New Jersey State Investment Council FY 2008 Annual Meeting Investment Environment and Results November 20, 2008 William G. Clark Division of Investment 1
Outline I. Summary of Market Environment II. III. How We Got Here Pension Fund Performance IV. Portfolio Decisions FY 2008 V. FY 2009 So Far VI. Concluding Thoughts 2
US Equities Market Returns for FY 2008 Returns Through June 30, 2008 1 Year 3 Years 5 Years S&P1500 Index -12.7% 4.7% 8.2% International al Equities MSCI EAFE ex -prohibited -11.7% 12.6% 16.5% Emerging Markets Equities MSCI Emerging Markets Index 46% 4.6% 27.1% 29.8% Investment-Grade Bonds Lehman Brothers US Treasuries Index 10.3% 4.6% 3.8% Lehman Brothers Corporate Index 3.1% 2.3% 3.0% Lehman Brothers Mortgage Backed Index 7.8% 4.8% 4.6% High Yield Bonds Lehman Brothers High Yield Index -1.6% 4.9% 6.9% 3
Market Returns for FY 2008 Returns Through June 30, 2008 1 Year 3 Years 5 Years Commodities 41.6% 19.8% 18.6% Private Equity -1.5% 1.6% 10.6% Real Estate NCREIF Property Index + 100% Index 10.3% 15.9% 15.8% Hedge Funds HFRI Funds of Funds Index -0.2% 8.1% 7.7% Cash 91 Day US T-Bill Index 3.6% 4.3% 3.2% 4
US Equities A Tale of Two Markets Performance For Key Sectors July 07 June 08 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% 27.74% 5.95% -40.81% Energy Basic Materials Financials 5
International Equities - Similar story plus additional volatility from Currency Changes July 07 June 08 Performance 20% 10% 0% -10% -20% -30% -40% -50% -60% France Germany Ireland Italy Norway Spain Sweden United Kingdom Australia Hong Kong Japan Canada USA US$ Local 6
From 2002 through 2007, the markets boomed with the Emerging Markets climbing to unprecedented levels Markets finally began to turn in 2008 1,000% 900% 800% 700% 600% 500% 400% 300% 200% 100% 0% Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 India: (48%) Brazil: (43%) Russia (69%) China: (64%) U.S. (35%) Japan: (44%) W. Europe: (40%) Equity Index Performance by Country / Region (Dec-2007 to Oct-2008) 7 Source: FactSet
US Fixed Income Performance By Sector/Industry One Year Performance as of June 30, 2008 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% US Treasury Agencies MBS Fixed Rate Corporate CMBS US Coporate High Yield ABS Home Equity 8
High Yield Bond spreads started to widen dramatically in late 2007 Will defaults follow? High Yield Bond Spreads and Defaults 1,200 U.S. Recession 14% ) 1,100 1,000 900 12-Month Average Default Rates STW Forecast Default Rates 12% 10% High Yield Defau High Yield STW (bps) 800 700 600 500 400 300 8% 6% 4% 2% lt Rates (Percent of Outstanding Issuers) 200 Jan Aug Mar Nov Jun Jan Sep Apr Nov Jul Mar Oct Oct 1990 1991 1993 1994 1996 1998 1999 2001 2002 2004 2006 2007 2009 0% Source: Moody s 9
After a rapid run-up up and fears of rampant inflation Commodity prices have now come crashing down WTI Crude Oil $160 1,000 CRB Metals Index $140 $120 800 US$ / Bb bl $100 $80 $60 600 400 $40 $20 $0 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 2008 10 Source: Commodity Research Bureau
The average Hedge Fund had negative returns as well But returns have beaten stocks Performance Comparison: 2006-20082008 YTD (1) Current Drawdown 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% 2206 2007 2008 YTD 00% 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -30.0% -35.0% -40.0% -45.0% Barclay CTA HFRI S&P 500 MSCI World MSCI Europe MSCI BRIC MSCI Asia ex Japan HFRI S&P 500 MSCI World Fund/Index Drawdown Starts Barclay CTA 7/31/2008 HFRI 10/31/02007 S&P 500 10/31/02007 MSCI World 10/31/02007 MSCI Europe 10/31/02007 MSCI BRIC 10/31/02007 MSCI ex Japan 10/31/02007 (1) As of Sept 30, 2008 11
How We Got Here DEBT 12
