, and for their continued oversight of the Investments Division in service to our members. Respectfully, Richard D. Shafer Chief Investment Officer February 17, 2016 (1) The Health Care 115 Trust, a separate Fund that invests in a combination of units of the DB Fund and short term securities, produced a return of -3.23% OPERS 2016 INVESTMENT PLAN Page 3

8 EXECUTIVE SUMMARY EXECUTIVE SUMMARY The following Summary outlines the strategies, asset allocation, and asset class strategies for OPERS Defined Benefit, Health Care, and Health Care 115 Trust Funds. New target benchmark allocation for the Health Care 115 Trust Fund was approved by the OPERS Retirement Board at its October 2015 meeting. Only 41% of assets are invested in the assets similar to the Health Care Fund, with the balance of 59% to be invested in cash and cash equivalents. This Summary also discusses initiatives and resources as well as performance and risk expectations.. FUND STRATEGIES Since the Defined Benefit, Health Care, and Health Care 115 Trust Funds achieved their strategic asset allocations approved by the OPERS Retirement Board, no asset class adjustments are expected. Within asset classes, adjustments will be made where portfolio liquidity can be improved for little give-up in return expectation and where internal management of assets provides a better expected net return. The following table outlines the projected base case returns with ranges for the Defined Benefit, Health Care, and Health Care 115 Trust Funds. The base case return expectations are higher than in 2015 for both the Defined Benefit and Health Care Funds largely due to higher expected returns for the Public Equity and Fixed Income asset classes. Base Case Return Active Tracking Information Return* Range Return Error Ratio Defined Benefit Fund % % to to Health Care Fund to to HC 115 Trust Fund to to *Base Case Return incudes the active return The active returns shown above incorporate an information ratio of This ratio measures the active return per unit of tracking error (active risk). OPERS 2016 INVESTMENT PLAN Page 4

9 EXECUTIVE SUMMARY Additional details regarding the Defined Benefit, Health Care, and Health Care 115 Trust Funds strategies are included later in this Annual Investment Plan. ASSET ALLOCATION AND ASSET CLASS STRATEGIES The Public Equity benchmark in the Defined Benefit, Health Care, and Health Care 115 Trust Funds is determined by the global weighting of U.S. Equity and Non-U.S. Equity based on the MSCI All Country World Index-Investable Market Index ( MSCI ACWI-IMI ). Therefore, market prices determine the split between U.S. and Non-U.S. Equities. Other initiatives within the traditional asset classes are being considered in order to manage a greater proportion of assets internally. These will be discussed as they are developed and will be part of a multi-year effort to continue to control risks and remain cost-effective. But they are implementation initiatives, not changes in allocation. Within the Alternatives asset class, no strategic allocation changes are expected. The Fund Management Committee will continue to monitor overall fund asset allocation and exposures, rebalancing as appropriate in observance of Board Policies Resources The Investments Division Staff is comprised of 66 budgeted positions including three new approved positions for Staff biographies are provided in the Appendix. The Investments Division submitted an estimated compensation and operating budget of $23.8 million for The budget includes the Finance Division s estimate of the 2016 incentive compensation payout, based on the prior year s budget. The budget includes the Investments Division s internal investment management expenses. Staff estimates the total cost to manage the OPERS asset base at 77.8 basis points or $693.3 million. The cost assumes a long-term growth trend in the fund s asset base, whereas an unanticipated bear market would reduce the cost. While asset allocation (e.g. alternative vs. traditional investments) and investment structure (internal management of portfolio vs. external management) are main drivers of investment expenses, success also raises fees (e.g. some managers get a slice of profits, and appreciation of asset values raises the total amount of assets on which fees are charged). The cost estimate also includes tens of millions of dollars in fees to private equity and private real estate managers that are repaid to OPERS along with its other capital contributions when investments are sold. To this extent, fee estimates can be overstated by material amounts. All returns reported in this AIP are net of all fees. Fees are discussed in greater details in later pages. OPERS 2016 INVESTMENT PLAN Page 5

10 FUND STRATEGIES FUND STRATEGIES DEFINED BENEFIT FUND Expected Asset Growth Defined Benefit Fund The table below summarizes Staff s estimate (base case) of market values and ranges for the Defined Benefit Fund at December 31, Pessimistic and optimistic cases are also provided for reference. Defined Benefit Fund 2016 Expected Asset Growth Estimated Market Values, Returns and Cash Flows Pessimistic Base Optimistic Case Case Case 12/31/15 Market Value ($ billions) $75.00 $75.00 $75.00 Expected Total Return -6.30% 7.40% 21.10% Expected Investment Gain ($ billions) -$4.73 $5.55 $15.82 Expected Cash Flow ($ billions) -$4.20 -$4.20 -$ /31/16 Market Value ($ billions) $66.07 $76.35 $86.62 The anticipated beginning market value of $75 billion for December 31, 2015 is derived by a smoothing projection from the actual market value as of November 30, Asset Allocation Defined Benefit Fund The 2016 target asset allocation and ranges for the Defined Benefit Fund reflect an estimate by Staff of the expected progress to be made toward dynamic asset allocation targets recommended by NEPC at the January 2016 Board meeting. Also included are 2013 Asset Liability Study strategic asset allocation and asset allocations for a peer group of large pension plans as of June OPERS 2016 INVESTMENT PLAN Page 6

11 FUND STRATEGIES * 12/31/ /31/ A/L Study Peer Asset Class Estimated Target Target Range Group* Public Equity 40.90% 40.90% 39.00% 31% to 47% 51.52% U.S. Equity 22.30% 22.30% 20.40% Mkt. Wgt. ± 5% 30.19% Non-U.S. Equity 18.60% 18.60% 18.60% Mkt. Wgt. ± 5% 21.33% Fixed Income 23.00% 23.00% 23.00% 16% to 30% 22.27% Core Fixed 9.60% 10.00% 10.00% 7% to 13% 11.52% Emerging Markets Debt 6.00% 6.00% 4.00% 2% to 8% 1.20% Floating Rate Debt 0.40% 0.00% 1.00% 0% to 2% 0.07% Securitized Debt 1.00% 1.00% 1.00% 0% to 2% 1.91% High Yield 3.00% 3.00% 4.50% 2% to 5% 0.81% Global High Yield 1.00% 1.00% 1.50% 0% to 2% 0.39% TIPS 1.00% 1.00% 1.00% 0% to 2% 0.81% U.S. Treasury 1.00% 1.00% 0.00% 0% to 2% 5.56% Alternatives 29.10% 29.10% 31.00% 22% to 40% 23.52% Private Equity 10.00% 10.00% 10.00% 5% to 15% 8.61% Real Estate 10.00% 10.00% 10.00% 5% to 15% 7.95% Hedge Funds 8.00% 8.00% 8.00% 4% to 12% 5.73% Opportunistic 0.10% 0.10% 2.00% 0% to 4% Commodities 1.00% 1.00% 1.00% 0% to 2% 1.23% Risk Parity 5.00% 5.00% 5.00% 2% to 8% 0.41% GTAA 2.00% 2.00% 2.00% 0% to 4% 0.17% Other 2.10% Total Defined Benefit Fund % % % % *The asset allocations are derived from the organizations in the Peer Group Comparison section on page 39. Schedule of Expected Performance and Volatility Active Return Active Return Target Tracking Average Performance Performance Tracking Error Target Allocation Objectives Contribution Error Range Information (%) (bps) (bps) (bps) (bps) Ratio U.S. Equity 22.3% Non-U.S. Equity 18.6% Fixed Income 23.0% Alternatives 29.1% Risk Parity 5.0% NA GTAA 2.0% Defined Benefit Fund 100.0% NA The above table shows a projected active management contribution of 44 basis points to the Defined Benefit Fund s return. The estimated tracking error of 110 basis points indicates a 68% probability that the active return will be in a range of -66 basis points to +154 basis points. This OPERS 2016 INVESTMENT PLAN Page 7

