14. Presentation by Pension Consulting Alliance -Real ...retirement.ladwp.com/AgendaItems/Agenda - 20110126 Agenda Item 14.pdf · • PCA’s current intermediate-term investment

14. Presentation by Pension Consulting Alliance - Real Return Asset Class Review

14

Real Return Class ReviewLos Angeles Dept. of Water & Power Employees’ Retirement Plan

January 2011

1Pension Consulting Alliance, Inc.

Agenda

I. Recap of WPERP Real Return Class

II. Rationale for a Real Return Class

III. Modeling the Real Return Class

IV. Findings & Recommendations

Appendix

2

Recap of WPERP Real Return Class

3


WPERP has invested in Real Return since February 2007

• Two external Fund of Hedge Fund managers funded in February 2007

• One external global TIPS markets managers funded in April 2010

• Current policy target 3%, but shifting to 7% during the second half of 2012

Current portfolio management structure represents a prudent core position for the Real Return Class

• Entire Real Return portfolio currently benchmarked against Tbills + 3%.

Asset Class Current Current Value Subcomponents Allocation 6/30/2010 (000)

TIMBER 0% $0COMMODITIES 0% $0OIL&GAS 0% $0TIPS 65% $127,514ABSOLUTE RET 35% $69 566

4

ABSOLUTE RET 35% $69,566TOTAL 100% $197,080


Aggregate Real Return Portfolio should outperform CPI + 4% over rolling fiveObjectives

CURRENT WPERP POLICY: OBJECTIVES AND STRATEGIES

Aggregate Real Return Portfolio should outperform CPI + 4% over rolling five-year periods

Objectives

Portfolio should be managed to accomplish the following;

Strategies Active management currently utilized for entire real return portfolio

Portfolio should be managed to accomplish the following;• prudently achieve long-term results above inflation

• hedge against inflation risks

diversify WPERP investments• diversify WPERP investments

Delegate management to external managers

5

WPERP and RHBF portfolios will have equivalent structures

Recap of WPERP Real Return ClassTOTAL REAL RETURN PORTFOLIO vs. WPERP BENCHMARK (through 11/30/10)

LADWP Real ReturnTbills + 3%

Dramatic declines such as 2008 should be mitigated with more real return segments

WAMCO (TIPS) funded in April 2010

Aetos and PAAMCO funded in February 2007

110

115

120

100

105

110

Gro

wth

of $

100

PAAMCO terminated in October 2010

90

95

Jan-07 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Nov-10

Poor relative underperformance due to 2008

Since inception the Real Return portfolio performance has been positive, resulting in no principal loss

6

Source: WPERP, MPI

Recap of WPERP Real Return ClassREAL RETURN PORTFOLIO vs. BENCHMARK

Post 2008, the WPERP Real Return Portfolio Has outperformed Its Benchmark(23 months, ending 11/30/10)

120

125

LADWP Real ReturnTbills + 3%

110

115

Gro

wth

of $

100

100

105

G

Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Nov-10

Results post 2008 have been strong

p p

7

Source: WPERP, MPI

Recap of WPERP Real Return ClassRETURN AND RISK ANALYSIS, PERIODS ENDING 11/30/10

Since InceptionReturn vs. Risk

4

6

8ur

n, %

WPERP Real Return Portfolio

0

2

Tota

l Ann

ualiz

ed R

etu

-4

-2

0 2 4 6 8 10 12 14 16 18 20 22 24 26Total Annualized StdDev, %

S&P 500 Index BC Aggregate Bond Merrill Lynch 3-month T-Bill LADWP Real Return MSCI AC World Index ex USA WPERP RR Bench (blend)

Overall Real Return portfolio has outperformed equities on a risk-adjusted basis

Driver of lagging risk-adjusted relative performance was the market conditions of

8

Source: Mellon, LDZ, PCA, MPI

gg g j p2008

Recap of WPERP Real Return ClassTOTAL REAL RETURN PORTFOLIO vs. Tbills + 3% BENCHMARK

Annualized Returns 6/30 Fiscal Years, except YTDReturns for Periods ending 11/30/2010

Quarter 1 Year 3 Years Inception Fiscal YTD 2009 2008WPERP Real Return 0.5 6.5 0.2 2.5 2.1 -13.7 5.0

Tbills + 3% 0.8 3.1 3.8 4.6 1.3 3.8 6.2

Difference (0.3) 3.4 (3.6) (2.1) 0.8 (17.5) (1.2)

9

Source: WPERP, MPI

Rationale for a Real Return Class

10


Under current policy, plan sponsor portfolios often exhibit 60%-70% equity exposure

• Institutional real estate portfolios have become more appreciation-oriented and may not diversify against equity risk

• Private equity and real estate portfolios may magnify, rather than diversify, public equity volatility

• Currently, WPERP’s equity exposure is a relatively low 59%

A prudently structured Real Return portfolio should diversify equity risk and provide inflation hedging

A Real Return class should be designed to produce relatively stable returns and principal protection regardless of market environment and recover principal losses relatively rapidly

