2014 Investment Plan - OPERS · On behalf of OPERS Investment Division, I am presenting the Annual...
Transcript of 2014 Investment Plan - OPERS · On behalf of OPERS Investment Division, I am presenting the Annual...
2014Investment Plan
Health Care Fund
Defined Benefit Fund
Ohio Public Employees Retirement System 277 East Town StreetColumbus, Ohio 43215 1.800.222.7377 www.opers.org
Table of Contents
Chief Investment Officer’s Letter............................................................................................. 1
Executive Summary………………………....………………………………………………………...2
FUND STRATEGIES ............................................................................................... 5
Defined Benefit Fund .............................................................................................................. 5
Health Care Fund ................................................................................................................... 9
ASSET CLASS STRATEGIES ................................................................................. 13
Tactical Outlook .....................................................................................................................13
Public Equity..........................................................................................................................19
Fixed Income .........................................................................................................................20
Alternatives ...........................................................................................................................22
Private Equity ....................................................................................................................23
Real Estate ........................................................................................................................23
Hedge Funds .....................................................................................................................23
Opportunistic .....................................................................................................................24
Commodities ......................................................................................................................24
Risk Parity…………………………………………………………………………………………….23
Global Tactical Asset Allocation ……………………………………………………………………24
POLICIES, COMMITTEES AND RESOURCES ........................................................... 26
OPERS Retirement Board Policies Governing Investment Activities .....................................26
Staff Committee Structure .....................................................................................................26
Staffing ..................................................................................................................................28
Peer Group Comparison ........................................................................................................32
APPENDIX ...............................................................................................................................33
Organizational Structure and Staff Biographies .....................................................................35
OPERS 2014 INVESTMENT PLAN Page 1
Chief Investment Officer’s Letter Members of the Ohio Public Employees Retirements System’s Retirement Board: On behalf of OPERS Investment Division, I am presenting the Annual Investment Plan (“AIP”) for the fiscal year ending December 31, 2014. The AIP clearly delineates our goals against which the Investment Division’s performance is measured and how we will achieve these goals. The Investments Division’s ultimate goal is sustained performance, which will help to provide secure retirement benefits to our members. Such performance can only be accomplished through clearly establishing our goals and diligently implementing and monitoring our objectives. The OPERS Investments Staff is prepared to meet the investment challenges in 2014 as we strive to succeed in an uncertain investment environment. Calendar year 2013 delivered a healthy 14.33% return (preliminary) for the Defined Benefit Fund and 11.33% return (preliminary) for the Health Care Fund, which exceeded target (described in 2013 AIP) returns of 6.96% and 6.40%, respectively. As of December 31, 2013, net assets of the Defined Benefit Fund and the Health Care Fund are $74.7 billion and $13.0 billion respectively, exceeding the asset growth targets for both Funds, and the balance of total funds is currently registering an all-time high of $87.7 billion. The Defined Benefit Fund outperformed its benchmark return by 10 basis points (preliminary) and the Health Care Fund outperformed its benchmark return by 64 basis points (preliminary). Staff successfully implemented internal and operational initiatives, and continued to generate alpha, or active return for both Defined Benefit and the Health Care Funds throughout the year. Finally, I would like to thank the OPERS Retirement Board members for their trust, support, and oversight of the Investment Division in 2013. Respectfully, John C. Lane, Chief Investment Officer January 15, 2014
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Executive Summary The following Summary outlines the strategies, asset allocation, and asset class strategies for OPERS Defined Benefit and Health Care Funds. This Summary also includes initiatives and resources as well as performance and risk expectations. Fund Strategies The Defined Benefit and Health Care Funds will continue transitioning toward their strategic asset allocations as a part of the Asset Liability Study approved by the OPERS Retirement Board in October 2013. Staff plans to complete these transitions by the first quarter of 2014, depending on the market environment. The following table outlines the projected base case returns with ranges for both the Defined Benefit and Health Care Funds. The base case return expectations are higher than 2013 for both the Defined Benefit and Health Care Funds largely due to higher expected returns for Fixed Income and the Alternative Asset Classes.