12 FUND STRATEGIES interval is calculated by subtracting the tracking error from, and adding the tracking error to, the expected active return. The projected active management contribution to the Defined Benefit Fund performance for 2015 was 44 basis points. Return and Risk Defined Benefit Fund The performance objectives for the Defined Benefit Fund are to: (1) exceed the return of the Policy benchmark within an appropriately risk-constrained framework, net of investment fees and expenses: and (2) exceed the actuarial interest rate over a reasonably longer time horizon. The Policy benchmark combines designated market indices for asset classes, weighted by asset allocation targets. Asset class targets and benchmarks are set by the OPERS Retirement Board. The return estimates in the following table were derived from the asset class return expectations developed by the OPERS Retirement Board s retained Investment Advisor, NEPC. The singlepoint estimate return of 7.40% is comprised of an expected return of 6.96% from the policy mix and an additional contribution of 0.44% from active management, net of fees. In the following table, Staff divides return and risk into two components. Policy: The return and risk derived from the policy asset allocation and the intermediate term return and risk forecast of the underlying asset classes Active: The return and risk associated with deviations from benchmark allocations at either the asset class level or portfolio level. It reflects the potential impact to relative performance from deviating from the asset class policy allocation targets, and from individual portfolio active risk The Policy Return and Active Return are calculated as weighted averages of expected returns and expected alphas of each sub-asset class. OPERS 2016 INVESTMENT PLAN Page 8

13 FUND STRATEGIES 2016 Policy Return Assumptions Asset Classes Pessimistic Base Optimistic Public Equity % 7.40% 25.50% U.S. Equity % 6.16% 24.46% Non-U.S. Equity % 8.47% 29.47% Fixed Income -3.30% 4.20% 11.70% Core Fixed -3.60% 2.43% 8.46% Emerging Markets Debt -7.60% 5.70% 19.00% Securitized Debt % 6.50% 23.50% High Yield -7.80% 5.20% 18.20% Global High Yield -7.85% 5.40% 18.65% TIPS -4.00% 2.50% 9.00% U.S. Treasury -3.75% 1.75% 7.25% Alternatives -6.30% 7.80% 21.90% Private Equity % 8.50% 31.50% Real Estate -8.40% 7.60% 23.60% Hedge Funds -3.25% 5.75% 14.75% Opportunistic % 7.25% 28.25% Commodities % 4.50% 23.50% Risk Parity -6.20% 7.00% 20.20% GTAA -5.90% 6.10% 18.10% Policy Return -6.24% 6.96% 20.16% 2016 Total Return Assumptions Sources of Return Pessimistic Base Optimistic Policy -6.24% 6.96% 20.16% Active -0.65% 0.44% 1.52% Total Return -6.30% 7.40% 21.10% 2016 Total Risk and Active Risk Assumptions Sources of Variability Information Sharpe Risk Risk Ratio Ratio Policy 13.20% 0.47 Active 1.09% 0.40 Total Risk 13.70% 0.49 OPERS 2016 INVESTMENT PLAN Page 9

14 FUND STRATEGIES Expected Asset Growth Health Care Fund HEALTH CARE FUND The table below summarizes Staff s estimate (base case) of market values and ranges for the Health Care Fund at December 31, Pessimistic and optimistic cases are also provided for reference. Health Care Fund 2016 Expected Asset Growth Estimated Market Values, Returns and Cash Flows Pessimistic Base Optimistic Case Case Case 12/31/15 Market Value ($ billions) $10.80 $10.80 $10.80 Expected Total Return -5.99% 6.51% 19.01% Expected Investment Gain ($ billions) -$0.65 $0.70 $2.05 Expected Cash Flow ($ billions) -$1.75 -$1.75 -$ /31/16 Market Value ($ billions) $8.40 $9.75 $11.10 The anticipated beginning market value of $10.80 billion for December 31, 2015 is derived by a smoothing projection from the actual market value as of November 30, Asset Allocation Health Care Fund The 2016 target asset allocation and ranges for the Health Care Fund reflect an estimate by Staff of the expected progress to be made toward dynamic asset allocation targets recommended by NEPC at January 2016 Board meeting. There is no peer universe of public pension plans with separate health care funds to compare to. OPERS 2016 INVESTMENT PLAN Page 10

15 FUND STRATEGIES 12/31/ /31/ A/L Study Asset Class Estimated Target Target Range Public Equity 44.90% 44.90% 43.00% 34% to 52% U.S. Equity 24.40% 24.40% 22.50% Mkt. Wgt. ± 5% Non-U.S. Equity 20.50% 20.50% 20.50% Mkt. Wgt. ± 5% Fixed Income 34.00% 34.00% 34.00% 24% to 44% Core Fixed 16.70% 17.00% 17.00% 12% to 22% Emerging Markets Debt 6.00% 6.00% 5.00% 2% to 8% Floating Rate Debt 0.30% 0.00% 1.00% 0% to 2% Securitized Debt 1.00% 1.00% 1.00% 0% to 2% High Yield 2.50% 2.50% 3.50% 0% to 5% Global High Yield 1.50% 1.50% 1.50% 0% to 4% TIPS 5.00% 5.00% 5.00% 2% to 8% U.S. Treasury 1.00% 1.00% 0.00% 0% to 2% Alternatives 14.10% 14.10% 16.00% 11% to 21% REITs 6.00% 6.00% 6.00% 3% to 9% Hedge Funds 6.00% 6.00% 6.00% 3% to 9% Opportunistic 0.10% 0.10% 2.00% 0% to 4% Commodities 2.00% 2.00% 2.00% 0% to 4% Risk Parity 5.00% 5.00% 5.00% 2% to 8% GTAA 2.00% 2.00% 2.00% 0% to 4% Health Care Fund % % % Schedule of Expected Performance and Volatility Active Return Active Return Target Tracking Average Performance Performance Tracking Error Target Allocation Objectives Contribution Error Range Information (%) (bps) (bps) (bps) (bps) Ratio U.S. Equity 24.4% Non-U.S. Equity 20.5% Fixed Income 34.0% Alternatives 14.1% Risk Parity 5.0% NA GTAA 2.0% Health Care Fund 100.0% NA The above table shows an anticipated active management contribution of 31 basis points to the Health Care Fund s return. The estimated tracking error of 78 basis points indicates a 68% probability that the active return will be in a range of -47 basis points to +109 basis points. This interval is calculated by subtracting the tracking error from, and adding the tracking error to, the OPERS 2016 INVESTMENT PLAN Page 11

16 FUND STRATEGIES expected active return. The expected active management contribution to the Health Care Fund performance for 2015 was 31 basis points. Return and Risk Health Care Fund The performance objective for the Health Care Fund is to exceed the return of the Policy benchmark within an appropriately risk-constrained framework, net of investment fees and expenses. The Policy benchmark combines designated market indices for asset classes, weighted by asset allocation targets. Asset class targets and benchmarks are set by the OPERS Retirement Board. The return estimates in the table below were derived from the asset class return expectations developed by the OPERS Retirement Board s retained Investment Advisor, NEPC. The singlepoint estimate return of 6.51% is comprised of an expected return of 6.20% from the policy mix and an additional contribution of 0.31% from active management, net of fees. In the following table, Staff divides return and risk into two components. Policy: The return and risk derived from the policy asset allocation and the intermediate term return and risk forecast of the underlying asset classes Active: The return and risk associated with deviations from benchmark allocations at either the asset class level or portfolio level. It reflects the potential impact to relative performance from deviating from the asset class policy allocation targets, and from individual portfolio active risk The Policy Return and Active Return are calculated as weighted averages of expected returns or expected alphas of each sub-asset class. OPERS 2016 INVESTMENT PLAN Page 12

17 FUND STRATEGIES 2016 Policy Return Assumptions Asset Classes Pessimistic Base Optimistic Public Equity % 7.40% 25.50% U.S. Equity % 6.16% 24.46% Non-U.S. Equity % 8.47% 29.47% Fixed Income -3.30% 4.20% 11.70% Core Fixed -3.60% 2.43% 8.46% Emerging Markets D -7.60% 5.70% 19.00% Securitized Debt % 6.50% 23.50% High Yield -7.80% 5.20% 18.20% Global High Yield -7.85% 5.40% 18.65% TIPS -4.00% 2.50% 9.00% U.S. Treasury -3.75% 1.75% 7.25% Alternatives -6.30% 7.80% 21.90% REITs % 6.80% 27.80% Hedge Funds -3.25% 5.75% 14.75% Opportunistic % 7.25% 28.25% Commodities % 4.50% 23.50% Risk Parity -6.20% 7.00% 20.20% GTAA -5.90% 6.10% 18.10% Policy Return -6.10% 6.20% 18.50% 2016 Total Return Assumptions Sources of Return Pessimistic Base Optimistic Policy -6.10% 6.20% 18.50% Active -0.45% 0.31% 1.07% Total Return -5.99% 6.51% 19.01% 2016 Total Risk and Risk Attribution Assumptions Sources of Variability Information Sharpe Risk Risk Ratio Ratio Policy 12.30% 0.44 Active 0.76% 0.41 Total Risk 12.50% 0.46 OPERS 2016 INVESTMENT PLAN Page 13