11

Rationale for a Real Return ClassEstimated Size of Potential Investment Markets

Abs Ret/Abs Ret/Hedge Fds

$1.8T

Commodities $6 0T

GlobalTIPS$1.3T

Abs Ret/

Hedge Fds

$1.8T

Infrastrucure $1.6T

$6.0T

Very new segment with significant potentialVolatile segment

Timber $500B

Real Return-oriented investments represent over $10 trillion in opportunity

Proven asset class with verifiable track recordWide range of strategies within segment

12

Other segments include Agriculture and Oil & Gas; LIBOR+ mandates may also be appropriate

Sources: RREEF Real Estate Research, AllianceBernstein, Forest Investment Associates, Mercer


Inflation is a key building block in establishing long-term return expectations and correlations for

INFLATION PROTECTION OF REAL RETURN ASSETS

the Real Return class

There are different types of inflation (headline vs. core, national vs. regional, consumer vs. wage, etc )etc.)

Investment consultants typically model national, headline, consumer inflation because this measure impacts broad long-term purchasing power

Headline inflation, while more volatile than core inflation, is typically much more stable than investment returns from the numerous classes

Headline inflation is impacted from changes in food/agriculture prices as well as changes in energy costs

13

Modeling the Real Return Class

14


Different plan sponsors may arrive at different structural definitions for the Real Return Class:

• TIPS

• Absolute return strategies PLAN SPONSOR ABC

• Timber

• Core real estate

• Return-driven real estate

• Infrastructure

• Oil & Gas projects

C ditiPLAN SPONSOR XYZ

• Commodities

• Agriculture

Once a set of components are determined as viable appropriate assumptions must be

15

Once a set of components are determined as viable, appropriate assumptions must be established

Modeling the WPERP Real Return Class

Assets considered as potential components of a Real Return Class:Assets considered as potential components of a Real Return Class:

• TIPS

• Absolute return strategies (i.e., low volatility hedge funds or hedge fund equivalents)

Current WPERP Real Return StructureAbsolute return strategies (i.e., low volatility hedge funds or hedge fund equivalents)

• Timber

• Oil & Gas projects

• Commodities

Potential new components

• Infrastructure

• Core real estate

16Source: PCA


Assets considered:• Timber

Timber has the abilit to pro ide a long term inflation hedge to the portfolio• Timber has the ability to provide a long-term inflation hedge to the portfolio

• Timber income has grown steadily with inflation

• Timber fundamentals provide expanding asset yield over time

• Timber returns have historically been competitive, provide low return volatility and have attractive diversification to traditional asset classes

Yearly Timber Income versus CPI Yearly Timber returns versus U.S. Equity

10.00

12.00

40.00

50.00

4.00

6.00

8.00

10.00

NCREIF Timber Income (avg. 4.50%)

CPI (avg. 3.09%)‐10.00

0.00

10.00

20.00

30.00

NCREIF Timber Appr (Avg.8.61%)

S&P 500 (avg.

0.00

2.00

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

‐50.00

‐40.00

‐30.00

‐20.00

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

11.07%)

17

Source: PCA


Assets considered:• Oil & Gas Projects

• Oil & Gas projects allow investors to capture high levels of cash flow while gaining positive exposure to inflation p j p g g g p passociated with volatile energy prices

• Income would exhibit some degree of inflation-linkage

• Commodities• Commodities are often seen as “insurance” against financial crises and/or surprises in inflation

• Commodity returns can move in near-opposite direction of other financial assets, providing potential diversification benefits

Asset Class Inflation Betas

1950-2009 Total Return Impact of 1% Inflation Increase

1 9%

6.2%

3.0%

4.0%

5.0%

6.0%

7.0%

1.9%

‐1.7%

0.3%0.8%

1.6%

3 0%

‐2.0%

‐1.0%

0.0%

1.0%

2.0%

18

Source: AllianceBernstein, PCA

‐3.0%

S&P 500 10‐Year U.S. Treasuries

3‐Month T‐Bills 10‐Year TIPS Farmland Commodity Futures


Assets NOT considered:Assets NOT considered:• Infrastructure

• PCA’s current intermediate-term investment outlook for infrastructure is negative

• Current costs and deal flow outweigh potential value added

• Core Real Estate

• The current use of leverage in the WPERP Real Estate portfolio is not suitable for the real return asset class

19Source: PCA


WPERP

Asset Class Subcomponents Current

Equal Weighted

Top Heavy Spread Balanced

Balanced Plus

Maximize CPI

CorrelationTIMBER 0% 20% 10% 25% 20% 25%COMMODITIES 0% 20% 10% 25% 15% 3%

Various Allocation Options for the Real Return Class

COMMODITIES 0% 20% 10% 25% 15% 3%OIL&GAS 0% 20% 0% 0% 0% 0%TIPS 65% 20% 20% 25% 45% 54%ABSOLUTE RET 35% 20% 60% 25% 20% 19%TOTAL 100% 100% 100% 100% 100% 100%