Base Case Return Active Tracking Information
Return* Range Return Error Ratio
2014 7.39 -5.76 to 20.54 0.44 1.10 0.40
2013 6.96 -5.89 to 19.81 0.44 1.10 0.40
2014 6.52 -5.73 to 18.77 0.31 0.78 0.40
2013 6.40 -6.35 to 19.15 0.38 0.94 0.40
Defined Benefit Fund - - - - - - % - - - - - - - - - - - % - - - - - -
Health Care Fund
*Base Case Return includes the active return.
The active returns shown above incorporate an information ratio of 0.40. This ratio measures the active return per unit of tracking error (active risk), which is a risk-adjusted return metric. Additional details regarding the fund strategies are included later in this Annual Investment Plan. Asset Allocation and Asset Class Strategies The OPERS Retirement Board approved the strategic asset allocation changes in the Defined Benefit and Health Care Funds at its January 2014 meeting, after the Board approved the strategic asset allocation as a part of the Asset Liability Study at its October 2013 meeting. The Defined Benefit and Health Care Funds’ Public Equity allocations were reduced by 3.5% and 4.5%, respectively. Both Funds’ allocations for the Risk Parity asset class were increased by 3% and both Funds’ allocation for the Hedge Funds sub-asset class were increased by 2% and 0.6%, respectively. Staff will liquidate the Liquidity portfolio within the Fixed Income asset class for both Funds (2% allocated for both Funds). Staff plans to complete these allocation changes by the end of the first quarter of 2014, depending on the market environment. The Public Equity allocation in the Defined Benefit and Health Care Funds targets the market-based global weighting between U.S. Equity and Non-U.S. Equity based on the MSCI All Country World Index-Investable Market Index (“MSCI ACWI-IMI”). The portfolio mandates that Staff expects to fund in 2014 include an internally managed public equity tilt portfolio.
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With regard to the Fixed Income allocation in the Defined Benefit and Health Care Funds, Staff plans to increase the allocations for the Emerging Markets Debt by 3% and 1% for the Defined Benefit Fund and Health Care Fund and decrease (increase) the allocation for the High Yield sub-asset class by 2% (1%) for the Defined Benefit Fund (Health Care Fund). The Global High Yield sub-asset allocation will be reduced by 0.5% for both Funds. Staff plans to create two new internally managed portfolios in the fixed income assets in 2014. The Interest Rate and Volatility portfolio provides exposure to the U.S. interest rate and volatility markets using a combination of U.S. Treasuries, futures and options on Treasuries futures or Eurodollar futures. The benchmark will be the Barclays U.S. Treasury Index with a duration of approximately five years. A internal U.S. high yield portfolio will provide exposure to the BB rated U.S. corporate bond market. The benchmark will be a Barclays BB High Yield Index. These new strategies should increase the proportion of internally managed assets for both Funds.
Within the Alternatives asset class, the Private Equity commitment pace will be slower than that of 2013, subject to finding attractive opportunities. Staff will focus on small to middle market private equity strategies in developed markets and will continue the build out a diversified co-investment program. In the Private Real Estate asset class, Staff will continue the strategy of seeking and exploiting underserved niches in the commercial real estate capital markets. Over the past three years, OPERS invested in secondary funds, opportunistic equity, distressed and transitional debt, apartment development, and open-end fund exit queues. In the coming year, Staff will search for niche opportunities such as the development or redevelopment of the hotel, industrial and retail property types. In the Hedge Funds sub-asset class, Staff will hire additional single strategy hedge funds to complete the allocation by the end of the first quarter of 2014. The Fund Management Committee will continue to monitor overall fund asset allocation and exposures. Initiatives Each year the Investments Division undertakes significant initiatives to enhance the capabilities
and performance of the Funds. The completed 2013 strategic initiatives, the continuation of
2013 initiatives, and the new 2014 strategic initiatives are highlighted below.