The bottom line is that systemic debt rose to unprecedented heights Total U.S. Credit Market Debt Has Risen to 350% of GDP % 350 330 310 290 Total Credit Market Debt / U.S. GDP (1) 270 Great Depression 250 230 210 190 170 150 130 Today 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 13 (1) Source: Ned Davis Research, 2008
Much of which supports an unprecedented growth in spending relative to income 275 250 Wages Index Spending Index This is not sustainable $ In Billions 225 200 175 1990 2000 Spending Growth: 75% Wage Growth: 75% 150 2000 2007 125 Spending Has Outpaced Income Spending Growth: 44% Wage Growth: 32% 100 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Selected equity research 14
Much of this increased spending went into housing 70% Homeownership Rate 69% 68% 67% 66% 65% 64% 63% 1983 1985 1987 1989 1991 1993 1995 1998 1999 2001 2003 2005 2007 The onset of subprime and other structured loans led to an unparalleled increase in homeownership (68% vs. long term trend of 64%) Source: Census Bureau, NBER, Merrill Lynch 15
Low interest rates, and an under-regulated regulated financial sector, served as the catalysts for this rapid growth in debt Real 10-Year Treasury Yield 1 Year ARM Rates 12% 13.0% 10% 12.0% 11.0% 8% 10.0% 6% 0% Real Borrowing 9.0% 8.0% Long term average 4% 7.0% 60% 6.0% 2% 5.0% 0% (2%) 1983 1988 1993 1998 2003 2008 Source: Bloomberg per The Conference Board and Factset 4.0% 30% 3.0% Ja n- 84 Oc t- 93 J ul- 03 Source: JP Morgan 16
We See It Here 50% Bank Loans as a Percent of GDP 45% 40% 35% 30% 25% 1970 1975 1980 1985 1990 1995 2000 2005 2010 It would take a 20% decline e to get to trend, which would imply a credit contraction of approximately $2 trillion 17 Source: Federal Reserve Board
This excess leverage led to strong economic growth around the world 8% Global Real GDP Growth 6% 5.3% 4.9% 5.4% 5.2% % Growth 4% 2% 2.5% 3.1% 4.0% 0% (2%) 2001 2002 2003 2004 2005 2006 2007 Source: IMF 18
Rating Agencies propagated the Illusion of a low-risk investment environment They assigned high, investment-grade ratings to opaque structured financial products and debt issued by highly leveraged companies Since the outbreak of the credit crisis, i they have downgraded d d more than $1.9 trillion of mortgage-backed securities Rating Agency Downgrades: Mortgage Backed Securities (1) ($ billions) 1,000 800 600 841 739 400 200 0 237 85 Q3 2007 Q4 2007 Q1 2008 Q2 2008 19 (1) Source: Citigroup. September, 17 2008
Unfortunately, the economy and financial markets are already unwinding these excesses 20% Home Prices (Case-Shiller Y-o-Y Y Change) 15% 10% Y-o-Y Chan nge 5% 0% (5%) (10%) (15%) Down 15% Y-o-Y (20%) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: First American Real Estate Solutions 20
Percent of Homes in Foreclosure or Arrears 10.0 Record High 9.0 8.0 7.0 60 6.0 5.0 4.0 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 21 Source: First American Real Estate Solutions
Financial institutions have sustained more than $500 billion in write-downs since credit crisis began IMF Comparison of Losses Across Financial i Crises (1) $ bil Minimum i 1,000 Anticipated Future 800 Losses 600 400 200 0 US Savings and Loan Crisis (1986-95) 95) Japan Banking Crisis (1990-99) 99) Asia Banking Crisis (1998-99) 99) Credit Crisis (2007-??? ) The IMF expects that total financial losses will exceed those of any past crisis 22 (1)International Monetary Fund, Global Financial Stability Report, April 2008
Then And Now November 2006 Today 23
Consumer confidence is approaching all-time lows Consumer Confidence 120 Consumer Confidence 110 Q1 1966 = 100 100 90 80 70 60 50 40 1 978 1 980 1 982 1 984 1 986 1 988 1 990 1 992 1 994 1 996 1 998 2000 2002 2004 2006 2008 24 Source: Selected equity research