“Optimal” structures reflect liquidity, skill sets, resources, current exposures, etc. and are not necessarily a function of a mean-variance process

Whil t t l diff i t l i l fi l t t i d i t li bilit While structural differences are incremental, a single final structure is used in asset-liability modeling

PCA recommends Balanced Plus structure for modeling purposes

20

Source: PCA


Modeled Real Return structures exhibit:

INITIAL EXAMINATION of MODELED OPTIONS Custom

YearUS

EquityIntl

EquityPrivate Equity

Covered Calls Fixed

WPERP Real Est Cash

Current Equal Weighted

Top Heavy

SpreadBalanced Balanced

Plus

Maximize CPI

Correlatio CPI

1970 2.51 (10.28) (23.21) 4.56 9.89 7.16 3.96 8.43 3.46 2.26 5.00 5.19 7.20 3.631971 12.09 25.33 2.60 8.54 4.85 10.26 2.53 2.50 4.84 3.90 5.32 4.78 2.40 2.271972 16.43 30.76 8.18 10.79 2.47 6.50 2.35 3.02 9.99 7.24 11.47 9.87 4.13 2.271973 (14.70) (13.40) (23.74) (4.99) (0.09) 6.50 4.36 9.33 18.35 9.48 25.93 21.94 17.61 5.771974 (25.58) (20.22) (20.62) (10.42) (1.48) 5.84 4.97 8.92 7.37 4.27 12.86 11.43 11.30 7.98

• Solid diversification characteristics versus both public and private equity

• Positive returns during difficult periods for fixed income

1975 33.27 30.34 26.06 22.00 6.42 2.52 3.56 2.51 0.81 4.07 (2.75) (1.32) 0.32 4.601976 20.98 1.87 44.09 13.94 8.58 10.48 2.99 10.25 5.36 10.75 4.28 5.77 8.40 3.181977 (13.18) 15.28 39.19 (2.53) 0.39 13.13 3.20 8.63 8.82 12.49 12.90 12.27 12.58 4.481978 1.20 27.94 44.76 5.99 (0.68) 25.54 4.46 7.55 11.24 12.31 14.10 13.01 9.65 5.901979 21.17 3.96 25.39 14.02 (0.34) 35.16 6.37 13.69 16.60 16.12 17.10 16.53 14.51 8.701980 28.93 19.52 67.17 22.73 0.18 29.92 7.36 6.15 8.54 11.54 5.79 6.44 3.75 8.111981 (5.21) (2.19) (4.96) 4.76 2.49 26.66 9.40 3.90 (3.39) (0.75) (4.48) (2.94) 2.42 5.841982 18.03 (2.06) 20.00 16.40 19.69 10.77 7.00 13.13 7.84 8.66 6.57 7.69 9.44 2.591983 19.89 19.69 31.09 15.05 3.87 18.94 5.46 1.25 5.56 6.60 3.66 3.63 (0.16) 2.531984 1.99 5.41 (3.09) 7.47 8.29 20.51 6.14 4.12 3.20 2.57 0.98 1.58 2.97 2.661985 28 61 47 09 7 49 19 07 12 84 14 76 4 75 11 46 7 86 6 65 5 49 6 43 8 31 2 53

• Positive modeled results in all four difficult economic environments

• Short principal loss periods combined with rapid recoveries

1985 28.61 47.09 7.49 19.07 12.84 14.76 4.75 11.46 7.86 6.65 5.49 6.43 8.31 2.531986 14.32 58.39 2.00 11.42 8.35 8.28 3.70 3.60 3.51 3.22 1.39 1.89 2.47 0.771987 0.68 19.95 3.32 4.94 0.21 7.61 3.49 3.61 7.80 4.39 9.21 7.94 6.97 2.921988 15.35 22.49 7.68 11.54 3.55 11.20 4.05 2.52 9.71 6.73 10.64 9.11 6.27 2.921989 25.97 8.95 4.44 20.41 7.89 7.09 5.26 6.88 14.42 8.51 15.29 13.43 11.34 3.051990 (5.80) (20.72) (1.46) 0.06 4.01 (5.00) 4.78 12.34 11.60 13.66 12.89 12.89 10.57 4.021991 29.99 10.58 16.58 19.81 9.14 (22.44) 3.39 5.46 5.56 7.75 3.89 4.51 5.76 2.071992 7.82 (10.68) 10.91 7.35 3.33 (19.51) 2.01 6.41 8.34 9.07 9.04 8.68 9.52 2.011993 8.93 28.46 20.73 9.85 5.19 (7.03) 1.66 11.62 6.74 14.63 6.56 8.09 9.95 1.881994 (0.97) 4.34 6.42 0.56 (3.60) 4.04 2.40 (5.92) (0.03) (3.18) (0.59) (1.59) (2.47) 1.811995 32.90 7.16 13.20 16.50 10.46 6.59 3.39 11.07 11.64 9.86 10.48 10.50 10.32 1.751996 19 05 4 38 27 32 11 21 1 31 12 70 3 07 4 42 11 76 10 33 10 83 9 89 4 41 1 94rapid recoveries

