OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OH 43215-4642 1-800-222-PERS (7377) www.opers.org MEMORANDUM DATE: October 31, 2006 TO: CC: FROM: RE: OPERS Retirement Board Members Christopher DeRose, Executive Director Jennifer Hom, Director Investments Greg Uebele, Senior Investment Officer- External Management Phil Paroian, Senior Investment Officer External Public Markets Opportunistic Fund Policy Action Requested The Board is requested to approve the attached Opportunistic Fund Policy which incorporates minor administrative changes. Discussion Subsequent to the recent revisions of the Defined Benefit Policy and to the recent approval of active currency for the opportunistic asset class, staff reviewed the Opportunistic Fund Policy and found that a few minor changes were required. In particular, staff found that some wording in the original Opportunistic Fund Policy approved in September 2004 was inadvertently omitted from the revised policy approved in June 2005. That wording has been added back, as highlighted below. Recommended changes to the policy by section: Section IV Allocation The allowable range has been changed from 0-2% to 0-3% in accordance with the recently approved changes to the Defined Benefit Policy, and wording has been added to specific that this applies only to the Defined Benefit Fund. Section V Investable Instruments We have added active currency, which was recently approved by the Investment Committee. 1
Furthermore, since the Opportunistic Fund Policy was established in 2004, the Investment Committee and OPERS approach to Ohio-qualified and minorityowned/women-owned firms has evolved considerably. Such firms are now included amongst the traditional asset classes of U.S. Equity, Global Bonds, and Non-U.S. Equity and OPERS has adopted a separate Ohio-Qualified and Minority Manager Policy. Therefore, the reference to Ohio and minority firms in the Opportunistic Fund Policy is out-of-date. Staff has removed those references from this policy, but added wording that all opportunistic searches will comply with applicable legislation and all of OPERS policies. Staff stresses that all public market manager searches, whatever the mandate or asset class, are always conducted in accordance with applicable legislation and with OPERS policies that ensure appropriate consideration be given to Ohio-qualified and minority firms. Section VI Performance Objectives The original policy approved in 2004 specified that the benchmark for the opportunistic asset class would be the weighted average of the underlying benchmarks for each program. This wording was inadvertently dropped from the policy when it was reapproved last year. This has been corrected and the original wording restored. Section VII Risk Management The original policy approved in 2004 specified that each program under this policy would be limited to a maximum of $100 million with a target initial funding of $25 million to $50 million. This wording was inadvertently dropped from the policy when it was reapproved last year. This has been corrected and the original wording restored. Next Steps We welcome feedback from the Investment Committee on the Opportunistic Fund Policy. If there is no feedback, we request that the Investment Committee approve the changes. If there is feedback, staff can incorporate those changes into the draft and bring the final policy back for approval next month. 2
2 5 Years MEMORANDUM To: Investment Committee Ohio Public Employees Retirement System From: Brady O Connell, CFA Kris Ford, CFA Date: November 3, 2006 Re: Opportunistic Policy Modifications Staff has presented the Investment Committee with a revised copy of the Opportunistic Fund Policy. The Opportunistic Fund exists to foster innovation and consideration of investments that do not fit neatly into the conventional parts of the OPERS investment portfolio. This revised copy of the policy contains some proposed changes that are being put forth to first, address changes made in the Investment Policy Review that established a new asset allocation for the Defined Benefit Plan, and second, to address changes that were inadvertently dropped from the original 2004 policy when it was revised and updated in 2005. Due to this oversight, many of these proposed changes may already be familiar to the Investment Committee as they were part of the first Opportunistic Policy. Major changes: 1. Allowable range. While the target for this portion of the Defined Benefit Plan remains 1% of assets, the range is being changed from 0-2% of assets to 0-3% of assets. This change is in keeping with the general broadening of policy ranges for asset classes within the Defined Benefit plan. 2. Investable Instruments. The policy is modified to reflect that active currency is a strategy that may be considered. Additionally, references to this space being the home for Ohio-based, minority- and femaleowned investment management firms have been removed. Managers fitting these descriptions are not part of the Opportunistic Fund unless they utilize an investment strategy fitting the opportunistic definition. A separate policy has been created to govern the usage of Ohio-qualified and minorityowned managers. Ennis Knupp + Associates vox 312 715 1700 10 South Riverside Plaza, Suite 1600 fax 312 715 1952 Chicago, Illinois 60606-3709 www.ennisknupp.com
