State Universities Retirement System Fiscal Year Agenda 2013 Investment Plan

Transcription

1 State Universities Retirement System Fiscal Year 2013 Agenda 2013 Investment Plan September 2012

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3 August 30, 2012 State Universities Retirement System of Illinois Serving Illinois Community Colleges and Universities 1901 Fox Drive Champaign, IL (217) (217) (FAX) Investment Department Board of Trustees State Universities Retirement System 1901 Fox Drive Champaign, IL RE: Agenda 2013 Dear Board of Trustees: The Investment Staff is pleased to provide the SURS Investment Plan for Fiscal Year This document was developed in order to formalize the strategic plans for the investment portfolio for the coming year and provide transparency of the planning process. The Investment Plan for Fiscal Year 2013 marks the second year of the formal plan for the SURS investment program. The Investment Plan reviews the results of Fiscal Year 2012 and defines the strategy for Fiscal Year 2013 in accordance with the Board-approved asset/liability study and Investment Policy. Since financial markets are dynamic, revisions to the plan may be required and will be communicated to the Board in a timely manner. After returns of 23.8% and 15.0% during the previous two fiscal years, the SURS investment program ended Fiscal Year 2012 with a nearly flat return of 0.5%, net of investment management fees. The portfolio lagged the policy portfolio benchmark return by 1.2% with investment manager underperformance, particularly in the private equity and U.S. equity portfolios, being the largest detractors. Asset allocation also detracted from relative performance during the period, but to a lesser extent. When compared to other large public funds, the performance of the SURS portfolio is quite competitive. The portfolio s 0.5% return nearly matched the 0.7% return of the Public Funds Index and ranked near median in a universe of large public plans for the past 12 months. Financial markets were marked by volatility and concerns over global economic growth. The market volatility was apparent in the returns of the SURS portfolio. The fiscal year contained one of the worst months and one of the best months in the history of the program. The 7.21% return in October 2011 marked the fourth best monthly return while the -5.87% return in September 2011 marked the eighth worst monthly return in the history of the SURS portfolio. As of June 30, 2012, the defined benefit plan is valued at just over $13.5 billion while the Self- Managed Plan (SMP) is valued at approximately $1.0 billion. Many of the accomplishments occurring during Fiscal Year 2012 were related to the implementation of the asset/liability study approved by the Board in June First, asset

4 structure analyses were completed and implemented in the U.S., non-u.s., and global equity portfolios in an attempt to create a more efficient total portfolio that is free of unintended biases relative to the benchmark. Next, a search for private real estate managers resulted in the retention of two qualified firms to make opportunistic real estate investments on SURS behalf. These new real estate investments will, over time, help to transition the portfolio toward the target real estate allocation approved by the Board in the June 2011 asset/liability study. In addition, SURS committed additional funds to the private equity portfolio to maintain vintage year diversification. Staff, with the assistance of Callan Associates, also completed searches for providers of master trust/custodian and securities lending services. Another significant accomplishment in Fiscal Year 2012 was the continued expansion of the Manager Diversity Program (MDP). The MDP focuses on qualified investment management firms owned by minorities, females, or persons with a disability (MFDB). As of June 30, 2012, the MDP is valued at approximately $1.2 billion. In total, assets under management with MFDB firms are approaching $3.2 billion or 23.3% of the Total Fund. Strategy in Fiscal Year 2013 will continue to focus on shifting the portfolio toward the longterm strategic policy targets. In order to implement the 10% target allocation to real estate, a request for initiation of a search for private core real estate managers will be presented to the Board in September Additional commitments to private equity investments will also be considered, including a potential search for qualified MFDB private equity fund-of-funds managers. The continuing challenge to SURS remains the funding status of the Plan. Despite strong long term returns, SURS remains substantially underfunded. SURS is approximately 41% funded as of June 30, The unfunded liability is approximately $19.3 billion. Meanwhile, the System s cash needs continue to increase. SURS expects to pay approximately $1.89 billion in benefit payments in Fiscal Year 2013, per the Fiscal Year 2011 actuarial valuation report prepared by SURS actuary, Gabriel Roeder Smith & Company. Investment performance alone cannot bridge the funding gap. The Investment Plan for Fiscal Year 2013 contains additional details on Fiscal Year 2012 accomplishments and investment strategies for Fiscal Year The investment team is excited to face the challenges of the coming year. I look forward to discussing Agenda 2013 at future meetings. Sincerely, Daniel L. Allen Chief Investment Officer cc: William E. Mabe, Executive Director

5 FY 2013 Investment Plan Table of Contents I. Purpose..1 Page II. Overview 2 Background Fiscal Year 2012 Performance Review Fiscal Year 2012 Accomplishments Challenges Fiscal Year 2013 Objectives Trustee Education Corporate Governanace Investment Management Fees Staffing III. IV. Asset Allocation / Risk Management 8 Economic Outlook.13 V. Investment Strategies 14 Total Fund Equity Fixed Income Real Estate Private Equity Opportunity Fund VI. VII. Manager Diversity Program 19 Self-Managed Plan Recovery Meets Reality: Finding Relative Value...APPENDIX A Taplin, Canida & Habacht, LLC Northern Trust U.S. Economic & Interest Rate Outlook... APPENDIX B

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7 I. Purpose The Investment Plan reviews the results of Fiscal Year 2012 and defines the strategy for Fiscal Year 2013 in accordance with the Board-approved asset/liability study and Investment Policy 1. This Plan is intended to be a living document. Since financial markets are dynamic, revisions to the plan may be required during the year. In the event of changing circumstances or opportunities during the year, items will be discussed with the Board as necessary. 1 The SURS Investment Policies can be found at 1 FY2013 Investment Plan