18 FUND STRATEGIES HEALTH CARE 115 TRUST FUND Expected Asset Growth Health Care 115 Trust Fund The table below summarizes Staff s estimate (base case) of market values and ranges for the Health Care 115 Trust Fund at December 31, Pessimistic and optimistic cases are also provided for reference. Health Care 115 Trust Fund 2016 Expected Asset Growth Estimated Market Values, Returns and Cash Flows Pessimistic Base Optimistic Case Case Case 12/31/15 Market Value ($ millions) $ $ $ Expected Total Return -1.48% 3.82% 9.12% Expected Investment Gain ($ millions) -$10.43 $26.93 $64.30 Expected Cash Flow ($ millions) -$ $ $ /31/16 Market Value ($ millions) $ $ $ The anticipated beginning market value of $705 million for December 31, 2015 is derived by a smoothing projection from the actual market value as of November 30, Asset Allocation Health Care 115 Trust Fund In September 2015, OPERS Retirement Board approved NEPC and Staff s recommendation to change the asset allocation for the Health Care 115 Trust Fund, different from the Health Care Fund. NEPC and Staff believe that a more conservative allocation is appropriate for the Health Care 115 Trust Fund given the IRS s decision and uncertainty surrounding the timing of their decision. NEPC agrees with Staff that Health Care 115 Trust Fund should be treated as a liquidating Trust for the time being and a more conservative allocation should be adopted to reduce the potential impact on the Trust Fund from a significant decline in the markets. With dual goals of capital preservation and lower volatility of the Fund, the dedicated short-term liquidity portfolio of target allocation of 59% was created. The 2016 target asset allocation and ranges for the Health Care 115 Trust Fund reflect an estimate by Staff of the expected progress to be made toward dynamic asset allocation targets recommended by NEPC at January 2016 Board meeting. Also included is new target strategic asset allocation approved in September There is no peer universe of public pension plans with separate health care funds to compare to. OPERS 2016 INVESTMENT PLAN Page 14

19 FUND STRATEGIES 12/31/ /31/ Approved Asset Class Estimated Target Target Range Public Equity 17.90% 17.90% 17.00% 0% to 21% U.S. Equity 9.80% 9.80% 8.90% Mkt. Wgt. ± 5% Non-U.S. Equity 8.10% 8.10% 8.10% Mkt. Wgt. ± 5% Fixed Income 12.00% 12.00% 12.00% 0% to 16% Core Fixed 7.00% 7.00% 7.00% 0% to 11% Emerging Markets Debt 2.00% 2.00% 2.00% 0% to 4% High Yield 1.00% 1.00% 1.00% 0% to 2% TIPS 2.00% 2.00% 2.00% 0% to 4% Alternatives 7.10% 7.10% 8.00% 0% to 12% REITs 3.00% 3.00% 3.00% 0% to 6% Hedge Funds 3.00% 3.00% 3.00% 0% to 6% Opportunistic 0.10% 0.10% 1.00% 0% to 2% Commodities 1.00% 1.00% 1.00% 0% to 2% Risk Parity 3.00% 3.00% 3.00% 0% to 6% GTAA 1.00% 1.00% 1.00% 0% to 2% Short Term Liquidity 59.00% 59.00% 59.00% 0% to 4% Health Care 115 Trust Fund % % % Schedule of Expected Performance and Volatility Active Return Active Return Target Tracking Average Performance Performance Tracking Error Target Allocation Objectives Contribution Error Range Information (%) (bps) (bps) (bps) (bps) Ratio U.S. Equity 9.8% Non-U.S. Equity 8.1% Fixed Income 12.0% Alternatives 7.1% Risk Parity 3.0% NA GTAA 1.0% Short Term Liquidity 59.0% HC 115 Trust Fund 100.0% NA The above table shows an anticipated active management contribution of 22 basis points to the Health Care 115 Trust Fund s return. The estimated tracking error of 55 basis points indicates a 68% probability that the active return will be in a range of -33 basis points to +77 basis points. This interval is calculated by subtracting the tracking error from, and adding the tracking error to, the expected active return. OPERS 2016 INVESTMENT PLAN Page 15

20 FUND STRATEGIES Return and Risk Health Care 115 Fund The performance objective for the Health Care 115 Trust Fund is to exceed the return of the Policy benchmark within an appropriately risk-constrained framework, net of investment fees and expenses. The Policy benchmark combines designated market indices for asset classes, weighted by asset allocation targets. Asset class targets and benchmarks are set by the OPERS Retirement Board. The return estimates in the table below were derived from the asset class return expectations developed by the OPERS Retirement Board s retained Investment Advisor, NEPC. The singlepoint estimate return of 3.82% is comprised of an expected return of 3.60% from the policy mix and an additional contribution of 0.22% from active management, net of fees. In the following table, Staff divides return and risk into two components. Policy: The return and risk derived from the policy asset allocation and the intermediate term return and risk forecast of the underlying asset classes Active: The return and risk associated with deviations from benchmark allocations at either the asset class level or portfolio level. It reflects the potential impact to relative performance from deviating from the asset class policy allocation targets, and from individual portfolio active risk The Policy Return and Active Return are calculated as weighted averages of expected returns or expected alphas of each sub-asset class. OPERS 2016 INVESTMENT PLAN Page 16

21 FUND STRATEGIES 2016 Policy Return Assumptions Asset Classes Pessimistic Base Optimistic Public Equity % 7.40% 25.50% U.S. Equity % 6.16% 24.46% Non-U.S. Equity % 8.47% 29.47% Fixed Income -3.30% 4.20% 11.70% Core Fixed -3.60% 2.43% 8.46% Emerging Markets Debt -7.60% 5.70% 19.00% High Yield -7.80% 5.20% 18.20% TIPS -4.00% 2.50% 9.00% Alternatives -6.30% 7.80% 21.90% REITs % 6.80% 27.80% Hedge Funds -3.25% 5.75% 14.75% Opportunistic % 7.25% 28.25% Commodities % 4.50% 23.50% Risk Parity -6.20% 7.00% 20.20% GTAA -5.90% 6.10% 18.10% Short Term Liquidity 0.50% 1.50% 2.50% Policy Return -1.40% 3.60% 8.60% 2016 Total Return Assumptions Sources of Return Pessimistic Base Optimistic Policy -1.40% 3.60% 8.60% Active -0.33% 0.22% 0.77% Total Return -1.48% 3.82% 9.12% 2016 Total Risk and Risk Attribution Assumptions Sources of Variability Information Sharpe Risk Risk Ratio Ratio Policy 5.00% 0.57 Active 0.55% 0.40 Total Risk 5.30% 0.58 OPERS 2016 INVESTMENT PLAN Page 17

22 TACTICAL OUTLOOK TACTICAL OUTLOOK The following tactical outlooks provide a background and context for the asset class strategies for the Defined Benefit, Health Care, and Health Care 115 Trust Funds. There are two components of the tactical outlook: the capital markets observations and the asset class outlook. The Investment Advisors (NEPC and Aon Hewitt Investment Consulting), retained by OPERS Retirement Board, provided these outlooks for Capital Markets Observations US economic expansion persists as Federal Reserve begins policy shift. Economic conditions and health of U.S. consumers remain supportive for growth. Profit margin declines and strong dollar are a challenge to corporate profitability. Central Banks continue to dictate the global investment outlook. Path of Fed policy over next two years matters more than timing of the next Fed action. ECB and BOJ likely to maintain and extend accommodative policies. Easing in China is broadly stimulative but currency policy is unpredictable. Persistent strength of US dollar reveals global market weakness. World economy has experienced a dollar recession as global output slows. Dollar strength tightens global monetary conditions and strains global growth. Weak growth should not lead to a financial crisis in emerging markets. Negative returns reflect adjustments necessary for future economic success. Further political and market reforms are necessary for improved economic conditions. Stressed credit liquidity magnifies the scale of price movements. Central bank easing and positive investor sentiment have masked deterioration in liquidity. Credit markets ability to absorb an exodus from crowded positions could be challenged. U.S. Equity Outlook Economic growth should continue at a modest pace. Consumer Discretionary could benefit due to healthy household balance sheets combined with savings from lower energy prices. Housing is a potential growth area. Financial/Banking could also benefit as the Fed begins to normalize interest rates. A steadily improving US economy likely means that the Fed will begin raising rates. Despite higher rates US economic growth and fundamentals should drive equities higher. Growth looks more attractive than value on a P/E basis. OPERS 2016 INVESTMENT PLAN Page 18