Completed 2013 Strategic Initiatives
Implemented the internally managed U.S. equity small cap tilt portfolio
Completed the implementation of the Fund-wide risk management system, BarraOne
Completed the funding of the externally managed active Floating Rate Debt mandate
Completed the funding of Risk Parity and GTAA asset classes
Completed the Hedge Funds sub-asset class allocation through the hiring of direct hedge funds identified with the assistance of OPERS’ Due Diligence Consultant, Cliffwater
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Continuation of 2013 Initiatives
Implement the internally managed Non-U.S. equity emerging markets small cap tilt portfolio
Complete the transition of the Internal Core Fixed portfolio to new Custom Core Fixed Income portfolio bases on market conditions
Manage internally a portion of the securities lending cash collateral portfolios utilizing four liquidity-based buckets
New 2014 Strategic Initiatives
Implement the internally managed Interest Rate and Volatility fixed income portfolio
Implement an internally managed high yield portfolio within the Fixed Income asset class
Implement a new tilt portfolio in public equity asset class
Resources The Investments Division Staff is comprised of 61 budgeted positions with five positions currently vacant. Detailed Staff biographies are provided in the Appendix. The Investments Division submitted an estimated compensation and operating budget of $21.24 million for 2014. The budget includes the Finance Division’s estimate of the 2014 incentive compensation payout, based on the prior year’s budget. The budget incorporates the Investments Division’s effort to maintain internal investment management, where appropriate, due to its material cost savings. Staff estimates the total cost to manage the OPERS asset base at 57.6 basis points or $501.24 million. The cost assumes a long-term growth trend in the fund’s asset base, whereas an unanticipated bear market would reduce the cost.
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FUND STRATEGIES
Defined Benefit Fund
Expected Asset Growth – Defined Benefit Fund The table below summarizes Staff’s estimate (base case) of market values and ranges for the Defined Benefit Fund at December 31, 2014. Pessimistic and optimistic cases are also provided for comparison purposes.
Defined Benefit Fund
2014 Expected Asset Growth
Pessimistic Base Optimistic
Case Case Case
12/31/13 Market Value ($ billions) $74.68 $74.68 $74.68
Expected Total Return -5.76% 7.39% 20.54%
Expected Investment Gain ($ billions) -$4.30 $5.52 $15.34
Expected Cash Flow ($ billions) -$3.50 -$3.50 -$3.50
12/31/14 Market Value ($ billions) $66.88 $76.70 $86.52
Estimated Market Values, Returns and Cash Flows
The anticipated market value of $74.68 billion for December 31, 2013 is derived by a smoothing projection from the actual market value as of November 30, 2013. Asset Allocation – Defined Benefit Fund
The 2014 target asset allocation and ranges for the Defined Benefit Fund reflect an estimate by Staff of the expected progress to be made toward the strategic asset allocation targets. Also included are asset allocations for a comparable peer group as of June 2013.
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12/31/2013 12/31/2014 Peer
Estimated Target Range Group*
Public Equity 44.00% 40.90% 31% to 47% 44.13%
U.S. Equity 22.00% 20.70% Mkt. Wgt. ± 5% 21.39%
Non-U.S. Equity 22.00% 20.20% Mkt. Wgt. ± 5% 22.74%
Fixed Income 24.50% 23.00% 16% to 30% 22.36%
Core Fixed 10.00% 10.00% 7% to 13% 16.60%
Emerging Markets Debt 3.00% 6.00% 2% to 8%
Floating Rate Debt 1.00% 1.00% 0% to 2%
Securitized Debt 1.00% 1.00% 0% to 2%
High Yield 5.00% 3.00% 2% to 8% 4.44%
Global High Yield 1.50% 1.00% 0% to 3%
TIPS 1.00% 1.00% 0% to 2% 1.32%
Liquidity 2.00% 0.00% N/A
Alternatives 27.50% 29.10% 8% to 30% 26.00%
Private Equity 10.00% 10.00% 0% to 14% 9.40%
Real Estate 10.00% 10.00% 0% to 14% 9.72%
Hedge Funds 6.00% 8.00% 0% to 9% 5.73%
Opportunistic 0.50% 0.10% 0% to 3%
Commodities 1.00% 1.00% 0% to 2% 1.15%
Risk Parity 2.00% 5.00% 0% to 8%
GTAA 2.00% 2.00% 0% to 4%
Other 7.51%
Total Defined Benefit Fund 100.00% 100.00% 100.00%
Asset Class
*The asset allocations are derived from the organizations in the Peer Group Comparison section
on page 31.