8 II. Overview Background The State Universities Retirement System (SURS) is the administrator of a cost-sharing, multiple employer public employee retirement system. SURS membership includes employees of the public universities and other affiliated organizations. Currently, SURS membership totals more than 213,000 active, inactive and retired participants. SURS maintains both a defined benefit and a defined contribution plan, known as the Self-Managed Plan (SMP). As of June 30, 2012, the defined benefit plan is valued at just over $13.5 billion while the SMP is valued at approximately $1.0 billion. The investment portfolio is broadly diversified across equities, fixed income, real estate, private equity and other opportunistic investments. Approximately 43% of the portfolio is managed in passive or structured active strategies while the remaining 57% is managed in active strategies. Fiscal Year 2012 Performance Review The financial markets were marked by volatility and concerns over global economic growth during fiscal year World equity markets were mixed during the period, with renewed concerns over the European debt crisis. Investors favored the safety of U.S. government bonds in the midst of the turmoil and uncertainty. The market volatility was apparent in the returns of the SURS portfolio. The fiscal year contained one of the worst months and one of the best months in the history of the program. The 7.21% return in October 2011 marked the fourth best monthly return while the -5.87% return in September 2011 marked the eighth worst monthly return in the history of the SURS portfolio. Direct real estate (+12.5%), Treasury Inflation- Protected Securities (+12.0%) and private equity (+8.4%) provided the strongest returns over the course of the fiscal year while non-u.s. (-13.5%) and global equity (-5.8%) were the worst performing areas. The table below illustrates the performance of the overall SURS investment portfolio relative to the policy portfolio, as of June 30, Investment Performance* As of June 30, Year 3 Years 5 Years 10 Years 20 Years 25 Years SURS 0.5% 12.7% 1.9% 6.8% 8.0% 8.1% Policy Portfolio 1.7% 13.3% 2.0% 6.8% 7.8% 7.6% *Net of investment management fees The portfolio s return of 0.5% lagged the return of the policy portfolio by 1.2% during fiscal year Investment manager underperformance, particularly in the private equity and U.S. equity portfolios, was the largest detractor to performance. Asset allocation also detracted from relative performance during the period, but to a lesser extent It is noteworthy that SURS has historically demonstrated robust investment performance over longer time periods, earning an 8.1% annualized rate of return over the past 25 years, well in excess of both the policy portfolio return and the 7.75% assumed rate of return. 2 FY2013 Investment Plan

9 When compared to a universe of other large public funds, the SURS return ranks near median for the year ending June 30, 2012, as illustrated in the chart that follows. The portfolio ranks more favorably in the peer universe over longer time periods. SURS Total Fund vs. Public Funds > $1 Billion Periods Ending 6/30/12 (1 = Best, 100 = Worst) Universe Ranking th 56th 21st 14th 43rd 30th 29th 30th Year 3 Years 5 Years 10 Years TUCS Universe > $1 B (GOF) Callan > $1B Universe (GOF) Fiscal Year 2012 Accomplishments The following projects were completed during Fiscal Year 2012: Restructuring of the U.S. equity portfolio to create an efficient portfolio that is free of unintended biases relative to the benchmark (such as value or growth tilts). The new structure created a more defined role for each manager within the portfolio, enhancing and documenting the portfolio management process. Slight increase to actively managed, small- and mid-cap strategies Approximately equal weighting of strategies in each sub-portfolio Completion of small cap growth equity search with $65 million initial allocation Increased allocations of $302 million to qualified investment management firms owned by minorities, females or persons with a disability (MFDB), including $113 million to investment managers in the Manager Diversity Program (MDP) Completion of opportunistic real estate search to begin implementation of 6% direct real estate policy target Committed a total of $125 million to two new opportunistic fund-of-funds managers Completion of searches for providers of master trust/custodian and securities lending services Retained The Northern Trust Company as SURS master trust/custodian Retained Deutsche Bank as third party securities lending provider Implementation of risk-averse lending program to better mitigate collateral reinvestment risk Restructuring of the non-u.s. and global equity asset classes 3 F Y2013 Investment Plan

10 Increase of $194 million to four qualified MFDB investment management firms Approval of a multi-year private equity funding plan for calendar years 2012, 2013 and 2014 at a level of $300 million, $100 million, and $250 million, respectively Committed $100 million to existing private equity fund-of-funds manager Expansion of Manager Diversity Program, which focuses on qualified investment management firms owned by minorities, females or persons with a disability (MFDB) Increase in MDP assets of more than $300 million during fiscal year 2012 from $908 million to $1.2 billion Total assets under management with MFDB firms approaching $3.2 billion or 23.3% of the Total Fund Expansion of Minority Brokerage Policy to further encourage utilization of brokerage firms owned by minorities, females or persons with a disability Expansion of risk management policy Provided trustee education on various topics over the course of the year Challenges The continuing challenge to SURS remains the funding status of the Plan. Despite strong long term returns, SURS remains substantially underfunded. SURS is approximately 41% funded as of June 30, 2012 (using the market value of assets method). The unfunded liability is approximately $19.3 billion. It is important to note, however, that SURS received the full FY 2012 contribution of $980.5 million from the State of Illinois. Funding Ratio 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% 88.2% 72.1% 58.9% 53.9% 66.0% 65.4% 65.6% 68.4% 58.5% 41.9% 40.2% 45.3% 41.1% *Using market value of assets SURS Funding Ratio* FY2000 to FY2012 Fiscal Year The Plan s cash needs continue to increase. SURS expects to pay approximately $1.89 billion in benefit payments in Fiscal Year 2013, per the Fiscal Year 2011 actuarial valuation report prepared by SURS actuary, Gabriel Roeder Smith & Company. Benefit payments rise by three percent per year as a result of the cost-of-living adjustment. $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Total Benefit Expenditures (in $ Millions) 4 FY2013 Investment Plan

11 Fiscal Year 2013 Objectives Much of the focus in the coming year will be moving the portfolio from its current asset allocation toward the strategic policy targets. Diversification and risk control continue to be of paramount importance. Projects planned for Fiscal Year 2013 include the following: Potential search for core real estate managers with the goal of increasing total real estate exposure to 10% over time Consideration of additional commitments to private equity investment opportunities to maintain vintage year diversification in the asset class Potential search to identify qualified private equity fund-of-funds manager focused on minorities, females, or persons with a disability Continued focus on diversity of investment managers, broker/dealers, and other service providers Annual manager reviews Trustee education Addition of investment professional to fill the vacancy on SURS Investment Team Trustee Education SURS strives to provide high quality continuing education for the Board of Trustees. Educational topics are routinely included on Investment Committee agendas. In addition, longer, more in-depth educational sessions, often faciliated by guest speakers, are provided in an annual Investment Forum. These sessions provide Trustees the opportunity to expand their investment knowledge and keep current with new trends in the marketplace. Input is sought from Trustees on topics of interest for future educational sessions. A key focus is on identifying potential investment opportunities that could positively impact the investment portfolio. Potential educational topics being considered for the coming year include: Real estate strategies Private equity investment opportunities Actuarial impact of GASB revisions Operational practices Risk management Corporate Governance SURS continues to place a high priority on corporate governance. Proxy voting is one important component of the System s corporate governance responsibilities. SURS has retained an industry expert, Marco Consulting Group, to ensure all domestic proxy ballots are voted in accordance with the proxy voting guidelines approved by the Board. Proxies of non-domestic shares are voted by SURS investment managers in the exclusive interests of System participants and beneficiaries. Additional efforts pertaining to corporate governance involve membership in the Council for Institutional Investors (CII), a nonprofit organization of pension funds, foundations, and endowments with combined assets of over $3 trillion. CII s mission is to 5 F Y2013 Investment Plan