23 TACTICAL OUTLOOK Large cap valuations are still above long term averages after falling from their high in February but still remain high. Small cap valuations have fallen from their early 2015 highs but are still above their long term average. There may still be some volatility within small caps in the short term but the 12 month outlook is that small caps look attractive versus large caps from a valuation perspective. Non-U.S. Equity Outlook Within emerging markets structural reforms within countries will drive returns. This also provides an opportunity to continue to look down the cap spectrum. Consider an overweight to the small cap stocks as well as a consumption play to best exploit the opportunity set within emerging markets. In developed markets outside the U.S. continued easing should help market returns. The ECB will have to undergo further QE which could lead to an opportunity to invest down the cap spectrum as bank lending fuels smaller company growth. Small companies within the Eurozone present a greater opportunity than their Japanese peers. Fixed Income Outlook The market anticipates a lift-off from zero interest rate policy by the Fed in December Pace and magnitude of tightening will drive relative performance across the duration and credit curves. The influence of monetary policy provides a basis for an extended U.S. economic cycle. Continued growth supports accrual of risk premia even in a low expected return environment ; US credit currently offers reasonable risk premia. Profit margin pressures and enhanced credit risk, however, are challenges of a maturing economic cycle. U.S. TIPS are cheap relative to nominal U.S. Treasury bonds as implied inflation breakeven levels are exceptionally low We would expect TIPS to appreciate if inflation is realized higher than expectations. Credit spreads widened amid the market volatility experienced in the third quarter on global growth concerns and uncertainty about Fed policy High yield debt lagged investment grade debt, but even investment grade credit spreads are wider since the start of 2015, in part due to heavy issuance by investment grade companies. The suppressed level of oil prices continues to roil the energy sector of the bond markets, with the market pricing in elevated defaults in After considerable widening of spreads in the high yield bond market, and particularly in the energy sector, valuations are looking more attractive than at the start of the year OPERS 2016 INVESTMENT PLAN Page 19

24 TACTICAL OUTLOOK Spreads have widened, but credit selection is critical as the credit cycle matures. Liquidity continues to be strained in the corporate credit markets; stressed liquidity magnifies the scale of price movements Central bank easing and positive investor sentiment have masked this deterioration in liquidity. The credit market s ability to absorb an exodus from crowded positions could be challenged. Weak growth should not lead to a financial crisis in emerging markets Negative returns reflect adjustments necessary for future economic success. Further political and market reforms are necessary for improved economic conditions. Superior real yields and fundamentals are expected to flow through to higher returns over time. Commodity dependent countries face unique financial challenges as they adjust to lower prices. Private Equity Outlook Barring a market correction, 2016 is likely to be a strong year for private equity realizations and exits, yet a difficult year for new investments due to signs of overheating in some areas of the industry: Total fundraising in 2015 is expected to be at or above that in 2014, making it a threeyear run of high levels of fundraising. Un-invested private equity assets ( dry powder ), has reached a new peak of just over $1 trillion. Allocations to private equity are generally increasing amongst institutional investors. The number of new deals has been declining, however, the value of those deals has increased. This may simply mean that larger deals are getting done, but it could mean that the higher price of deals is causing a decline in the number of deals completed. Private equity funds with strong performance are raising larger funds, often with only one close, while others continue to experience increased fundraising timelines. Investors are being discerning, but are moving quickly for the best names and are potentially pushing those managers to raise larger funds that may need to stretch more for returns. Capital markets are robust with high valuations and high availability of debt: Average purchase prices are at peak levels of 10.1x earnings [1] in both large cap and mid-cap investments. Debt continues to be broadly available at very borrower-friendly terms, hovering near peak leverage levels. There are no indications this trend will slow. If interest rates increase we could see a slowdown, but do not expect an increase in defaults as many financing packages were done with little to no covenants. This is attractive over the short-term but may pose challenges as interest rates rise. Private equity exits are at an all-time high both in number and value as sellers take advantage of debt availability and high valuation multiples. Growth in the U.S. economy continues to be slow, but steady. Overall, Europe s economy is growing at a slower rate with little to point to as a catalyst for near-term increased OPERS 2016 INVESTMENT PLAN Page 20

25 TACTICAL OUTLOOK growth. Asia, specifically China, is showing signs of weakness. We see this continuing into The dislocation in commodity prices and energy markets has created a wide range of expectations between public and private investors and an increasing funding gap. While a number of energy funds are raising capital to take advantage of the opportunity in the space, we expect increased opportunities in 2016 to deploy capital for investors with longer-term horizons at attractive rates of return. Venture capital is seeing increasing interest as evidenced by funds raised, deals done and dry powder. We expect 2016 to experience similar interest. Strong recent venture capital returns are luring investors back to this riskier sub asset class as they seek increased return. Investment activity in venture is at its highest level since Non-traditional investors like hedge funds and mutual funds have entered the fray especially in late stage venture capital investing. While the exit environment is good, it is somewhat inconsistent. There continues to be a significant backlog of companies who have filed to go public, but have yet do so. Consistent with last year, technology and healthcare companies are flush with cash and continue to seek growth through acquisition. Despite a great deal of demand in this asset class and higher valuations, there are pockets of attractive investment strategies within all sectors of private equity. We favor investment in all private sectors over multiple investment or vintage years in order to avoid overexposure to any one strategy or economic cycle due to two reasons: 1) as one cannot time the market, and 2) good funds are raised in all vintage years. It may be prudent to temper allocations to secondaries, mezzanine strategies, mega cap markets and venture, especially late stage. As always, manager selection will be the key to generating the best returns with a current focus on choosing managers with strong operational capabilities and high levels of valuation discipline on new deals. OPERS 2016 INVESTMENT PLAN Page 21

26 TACTICAL OUTLOOK Real Estate Outlook 2016 The U.S. commercial real estate recovery has proceeded at a fairly steady pace in 2015 to-date, supported by the continued economic recovery, the expansion of the labor market, and solid real estate sector fundamentals. The U.S. real estate cycle is now fairly mature, with many markets back in the expansionary phase of their cycle. While timing of the next cyclical downturn is difficult to predict, we believe 2016 will be a good year to plan for the next cyclical swing and to continue to implement portfolio downside risk measures, while continuing to receive still attractive returns from the asset class overall Real estate returns have remained well above-average this market cycle-to-date being supported by robust capital flows, attractive fundamental growth and historically favorable interest rates. This trend, however, is not likely to hold too much longer. The consensus forecast for 2016 for unlevered core real estate return is 8.5% which, while more moderate, is in line with the sector s long-run return and still attractive. Sector fundamentals are expected to continue to strengthen in 2016 albeit at a moderating pace. Growth in net operating income from properties, in particular, is projected to support and drive total returns going forward. Demand for properties is forecast to continue to outpace new supply through 2018, except in Multifamily (apartments), but the gap is narrowing. Factors to consider in 2016 as the real estate cycle matures further: The market recovery in core (higher-quality, low leverage) properties is mature and in most coastal markets fully valued. Growth in net operating income generally still has room to improve and is expected to be the primary driver of returns at this point in the cycle. Attractive tactical opportunities still exist, although return expectations for newer funds are lower than the past few years. Manager, strategy, structure and regional selections are even more important at this point in the real estate investment cycle. Portfolio construction is important as the sector moves closer to its next cyclical turn even though the timing of the next downturn is not obvious yet. We are recommending that our clients: Pay attention to use of leverage. Preferred equity and debt structures are important to incorporate now to help mitigate medium term cyclical risks. Manager underwriting should be monitored. Signs are emerging that some investors have started to reach to justify current pricing, especially in primary markets. At this stage in the cycle it is vital that risk mitigation measures are a staple in investment portfolios OPERS 2016 INVESTMENT PLAN Page 22