Active Return Active Return Target Tracking
Average Performance Performance Tracking Error Target
Allocation Objectives Contribution Error Range Information
(%) (bps) (bps) (bps) (bps) Ratio
U.S. Equity 20.7% 20 5 50 0-100 0.40
Non-U.S. Equity 20.2% 60 12 150 0-300 0.40
Fixed Income 23.0% 20 5 50 0-200 0.40
Alternatives 29.1% 65 19 500 250-750 0.13
Risk Parity 5.0% 0 0 NA NA NA
GTAA 2.0% 160 3 400 200-600 0.40
Total DB Fund 100.0% NA 44 110 0-300 0.40
Schedule of Expected Performance and Volatility
The above table shows an anticipated active management contribution of 44 basis points to the Defined Benefit Fund’s return. The estimated tracking error of 110 basis points indicates a 68% probability that the active return will be in a range of -66 basis points to +154 basis points. This interval is calculated by subtracting the tracking error from, and adding the tracking error to, the
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expected active return. The expected active management contribution to the Defined Benefit Fund performance for 2013 was also 44 basis points. Return and Risk – Defined Benefit Fund
The performance objectives for the Defined Benefit Fund are to: (1) exceed the return of the Policy benchmark within an appropriately constrained risk framework, net of investment expenses: and (2) exceed the actuarial interest rate over a reasonably longer time horizon. The Policy benchmark combines designated market indices for asset classes, weighted by asset allocation targets. The return estimates in the following table were derived from the asset class return expectations developed by the OPERS Retirement Board’s retained Investment Advisor, NEPC. The single-point estimate return of 7.39% is comprised of an expected return of 6.95% from the policy mix and an additional contribution of 0.44% from active management, net of fees. In the following table, Staff divides return and risk into two components. Policy: The return and risk derived from the policy asset allocation and the intermediate term
return and risk forecast of the underlying asset classes Active: The return and risk associated with deviations from benchmark allocations at either the
asset class level or portfolio level. It reflects the potential impact to relative performance from deviating from the asset class policy allocation targets, from asset class benchmark mismatches and from individual portfolio active risk
The Policy Return and Active Return are calculated as weighted average of expected returns and expected alphas of each sub-asset class.
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Asset Classes Pessimistic Base Optimistic
Public Equity -10.40% 7.60% 25.60%
U.S. Equity -11.78% 6.32% 24.42%
Non-U.S. Equity -12.35% 8.35% 29.05%
Fixed Income -3.47% 4.16% 11.79%
Core Fixed -3.94% 2.55% 9.04%
Emerging Markets Debt -7.34% 5.46% 18.26%
Floating Rate Debt -3.00% 5.00% 13.00%
Securitized Debt -11.00% 8.00% 27.00%
High Yield -8.50% 4.50% 17.50%
Global High Yield -8.25% 4.75% 17.75%
TIPS -5.00% 2.50% 10.00%
Alternatives -10.75% 7.49% 20.84%
Private Equity -18.25% 8.75% 35.75%
Real Estate -10.75% 6.25% 23.25%
Hedge Funds -3.50% 5.50% 14.50%
Opportunistic -3.50% 5.50% 14.50%
Commodities -13.00% 5.00% 23.00%
Risk Parity -11.56% 6.64% 24.84%
GTAA -6.30% 5.55% 17.40%
Policy Return -5.84% 6.95% 19.74%
Sources of Return Pessimistic Base Optimistic
Policy -5.84% 6.95% 19.74%
Active -0.66% 0.44% 1.54%
Total Return -5.76% 7.39% 20.54%
Sources of Variability Information Sharpe
Risk Risk Ratio Ratio
Policy 12.79% 0.48
Active 1.10% 0.40
Total Risk 13.15% 0.50
2014 Total Return Assumptions
2014 Total Risk and Active Risk Assumptions
2014 Policy Return Assumptions
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Health Care Fund Expected Asset Growth – Health Care Fund
The table below summarizes Staff’s estimate (base case) of market values and ranges for the Health Care Fund at December 31, 2014. Pessimistic and optimistic cases are also provided for comparison purposes.