and unemployment is quickly ticking up 8.25% Unemployment Rate 7.75% 7.25% 6.75% 6.25% 5.75% 5.25% 5% 4.75% 4.25% 3.75% 1990 1991 1992 1993 1994 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: Bureau of Labor Statistics / Haver Analytics 25
U.S. stocks are near a 200-year low but look at what has followed 22.5% U.S. Stocks 10 Year Rolling Annualized Total Return (1827 2008) 2008) 20.0% 17.5% 15.0% 12.5% 10.0% 7.5% 5.0% 2.5% 0.0% 1827 1837 1846 1856 1866 1876 1886 1896 1906 1916 1926 1936 1946 1956 1966 1976 1986 1996 2006 Source: GS Research 26
New Jersey Pension Fund Performance 25% Fiscal Year Performance % 20% 15% 10% 5% 0% -5% -10% -15% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 27 Figures are unaudited and are subject to change As of June 30, 2008 Annualized Performance 1 Year -2.9% 3 Years 7.7% 5 Years 9.2% 10 Years 5.4%
Portfolio decisions made in FY08 build on change in asset allocations since June 05 Asset Class June 05 June 08 Medium-Term Goal US Equities 50.0% 30.8% 27.5% International Equities 16.2% 17.4% 18.5% Emerging Markets Equities 0 1.4% 2.5% US Fixed Income 26.2% 24.1% 24.0% US High yield 0 0.9% 3.5% International Fixed Income 2.2% 2.7% 0.0% Commodities/Real Assets 0 1.2% 3.0% TIPs 0 4.5% 3.0% Private Equity 0 3.4% 5.0% Real Estate 0 2.4% 4.0% Absolute Return 0 4.2% 6.0% Cash 5.4% 7.0% 3.0% 28
How did returns compare among funds? Fiscal Year Ended June 30, 2008 New Jersey -2.9% TRS of Texas -2.1% CalPERS -2.4% PA Public Schools Connecticut Florida SBA Figures are unaudited and are subject to change -2.8% -4.6% -4.4% CalSTRS -3.7% NYC Employees (NYCERS) -9.5% Institutional average, per Wilshire Associates: -5 % Harvard 8.6% Princeton 5.6% Yl Yale 2.0% 20% Institutional average, per Wilshire Associates: - 3% 29
Within our internally managed portfolios, our performance vs. benchmarks has been excellent 6/06 6/07 6/08 (1) ($millions) Excess Returns Domestic Equities 10.5% 20.6% -10.2% 1,371 Benchmark 9.2% 20.2% -12.7 International Equity 28.0% 28.5% -9.8% 637 Benchmark 26.6% 27.3% -11.5% Domestic Fixed Income -1.0% 5.2% 9.1% 271 Benchmark -1.5% 7.0% 6.8% Total $2.27 BILLION Division Staff added nearly $2.3 billion of value based on their investment decisions relative to the market over the past 3 years (1) Figures are unaudited and are subject to change 30
Current Division staff dedicated to internal management 6/30/2008 Investment Amount ($mm) Investment Professional FTEs* Asset Per Investment Professional ($mm) Cash Management 18,814 1.50 12,543 Domestic Fixed Income 20,957 1.25 16,766 Intl Fixed Income 2,081 025 0.25 8,324 Subtotal - Fixed Income 41,852 3.00 13,951 Domestic Equity 23,959 8.00 2,995 Intl Equity 14,693 6.00 2,449 Subtotal - Public Equity 38,652 14.00 2,761 Total 80,504 17.00 4,736 * Excludes Director and Deputy Director Figures are unaudited and are subject to change 31
Putting the Year in Perspective The Division had minimal or no exposure to Debt 1) Subprime Mortgage Securities 2) Non-agency Mortgage Backed Securities 3) CDOs 4) Asset Back Commercial Paper/SIVs 5) Student Loan Paper Equities 6) Mortgage Brokers 7) Monoline Insurers 8) Student Loan Issuers 9) Thrifts/S&L s 10) Auto Makers (GM/Ford) 11) Freddie Mac/Fannie Mae Commons 12) Rating Agency Stocks (Moody s & McGraw Hill) 13) Bear Stearns 32
How do our management fees compare to our peers? Fund Name Fiscal Year Ended Total Net Assets ($ Billions) Total Fees to Alternatives & External Managers ($ Millions) Cost Per Each $100 Under Management Pennsylvania School Employees 2007 $67.5 $307.2 $.46 CalPERS 2007 251.1 953.3.38 Massachusetts PRIM 2007 50.4 116.0.23 Oregon 2007 62.9 147.1.23 New York Common 2008 153.9 275.7.18 Florida SBA 2007 136.3 206.1.15 Ohio Public Employees 2007 83.6 124.0.15 New York State Teachers 2007 105.0 143.1.14 CalSTRS 2007 172.4 137.0.08 (1) New Jersey 2007 $97.4 B $76.2 M.08 (1) Excludes fees paid for private equity managers that are not disclosed in CAFR 33