27 TACTICAL OUTLOOK Hedge Funds Outlook 2016 For 2016, our performance outlook for hedge fund strategies is attractive on a riskadjusted basis relative to traditional stock and bond markets due to several factors, including: Broad stock market index levels are high despite recent declines in corporate earnings and revenue, which represents a further expansion of price multiples and reduces forward return expectations. Credit spreads have widened over the past year, increasing the appeal of corporate bonds relative to government issues, however overall bond yields remain at very low levels as central banks globally continue to implement easing mechanisms. Volatility and dispersion across asset classes will likely be higher than in recent years, which favors managers with broader, less constrained mandates and flexible implementation, such as hedge funds. Consistent with responses from a wide range of surveys, we expect institutional investors to continue to invest in hedge funds, and for pension funds to serve as the primary source of asset growth within the asset class. Hedge fund investors are focused on manager selection, expanding strategy allocations where opportunities appear most attractive and obtaining more attractive terms and conditions where possible. Capacity reservation remains an issue as investors vie for the most compelling hedge fund offerings. Long/short equity managers should continue to benefit from low correlations between stocks. Despite the macroeconomic headwinds and high valuations that suggest limited upside in the broad equity markets, equity hedge funds have a favorable environment for long and short stock selection with high dispersion existing across sectors and regions. Following years of historically low market volatility, the outlook for macro hedge fund managers continues to be promising for trend-following and thematic strategies. Consistent with recent events, we expect sudden government and central bank policy actions to significantly impact near-term performance for macro funds, however, policy divergences across regions should present compelling investment opportunities for hedge fund managers. While credit default activity has remained subdued, many event-driven hedge fund strategies have struggled amid a resurgence of volatility, especially those invested in companies exposed to commodity price swings. Current stress in the credit markets could lead to more interesting entry points for investors focused on distressed securities in the coming year. Meanwhile, robust merger activity has created more attractive opportunities for managers that employ merger arbitrage strategies in their event-driven toolkit. We continue to believe multi-strategy hedge fund managers are best positioned to dynamically rotate allocations to underlying hedge fund sub-strategies, and those that are well-resourced with a global presence are competitively advantaged to identify the best investment opportunities. OPERS 2016 INVESTMENT PLAN Page 23

28 ASSET CLASS STRATEGIES ASSET CLASS STRATEGIES PUBLIC EQUITY The Defined Benefit and Health Care Fund s Public Equity allocation is unchanged from For Health Care 115 Trust Fund, Public Equity allocation was set as 17%. The Public Equity allocation is based on the global market weighting between U.S. equity and Non U.S. equity based on the MSCI All Country World Index-Investable Market Index ( MSCI ACWI-IMI ). The weighting is rebalanced at approximately 90-day intervals. Sub-asset class allocations within the Non-U.S. Equity asset class are currently in alignment with the custom strategic benchmark ( custom benchmark ) approved by the Board in July The custom benchmark includes an allocation to the Emerging Markets small cap segment (4%) and an explicit allocation to Developed Markets small cap securities (10%). The custom benchmark is composed of 55% MSCI World Index (ex U.S.) Standard Index; 10% MSCI World Index (ex U.S.) Small Cap Index; 31% MSCI Emerging Markets Standard Index; and 4% MSCI Emerging Markets Small Cap Index. This structure reflects a strategic overweight to Emerging Markets compared to the Emerging Markets allocation of MSCI All Country World Index ex U.S. Investable Markets Index ( MSCI ACWI ex U.S. IMI ). The Investments Division has established a significant base of internally managed Non-U.S. Equity portfolios. The following table shows the benchmarks and performance objectives for the Public Equity asset class. Alpha Target Target Tracking Target (net of fees) Error Information Benchmark (bps)* (bps) Ratio U.S. Equity Russell Non-U.S. Equity Custom Benchmark *bps = basis points Public Equity Asset Calss Expected Performance and Tracking Error A tilt index, or alternatively weighted investment strategy, seeks to weight securities based on fundamental factors (such as sales and cash flow) or risk factors (such as volatility) as opposed to traditional indices, which are based upon market capitalization. The strategy, referred to as alternatively weighted indexing, is a systematic, rules-based approach for gaining cost-effective exposure to active management styles. It is implemented through the existing index management process leveraging the team s expertise in index management, rules-based investing approaches, and quantitative modeling techniques. Staff expects this strategy to outperform its respective capitalization weighted indices over a market cycle of three to five years. Staff has already implemented a U.S. equity small cap tilt portfolio, a Non-U.S. equity developed markets small cap tilt portfolio, an emerging markets small cap tilt portfolio, and a developed markets large cap factor index portfolio. Staff may consider additional tilt strategies or refinements in OPERS 2016 INVESTMENT PLAN Page 24

29 ASSET CLASS STRATEGIES FIXED INCOME The Defined Benefit and Health Care Fund s Fixed Income allocation is unchanged from For Health Care 115 Trust Fund, Fixed Income allocation was set as 12%. Staff may introduce new portfolios in the Fixed Income Asset Class in 2016 using existing sub-asset classes. The Floating Rate Debt portfolio will continue to be phased out in an orderly fashion. U.S. Treasury sub-asset class was created as a part of 2015 NEPC dynamic asset allocation recommendation, which was approved by the OPERS Retirement Board in its January 2015 meeting. The move from Floating Rate Debt to U.S. Treasury allocation would result in the improvement in liquidity of the Funds. Additional liquidity from U.S. Treasury portfolio will be valuable if the corporate credit markets continue to be strained in 2016, as is observed by the Investment advisor, NEPC. Treasury account should be the last resort source to be tapped for benefit payments during extremely distressed and correlated market events. The following table shows the benchmarks and performance objectives for the Fixed Income asset class. Fixed Income Asset Class Expected Performance and Tracking Error Alpha Target Target Tracking Target (net of fees) Error Information Benchmark (bps)* (bps) Ratio Core Fixed Barclays Aggregate/Custom Benchmark Emerging Markets Debt EMD Custom Benchmark** Securitized Debt Non-Agency Barclays CMBS + 2% High Yield Barclays U.S. High Yield Global High Yield Barclays Global High Yield TIPS Barclays TIPS 0 75 NA U.S Treasury Barclays U.S. Treasury Index 0 30 NA *bps = basis points ** 50/50 mix of the JP Morgan EM Bond Index Global & the JP Morgan Government Bond Index- Emerging Markets Global Diversified OPERS 2016 INVESTMENT PLAN Page 25

30 ASSET CLASS STRATEGIES Securities Lending In the securities lending program, Staff utilizes multiple lending agents to maximize lending revenue. Staff strives to hire agents who provide competitive fee splits, while providing risk controls and expertise in the asset class being loaned. We are biased toward lending assets in an auction environment so borrowers are providing maximum revenue in a competitive environment on a regular basis. In 2016, Staff will continue lending the Treasury and Agency assets in-house. This effort has increased revenues from Treasury lending. The collateral from the securities lending program is managed internally. The combination of lending revenue and investment income comprise the total securities lending performance. Cash Management The cash portfolios are managed with a low-to-moderate risk profile that results in principal preservation while exceeding the performance of the respective benchmarks. The benchmark for the OPERS Short Term Investment Funds ( STIF ) and the cash portion of the Health Care 115 Trust Fund ( 115 STIF Fund ) is the Merrill Lynch 3-month Treasury Bill Index. The benchmark for the Securities Lending STIF is the Fed Funds Open Rate. OPERS 2016 INVESTMENT PLAN Page 26

31 ASSET CLASS STRATEGIES ALTERNATIVES The Alternatives Asset Class is composed of Private Equity, Real Estate, Hedge Funds, Opportunistic, REITs, and Commodities investment strategies. The Defined Benefit, Health Care, and Health Care 115 Trust Funds invest in different sub-asset classes and weightings in the Alternatives Asset Class to meet their unique investment objectives. The following table summarizes the benchmark, performance objectives and tracking error for the various alternative investment strategies utilized within the Fund. Alpha Target Target Tracking Target (net of fees) Error Information Benchmark (bps) (bps) Ratio Private Equity State Street Private Equity Index Real Estate Net NFI-ODCE % Hedge Funds Custom Benchmark* Opportunistic Custom Benchmark** REITs DJ U.S. Select RESI 0 10 NA Commodities S&P GSCITR Index * Weighted average of underlying strategies in page 29 ** Market cap weighted average of underlying investments Alternatives Asset Class Expected Performance and Tracking Error Private Equity The Private Equity Program ( Program ) is approximately 2.5% above its target allocation in the Defined Benefit Fund, and Staff expects the actual allocation to Private Equity to remain one to two percent above its target allocation for the next few years, subject to changes in value of the overall Defined Benefit Fund. Over the next three to five years the allocation should reach the long-term target of 10% due to the cash flow profile of the investments in secondary funds, the maturing primary commitments made in 2010 and 2011, the ongoing robust environment for selling companies, and the reduced number of commitments made and expected to be made during 2014, 2015 and 2016, respectively. Staff anticipates a number of existing managers will raise new funds during 2016 and the planned commitment levels for these funds total just over $1 billion. As Staff looks five years ahead at the Program s expected allocations, Staff identifies a need to add new US-focused small to middle market buyout exposure as well as energy exposure. Sourcing efforts will continue for these strategies during 2016, and Staff may decide to commit an additional $200 to $400 million to new funds. Staff will also focus on growing the co-investment program from its current 6.5% weight. Improved terms for OPERS will continue to be a priority for Staff with the expectation of continuing our successful results of reducing the costs of the Program. OPERS 2016 INVESTMENT PLAN Page 27