Health Care Fund
2014 Expected Asset Growth
Pessimistic Base Optimistic
Case Case Case
12/31/13 Market Value ($ billions) $13.00 $13.00 $13.00
Expected Total Return -5.73% 6.52% 18.77%
Expected Investment Gain ($ billions) -$0.74 $0.85 $2.44
Expected Cash Flow ($ billions) -$1.30 -$1.30 -$1.30
12/31/14 Market Value ($ billions) $10.96 $12.55 $14.14
Estimated Market Values, Returns and Cash Flows
The anticipated market value of $13 billion for December 31, 2013 is derived by a smoothing projection from the actual market value as of November 30, 2013. Asset Allocation – Health Care Fund
The 2014 target asset allocation and ranges for the Health Care Fund reflect an estimate by Staff of the expected progress to be made toward the strategic asset allocation targets, which are shown below. There is no peer universe of public pension plans with separate health care funds.
12/31/2013 12/31/14
Estimated Target Range
Public Equity 47.80% 44.10% 34% to 52%
U.S. Equity 23.20% 21.90% Mkt. Wgt. ± 5%
Non-U.S. Equity 24.60% 22.20% Mkt. Wgt. ± 5%
Fixed Income 33.50% 34.00% 24% to 44%
Core Fixed 17.00% 17.00% 12% to 22%
Emerging Markets Debt 5.00% 6.00% 2% to 8%
Floating Rate Debt 1.00% 1.00% 0% to 2%
Securitized Debt 1.00% 1.00% 0% to 2%
High Yield 2.00% 2.50% 0% to 5%
Global High Yield 2.00% 1.50% 0% to 4%
TIPS 3.50% 5.00% 2% to 8%
Liquidity 2.00% 0.00% NA
Alternatives 14.70% 14.90% 2% to 14%
Private Equity 0.80% 0.80% 0% to 2%
REIT 6.00% 6.00% 2% to 10%
Hedge Funds 5.40% 6.00% 0% to 10%
Opportunistic 0.50% 0.10% 0% to 4%
Commodities 2.00% 2.00% 0% to 4%
Risk Parity 2.00% 5.00% 0% to 8%
GTAA 2.00% 2.00% 0% to 4%
Total Health Care Fund 100.00% 100.00%
Asset Class
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Active Return Active Return Target Tracking
Average Performance Performance Tracking Error Target
Allocation Objectives Contribution Error Range Information
(%) (bps) (bps) (bps) (bps) Ratio
U.S. Equity 21.9% 20 4 50 0-100 0.40
Non-U.S. Equity 22.2% 60 13 150 0-300 0.40
Fixed Income 34.0% 20 7 50 0-200 0.40
Alternatives 14.9% 23 4 300 200-400 0.08
Risk Parity 5.0% 0 0 NA NA NA
GTAA 2.0% 160 3 400 200-600 0.40
Total HC Fund 100.0% NA 31 78 0-300 0.40
Schedule of Expected Performance and Volatility
The above table shows an anticipated active management contribution of 31 basis points to the Health Care Fund’s return. The estimated tracking error of 78 basis points indicates a 68% probability that the active return will be in a range of -47 basis points to +109 basis points. This interval is calculated by subtracting the tracking error from, and adding the tracking error to, the expected active return. The expected active management contribution to the Health Care Fund performance for 2013 was 38 basis points. The decrease in active management contribution is due to the change in the REITs portfolio management style from active management to passive management.