• Correlations are low versus major asset classes

1996 19.05 4.38 27.32 11.21 1.31 12.70 3.07 4.42 11.76 10.33 10.83 9.89 4.41 1.941997 28.24 0.42 22.69 21.99 4.78 20.66 3.06 3.71 3.49 7.21 1.45 2.35 3.77 1.161998 21.16 10.73 18.38 14.55 3.17 25.83 2.94 (1.69) (8.43) (6.80) (9.60) (8.22) (1.20) 1.291999 18.18 24.82 69.64 16.70 (1.48) 15.04 2.74 7.67 14.22 17.45 14.98 14.23 6.20 1.922000 (8.02) (14.38) (21.52) 3.36 5.47 16.99 3.53 6.19 11.11 7.14 12.79 11.29 6.20 2.272001 (11.71) (18.15) (18.67) (14.37) 3.69 6.01 2.32 2.97 (6.68) (2.09) (7.74) (5.68) 0.37 1.262002 (21.03) (14.08) (25.94) (11.20) 4.82 4.83 0.77 7.01 5.20 4.57 9.17 8.39 6.43 1.602003 27.60 33.52 46.93 14.95 2.21 9.78 0.36 6.07 10.31 8.43 8.32 8.02 5.32 1.282004 9.92 16.52 14.71 4.24 1.65 21.94 0.47 4.58 9.46 5.69 6.90 6.45 4.94 2.172005 4.53 12.86 4.78 0.31 0.18 34.28 1.61 1.79 12.22 6.26 8.77 7.55 3.98 2.272006 13.40 21.42 8.18 9.11 1.65 26.60 2.75 1.43 1.93 3.47 (1.06) (0.25) 1.61 1.68( ) ( )2007 3.62 13.29 9.54 2.58 2.65 24.93 2.74 7.36 14.40 9.75 12.52 11.52 8.33 2.722008 (35.60) (39.92) (36.95) (31.55) (0.04) (24.37) 0.84 (10.28) (16.20) (16.27) (13.26) (13.16) (6.19) 0.122009 25.06 30.62 56.70 21.29 4.02 (54.31) (0.22) 7.37 (4.54) 2.07 (7.11) (4.16) 3.15 2.12

Average 9.25 9.75 12.50 7.83 4.00 9.41 3.50 5.53 6.35 6.25 6.25 6.15 5.82 3.00StdDev 17.00 20.00 25.00 11.33 4.50 17.10 2.00 4.81 7.02 6.25 7.94 6.98 4.77 2.00

Number of Down Years 3 6 5 8 8 4 Minimum Return (10.28) (16.20) (16.27) (13.26) (13.16) (6.19)

Maximum Drawdown Period (in Yrs) 1 2 1 2 2 1Recovery from Max Drawdown (in Yrs) unc unc unc unc unc unc

21

Source: PCA

Performance During Challenging Equity Periods73-74 (20.33) (16.88) (22.20) (7.74) (0.79) 6.17 4.66 9.12 12.72 6.84 19.22 16.57 14.41 6.8790-92 9.70 (7.83) 8.41 8.78 5.46 (15.98) 3.39 8.03 8.47 10.13 8.54 8.64 8.59 2.7000-02 (13.76) (15.56) (22.10) (7.71) 4.66 9.14 2.20 5.37 2.94 3.13 4.34 4.40 4.29 1.71

07-08 (18.31) (17.50) (16.89) (16.20) 1.30 (2.79) 1.79 (1.86) (2.09) (4.14) (1.21) (1.59) 0.81 1.41


Correlations are reasonable vs. inflation, better than TIPS alone, Balanced Plus Option has lowest U.S. equity correlation of -0.04lowest U.S. equity correlation of 0.04

Asset Class Subcomponents Current

Equal Weighted

Top Heavy Spread Balanced

Balanced Plus

Maximize CPI

CorrelationTIMBER 0% 20% 10% 25% 20% 25%COMMODITIES 0% 20% 10% 25% 15% 3%

Various Allocation Options for the Real Return Class

OIL&GAS 0% 20% 0% 0% 0% 0%TIPS 65% 20% 20% 25% 45% 54%ABSOLUTE RET 35% 20% 60% 25% 20% 19% 90TOTAL 100% 100% 100% 100% 100% 100%

Equal Top Heavy BalancedMaximize

CPI Private Covered WPERP

Other Main WPERP Strategic Classes

CurrentEqual

WeightedTop Heavy

Spread BalancedBalanced

PlusCPI

Correlation US Equity Intl EquityPrivate Equity

Covered Calls Fixed

WPERP Real Est Cash

Average 5.53 6.35 6.25 6.25 5.93 5.82 9.25 9.75 12.50 7.83 4.00 9.41 3.50SD 4.81 7.02 6.25 7.94 6.25 4.77 17.00 20.00 25.00 11.33 4.50 17.10 2.00