32 ASSET CLASS STRATEGIES Real Estate Private market real estate has a target allocation to the Defined Benefit ( DB ) Fund of 10.0%. The portfolio began 2015 with an estimated net asset value of $7.65 billion or 10.0% of the DB Fund. The Health Care ( HC ) Fund has a target real estate allocation of 6.0%, and this exposure is obtained through investments in publicly traded real estate securities known as Real Estate Investment Trusts or REITs. The value of the REITs portfolio was $ million or 6.1% of the HC Fund at the beginning of The REITs portfolio is managed by internal Staff. Staff is concerned that the Super Cycle for domestic commercial real estate returns may be coming to an end: 2015 was the fifth consecutive year of double digit returns for the ODCE. Staff does not anticipate a violent correction as was experienced during the Global Financial Crisis, but rather a modest decline over the next few years. We expect that property fundamentals will continue to improve due to growth in GDP, increasing employment and modest levels of new construction. However, we believe that cap rate compression will end in a rising interest rate environment. Staff anticipates that commercial real estate returns will mean revert to levels that fall between the returns of bonds and stocks. Staff intends to continue to reduce portfolio risk in anticipation of a correction in the domestic commercial real estate capital markets. Staff intends to pursue tactical sales of existing assets. Staff plans to continue to sell assets when the capital markets value properties at premium prices. We intend to cull the portfolio and sell assets that we would prefer not to own in a correction. We intend to deploy capital in new investments that are expected to produce stable cash flows and where most of the expected returns come from current cash yields. We intend to focus on debt investments and preferred equity that are expected to outperform our benchmark but provide protection by being more senior in the capital structure to the first-loss equity capital. We also intend to diminish potential return volatility by decreasing portfolio-level leverage. OPERS 2016 INVESTMENT PLAN Page 28

33 ASSET CLASS STRATEGIES Hedge Funds The Hedge Funds sub-asset class is near its target allocations of 8% in the Defined Benefit Fund, and 6% in the Health Care Fund. In 2016, Staff will continue to focus on activities with potential to enhance performance including: 1) reducing fees with existing managers, 2) identifying lower cost strategies, and 3) researching niche strategies for potential inclusion in the portfolio. Opportunistic Hedge Funds Strategy Allocation Target and Range for 2016 Strategy Target Range Multi-Strategy 15% 0-35% Equity Hedge 20% 0-35% Event Driven 30% 0-40% Relative Value 15% 0-30% Macro/Tactical 20% 0-30% The Opportunistic sub-asset class is intended to permit investments in assets or strategies not presently contemplated in the respective Defined Benefit or Health Care Funds. The maximum size for any single benchmarked strategy is 0.5% of the total fund. The Opportunistic allocation currently contains an Interest Rate and Volatility portfolio which provides exposure to the U.S. interest rate and volatility markets using a combination of Treasuries, futures and options. The benchmark is the Barclays U.S. Treasury Index with a duration of approximately five years. Uncommitted portions of the Opportunistic asset class will be allocated into the non-u.s. equity exposure within the Opportunistic asset class. Staff plans to use dedicated account within the Opportunistic asset class to take EAFE exposures against the MSCI EAFE standard benchmark. Commodities The Commodity sub-asset class provides exposure to both the Defined Benefit and Health Care Funds as shown in the Fund Strategies sections. The allocation includes a risk-controlled mix of index and enhanced index commodity strategies.. OPERS 2016 INVESTMENT PLAN Page 29

34 ASSET CLASS STRATEGIES RISK PARITY Risk parity is an approach which focuses on allocation of risk rather than allocation of capital. When asset allocations are adjusted to the same risk level, the portfolio can achieve a higher risk adjusted return and can be more resistant to equity market downturns than a traditionally equitycentric portfolio. OPERS has applied 5% of both Defined Benefit and Health Care assets to the Risk Parity concept. For operational reasons it is treated as an asset class. The performance benchmark for the Risk Parity asset class is the weighted average of underlying managers performance benchmarks. Knowing that risk parity managers are trying to construct diversified balanced portfolios and not trying to outperform a benchmark, the Risk Parity asset class has an expected alpha target of zero. GLOBAL TACTICAL ASSET ALLOCATION Global Tactical Asset Allocation, or GTAA, is a top-down investment strategy that attempts to exploit short-term mis-pricings among a global set of asset classes. This strategy focuses on general movements in markets rather than on performance of bottom-up security selection. Target allocations of 2% for the Defined Benefit and Health Care Funds were completed in the first quarter of The performance benchmark for the GTAA asset class is the weighted average of underlying managers performance benchmarks. GTAA has an alpha target of 160 basis points with a target tracking error of 400 basis points. OPERS 2016 INVESTMENT PLAN Page 30

35 POLICIES, COMMITTEES, AND RESOURCES POLICIES, COMMITTEES, AND RESOURCES OPERS RETIREMENT BOARD POLICIES GOVERNING INVESTMENT ACTIVITIES The following exhibit illustrates the structure and relationship of the Policies within the total System and its three investment Funds. All Policies are available at OPERS FUNDS FUND POLICIES DEFINED BENEFIT FUND Investment Objectives and Asset Allocation Policy HEALTH CARE FUND Investment Objectives and Asset Allocation Policy HEALTH CARE 115 TRUST FUND Investment Objectives and Asset Allocation Policy ASSET/SUB-ASSET CLASS POLICIES Public Equity Policy Fixed Income Policy Private Equity Policy Real Estate Policy Risk Parity Policy Cash Policy Commodity Policy Hedge Funds Policy Opportunistic Fund Policy GTAA Policy INVESTMENT-WIDE POLICIES Broker - Dealer Policy Ohio-Qualified & Minority-Owned Manager Policy Corporate Governance Personal Trading Policy Leverage Policy Proxy Voting Guidelines Derivatives Policy Responsible Contractor Policy External Investment Managers Insurance Policy Securities Lending Policy Iran and Sudan Divestment Policy Soft Dollar/Other Commission Arrangements Policy Material Nonpublic Information STAFF Policy COMMITTEE STRUCTURE OFAC Policy DC Fund Policy OPERS 2016 INVESTMENT PLAN Page 31

36 POLICIES, COMMITTEES, AND RESOURCES The Chief Investment Officer ( CIO ) utilizes a variety of committees, working groups and meeting structures to govern the Investments Division s activities. Committees enhance collective inputs, retain institutional knowledge, document due diligence and other processes, promote transparency and accountability, and formalize decision-making. Committees are designed to combine structure and flexibility to efficiently share information and bring appropriate decision makers together on a timely basis, while minimizing operational risk. The committees and working groups vary in both the frequency of meetings and the degree of structure and formality. Here is an outline of the Investment related committees. Committee/Meeting Investment Committees Broker Review* Counterparty* Fund Management* DC Funds Staff Investments Committee* Operational Risk* Risk Steering Purpose and Description Approvals and Decisions Monitor/Approve and Evaluate Brokers, Complete ORSC Reports Set Counterparty Limits and Monitor Counterparty Exposures Implement Asset Allocation and Investment Strategies, Cash Forecasting, Fund and Portfolio Exposure Metrics, and Set Quarterly Fund Target Benchmark Allocations Transitions, Liquidity Management Review/Monitor Defined Contribution Fund's Allocation and Rebalancing Activities Identify and Monitor Operational Risks Risk Assessments and Prioritization Investment Meetings External Public Markets* Private Equity* Real Estate* Investment Meetings Active Equity Global Bonds Derivatives Portfolios Transition Management Internal Equity Index/Tilt Portfolio Progress Meeting External Portfolio Management Review External Public Managers and Manager Searches for CIO Approval Review PE Opportunities for CIO Approval Review RE Opportunities for CIO Approval Internal Portfolio Management Sector Reviews/Outlooks, Portfolio Composition and Risk Management Sector Reviews/Outlooks, Portfolio Composition and Risk Management Review Markets, Strategies, and Internally Managed Index Portfolios Transition Assets Between Managers and Conduct Rebalancing Strategy and Tactics New Portfolio Planning and Implementation Non-Investment Division Committees Committees with Investment Staff Involvement Iran/Sudan Divestiture* Leadership Team* Corporate Governance* * Committee has a charter. OPERS 2016 INVESTMENT PLAN Page 32