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Return and Risk – Health Care Fund
The performance objective for the Health Care Fund is to exceed the return of the Policy benchmark within an appropriately constrained risk framework, net of investment expenses. The Policy benchmark combines designated market indices for asset classes, weighted by asset allocation targets. The return estimates in the table below were derived from the asset class return expectations developed by the OPERS Retirement Board’s retained Investment Advisor, NEPC. The single-point estimate return of 6.52% is comprised of an expected return of 6.21% from the policy mix and an additional contribution of 0.31% from active management, net of fees. In the following table, Staff divides return and risk into two components. Policy: The return and risk derived from the policy asset allocation and the intermediate term
return and risk forecast of the underlying asset classes Active: The return and risk associated with deviations from benchmark allocations at either the
asset class level or portfolio level. It reflects the potential impact to relative performance from deviating from the asset class policy allocation targets, from asset class benchmark mismatches and from individual portfolio active risk
The Policy Return and Active Return are calculated as weighted average of expected returns or expected alphas of each sub-asset class.
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Asset Classes Pessimistic Base Optimistic
Public Equity -10.40% 7.60% 25.60%
U.S. Equity -11.78% 6.32% 24.42%
Non-U.S. Equity -12.35% 8.35% 29.05%
Fixed Income -2.97% 3.71% 10.39%
Core Fixed -3.94% 2.55% 9.04%
Emerging Markets Debt -7.34% 5.46% 18.26%
Floating Rate Debt -3.00% 5.00% 13.00%
Securitized Debt -11.00% 8.00% 27.00%
High Yield -8.50% 4.50% 17.50%
Global High Yield -8.25% 4.75% 17.75%
TIPS -5.00% 2.50% 10.00%
Alternatives -6.15% 6.45% 19.05%
Private Equity -18.25% 8.75% 35.75%
REIT -14.75% 6.25% 27.25%
Hedge Funds -3.50% 5.50% 14.50%
Opportunistic -3.50% 5.50% 14.50%
Commodities -13.00% 5.00% 23.00%
Risk Parity -11.56% 6.64% 24.84%
GTAA -6.30% 5.55% 17.40%
Policy Return -5.77% 6.21% 18.19%
Sources of Return Pessimistic Base Optimistic
Policy -5.77% 6.21% 18.19%
Active -0.47% 0.31% 1.09%
Total Return -5.73% 6.52% 18.77%
Sources of Variability Information Sharpe
Risk Risk Ratio Ratio
Policy 11.98% 0.46
Active 0.78% 0.40
Total Risk 12.25% 0.47
2014 Policy Return Assumptions
2014 Total Return Assumptions
2014 Total Risk and Risk Attribution Assumptions
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ASSET CLASS STRATEGIES
Tactical Outlook
The following tactical outlook provides a background and context for the asset class strategies for the Defined Benefit and Health Care Funds. The following are overviews of the two components of the tactical outlook: the capital markets observations and the asset class outlook. The Investment Advisors (NEPC and Hewitt EnnisKnupp), retained by the OPERS Retirement Board, provided these outlooks for 2014.