Skew -0.96 -1.12 -1.26 -0.37 -0.24 -0.01 -0.70 -0.09 0.32 -1.29 1.23 -1.57 0.6790th tile 11.47 14.24 12.61 14.19 12.13 11.31 28.64 30.63 44.98 20.50 9.22 26.60 6.1610th tile 1.41 -3.50 -0.89 -4.74 -2.04 0.27 -13.33 -14.76 -21.69 -5.53 -0.37 -8.28 0.83

Corr to CPI 0.43 0.36 0.37 0.42 0.47 0.50 -0.09 -0.10 0.14 0.05 -0.26 0.32 0.64Corr to US Eq 0 22 0 22 0 37 -0 02 -0 04 -0 01

Source: PCA

Corr to US Eq 0.22 0.22 0.37 0.02 0.04 0.01

Ret/Risk 1.15 0.90 1.00 0.79 0.95 1.22 0.54 0.49 0.50 0.69 0.89 0.55 1.75

22

Key: Maximize correlations to CPI and minimize correlations to U.S. equity assets


Asset Class6/30/2010 6/30/2011 6/30/2012

WPERP Current Asset Allocation Timeline

Cash 2 1 1Fixed Income 40 33 24Real Return 3 5 7Real Estate 3 4 5Domestic Equity 33 34 34International Equity 17 20 24Private Equity 2 3 5

Estimated value using 6/30/2010 market value at current 7% investmentEst value using

Asset Class Subcomponents

Current Allocation

Current Value 6/30/2010 (000)

Balanced Plus

Est. value using 6/30/2012

allocation (000)Difference in

funding valueTIMBER 0% $0 20% $101,136 $101,136COMMODITIES 0% $0 15% $75,852 $75,852OIL&GAS 0% $0 0% $0 $0TIPS 65% $127,514 45% $227,556 $100,042ABSOLUTE RET 35% $69,566 20% $101,136 $31,570TOTAL 100% $197,080 100% $505,680 $308,600

23

Source: PCA

Current Asset Allocation policy calls for an increase in Real Return investing

Findings and Recommendations

24

Findings and RecommendationsSUMMARY and FINDINGS

Real Return portfolio should be optimally structured to deal with different types of inflation Real Return portfolio should be optimally structured to deal with different types of inflation

Current structure has resulted in a prudent core Real Return Portfolio but further segments are warranted

Given the Board’s current adopted increase to Real Return, restructuring is warranted

• An additional $200 million - $250 million expected to flow into real return• Consider new active management expertise, particularly in the Timber and Commodity segments• Develop investment guidelines for the new class segments• Re-evaluate the current asset class benchmark for desired risk/return profile • Fund new mandates depending on A/L outcome

25

Findings and Recommendations

Include the modeled Real Return class (Balanced Plus) in the A/L study to determine its

RECOMMENDATIONS

Include the modeled Real Return class (Balanced Plus) in the A/L study to determine its attractiveness versus other classes

• WPERP already has exposure to TIPS and Absolute Return in its current Real Return asset structure

• Adding Timber and Commodities better diversifies Real Return in WPERP’ s overall portfolio

O d b i i l i f R l R f li b l i d Once approved, begin implementation of new Real Return portfolio by evaluating and enhancing the Absolute Return segment through the use of customized accounts

26

Appendix

Modeling the Real Return Classg

A Brief Description of

1) Global Inflation-Linked Bonds

2) Ti b2) Timber

3) Commodities

5) Absolute Return

27


Modeling process for underlying components:

• Gather actual historical time series (varies significantly by component)

• Where historical data is lacking, first model existing time series using multiple regression with th ll k t l l t i blother well-known asset classes as explanatory variables

• Use derived multiple regression model to simulate needed time series history

• Verify that summary statistics of modeled results are consistent with those of other asset class expectations

• Disclose and discuss modeled results

• Include final modeled time series in aggregate Real Return Class

28


Example – Modeling Oil & Gas

• Goal: develop a time series of investment returns (for use in A/L simulations) that reflects the results of oil & gas projects, before capital structuring

• Oil & Gas time series data is limited (e.g., first full year of Amex Oil Index data is 1984)

• Oil & Gas index data consists corporations utilizing significant leverage in their capital structures

• Construct historical time series: (i) actual index where possible, (ii) use proxy, (iii) model returns

• Adjust time series to “back out” capital structure

• Reconcile time series to other strategic class assumptions using expected equity returns and volatilities

29


Begin with oil & gas index time seriesModel remaining history “Back out” financial leverage

1984 15.151985 22 10

1970 -3.501971 4.461972 6.071973 -15.921974 -19.831975 20.57

1970 -0.241971 5.291972 6.391973 -9.331974 -11.921975 17.221985 22.10

1986 15.261987 2.761988 7.891989 14.531990 8.591991 16.45

1976 13.271977 -10.301978 -0.071979 19.941980 26.361981 -0.011982 15.481983 15.921984 15 15

1976 11.931977 -4.951978 2.241979 16.741980 21.581981 3.411982 15.101983 15.311984 14 261992 7.54