12 educate its members, policymakers and the public about corporate governance, shareowner rights and related investment issues, and to advocate on members behalf. In addition, SURS is a signatory to the United Nations-backed Principles for Responsible Investment (PRI) initiative. The PRI initiatives are voluntary principles that acknowledge the importance of environmental, social and corporate governance (ESG) issues to company performance. SURS strives to keep abreast of trends and issues in this area and continues to explore efforts that might further enhance the value of the investment portfolio. Investment Management Fees SURS pays close attention to the level of investment management fees paid to its external investment managers. Fees are negotiated with investment managers prior to the commencement of the relationship with SURS and may be subsequently renegotiated, if appropriate. Fees vary significantly among investment managers, with the services of private markets managers, such as those in real estate, private equity, infrastructure, etc., being generally more expensive than those of public markets managers. SURS paid a total of $43.3 million or approximately 31 basis points in investment management fees and expenses for fiscal year Staffing The Investment Department is made up of eight professionals, including six investment professionals, one compliance and governance professional and one administrative professional. Currently, vacancies exist in one Investment Officer position, for which a search is currently underway, and an administrative professional position. SURS Investment Team members have an average of more than 16 years of investment experience. All investment team members have undergraduate degrees, and approximately 83% have graduate degrees. Professional certifications among the team members include two Certified Public Accountants and two Chartered Financial Analysts. SURS is committed to staff development and training to assist employees in realizing their maximum potential. In addition, SURS continues to strive to maintain competitive compensation and promote a positive workplace environment for all employees. The table below lists the individuals on the SURS Investment Team and their tenure with SURS. Name Title Years with SURS Daniel L. Allen Chief Investment Officer 12 Douglas C. Wesley, CPA, CFA Deputy Chief Investment Officer 15 Kimberly K. Pollitt, CFA Senior Investment Officer 9 Marilyn J. Branson Investment Governance & Compliance Officer 9 Lou Ann Fillingham, CPA Investment Officer 7 Joseph M. Duncan Investment Officer 2 An organizational chart of the Investment Department is shown on the following page. 6 FY2013 Investment Plan

13 SURS Investment Department Organization Chart June 30, F Y2013 Investment Plan

14 III. Asset Allocation / Risk Management Asset Allocation The purpose of the asset allocation policy is to establish an Investment Policy framework for SURS with a high likelihood, in the Board s judgment, of realizing SURS investment objective. The most recent asset/liability study was completed in June 2011 with the assistance of Callan Associates (Callan). When selecting the optimal asset mix for SURS, the following considerations are key. Investment policy alone cannot close the SURS plan deficit. The deficit is too large. SURS faces the real risk that the assets could be depleted in less than ten years. The investment and contribution experience in the next five years will be crucial in determining whether the Plan will remain sustainable or shift to depletion. The asset allocation decision depends, in large part, on expected State contributions. Statutory rate contributions are expected to sustain the funded ratio; flat rate contributions will not. Differing expectations lead to dramatically different asset allocation decisions. In June 2012, Callan Associates again examined the SURS optimal asset mix using its revised and slightly diminished capital market assumptions (see section below) and found the current strategic targets continue to be appropriate. The next asset/liability study is tentatively scheduled for fiscal year Liquidity Considerations During the 2011 asset/liability study, Callan Associates suggested the SURS Board of Trustees has an obligation to prepare for the risk of depletion. Although it is reasonable to plan to receive the statutory contributions from the State, it is important to acknowledge there is a risk of receiving a level of contributions less than the required amount. As mentioned previously, SURS funding experience over the next several years is critical in determining the future financial health of the System. In FY 2012, SURS received its full $980.5 million appropriation from the State of Illinois. The certified contribution for FY 2013 is approximately $1.4 billion. SURS believes continued substantial exposure to risk assets, including modest exposure to illiquid investments, is appropriate. Risk assets provide the potential for investment returns meeting or exceeding the Plan s return objectives. To acknowledge the funding and capital market uncertainties, however, illiquid asset class exposures should be limited to current target levels. Liquidity to pay benefits and respond to adverse funding or financial market downturns is critical. New asset classes and strategies such as absolute return will continue to receive consideration. However, funding a new strategy with so much uncertainty regarding the Plan s financial condition may not be optimal. It also may be appropriate to consider the creation of a liquidity reserve, carved out of the fixed income allocation, to meet expected outflows. Capital Market Assumptions The projected return and risk assumptions used in the process were developed by Callan Associates. Callan refreshes its assumptions annually. Callan s most recent capital market projections are shown in the table on the following page. Most capital market expectations represent passive exposure (i.e., beta only), except for hedge funds and private equity, which include an active management premium. Return expectations are net of passive fees. 8 FY2013 Investment Plan

15 Callan Associates Capital Market Projections Projected Risk and Return ( ) 9 F Y2013 Investment Plan

16 Strategic Policy Targets The strategic policy targets resulting from the most recent asset/liability study are shown in the following table. Using Callan s most recent risk and return projections, a passive portfolio composed in such a manner is projected to produce a geometric return of 7.2% and a real return of 4.7% over time. This is slightly lower than the 7.75% actuarial rate of investment return assumption and the projected 5.0% real return assumption. However, it is important to note the timing mismatch between Callan s return and inflation projections, which are based on 10-year estimates, and the actuarial return and inflation assumptions, which are based on longer-term estimates. In addition, active management is projected to add additional value over and above passive implementation. SURS periodically reviews the actuarial return assumption for reasonableness. Asset/Liability Study Outputs New Policy Asset Class Targets U.S. Equity 30% Non-U.S. Equity 20% Global Equity 10% Fixed Income 19% TIPS 4% REITS 4% Real Estate 6% Private Equity 6% Opportunity Fund Total 1% 100% Geometric Returns (Nominal) 7.2% Real Return 4.7% Standard Deviation of Nominal Return 14.5% Sharpe Ratio Equity 60% Fixed Income/Cash 24% REITS 4% Alternatives/Illiquid 12% Risk Management Risk is monitored through various forms of analysis and reporting in an attempt to understand risks within the Fund, and to ensure adequate compensation for the level of risk assumed. Analysis will occur at various levels of detail, which include individual manager, asset class and total Fund level analysis. In addition to relative performance evaluation, an analysis of diversification, benchmark risk, active risk, total risk, value at risk, and other risk measures will 10 FY2013 Investment Plan