37 POLICIES, COMMITTEES, AND RESOURCES Committee Structure Board Board Investment Committee Rick Shafer CIO Investment Related Risk Related Management Related External Public Markets Fund Management Risk Steering Leadership Team Real Estate DC Funds Staff Investments Committee Counterparty Corporate Governance Private Equity Internal Equity Index/tilt Operational Active Equity Iran Sudan Divestiure Broker Review Global Bonds Portfolio Progress Meeting OPERS 2016 INVESTMENT PLAN Page 33

38 POLICIES, COMMITTEES, AND RESOURCES STAFFING Recruiting and retaining the best and most talented Staff is a critical priority for the Investments Division. The following table shows the anticipated staffing for Investment Plan Projected Staffing Target Staffing for Year End 2016 Fixed Active Office Income Equity Index Total of the Internal Internal Quant Fund Cash/ External Invest. CIO Mgmt. Mgmt. Trading Management Sec Lending Funds Division Staffing Costs Assuming full staffing levels for 2016, the chart below details the estimated $16.16 million of compensation for the Investments Division. This represents approximately 1.82 basis points of cost, an increase of only 0.22 basis points from the 2015 projection despite three Staff additions. Estimated 2016 Total Compensation Costs ($ millions) Office of the Internal External Projected Projected CIO Mgmt. Mgmt. Total Total Salaries $ 1.27 $ 6.11 $ 1.88 $ 9.25 $ 8.34 Benefits $ 0.62 $ 2.98 $ 0.91 $ 4.51 $ 4.16 Incentive Compensation $ 0.32 $ 1.59 $ 0.48 $ 2.40 $ 2.00 Total Compensation $ 2.20 $ $ 3.27 $ $ Average Assets ($ billions) $ $ $ $ $ Compensation (Basis Points) OPERS 2016 INVESTMENT PLAN Page 34

39 POLICIES, COMMITTEES, AND RESOURCES Operating Budget The Investments Division s 2016 operating budget (excluding compensation) is $9.02 million. This operating budget reflects an increase of $1.61 million from the 2015 budget. Operating Budget less Total Compensation ($ millions) Total Internal External Invest. Mgmt. Mgmt. Division 2015 Operating Budget $ 4.01 $ 3.62 $ Operating Budget $ 5.40 $ 3.62 $ 9.02 Percent Change 34.7% 0.0% 18.2% Percent of Total 56.4% 43.6% 100.0% Average Assets ($ billions) $ $ $ Operating Budget (Basis Points) Management Cost The expected annual external management fees by asset class and sub-asset class for the Investments Division are in the table below. The estimate of fees is based on the projected average market value for the Defined Benefit and Health Care Funds, as shown by sub-asset class in the average assets column below. For three sub-asset classes within the Alternatives Asset Class, Staff estimates the performance fees based on the average performance assumption over the market cycle of each sub-asset class. Since the performance fee is based on yearly performance, its hurdle rate and other fee payment conditions, this portion is the most difficult to estimate. OPERS 2016 INVESTMENT PLAN Page 35

40 POLICIES, COMMITTEES, AND RESOURCES Estimate of External and Internal Management Costs Total for 2016 Internal Management External Management Average Annual Annual Average Annual Annual Assets Cost Cost Assets Cost Cost ($ millions) ($ millions) (bps) ($ millions) ($ millions) (bps) Public Equity 16, , U.S. Equity 14, , Non-U.S. Equity 2, , Public Fixed Income 12, , Core Fixed 9, Emerging Markets Debt , Floating Rate Debt U.S. Treasury Securitized Debt High Yield , Global High Yield TIPS 1, Alternatives 2, , Private Equity , Real Estate , REITs Hedge Funds , Opportunistic 1, Commodities Risk Parity , GTAA , Short-Term Liquidity Total 31, , Custody Total Fund 31, , Performance Fee Private Equity , Real Estate , Hedge Funds , Total Performance Fee , Total Fund with Perf. Fee 31, , OPERS 2016 INVESTMENT PLAN Page 36

41 POLICIES, COMMITTEES, AND RESOURCES There is a significant cost advantage for passive and systematic forms of asset management and further savings are achieved for internally-managed assets. Sources of internal cost savings arise from lower rent, less travel, no marketing costs, no stand-alone business expenses and no profit margin. But there are also many appropriate business and risk management reasons why OPERS uses external management for some asset classes and portfolios. Total Costs All investment performance returns are reported after fees. Using the same CEM compatible* fee calculation used in prior years, the total costs of the investment program in 2016 are projected to be $587.4 million, or 66.0 basis points of assets under management. However, the CEM method excludes the estimated carry costs from Private Equity, Including these latter costs raises the total fees, estimated for 2016 to 77.8 basis points, or $693.3 million. Estimated 2016 Total Costs ($ millions) Total Internal External Invest. % of Mgmt. Mgmt. Division Total Total Compensation % Operating Budget less Compensation % Manager Fees % Custody % Total Costs % Percent of Total Average 2016 Asset Size ($ billions) Costs in Basis Points NA Costs in Basis Points to Total Fund NA NA 77.8 *CEM Benchmarking, Inc. is an independent firm that provides an assessment of pension plans and it evaluates OPERS investment program relative to a peer group of comparably sized public plans. OPERS 2016 INVESTMENT PLAN Page 37

42 POLICIES, COMMITTEES, AND RESOURCES Peer Group Comparison The following chart compares OPERS asset size and Investment Staff to its peer group as of June 30, While differences in the percentage and types of assets managed internally exist, OPERS compares very favorably. Data are from Pension Fund Data Exchange. $350 $300 Public Plan Peer Group Asset Size and Investment Staff 6/30/2015 Asset Size ($billions) $250 $200 $150 $100 $50 $ Investment Staff The following table lists the public pension peer group referenced in the chart. OPERS 2016 INVESTMENT PLAN Page 38

43 POLICIES, COMMITTEES, AND RESOURCES Public Plan Peer Group (as of 6/30/2015) Peers Asset Size ($ millions) Investment Staff Assset Size per Investment Staff North Carolina Retirement System $90, $2,817 State Board of Administration of Florida $149, $1,675 Ohio Public Employees Retirement System $91, $1,608 Employees Retirement System of Georgia $82, $1,581 California State Teachers' Retirement System $189, $1,550 New York State Teachers' Retirement System $107, $1,515 New Jersey Division of Investment $81, $1,289 Washington State Investment Board $78, $930 California Public Employees' Retirement System $300, $764 State of Wisconsin Investment Board $105, $633 Ohio State Teachers Retirement System $74, $627 Average $122, $1,363 OPERS 2016 INVESTMENT PLAN Page 39

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45 Appendix

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47 Vacant Portfolio Assistant PRIVATE EQUITY FUND MANAGEMENT RISK MANAGEMENT FIXED INCOME Samir Sidani Portfolio Manager (Lead) Lewis Tracy Portfolio Manager Cheri Woolsey Portfolio Manager Greg Cotterman Investment Analyst Bradley Carr Investment Analyst REAL ESTATE Brad Sturm Portfolio Manager (Lead) Stephen Stuckwisch Portfolio Manager A.J. Sayers Investment Analyst HEDGE FUNDS John Blue Portfolio Manager Andy Urban Investment Analyst Vacant Investment Analyst Prabu Kumaran Fund Manager JG Lee Quantitative Manager David Dury Investment Analyst Chad Hamberg Investment Analyst Zach Zerman Associate Investment Analyst Joyce Williams Executive Assistant Dan German Investment Risk Officer Lincoln Carnam Senior Op Risk Analyst Jack Lake Senior Risk Analyst Michelle Lewis Risk Analyst Aron Lau Associate Risk Analyst INVESTMENTS - ORGANIZATIONAL STRUCTURE Mark Ehresman Senior Portfolio Manager Chris Rieddle Portfolio Manager Todd Soots Portfolio Manager Vacant Senior Investment Analyst Nick Kotsonis Senior Investment Analyst David Buchholz Investment Analyst Erik Cagnina Portfolio Manager Sajjad Hussain Portfolio Manager Tony Enderle Trading Manager JoAnn Yocum Investment Assistant HIGH YIELD Vacant Portfolio Manager Vacant Senior Investment Analyst Vacant Senior Investment Analyst Vacant Investment Analyst Rick Shafer CIO ACTIVE EQUITY Edward Painvin Senior Portfolio Manager Vacant Portfolio Manager Vacant Portfolio Manager Jeff Golden Senior Investment Analyst Steve Barker Senior Investment Analyst Ryan Khoury Senior Investment Analyst Mike Parker Senior Investment Analyst Tim Swingle Senior Investment Analyst Mac Price Senior Investment Analyst Zach Martin Investment Analyst Kurt Grove Associate Investment Analyst Paul Greff Deputy CIO QUANT EQUITY Gerry Peters Senior Portfolio Manager Xinyang Gu Quantitative Analyst Erick Weis Index Portfolio Manager Alex Hamilton Senior Investment Analyst Roger Tong Quantitative Analyst Vacant Investment Analyst TRADING Joan Stack Head Trader Matt Sherman Senior Trader Christy Ruoff Trader II Lori Davie Trader I EXTERNAL MANAGEMENT DeAnne Mannion Portfolio Manager (Lead) Brian Wright Portfolio Manager Ryan Casebolt Investment Analyst CASH / SEC LENDING Jerry May Portfolio Manager Teresa Black Senior Investment Analyst Greg Corcoran Associate Investment Analyst Positions as of December 31, 2016 Current Position Vacant Position New Position INVESTMENT ORGANIZATION STRUCTURE INVESTMENT ORGANIZATION STRUCTURE OPERS 2016 INVESTMENT PLAN Page 40