1993 10.401994 3.541995 22.561996 21.621997 16.451998 -4 66

1984 15.151985 22.101986 15.261987 2.761988 7.891989 14.531990 8.591991 16.451992 7.54

1984 14.261985 19.421986 14.151987 4.551988 8.311989 13.161990 8.781991 14.411992 7.891998 -4.66

1999 16.122000 6.612001 -3.032002 -14.072003 25.912004 28.17

1993 10.401994 3.541995 22.561996 21.621997 16.451998 -4.661999 16.122000 6.612001 3 03

1993 9.751994 4.591995 18.391996 17.611997 13.861998 -1.251999 13.382000 6.742001 0 01

Source: AMEX Oil Index

2005 36.852006 20.402007 31.272008 -37.202009 9.04

2001 -3.032002 -14.072003 25.912004 28.172005 36.852006 20.402007 31.272008 -37.202009 9.04

2001 0.012002 -8.032003 20.362004 21.742005 27.932006 16.072007 23.932008 -24.982009 8.07

30

Source: PCA

Simulated based on regression model using Russell 3000 and West Texas oil price time series,

R-sqd: 0.60

De-levered based on capital structure of UBS Oil & Gas industry sector. As of 2/2010, debt/equity ratio was 40%.

Modeling the Real Return ClassFinal step: reconcile to current plan sponsor assumptions for other classes1970 -0.24

1971 5.291972 6.391973 -9.33

1970 -2.721971 2.921972 4 04

1974 -11.921975 17.221976 11.931977 -4.951978 2.241979 16.741980 21.581981 3.41

1972 4.041973 -11.991974 -14.631975 15.091976 9.691977 -7.521978 -0.191979 14.601980 19.531981 1 001982 15.10

1983 15.311984 14.261985 19.421986 14.151987 4.551988 8.311989 13.161990 8 78

1981 1.001982 12.921983 13.141984 12.071985 17.331986 11.951987 2.161988 6.001989 10.941990 6 481990 8.78

1991 14.411992 7.891993 9.751994 4.591995 18.391996 17.611997 13.861998 -1.25

1990 6.481991 12.221992 5.571993 7.471994 2.201995 16.281996 15.481997 11.661998 -3.75

Based on modeled results, Oil & Gas produced average returns that were 77% of historical equity returns with volatility that was 64% of the volatility level of equity. These ratios used to reconcile to PCA’s current assumptions.

1998 1.251999 13.382000 6.742001 0.012002 -8.032003 20.362004 21.742005 27.932006 16.07

1999 11.172000 4.402001 -2.472002 -10.662003 18.292004 19.692005 26.012006 13.912007 21.93

31

Modeled time series then combined with series of other components to create Real Return Class series used for simulation purposes in Asset-Liability model.

2007 23.932008 -24.982009 8.07

2008 -27.952009 5.75

Average 6.75Std Dev 11.00

Modeling the Real Return ClassTime series models of components considered for WPERP Real Return Class

TIMBER COMMODITIES OIL&GAS TIPS HEDGE FOF

1970 (0.82) 8.93 (2.72) 14.22 (2.32)1971 0.99 15.01 2.92 2.18 3.101972 4.90 34.09 4.04 2.02 4.891973 31.68 60.09 (11.99) 17.16 (5.21)( ) ( )1974 10.92 29.15 (14.63) 16.43 (5.04)1975 (0.82) (19.02) 15.09 (1.91) 10.731976 7.91 (14.27) 9.69 6.77 16.721977 26.86 5.26 (7.52) 6.03 13.451978 16.33 22.77 (0.19) 4.96 12.351979 16.93 22.99 14.60 12.41 16.071980 1.59 3.57 19.53 (0.52) 18.541981 (0.22) (24.16) 1.00 5.46 0.991982 (2 47) 4 43 12 92 15 36 8 981982 (2.47) 4.43 12.92 15.36 8.981983 (1.42) 9.04 13.14 (4.04) 11.071984 0.09 (4.10) 12.07 4.47 3.471985 (2.62) 4.18 17.33 14.38 6.031986 0.09 (2.23) 11.95 3.00 4.721987 14.53 16.62 2.16 5.37 0.331988 16.69 19.83 6.00 1.36 4.671989 21.09 28.12 10.94 8.98 2.991990 5.26 20.46 6.48 11.02 14.801991 10.80 (9.17) 12.22 1.93 12.011992 21.03 0.64 5.57 4.47 10.011993 12.06 (14.28) 7.47 5.54 22.911994 7.85 1.02 2.20 (6.66) (4.55)1995 6.89 13.89 16.28 12.25 8.891996 5.02 26.00 15.48 0.38 11.921997 9.95 (16.14) 11.66 (1.61) 13.581998 2.13 (35.13) (3.75) 0.67 (6.06)1999 5 14 32 36 11 17 (0 61) 23 041999 5.14 32.36 11.17 (0.61) 23.042000 1.23 39.29 4.40 8.22 2.412001 (4.55) (31.53) (2.47) 3.90 1.232002 (0.34) 26.41 (10.66) 11.00 (0.40)2003 3.21 16.39 18.29 4.31 9.352004 5.32 12.94 19.69 4.36 4.982005 10.26 19.50 26.01 (0.24) 5.562006 6.81 (17.05) 13.91 (2.23) 8.232007 9.67 25.35 21.93 6.96 8.10