17 be reported. Analysis will be conducted on an ex-post and ex-ante basis to identify and quantify both forward looking and backward looking risk metrics. Staff will review portfolios, asset classes, and total Fund information on an ongoing basis in order to maintain an understanding of potential risks within the portfolio. Individual manager portfolios or asset classes demonstrating higher than expected levels of risk will be examined in greater detail and any necessary adjustments will be made immediately, or a plan for doing so will be developed. Alternatively, justification for maintaining the exposure will be provided to the Investment Committee. A Total Fund risk analysis prepared by Callan Associates is shown on the following page. 11 F Y2013 Investment Plan

18 12 FY2013 Investment Plan

19 IV. Economic Outlook A variety of sources were used to develop this outlook for Fiscal Year Consideration was given to information from investment consultants, investment managers, discussions with peers and informational publications. Summary: Although economic conditions have improved since 2008, the U.S. and most of the developed world will continue to suffer slow growth, high debt, and stubborn unemployment in the coming year. The increasing political divide in the U.S. will continue to add to the uncertain economic environment. If unresolved, the approaching fiscal cliff (the expiration of the Bush-era tax cuts, expiration of fiscal stimulus measures, and automatic spending cuts) in the U.S. threatens even more severe economic consequences in 2013 and beyond. The Eurozone debt crisis will continue to add volatility and uncertainty as no painless solutions exist to the structural imbalances. The potential for extreme outcomes in the U.S. and Europe appears to be increasing. Growth in emerging markets will continue but at a slower pace as their economies face challenges due to decreased global exports. Interest rates in the U.S. will continue to remain low, as seen in the yield curve charts below. The Federal Reserve is not expected to begin raising interest rates until late Current Yield as of US Treasury Market June 30, 2011 June 29, 2012 % Change 3-Month Treasury Bill 0.01% 0.08% 0.07% 2-Year Treasury Note 0.46% 0.30% -0.16% 5-Year Treasury Note 1.76% 0.69% -1.07% 10-Year Treasury Bond 3.16% 1.58% -1.58% 30-Year Treasury Bond 4.37% 2.68% -1.70% Illinois Gen Obligation 10-Year 4.62% 3.67% -0.95% Yield to Maturity US Treasury Yield Curve 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Month 2 Year 5 Year 10 Year 30 Year Years to Maturity 6/30/2011 6/29/ F Y2013 Investment Plan

20 V. Investment Strategies Financial Goal & Strategic Objectives The assets of the System will be invested solely for the benefit of participants and beneficiaries within the constraints of applicable Illinois Statutes and the guidelines contained in the SURS Investment Policy document. In addition, the following financial goal and strategic objectives for the SURS plan have been established: The SURS Financial Goal The financial goal as set forth in the SURS Strategic Plan is: To ensure the financial soundness of the System. The strategic objectives designed to achieve the SURS Financial Goal are as follows: Secure the annual required contribution Achieve long term, sustainable, above average, risk-adjusted returns Manage the risk and volatility of assets and liabilities to assist in maintaining sufficient funds to pay benefits and mitigate the cost of contributions Manage expense at an optimal level to achieve the greatest return on investment. Make modifications to benefit/plan design as required In addition, SURS has a goal of protecting assets through sound risk management and ethical practices. Strategic Policy Asset Allocation Targets The overarching strategy for Fiscal Year 2013 will be to continue to position the investment portfolio closer to the strategic policy targets approved by the Board at the June 2011 Board meeting. The table below illustrates the portfolio s current asset allocation (as of June 30, 2012) relative to the strategic policy targets. $ s (in millions) Actual % Strategic Policy % Difference (%) U.S. Equity $ 4, % 30.0% +0.1% Private Equity 1, % 6.0% +2.3% Non-U.S. Equity 2, % 20.0% -2.0% Global Equity 1, % 10.0% -0.1% Fixed Income 2, % 19.0% +2.2% TIPS % 4.0% -0.2% Real Estate % 10.0% -2.8% Opportunity Fund % 1.0% +0.5% Total Fund $ 13, % 100.0% Implementation of the strategic policy targets will continue during Fiscal Year 2013 and will occur gradually over time. 14 FY2013 Investment Plan

21 Fiscal Year 2013 Total Fund Strategy The following actions are planned for the coming fiscal year, many of which are designed to shift the portfolio toward the long-term strategic policy targets. A request for initiation of a search for private core real estate managers will be presented to the Board in September 2012 with the goal of increasing total real estate exposure to 10% over time. As illustrated in the previous table, the real estate portfolio is the asset class farthest away from its policy targets, as of June 30, 2012, and so should be addressed in a timely manner. Although the portfolio is currently overweight in private equity, recommendations for additional commitments to the asset class will be presented for consideration to the Board during the coming fiscal year. Due to the long-term nature of private equity investments, funds committed today will, on average, take several years to be fully invested. As a result, funding needs must be anticipated well in advance in order to maintain the target allocation and vintage year diversification of the private equity portfolio. A request for initiation of a search for qualified private equity fund-of-funds managers owned by minorities, females, or persons with a disability (MFDB) will be presented to the Board in September As mentioned previously, additional commitments in the private equity area will serve to maintain vintage year diversification. In accordance with Public Act , SURS has a goal that 10% of new private market commitments be allocated to firms owned by minorities, females, or persons with a disability. SURS will make continued efforts to enhance and expand the Manager Diversity Program (MDP). As of June 30, 2012, the MDP is valued at approximately $1.2 billion and includes 18 MFDB investment management firms and 19 strategies. SURS will also continue to strive to enhance and expand its relationships with MFDB managers outside the scope of the MDP. Overall, SURS contracts with 23 MFDB investment management firms. Assets managed for SURS by these 23 firms are nearly $3.2 billion, or 23.3% of the Total Fund, as of June 30, SURS staff and Callan Associates will complete formal reviews on each investment manager in the SURS portfolio. SURS staff and Callan Associates will complete formal reviews of the Self-Managed Plan (SMP). Trustee education will continue to be a priority during Fiscal Year F Y2013 Investment Plan

