Overview of Asset/Liability Process City of Jacksonville Police & Fire Pension Fund February 9, 2018
Overview of the Asset/Liability Study An asset/liability study incorporates all facets of the asset allocation process. Development of asset class assumptions. Analysis of key pension metrics. Development of the evolution of liabilities over time. Modeling of various asset allocation to illustrate risk/return effects on key pension metrics. An asset/liability study begins with analysis of the latest actuarial valuation. Consideration given to the following to gain understanding of necessary risk posture: Plan Status: Open/Closed/Frozen Current Funded Status Time Horizon Liquidity Needs Goals/Objectives Statutory Limitations Plan Provisions & Assumptions, Demographics Model evolution of liabilities to establish baseline consideration of key pension metrics. 1
Overview of the Asset/Liability Study Introduce and discuss capital market assumptions, current market environment, and relative valuation of asset classes. Develop customized asset allocations for consideration in a manner to minimize risk. Evaluate risk/return expectations for each. Examine possible range of return for each. Combine asset modeling with liabilities to valuate effects on key pension metrics of various asset allocations. Apply risk analysis including: factor risk analysis, scenario analysis, and expected tail loss to provide risk perspective. Recommend a target asset allocation. Modify and remodel as necessary after discussion. Adopt a final target asset allocation. Outline necessary implementation steps. The following slides use illustrations from past asset/liability studies as examples. 2
Overview of The Asset/Liability Study Pension Model: Participant data and valuation results as The last actuarial valuation.. Funding methods and assumptions as described in the actuarial valuation report. Economic Environment Ten-year projection period. Active population remains level. Baseline Projection: Assets Funded Status Liabilities Deterministic outcomes based on a specific, predetermined set of asset returns for the projection period. Portfolio earns Target Allocation expected return of 7.0% in second and subsequent years. Assessment of impact of various investment returns on funded status and cumulative contributions. Investment Policy/ Allocation Contributions Benefit Payments Funding Results/Contributions Benefits Promised Demographic Experience Stochastic Analysis: Incorporates volatile asset returns utilizing Summit s current capital market assumptions. 3
Plan Summary as of June 30, 2015 Net Cash Outflow of $101 mil (4.1% of assets) A S S E T S L I A B I L I T I E S Contributions Employer: $121 mil Employee: $30 mil Normal Cost Employer: $41 mil Employee: $30 mil Market Value of Assets $2.47 bil 70% Funded Ratio Actuarial Accrued Liability $3.54 bil R e t u r n t s I n t e r e Benefit Payments $252 mil 7.5% Return on Assets (Volatile) Benefit Payments $252 mil 7.5% Discount Rate (Static) The illustration to the left shows the status at the beginning of an asset liability study used to set the stage. It illustrates the plumbing of how the Plan works. It also promotes the notion that Assets and Liabilities can be viewed as two portfolios Assets decline as benefits are paid or from negative investment returns. Assets increase as contributions are made and from positive investment returns. The actuarial accrued liability declines as benefits are paid and increases as new benefits are earned (normal cost) and over time by the discount rate. 4
Baseline Projection: Benefit Payments, Contributions, and Cash Outflow The growth of projected benefit payments, employer contributions and employee contributions over the projection period are illustrated. Also illustrated is the projected cash outflow over the projection periods as a percentage of assets to help show the liquidity needs of the Plan. Observations are noted regarding rate of contribution growth, cumulative contributions over the projection period and whether liquidity needs may be adequately covered by income generated by the portfolio. 5
Baseline Projection: Assets, Liabilities, and Funded Status The baseline projection illustrates the projected growth of assets, liabilities, and funded status based on actuarial assumptions. Shown on a market value and actuarial-value basis. Observations are noted how each component evolves over the projection period.