3. Performance Benchmark. Another aspect of the initial policy not included in the 2005 update was requiring the Opportunistic Fund total benchmark to be a weighted average of the benchmarks of the underlying investments rather than the return of the total Defined Benefit plan. When each underlying investment is presented for consideration, a primary benchmark is put forth for measuring the success of implementing that investment. Listed as a secondary benchmark is the overall return of the Defined Benefit plan, which is included as it is a measure of the opportunity cost of investing in this category. For shorter term periods, the Investment Committee should expect the Opportunistic Fund to outperform the weighted average benchmark, while exceeding the return of the broader Defined Benefit portfolio may be a longer term objective. 4. Allocation Limits. In the risk management section, specific allocation limit sizes are established. These caps are necessary due to the policy s statement that the limited size of the opportunity fund is its primary risk control mechanism. For investment strategies new to OPERS, we believe initial allocations of $25-$50 million are prudent. Investment strategies are limited to $100 million in total so that these strategies can actively be considered for the mainstream portfolio if they prove successful. These caps were also part of the initial policy approved in 2004. EnnisKnupp recommends the Investment Committee adopt the proposed changes so that the Opportunistic Fund Policy is congruent with the Defined Benefit Policy and also so that aspects of the 2004 policy accidentally dropped in the 2005 revision are fully reincorporated into the Policy. Ennis Knupp + Associates 2
Ohio Public Employees Retirement System Opportunistic Fund Policy November 2006June 2005
TABLE OF CONTENTS I. SCOPE... 1 II. PURPOSE... 1 III. INVESTMENT PHILOSOPHY... 1 IV. ALLOCATION... 1 V. INVESTABLE INSTRUMENTS AND RESTRICTED INVESTMENTS... 1 VI. PERFORMANCE OBJECTIVES... 221 VII. RISK MANAGEMENT... 2 VIII. ROLES AND RESPONSIBILITIES... 2 A. BOARD OF TRUSTEES...3 B. INVESTMENT STAFF...3 C. INVESTMENT ADVISOR...4 IX. MONITORING AND REPORTING... 5 A. ANNUAL...5 B. QUARTERLY...5 Revision History Date Approved Policy Established August 17, 2004 Policy Revised June 14, 2005 Policy Revised Nov 14, 2006
I. SCOPE This policy applies to the opportunistic assets within the Ohio Public Employees Retirement System ( OPERS ) Defined Benefit Fund. II. PURPOSE This policy provides the broad strategic framework for managing the opportunistic investment program.. III. INVESTMENT PHILOSOPHY Opportunistic investing allows OPERS to conduct controlled experimentation of investment strategies and new instruments that do not fit neatly into one of the traditional asset class categories. The opportunity fund will serve as an incubator of new investment ideas and strategies. Staff will gain hands-on experience and knowledge directly from its involvement with the strategies in the opportunity fund. Staff will determine if any of the programs within the opportunity fund deserve to have a larger and permanent role in the Defined Benefit Fund. IV. ALLOCATION The opportunity fund asset allocation is established with a target of 1% market value. The range is set at 0 to 23% with a maximum ceiling of 23% of total fund assets in the Defined Benefit Fund. V. INVESTABLE INSTRUMENTS AND RESTRICTED INVESTMENTS Programs that may be considered for the opportunity fund would include, but not be limited to: Hedge funds Commodities Derivatives Active currency Ohio-based investment managers Minority-owned investment managers Woman-owned investment managers Emerging investment managers Internally-managed experimental funds All searches in the opportunistic asset class will be conducted in accordance with applicable legislation and in accordance with all applicable OPERS policies. 1
VI. PERFORMANCE OBJECTIVES The overall benchmark for the opportunity fund is the OPERS performance benchmark. The total fund benchmark serves as the appropriate measure of the opportunity cost of investing funds in this category. Every program approved for experimentation within the opportunity fund will require its own specific performance benchmark. The overall benchmark for the opportunistic class is the weighted average of the underlying benchmarks for each program within the class. In addition, the expectation is that longterm returns from this asset class should match or exceed OPERS total fund benchmark, which is a measure of the opportunity cost of investing in this category. VII. RISK MANAGEMENT The limited size of the opportunity fund is its primary risk control mechanism. To provide for diversification, each program will be limited to a maximum of $100 million, with a target initial funding of $25 million to $50 million. It is envisioned that once the opportunity fund is mature, no single program within the opportunity fund will account for more than 35% of the total market value of the opportunity fund. Staff will closely monitor the individual programs. Risks may include a loss of a significant portion of the original investment. VIII. ROLES AND RESPONSIBILITIES A. Board of Trustees The Board is responsible for approving the Opportunistic Fund Policy. The Board will also review this document periodically and approve any changes as well as participate in the presentation of opportunistic fund research reports. Commitments for the individual programs require approval of the Board of Trustees. B. Investment staff Staff is responsible for recommending the Policy and managing the Opportunistic Program under the framework of the Board approved Policy. Staff is also responsible for monitoring and reporting to the Board in accordance with the requirements of the OPERS Investment Policy. Staff will be required to outline the program s alpha opportunities, educational objectives, timelines for implementation, monitoring process and performance benchmark in its recommendation memorandum to the Board. Due diligence, legal review, compliance and administration are reviewed with the Director of Investments and the investment advisor before submitted to the Board of Trustees. 2
Reports to the Investment Committee address whether the goals of experience and learning are being met, as well as risks decomposition, performance and activity. These reports are presented through a comprehensive annual review. These reports will also discuss the status of a potential permanent role for each of the programs within the opportunity fund. C. Investment advisor The investment advisor assists staff with the policy recommendations and provides advice to the Board. The investment advisor also assists staff in monitoring the investments and researching new ideas. 3
IX. MONITORING AND REPORTING A. Quarterly Performance report prepared by investment advisor Investment report prepared by staff Compliance report prepared by staff B. Annual OPERS Annual Investment Plan submitted by staff. Year-end program review submitted by staff. 4