22 Fiscal Year 2013 Equity Strategy With the implementation of last year s equity structure analyses complete, no large scale changes are currently planned for the U.S., non-u.s. or global equity portfolios. The primary focus in fiscal year 2013 will be on monitoring the portfolio and underlying investment managers for performance that meets or exceeds expectations and for compliance with the Investment Policy and investment manager guidelines. Callan Associates, the general investment consultant for SURS, will assist in the monitoring and strategy efforts. US Equity 30% Non-US Equity 18% Global Equity 10% Both the U.S. and global equity portfolios are within one percentage point of their respective strategic policy targets. However, the non-u.s. equity portfolio currently comprises 18.0% of the Total Fund, as of June 30, 2012, less than the 20.0% policy target. SURS staff may take steps to bring the allocation closer to target levels as opportunities arise. Fiscal Year 2013 Fixed Income Strategy Major changes to the fixed income portfolio are not anticipated during Fiscal Year A restructuring of the fixed income portfolio concluded in late 2010, during which time revisions were made to the investment manager lineup to improve relative returns and increase the liquidity of the portfolio. The allocation to core fixed income is +2.2% overweight relative to the strategic policy target. Over time, this overweight will be reduced as assets are deployed to the private real estate asset class. The TIPS allocation is very close to the strategic policy target so major reallocations will be unnecessary in that space. TIPS 4% Fixed Income 21% Alternative Strategies Fiscal Year 2013 Real Estate Strategy As of June 30, 2012, investments in real estate investment trust securities (REITS) comprise 4.0% of the total portfolio, and investments in private real estate investments total 3.2% of the portfolio. The long-term strategic policy target mix allocates 4% to REITS and 6% to private real estate. The allocation to private real estate will rise over time as funds are deployed to the two recently hired opportunistic fund-of funds real estate managers. In addition, staff intends to request authorization for a private real estate search at the September 2012 Board Real Estate 7% meeting. The search will likely be focused on the core segment of the real estate market. The chart that follows illustrates the diversification of the real estate portfolio by type, as of June 30, FY2013 Investment Plan

23 Opportunistic Real Estate* 21% SURS Real Estate Portfolio Diversification by Type Value Added Real Estate 1% REITS 47% Core Real Estate 31% *The allocation to opportunistic strategies shown above represents the commitment made to each fund, not the current market value. Fiscal Year 2013 Private Equity Strategy The total portfolio remains overweight to the private equity asset class. The June 30, 2012, allocation of 8.3% exceeds the 6.0% strategic policy target. However, the private equity program is nearing full commitment with the existing funds due to increasing distributions from partnerships and minimal new commitments. In March 2012, the Board approved a three-year private equity funding plan for calendar years to maintain vintage year diversification in the private equity portfolio. The amounts specified are $300 million for 2012, $100 million for 2013 and $250 million for Thus far, $100 million has been committed in Additional commitments will be considered for the coming fiscal year. A request for initiation of a search for qualified private equity fund-of-funds managers owned by minorities, females, or persons with a disability (MFDB) is tentatively scheduled at the September 2012 Investment Committee meeting. The chart that follows illustrates the diversification of the private equity portfolio by type, as of June 30, Private Equity 8% 17 F Y2013 Investment Plan

24 SURS Private Equity Portfolio Diversification by Type Other 7.5% Buyouts 43.3% Mezzanine 1.3% Secondaries 0.3% Fund of Funds 33.3% Venture Capital 14.4% Fiscal Year 2013 Opportunity Fund Strategy At this time, no new investments are currently being considered for the Opportunity Fund. Potential opportunities arising during Fiscal Year 2013 may be brought to the Board s attention, if appropriate. Opportunity Fund 1% 18 FY2013 Investment Plan

25 VI. Manager Diversity Program Overview The Manager Diversity Program (MDP) is a manager of managers program that is overseen by SURS Staff. The primary goal of the MDP is identifying highly successful minority-, female-, and persons with a disability-owned (MFDB) investment managers that can then be awarded meaningful allocations in the actively managed portfolio. Key items of note: Developed in 2004 to identify and retain MFDB firms Managers contract directly with SURS Market Value of $1.212 billion, as of June 30, components: Number of MFDB Firms Commitment Amount (Private Equity & Real Estate Only) Market Value* Asset Class as of June 30, 2012 U.S. Equity 7 $462 million N/A Core Fixed Income 4 $227 million N/A TIPS 2 $216 million N/A Non-U.S. Equity 3 $259 million N/A Private Equity 1 $31 million $50 million Real Estate 1 $16 million $75 million Total 18** $1,212 million *Totals may not add due to rounding **18 firms and 19 strategies due to two strategies with one private equity investment manager Performance Objectives The performance objective of the MDP is to seek annualized investment returns, net of investment management fees, in excess of the market goal for 1, 3, 5, and 10 year periods. While individual investment managers may underperform in any given year, the diversification within the program should limit the underperformance at the program level. Fiscal Year 2012 Performance Review The MDP lagged its benchmark during Fiscal Year 2012 primarily due to manager underperformance in the U.S. equity, private equity, and TIPS portfolios. In the aggregate, managers in the non-u.s. equity and core fixed income portfolios outperformed the benchmark during the period. Although the MDP also lags the benchmark for the most recent three-year period, the program s returns exceed those of the benchmark for the five year and since inception periods, as shown in the table below. Investment Performance* As of June 30, Year 3 Years 5 Years Since Inception SURS MDP 1.6% 12.7% 1.6% 4.8% Benchmark 1.9% 13.9% 1.5% 4.7% *Net of investment management fees 19 F Y2013 Investment Plan

26 Fiscal Year 2012 MDP Accomplishments The Manager Diversity Program continued its expansion during Fiscal Year As of June 30, 2012, the MDP is valued at approximately $1.2 billion, an increase of more than $300 million from the previous year. A summary of MDP activities follows. At the September 2011 meeting, the Board approved a structure analysis for the U.S. equity portfolio. The new structure created a more defined role for each manager within the portfolio, enhancing and documenting the portfolio management process. The changes resulted in a slight increase to actively managed, small- and mid-cap strategies, while also equal weighting the strategies in each sub-portfolio. Nine qualified MFDB firms earned additional allocations totaling $302 million, which includes $113 million to investment managers in the Manager Diversity Program. The restructuring of the non-u.s. equity asset class resulted in additional allocations of $194 million to four MFDB firms, including $138 million to three MDP managers. Contract negotiations were completed and investing commenced with a real estate fundof-funds manager, whose mandate is to identify capable emerging, minority- and femaleowned real estate funds for SURS. SURS is investing in this strategy with a consortium of other pension plans, including the Illinois Municipal Retirement Fund and the Public School Teachers Pension and Retirement Fund of Chicago. SURS commitment amount is $75 million. SURS partnership with MFDB firms is not limited to the MDP. In total, SURS utilizes the services of 23 MFDB managers. As of June 30, 2012, total assets under management with MFDB firms are approaching $3.2 billion or 23.3% of the Total Fund. Fiscal Year 2013 MDP Strategy Plans for the MDP in FY 2013 include the following: Request Board authorization for a search to identify qualified private equity fund-offunds managers focusing on minorities, females, or persons with a disability (MFDB). SURS has a goal that 10% of new private market commitments be allocated to firms owned by minorities, females, or persons with a disability. Continue diligent monitoring of the overall program, manager structure, and risk parameters within the program Provide a thorough review of the MDP to the Board at the March 2013 Board meeting Identify potential opportunities to increase/decrease funding for existing qualified investment managers Continued interaction with system consultant, Callan Associates, via more frequent discussions regarding managers within the MDP 20 FY2013 Investment Plan