Sensitivity Analysis of Investment Return The chart above illustrates the impact of various investment returns on cumulative contributions and ending funded status. The chart above quantifies the annual change in contributions needed to achieve the baseline funded status to achieve the actuarial assumed rate of return. 7
Baseline Conclusions Observations regarding contributions, assets, liabilities, and funded status are discussed at the end of the baseline projection section. Key points include discussion of the risk necessary to close the funding gap over time and actions that may be necessary to cover liquidity needs over the projection period. 8
Capital Market Assumptions as of December 31, 2015 An example of Summit s Capital Market Assumptions are illustrated to the left. Asset class assumptions are geometric (shown net of volatility), use a 10-year investment time horizon, and are net of fees. Points on the chart do not include manager alpha. Portfolios are modeled with and without alpha to illustrate the effect of active management where implemented. Discussion of how capital Market assumptions are derived is included in the Appendix. 9
Asset Class Valuation Overview 10
Target Allocation Hedge Funds Real Estate Fixed Income High Yield Emerging Market Debt Public & Private Energy/Natural Resources Private Equity International Equity 100% 90% 80% 70% 60% 50% 40% 30% 20% 10.5% 10.5% 9.5% 5.3% 5.3% 12.6% 5.3% 20.5% The chart on the left illustrates the then current target allocation. Target and other modeled asset allocations for consideration can be modeled at the asset class level, broken into subcomponents, or a combination of both. Summit s capital market assumptions are applied to the target asset allocation to determine expected return and expected standard deviation over the projection period. This serves as a starting point for asset modeling. Multiple asset allocations are modeled to consider how to maximize expected return and minimize expected risk including: Consideration of the role asset classes play in the portfolio: growth, income, and diversification. Domestic Equity 10% 20.5% Variation in the size of each asset class. 0% Target W/O RP 10 Year Expected Return - Beta 7.0% 10 Year Expected Return - Alpha 0.6% 10 Year Expected Return - Total 7.6% Standard Deviation 11.5% Return/Risk 0.66 Variation in sub-asset classes or strategies within asset classes. Introduction of new asset classes or strategies including private asset classes/strategies. Consideration is given to current market condition and asset class relative valuation. 11
Portfolio Considerations Recommended Reserves 100% 3.5% 3.5% 3.5% 3.5% 3.5% Hedge Funds 90% 10.2% 10.2% 10.2% 10.2% 15.2% Real Estate Fixed Income High Yield Emerging Market Debt Public & Private Energy/Natural Resources Private Equity 80% 70% 60% 50% 40% 10.2% 10.2% 12.2% 10.2% 10.2% 9.1% 9.1% 9.1% 9.1% 6.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% 12.2% 12.2% 10.2% 12.2% 10.2% 5.1% 5.1% 5.1% 10.1% 5.1% International Equity 30% 19.8% 19.8% 19.8% 17.3% 19.8% 20% Domestic Equity 10% 19.8% 19.8% 19.8% 17.3% 19.8% 0% Target W/O RP & W/ Reserves Increase Core from TIPS Increase Non- Core RE from MLPs Increase PE from Public Equity Increase HF from TIPS, MLPs & Core+ 10 Year Expected Return - Beta 6.9% 6.9% 6.9% 7.0% 6.9% 10 Year Expected Return - Alpha 0.6% 0.6% 0.5% 0.6% 0.5% 10 Year Expected Return - Total 7.5% 7.5% 7.4% 7.6% 7.4% Standard Deviation 11.1% 11.1% 11.0% 11.0% 11.2% Return/Risk 0.67 0.67 0.67 0.69 0.67 12
Stochastic Analysis Stochastic analysis, also called a Monte Carlo simulation, is the process of analyzing financial outcomes across thousands of possible scenarios. The distribution of results helps to define the likelihood and magnitude of possible outcomes: expected, best, and worst cases. This approach is effective in conducting an asset allocation study for a pension plan because it captures the return volatility of the portfolio and its impact on the plan s critical metrics, such as market value of assets, funded status, and contribution requirements. In our analysis, 10,000 possible market conditions are simulated over the projection period. In each scenario the asset volatility was combined with the actuarial assumptions and liability projections, which allowed the plan to evolve through the projection period. The chart below illustrates how the Plan s asset value evolves through time for each trial. Best Case: 95% Percentile and above Expected Case: Median Worst Case: 5% Percentile and below Dispersion of possible MVA 13
Stochastic Results Stochastic modeling results are shown for key metrics such as market value, funded status and cumulative contributions. Focus should be on results at the expected level (50th percentile) and worst case scenario (95th percentile). Risk/return trade offs among asset allocations under consideration may be considered for their effects on key metrics. 14
Probability Of Achieving 7.5% 15
Factor Analysis Risk factor contribution for each asset allocation under consideration will be identified and considered. Equity risk is the single largest factor for most public pension portfolios. Introduction of new asset classes/strategies will be evaluated relative to their ability to diversify risk factors. 16
Historical And Stress Tests Stress tests as well as ETL analysis will be conducted to help qualify risk of asset allocations under consideration. Market value loss under various historical periods and theoretical stress tests will be considered. The bottom chart calculates the 1-year expected tail loss (ETL) in dollar terms. The ETL is the average loss beyond a given percentile. For example, the ETL (95%) is the average of the worst 5% of losses. 17
Recommended Asset Allocation and Implementation Ultimately a target asset allocation is recommended for discussion and adoption. Action items following adoption of a target allocation include: Amendment of Investment Policy Statement as necessary. Evaluation of how asset classes are currently implemented. Consideration efficiency in implementation. Changes in manager line-up as necessary. 18
Disclosures Disclaimer: Although (Summit) believes the modeling contained in this document to be reliable, the modeling of complex financial transactions has inherent limitations. Summit does not guarantee the results to be obtained by the use of this model. This model is developed by Summit based on information obtained from sources which Summit believes are reliable, but Summit does not warrant or guarantee the accuracy, completeness, or reliability of such information. Any information contained in or provided in connection with the model is for information purposes only, for the exclusive use by the client for which it was prepared, and is not intended and should not be construed to be an offer to buy or sell any securities, investment consulting or investment management services. No model can, in and of itself, be used to determine which securities or investments to buy or sell. All forward-looking projections are based on assumptions that Summit believes may be reasonable, but are subject to a wide range of risks, uncertainties and the possibility of loss. Accordingly, there is no assurance that any estimated performance projections of any model will occur in the amounts and during the periods indicated, or at all. Actual results and performance will differ from those expressed or implied by such forward-looking projections. Any decision to use or not use the model and any information accompanying or produced with the model remains solely with the client. 2018. All rights reserved. 19