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2008 4.31 (31.84) (27.95) (4.49) (21.03)2009 (4.28) (39.40) 5.75 6.77 8.48

Average 7.00 6.50 6.75 5.00 6.50Std Dev 8.50 22.50 11.00 6.00 8.50Source: PCA


Based on GSCI Total Return Index since 1970

Modeled to set roll return to zero and spot index return equal to CPI (roll+spot=excess return over cash)

Commodities

SUMMARY OF ASSET COMPONENTS

Modeled to set roll return to zero and spot index return equal to CPI (roll spot excess return over cash)

NCREIF Timber Index since 1978

Hancock Timber returns 1970-1977

Timber

HFR Total Hedge Fund Index since 1993

Simulated modeled returns 1970 – 1992

Absolute Return

Amex Oil Index 1984 – 2007

Simulated modeled returns 1970 – 1983

De-levered using D/E ratio of 50% source: UBS

Oil & Gas

De-levered using D/E ratio of 50%, source: UBS

BC TIPS Index 1997-2009

Simulated modeled returns 1970-1996 by Bridgewater

TIPS

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A Brief Description of Global Inflation Linked BondsREAL RETURN - TIPS

Objective• Produce inflation-protected income/returns over extended periods

• TIPS can help plan sponsors secure more steady real returns over time

K M k t T d /I Key Market Trends/Issues• Returns on TIPS have proven cyclical as a result of supply/demand factors as well as expectations for economic growth

• The bulk of global TIPS issuance has come from sovereign governments

• The market of TIPS has grown significantly in recent years

Compared to other major classes TIPS have exhibited better inflation protection characteristics• Compared to other major classes, TIPS have exhibited better inflation-protection characteristics

• In the 2008 crisis, TIPS became attractively priced relative to U.S. Treasuries for lack of liquidity reasons

Investment Management Trends/Issues Investment Management Trends/Issues• Institutional TIPS management totals approximately $125 billion

• Several plan sponsors have dedicated TIPS asset class portfolios, while others consider TIPS a Real Return component

• Track records of active TIPS managers is mixed and relatively sparse

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A Brief Description of Global Inflation Linked BondsREAL RETURN - TIPS

1 600

Global Index-Linked Bond Issuance

1,200

1,400

1,600

600

800

1,000

$ Tr

illio

n

200

400

600

0

2004 2006 2008 2010

U.S. U.K. France Japan Germany Other Euro/CDA

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A Brief Description of TimberREAL RETURN - TIMBER

Objective:• Produce inflation-protected income/returns over extended periodsp p

• Low correlation to traditional public market investments

I t d d B fit Intended Benefit:• Primary: improve risk-adjusted return of overall portfolio

• Secondary: incremental diversification

• Secondary: long-term investment with inflation hedging characteristics

Potential Drawbacks:• Primary: loss of investment capital

• Secondary: Long investment time-period

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A Brief Description of CommoditiesREAL RETURN - COMMODITIES

Objective:• Provide diversification and inflation protection over equity markets over extended periodsp q y p


I t d d B fit Intended Benefit:• Primary: improve risk-adjusted return of overall portfolio

• Secondary: incremental diversification

• Secondary: long-term investment with inflation hedging characteristics


• Secondary: High volatility relative to other real return assets

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A Brief Description of CommoditiesCOMPONENTS WITHIN COMMODITIES

Abs Ret/

Energy Crude OilBrent Crude OilHeating OilAbs Ret/

Hedge Fds$1.8T

Heating OilUnleaded GasNatural Gas

Livestock Live CattleLean hogsF d ttlFeeder cattle

Agriculture CornSoybeansWheatSoybean oilCoffeeCocoaSugarCotton

Industrial Metals AluminumZincNickelLeadCopper

Precious Metals Gold

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Sources: Russell

Precious Metals GoldSilverPlatinum

A Brief Description of Oil & Gas

Objective• Oil & Gas projects allow investors to capture high levels of cash flow while gaining some positive exposure to inflation

REAL RETURN – OIL AND GAS

• Oil & Gas projects allow investors to capture high levels of cash flow while gaining some positive exposure to inflation trends

• Income would exhibit some degree of inflation-linkage

Key Market Trends/Issues Key Market Trends/Issues• Many investors have gained exposure to energy indirectly, via broader commodity-oriented and/or infrastructure mandates

• The energy sector is a large component of the economy with several types of entry points: private investments, Master Limited Partnerships (MLPs), sector-focused long equity portfolios, various long-short strategies

• While there has been significant positioning with respect to developing dedicated infrastructure investments, dedicated energy-oriented portfolios have not received significant interest

• MLP sector is developing significant scale – now over $100 billion in equity issuance; most MLPs have an energy orientation

• Similar to REITs, MLPs pass a large proportion of their income directly to investors, allowing for high cash-on-cash yields

• MLP market consists of numerous alternatives, with varying degrees of operating risk and liquidity

Investment Management Trends/Issues• While early in its stages, a few investors are considering MLP-type investments

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Source: HFR

A Brief Description of Oil & GasREAL RETURN – OIL AND GAS

Near-term prospects:

• Colder than average winter….