27 VII. Self-Managed Plan Overview The Self-Managed Plan (SMP) is a defined contribution option available to SURS participants. The SMP has grown steadily since the plan s inception in April To date, over 24,500 participants have participated in the plan. Highlights of the plan include: $1.041 billion in assets as of June 30, 2012 (including the SMP forfeiture and disability reserves of more than $70 million) Two Service Providers Fidelity Investments ($555 million in assets) TIAA-CREF ($416 million in assets) 31 investment options as of June 30, 2012 Includes series of lifecycle funds in both TIAA-CREF and Fidelity lineups Over 16,600 Participants Fiscal Year 2013 SMP Strategy Given the diversity and number of investment options in the SMP, there are no plans to expand the offerings. However, SURS staff continually monitors them for performance and cost effectiveness. If there were an opportunity to replace an option, SURS would look to consider another fund for inclusion. Also, SURS takes into consideration that the SMP is a primary retirement plan, as well as participant inquiries and requests, when determining what funds to potentially include in the lineup. Participant education also will continue to be a priority in the coming year. 21 F Y2013 Investment Plan

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29 Appendix A

30 RECOVERY MEETS REALITY: FINDING RELATIVE VALUE In this piece we discuss the state of the fixed income market in the context of the US and world economies. The possible effects of the upcoming fiscal cliff and the US presidential elections on the market are examined. We then look at trends in corporate behavior since the recession ended. Finally, we look at market valuations and provide strategic investment recommendations. Economic Outlook It has been three years since the recession officially ended in the United States, and while the risk of a double dip has declined, the US fiscal situation and economic statistics suggest that we are far from a healthy recovery. Although economic metrics such as consumer confidence, small business optimism, home sales and initial jobless claims have improved from their low points, levels remain depressed when compared to the start of the recession. Industrial capacity utilization remains below long-term historical averages due to lackluster demand in the economy. Unemployment and GDP growth stand out because they have lagged significantly versus prior recoveries (see chart above), highlighting how weak consumers and the overall economy remain. Further clouding the economic outlook are the following factors: 1. Slowing global growth, which has been pressured by the European debt crisis and recent slowdown in emerging markets; 2. US Presidential election, with its uncertain outcome and with important implications for business confidence; and 3. Fiscal cliff, which continues to cast shadows over future policy decisions and the impact on the economic environment. International Outlook 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% Recovery Trends following US Recessions Jul 81- Nov 82 Jul 90- Mar 91 Mar 01- Nov 01 Dec 07 - Jun 09 GDP Growth Avg* Change in Unemployment** * Average GDP Growth for the 3 years following the end of each recession. **Unemployment rate 54 months after the beginning of recession minus pre-recession level. Source: Bloomberg In Europe, politics continue to take center stage as ministers debate the funding mechanics and implications of various European rescue entities. Subordination concerns by official creditors and heightened risks of another Greek debt restructuring are acting as an overhang on increased private investor participation in peripheral sovereigns. Meanwhile, fiscal austerity and reform programs reduce consumer confidence and temper economic recoveries. In addition, the economic trend in Europe is still heading downward as more countries fall into recession. While emerging markets such as China and Brazil continue to support global GDP growth, growth is slowing and providing less support to developed economies than in the previous years. Taplin, Canida & Habacht, LLC P a g e 1

31 We expect a slow resolution to the European crisis and believe global investment returns during the next year will be limited by a series of headline events, such as the next bailout payment to Greece. Even if a comprehensive plan is achieved in Europe and global confidence is restored in the region, European economies will be depressed for the next few years due to austerity measures, high unemployment, continuing problems from the housing crises and a weakened banking system. Due to the size of Europe as an economic block, we anticipate this will continue to act as a brake on global economic growth. Annual GDP Growth (2) (4) Emerging Markets % growth Developed Markets % Growth Source: IMF and Taplin, Canida & Habacht Domestic Outlook The US is facing two major events within the next six months, the fiscal cliff and presidential election. We believe these events create an overhang on the overall economic environment and add to uncertainty, which could potentially increase volatility to investment returns. While we believe the outcome of the election and resolution of the fiscal cliff carry meaningful economic and market implications, we believe the long-term impact will be muted by the global risks discussed above, the unemployment picture and the current financial position of the US government. The fiscal cliff refers to a series of governmental policy changes that will kick in if Congress fails to pass new legislation by the end of The three largest items are the Bush tax cuts, the Obama payroll tax cut and the cost of indexing the Alternative Minimum Tax (AMT) eligibility cutoff for inflation. Courtesy of the CBO, the cost of the fiscal cliff items is shown below, measured as the amount of deficit reduction they each would represent. Federal Deficit Reduction in 2013 Congress is divided on how to deal with the issue. If nothing is passed before these items expire (from 12/31/2012 to 1/15/2013 for the largest items), then Payroll Tax Cut Expiration, 16% the tax cuts will end and spending cuts will kick in Other Revenue simultaneously. (The spending cuts were created as Budget Control and Spending Act Automatic Changes, 17% Cuts, 11% an automatic mechanism used to resolve the debt ceiling debates in August 2011.) Based on Other Expiring Congress poor track record, including its Provisions, 11% Unemployment 2001/2003/2010 mismanagement of debt ceiling negotiations, we don t expect a quick resolution. Further, it is highly Benefits Tax Cuts & AMT Expiration, 4% Patch Expiration, unlikely anything will happen prior to the election 36% Affordable Care Act Tax Increase, in November, leaving only eight weeks to deal with 3% Medicare "Doc Fix" Expiration, 2% Source: Congressional Budget Office the issue during a typically difficult time to pass major legislation. The effects of these items in 2013 would be significant, and economists suggest the US economy could flatline, or possibly fall into recession again. In addition, international economies Taplin, Canida & Habacht, LLC P a g e 2