48 STAFF DIRECTORY STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Active Equity Senior Investment Analyst MBA, The Ohio State University BS, The Ohio State University Cash/Securities Lending Senior Investment Analyst BS, The Ohio State University Passed Level I of the CFA Program Steven Barker Teresa Black Hedge Funds Portfolio Manager Fixed Income Investment Analyst MBA, The Ohio State University BS, The Ohio State University BS, Wright State University 7 10 CAIA Charterholder John Blue David Buchholz Fixed Income Portfolio Manager Risk Management Senior Operational Risk Analyst MBA, Case Western Reserve BS, Miami (OH) University MBA, William & Mary Mason School of Business BA, Muhlenberg College 3 16 Erik Cagnina Lincoln Carnam Private Equity Investment Analyst External Public Markets Investment Analyst BS, The Ohio State University 4 7 BS, The Ohio State University 2 13 CAIA Charterholder Passed Level I of the CAIA Program Bradley Carr Ryan Casebolt Cash/Securities Lending Associate Investment Analyst Private Equity Investment Analyst BS, St. Michaels College 2 7 BS, Franklin University BMus, Capital University 6 14 Greg Corcoran Greg Cotterman OPERS 2016 INVESTMENT PLAN Page 41

49 STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Trading Trader I BA, Ashford University CP (Certified Paralegal) Series Fund Management Investment Analyst BS, Xavier University Lorie Davie David Dury Fixed Income Senior Portfolio Manager Fixed Income Trading Manager MBA, Case Western Reserve BS, Miami (OH) University BS, Bowling Green State University Mark Ehresman Tony Enderle Risk Management Investment Risk Officer Active Equity Senior Investment Analyst MBA, University of Pittsburgh BS, Allegheny College 8 17 BS, Princeton University 1 16 Dan German Jeff Golden Public Markets Deputy CIO Active Equity Associate Investment Analyst MBA, University of Detroit BA, Kalamazoo College 7 26 BS, The Ohio State University Level III Candidate in the CFA Program Paul Greff Kurt Grove Quantitative Equity Quantitative Analyst MS, The Ohio State University BS, Southeast University, China Fund Management Investment Analyst MBA, Wright State University BS, Wright State University 2016 Level II Candidate in the CFA Program 4 13 Xinyang Gu Chad Hamberg OPERS 2016 INVESTMENT PLAN Page 42

50 STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Quantitative Equity Senior Quantitative Analyst Fixed Income Portfolio Manager BS, Ohio State University 3 8 BA, Northwestern University 6 18 Alex Hamilton Sajjad S. Hussain Active Equity Senior Investment Analyst Fixed Income Senior Investment Analyst BS, University of Minnesota, Twin Cities 6 17 BS, Miami (OH) University 8 11 Ryan Khoury Nick Kotsonis Fund Management Fund Manager Risk Management Senior Risk Analyst MBA, Asian Institute of Management B Eng (Mech), Anna University 7 18 MBA, Case Western Reserve BS, Marist College 8 22 Prabu Kumaran Jack Lake Risk Management Associate Risk Analyst Fund Management Quant Manager BS, The Ohio State University 1 5 PhD, The Ohio State University FRM Charterholder PRM Charterholder Aron Lau J.G. Lee Risk Management Risk Analyst External Public Markets Lead Portfolio Manager MBA, University of Phoenix BA, Wright State University 5 5 MBA, The Ohio State University BA, The Ohio State University BA, Mt. Holyoke College Michelle Lewis 2016 Level II Candidate in the CFA Program DeAnne Mannion 2016 Level II Candidate in the CFA Program OPERS 2016 INVESTMENT PLAN Page 43

51 STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Active Equity Investment Analyst Fixed Income Portfolio Manager BBA, University of Kentucky 2016 Level III Candidate in the CFA Program 4 6 MBA, Ashland University BA, Abilene Christian University CTP Zachary Martin Jerry May Active Equity Senior Portfolio Manager Active Equity Senior Investment Analyst MBA, Wake Forest University BA, Flagler College 2 18 BS, Wharton, University of Pennsylvania 7 13 CMT Charterholder Edward Painvin Mike Parker Quantitative Equity Senior Portfolio Manager MBA, Drexel University BS, Lafayette College 5 29 Active Equity Investment Analyst MBA, Boston University JD, University of Chicago BA, James Madison University 4 9 Gerry Peters Mac Price Fixed Income Portfolio Manager Trading Trader II MBA, Indiana University BS, Indiana University 9 26 BS, Franklin University Series 63 Chris Rieddle Christy Ruoff Real Estate Investment Analyst BA, The Ohio State University Passed Level III of the CFA Program CAIA Charterholder 3 3 CIO BA, Dartmouth College 7 42 A.J. Sayers Rick Shafer OPERS 2016 INVESTMENT PLAN Page 44

52 STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Trading Senior Equity Trader Private Equity Lead Portfolio Manager MBA, Otterbein College BA, The Ohio State University Series BA, University of Rochester CAIA Charterholder Matthew Sherman Samir Sidani Fixed Income Portfolio Manager MBA, The Ohio State University BS, The Ohio State University Trading Head Trader Equities MBA, Fordham University BA, Mt. Holyoke College Todd Soots Joan Stack Real Estate Portfolio Manager Real Estate Lead Portfolio Manager Stephen Stuckwisch MBA, The Ohio State University BA, Hanover College CAIA Charterholder Bradley Sturm MBA, The Ohio State University MA, University of Cincinnati MAIR, University of Cincinnati BA, University of Cincinnati CAIA Charterholder Active Equity Senior Investment Analyst Quantitative Equity Quantitative Analyst Timothy J. Swingle BSBA, The Ohio State University CMT Charterholder CPA (Inactive) CMA Roger Tong MBA, The College of Insurance MS, New Jersey Institute of Technology Passed Level I of the CFA Program Lewis Tracy Private Equity Portfolio Manager PhD, The Ohio State University MBA, The Ohio State University BA, University of California at Berkeley CAIA Charterholder Andrew Urban Hedge Funds Investment Analyst BBA, Ohio University CAIA Charterholder 5 11 OPERS 2016 INVESTMENT PLAN Page 45

53 STAFF DIRECTORY Name Department/Title Investment Experience Education/Designation/ License OPERS Total Name Department/Title Investment Experience Education/Designation/ License OPERS Total Quantitative Equity Portfolio Manager External Management Portfolio Assistant MBA, The Ohio State University BBA, University of Toledo BS, Franklin University Awarded the Claritas Investment Certificate (2014) 6 8 Erick Weis Joyce Williams Private Equity Portfolio Manager External Public Markets Portfolio Manager MBA, Baylor University BA, Baylor University 5 24 BSBA, Auburn University MS, Indiana University 6 9 CPA (Inactive) Cheri Woolsey Brian Wright Fixed Income Investment Assistant Fund Management Associate Investment Analyst BS, Miami (OH) University 1 9 AS, Bliss Business College JoAnn Yocum Zachary Zerman OPERS 2016 INVESTMENT PLAN Page 46