US Equities Financials were a major driver of relative returns Millions FINANCIALS Transactions Purchase Net Over/Under weight 250,000 200,000 150,000 100,000 50,000 0-50,000-100,000-150,000-200,000-250,000-300,000 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 0-0.5-1 -1.5 15-2 -2.5-3 34
Int l Equities Financials were a major driver of relative returns INTL FINANCIALS Transactions Net Purchase/Sale Net Over/Under weight Millions 0-50,000-100,000-150,000-200,000-250,000-300,000-350,000 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 0-1 -2-3 -4-5 -6-7 -8-9 -10 35
Domestic Fixed Income Exposure to Agency MBS was the major difference from the benchmark 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% US Treasuries Us Agencies Industrial/Telephone As of June 30, 2008 Utilities Bank/Finance Canadian/Supra's Agency MBS Domestic Bond Portfolio Lehman Long Govt/Credit Benchmark 36
How We Have Structured our Private Equity Portfolio Commitments Through Actual Commitments 6/30/07 (mm) FY08 (mm) Total Commitments (mm) Percent Large Buyout 1,076 900 1,576 23.20% Domestic MM Buyout 970 650 1,770 26.06% Domestic Small Mkt Buyout 325 152 525 7.73% 73% Int l Buyout 567 462 717 10.55% Emerging Managers 100 108 200 2.94% Venture 150 41 300 4.42% Distressed 520 400 820 12.07% Mezzanine 285 175 435 6.40% Co-Investments 100 57 200 4.42% Secondaries 101 0 150 2.21% Total 4,194 2,945 6,793 100.00% 37
Current state of our Hedge Fund Portfolio 6/08 ($mm) Percent of Portfolio Fund of Funds 1,250 25.0% (Goldman, Rock Creek, Blackstone) Credit (Angelo Gordon, BlackRock, Canyon, Golden Tree) 725 14.5% Distressed (Centerbridge, King Street, Pimco) 800 16.0% Event Driven (Davidson Kempner, Pendragon, York) 535 10.7% Equity Long/Short (Wellington, Omega, Ascend, Glenview) 890 17.8% Multi Strategy t (Angelo Gordon, Black River, Och-Ziff, Farallon) 800 16.0% 38
This puts the overall market into perspective 1-Year Performance % of Stocks in S&P500 S&P500 Company 1-Year Performance Down >50% 31% (86%) (84%) (81%) Down 25-50% 50% 42% (79%) Down 0-25% 22% (71%) (70%) (66%) Flat or Up 5% (66%) (59%) 39 Source: FactSet
The Perils of Market Timing Value of a Hypothetical $10,000 Investment in the S&P 500 Over 10 Years (12/31/97 12/31/07) $20,000 $15,000 $10,000 $5,000 $0 $15,131 +4.23% 423% average annual price $9,534 Lost 4.7% $6,599 Lost $4,760 $3,590 34.0% Lost 52.4% Lost 64.1% Invested entire Missed 10 best Missed 20 best Missed 30 best Missed 40 best period days days days days Source: American Funds, Standard & Poor s 500 Composite Index, an unmanaged measure of large-company US stocks. The numbers shown above do not take into account reinvested distributions, nor do they reflect sales charges, commissions or expenses. 40
Why We Shouldn t Change Our Long-Term Strategy We ve had business cycles before, and come out of them Governments globally are cooperating to aggressively address the problems Potential returns on investments look attractive Diversification across asset classes ALWAYS makes sense We have confidence in our team of investment professionals WE ARE LONG-TERM INVESTORS, NOT DAY TRADERS 41
U.S. stocks are near a 200-year low but look at what has followed 22.5% U.S. Stocks 10 Year Rolling Annualized Total Return (1827 2008) 2008) 20.0% 17.5% 15.0% 12.5% 10.0% 7.5% 5.0% 2.5% 0.0% 1827 1837 1846 1856 1866 1876 1886 1896 1906 1916 1926 1936 1946 1956 1966 1976 1986 1996 2006 Source: GS Research 42
New Jersey State Investment Council FY 2008 Annual Meeting Investment Environment and Results November 20, 2008 William G. Clark Division of Investment 43