32 could be adversely affected from the loss of confidence and domino effect of a slowing US economy. Although we believe both sides of the aisle recognize the severity of the looming problem, vast differences of opinion will likely make it difficult to compromise. We see three major scenarios playing out: 1. Kick the can down the road by extending the items in questions without achieving any real progress on fiscal reform; 2. Compromise on a combination of tax increases and spending cuts, driving long-term fiscal reform; 3. Let the tax cuts expire and spending cuts kick in. Regardless of who wins the election, we don t think Option 3 will play out because it would be too disastrous for the economy and politicians would be unwilling to take responsibility for the effects of the US economy dipping back into recession. We are hopeful about Option 2 but remain concerned given recent attempts at compromise, especially when considering the condensed timeline following the election. Therefore, Option 1 appears most likely. While this will address a near-term concern, we fear this will create yet another overhang on the economy due to its implications for US creditworthiness, hampering a stronger economic recovery. Beyond the impact of the fiscal cliff, we believe the outcome of the Presidential election could have meaningful economic impact. As an example, the election could stimulate business hiring, which could start a virtuous feedback loop between consumers and businesses. However, we also believe that outcomes are muted by gridlock in a polarized Congress, hampering meaningful legislation in the areas of tax policy, spending cuts and entitlement reform. Given the current weak pace of recovery, our base case is that the US government will continue to be a source of investor concern over the near term regardless of the winner of the presidential election. Labor Force Reality We view optimism following the best-case scenarios outlined above reluctantly because we expect unemployment to remain at elevated rates for the next few years due to the currently very low labor force participation rate. If hiring picks up, more workers would return to the work force, acting as a drag on the overall unemployment rate. As the graph below shows, labor force participation was fairly flat at 66.0% in the year and a half going into the recession but has since steadily dropped from 66.0% to 63.7% as discouraged workers have stopped looking for work and left the labor force. Although the official unemployment rate is 8.3%, if labor force participation today were the same as pre-crisis (66.0%), the labor force would be larger by 5.5 million people and the unemployment rate would be 11.4% today. A 1.0% increase in the participation rate is equal to 2.4 million new job seekers entering the labor force. To maintain unemployment at its current rate, an equivalent number of jobs have to be created as workers entering the workforce. This means a labor force participation rate increase of 1.0% (from 63.7% to 64.7%) requires 200,000 jobs be created per month for 12 months in a row (in July 2012 job growth was 163,000) just to keep unemployment at the current rate. This is why it is possible to have a simultaneous increase in the number Taplin, Canida & Habacht, LLC P a g e 3

33 Percent of jobs created per month and an increase in the unemployment rate. Therefore, our outlook regarding the US consumer - and consequently the US economy - remains very cautious. US Sovereign Valuations Source: Federal Reserve Treasury Yields 10Yr 5 Yr 2 yr Despite the bleak picture described above (reinforced by S&P s downgrade of credit ratings a year ago and Moody s and Fitch s negative outlooks), US Treasury securities tell a very different story. US debt prices have surged and yields are at record lows. Typically, the economic trends and uncertainties described above would result in the opposite trend. Despite economic concerns, the US benefits from its relative sovereign strength and its reserve currency status, which prompts buying of US assets in a flight-to-quality from domestic and international investors during periods of uncertainty. Further, the Federal Reserve has proven to be very accommodative in its policy, providing monetary policy support to the economy during the last five years. Most recently this has resulted in QE1 and QE2, which included direct purchases of US debt, increasing demand for bonds and putting further pressure on yields. While the stated Fed goal of quantitative easing is to lower borrowing costs for consumers and businesses in order to stimulate the economy as well as to push investors into risk assets by lowering yields on US Treasuries, the added demand from a flight-to-quality environment has also taken yields to record lows. We expect the Fed to remain accommodative in its policy actions due to recent comments from Ben Bernanke and continued economic weakness. This leaves the door open to QE3 in the short-to-medium term. We think the current environment sets Treasury yields up for a swift reversal should macro concerns stabilize and a flight-from-quality into risk assets occurs. The fact real Treasury rates are negative looking 20 years forward also supports this risk. However, we still view risk as low in the short-tomedium term because of the Fed s strong influence on the market and the slowing state of the US and global economy, which will likely continue a natural bid for US Treasuries as a flight-to-quality. Corporate Trends We find it interesting to examine how corporations have fared in the post-crisis period. As the economy weakened in 2008, companies retrenched and entered a risk-averse period Phase I, focusing on strengthening balance sheets and improving liquidity. Companies focused on raising cash, adopting more conservative financial policies, refinancing debt and extending maturity profiles. To support this, operations were optimized through non-core business divestitures, headcount reductions, productivity improvements and efficiency gains. Taplin, Canida & Habacht, LLC P a g e 4

34 Percent Percent Tier 1 Capital % NPL% 12/06 3/07 6/07 9/07 12/07 3/08 6/08 9/08 12/08 3/09 6/09 9/09 12/09 3/10 6/10 9/10 12/10 3/11 6/11 9/11 12/11 3/12 6/12 ($) (%) Operating improvement initiatives crossed corporate sectors. While many industrials were focused on supporting profitability, financial institutions also made changes to offset a dramatically different operating environment and changes in regulation. Despite downgrades of financial institutions, which reflected the change of sovereign support and volatility of core businesses, core credit metrics - including liquidity, leverage, asset quality and capital support - were improved. However, with soft economic trends persisting, returns as measured by ROE and ROA (see chart) failed to meet historical levels despite an initial rebound. 450, , , , , , , , , , ,000 Source: S&P S&P 500 Efficiency Trends Rev/Employee (Median) EBITDA Margin (Median) With the benefits from the low-hanging fruit of Phase I largely exhausted and growth through initiatives such as cost reductions reaching an upper limit, companies found it necessary to enter a second stage of strategic initiatives ( Phase II ), seeking to satisfy shareholders and elevate returns on equity towards historical levels. Phase II 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% began early in 2010 and has been characterized US Avg (Assets > $100B) by boosting shareholder returns through Source: Standard & Poor's increasing share repurchase programs and looking for inorganic growth opportunities such as acquisitions, especially in higher growth S&P 500 Corporate Returns regions and sectors, all fueled by cheap credit provided by yield-hungry investors. Unlike Phase I, which drove improvement across companies credit metrics, in many cases to record strength, Phase II has been executed at the expense of creditors, somewhat offsetting gains from initial initiatives as companies borrow to finance these programs. Large media companies, for example, have been actively issuing debt to finance share ROE (Median) ROA (Median) repurchases and/or diverting more free cash flow Source: Standard & Poor's to shareholders, while we ve seen some of the largest acquisitions on record in the food/beverage and energy sectors. Looking forward, we expect Phase II to continue for the foreseeable future, and although we generally expect credit profiles to worsen as a result, we also expect them to remain better than prior to the recession. 13.0% 12.0% Global Banking Credit Trends US Universal Avg (JPM, BAC, C, WFC) % 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Taplin, Canida & Habacht, LLC P a g e 5