• …while aggregate demand and production is picking up in the US and elsewhere as move out of recession continues…

• …and supplies are expected to peak in early-2011

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A Brief Description of Absolute ReturnREAL RETURN – ABSOLUTE RETURN

Objective:Objective:• Stable risk-adjusted performance


Intended Benefit:• Primary: improve risk-adjusted return of overall portfolio

S d i t l di ifi ti• Secondary: incremental diversification

• Secondary: more liquid than private equity


• Secondary: limited capital withdrawals, depending upon investors contract terms

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A Brief Description of Absolute ReturnREAL RETURN – ABOSLUTE RETURN

Strategies Definition Relative Value Convertible Arbitrage Invests in the convertible securities of a company. A typical investment is to be long the convertible bond and short the

common stock of the same company Positions are designed to generate profits from the fixed income security as well as the

Hedge Funds - Characteristics and Terms

common stock of the same company. Positions are designed to generate profits from the fixed income security as well as the short sale of the stock, while protecting the principal from market moves.

Fixed Income Arbitrage Fixed income arbitrage managers seek to exploit pricing anomalies within and across global fixed income markets and their derivatives, using leverage to enhance returns. In most cases, fixed income arbitrageurs take offsetting long and short positions in similar fixed income securities that are mathematically, fundamentally or historically interrelated. The relationship can be temporarily distorted by market events, investor preferences, exogenous shocks to supply or demand, or structural features of the fixed income market.

Equity Market Neutral Equity market-neutral is designed to produce consistent returns with very low volatility and correlation in a variety of market environments. The investment strategy is designed to exploit equity market inefficiencies and usually involves being simultaneously long and short matched equity portfolios of the same size within a country. Market neutral portfolios are designed to be either beta or currency-neutral or both. Equity market-neutral is best defined as either statistical arbitrage or equity long/short with zero exposure to the market.

Event Driven Risk Arbitrage Risk arbitrage (also known as merger arbitrage) specialists invest simultaneously in long and short positions in both companies

involved in a merger or acquisition. In stock swap mergers, risk arbitrageurs are typically long the stock of the company being acquired and short the stock of the acquiring company. In the case of a cash tender offer, the risk arbitrageur is seeking to capture the difference between the tender price and the price at which the target company’s stock is trading.

Distressed Securities Distressed securities funds invest in the debt or equity of companies experiencing financial or operational difficulties or trade Distressed Securities Distressed securities funds invest in the debt or equity of companies experiencing financial or operational difficulties or trade claims of companies that are in financial distress, typically in bankruptcy. These securities generally trade at substantial discounts to par value. Hedge fund managers can invest in a range of instruments from secured debt to common stock. The strategy exploits the fact that many investors are unable to hold below investment grade securities.

Opportunistic Macro Macro hedge funds pursue a base strategy such as equity long/short or futures trend following to which large scale and highly

leveraged directional bets in other markets are added a few times each year. They move from opportunity to opportunity, from trend to trend, from strategy to strategy.

Short Sellers The short selling discipline has an equity as well as fixed income component. Short sellers seek to profit from a decline in the l f t k I dditi th h t ll i t t th h d f th h t l f t kvalue of stocks. In addition, the short seller earns interest on the cash proceeds from the short sale of stock.

Long Region, Industry, or Style

Traditional equity fund structured like a hedge fund; ie, uses leverage and permits managers to collect an incentive fee. Focus of the fund could be a specific geographic region (i.e., Japan) , industry (i.e., technology) or style (i.e., growth)

Emerging Markets Emerging market hedge funds focus on equity or fixed income investing in emerging markets as opposed to developed markets. This style is usually more volatile not only because emerging markets are more volatile than developed markets, but because most emerging markets allow for only limited short selling and do not offer a viable futures contract to control risk. The lack of opportunities to control risk suggests that hedge funds in emerging markets have a strong long bias.

Long/Short Equity Long/short strategies combine both long as well as short equity positions. The short positions have three purposes, which can vary over time or by manager. First, the short positions are intended to generate alpha. This is one of the main differences

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vary over time or by manager. First, the short positions are intended to generate alpha. This is one of the main differences when compared with traditional long-only managers. Stock selection skill can result in doubling the alpha. A long/short equity manager can add value by buying winners as well as selling losers. Second, the short positions can serve the purpose of hedging market risk. Third, the manager earns interest on the short as he collects the short rebate.

14. Presentation by Pension Consulting Alliance -Real ...retirement.ladwp.com/AgendaItems/Agenda - 20110126 Agenda Item 14.pdf · • PCA’s current intermediate-term investment

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