35 110% 100% 90% 80% 70% 60% 50% 40% Change in Leverage from YE06: S&P 500 Median 60% 50% 40% 30% 20% 10% 0% S&P 500 Cash Usage Trends 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% Net Debt / EBITDA+'Net Debt to EBITDA as % of base year (2006) Source: Standard & Poor's Share Repurchase / Levered FCF (Median) Source: Standard & Poor's Cash to Total Assets (Median) Corporate Valuations Although equity markets have nearly recovered to pre-recession levels and volatility as measured by the VIX Index is near its pre-recession lows, we would not characterize equity markets as expensive. The average and median P/E ratio s since 2006 were 15.9x and 16.1x, respectively, compared to a relatively low current P/E of 14.3x. S&P 500, CDX, OAS: Relative Trends A similar positive trend can be seen in fixed income markets since the end of the recession. The CDX IG Index is composed of Credit Default Swap levels of 125 North American investment grade companies across a wide range of market sectors Using the CDX IG Index as a proxy for the fixed income market, we compare it to the performance of the S&P 500 CDX (5YR Generic) (LHS) Corporate OAS (LHS) S&P 500: Inverted (RHS) (see chart; note the S&P 500 Source: Barclays,Bloomberg chart is inverted for comparison purposes). While we find the markets to be highly correlated, fixed income continues to price in higher risk versus pre-recession levels, and has underperformed the S&P despite representing claims higher in the capital structure. When we layer in cash spreads, as measured by Barclays Capital Corporate OAS, the underperformance becomes even clearer. When we put spreads in the context of the business changes highlighted above (see charts below), the story becomes more compelling for credit investment. Specifically, we see: 1) Investors receive more spread per unit of corporate leverage versus pre-crisis (nearly double in longer-dated securities); 2) Steepness in credit curves creates opportunity in long-term securities; and 3) Lower-rated names have underperformed, remaining near post-recession wide spreads on a relative basis. Taplin, Canida & Habacht, LLC P a g e 6

36 12/31/ /11/ /05/ /07/ /13/ /13/ /11/ /10/ /10/ /09/ /07/ /08/ /08/ /08/ /05/ /05/ /05/ /01/ /28/ /29/ /29/ /27/ /23/ /27/ /26/ /22/2012 bps (x) 300 Industrial Spread Trends Relative Spread Performance (By Rating) June 2007 March 2009 June 2011 Dec 2011 June 2012 August YR Spread / Leverage (bps) 30YR Spread / Leverage (bps) Net Debt / EBITDA (x) Source: Barclays,Standard & Poor's Source: Barclays A vs AA BBB vs AA Conclusions Generally, we remain cautious in the short-to-medium term due to domestic uncertainties from the fiscal cliff and elections, continuing problems in Europe, slowing emerging markets and a slow domestic recovery. Tempering our caution is a very accommodative Fed, which will support markets. From a corporate bond perspective, the Fed s stance bolsters our case for corporate credit investment on a relative basis. However, we think it makes sense to be extremely selective with purchases and disciplined about selling rich bonds due to economic uncertainties, Phase 2 initiatives and low absolute yields. From a bottom-up perspective, we continue to find credit opportunities in a wide range of market sectors where fundamentals and valuation continue to be disconnected and present attractive opportunities to outperform. In addition, market fear has resulted in oversold situations in international markets. Despite the fact bond spreads have tightened substantially in 2012, we think there is potential for further spread tightening because spread levels remain above historical averages. Structurally, we continue to favor a barbell, which allows us to capture real yield in underlying Treasuries and take advantage of steep Treasury and spread curves. Further, while we believe rates will remain range bound for the near to intermediate term, we think tighter monetary policy and flights-from-quality will result in a flattening yield curve, with the long end of the yield curve outperforming, similar to what we saw from late 2004 through Written: Aug 2012 TCH Investment Research Team Taplin, Canida & Habacht, LLC P a g e 7

37 Appendix B

38 Northern Trust Global Economic Research 50 South LaSalle Chicago, Illinois northerntrust.com Carl R. Tannenbaum Chief Economist Citius, Altius, Fortius August 10, 2012 Countries Across the Globe Seek Faster, Higher, Stronger Growth Summary: Central banks in the United States and Europe are both seeking new ways to stimulate economic activity. Recent news from the housing market has been encouraging, but the race to recovery is likely to be a marathon, not a sprint. Headwinds blowing from Europe and China will continue to present significant downside risks to U.S. economic growth. Like many of you, I ve enjoyed starting my recent days watching the Games from London. For those of you wondering about this month s title, it s the Olympic motto: from the Latin for faster, higher, stronger. I always wanted to be an Olympic athlete, but when my swim coach told me that I d have to spend six hours a day in the pool instead of three, my ambition waned. However, my wife decided last week that she would like to train for the shooting competition should I be worried about that? The world s athletes work awfully hard to prepare for their events. But chance also plays a role in separating the gold medal winners from the also-rans. Even the most practiced competitors have periods of poor form or fitness that can, unfortunately, occur during the Olympic fortnight. Economic policy makers on both sides of the Atlantic met last week to figure out how to engineer faster, higher, and stronger rates of growth. With both the U.S. and Europe still working through the fallout from real estate collapse and consequent financial crisis, achieving this ideal is dependent on both sound preparation and good fortune. And the struggle is having consequences across the five continents represented by the Olympic rings. The Fed: Steady for Now, But Leaning We went one for two with our predictions for the FOMC meeting. The group opted not to change the interest rate on excess reserves (see the July 24 View from Here), but also declined, for now, to initiate a third round of quantitative easing. Our premeeting analysis suggested that the case for additional stimulus measures was