Capital Markets Observations
Diversification still matters, especially after a period when not rewarded The discipline of long-term strategy allows for participation in rising markets while
maintaining a defensive position when markets correct
Divergence in economic conditions will likely lead to varying outcomes across countries (U.S. vs. Europe vs. emerging markets and within regions as well)
Differences reflect each country’s response to the Financial Crisis Market risks continue to simmer beneath strong equity returns
Kick-the-can fiscal policies of the developed world have hindered growth Impact of tightening is likely to subside and be less of a hindrance going forward Inaction may lead to difficult long-term consequences Lack of proactive fiscal response is in stark contrast to audacious moves of
central banks
U.S. Taper will continue to occur in 2014 and have global implications Economic conditions will dictate changes to path (timing and scale) of tapering Methodical approach to taper means policy will remain accommodative Ability to support risky assets could wane over time if impact of Quantitative
Easing (“QE”) diminishes
Upward pressure on interest rates may have subsided Markets have absorbed the increase in rates Further increase in interest rates must coincide with stronger economic growth Higher rates and slowing growth could perpetuate a currency crisis for some
emerging markets countries
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U.S. Equity Outlook
Equity markets are more attractive for large cap stocks. While earnings have recovered and market multiples have expanded, large cap valuations still appear attractively valued to fair-valued ( i.e. far from overvalued)
Furthermore, earnings yield on stocks is still attractive relative to bond yield
Net inflows have turned positive Flows have turned positive for the first time since 2006 as retail investors are
now just coming back to the equity market and looking for more risky assets
Fundamentals have been ignored and are poised to return to the forefront for investors (barring any major macro headline)
Relative stock price volatility has decreased Companies able to sustain topline and margin growth, which have peaked,
should be rewarded Moreover, with excess cash on balance sheets, capital allocation policies by
company management could impact how investors value them
Some investment managers have identified pockets of opportunities Intra-sector valuation analysis shows Technology as significantly attractive Common secular growth themes include mobile transaction, mobile devices and
services and shale plays within Energy
Expect volatility to be high especially around the timing of the Fed’s tapering announcement
Non-U.S. Equity Outlook
A slight improvement in Europe coupled with supportive comments from European Central Bank presented an opportunity for market gains within Eurozone economies.
However, low growth environment, austerity programs and Euro uncertainty extend a heightened level of continued currency volatility
Uncertainty surrounding economic reforms within Japan may create headwinds to recent market success within the country
Economic stimulus was the catalyst to currency devaluation and strong equity market returns
Emerging markets continue to present high risk-adjusted returns for long-term investors as they will be the drivers of global growth
Continued conviction in high growth prospects translates into emerging equities having a significantly higher return expectation than U.S. large cap and international developed stocks
Investors generally remain underweight Emerging Markets There is a market opportunity to diversify emerging market allocations with
emerging market small cap and consumption focused strategies Macro factors have caused dispersion in returns amongst emerging market
countries and sectors presenting an opportunity for active management
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Fixed Income Outlook
Fixed income investors continue to focus on the Federal Reserve Bank and the inevitable unwinding of QE
Notwithstanding the rise in interest rates during 2013, yields remain below historical averages. Duration risk is at the forefront of investor concerns
Corporate balance sheets remain in a healthy state - leverage and interest coverage ratios are in check despite availability of easy credit in the system. However, signs that the market is overheating are emerging:
Increased activity in Leveraged Buy Out and dividend deals Covenant-lite loan issuance at all-time highs
Investors should expect periods of elevated volatility in corporate credit sectors, specifically in high yield and leverage loans, due to:
Increased retail ownership as percentage of total market Lack of dealer capacity Potential for unanticipated Fed action and rhetoric
As a whole, emerging markets economies are in a fundamentally better position fiscally than developed markets economies but economic conditions are weakening, specifically in emerging countries with current account deficits. Volatility is elevated but investors may begin to see greater divergence in individual country-by-county performance
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Private Equity Outlook
2014 is likely to be a strong year for private equity primarily with regards to returns and distributions.
New deal activity, which will impact future returns, is an area of concern as the markets are becoming fairly hot, although not yet irrational or overheated.
Total fundraising in 2014 is expected to be consistent with slightly higher than 2013.
As much of the capital being successfully raised is in large and mega cap funds, the large cap or upper-middle market is at risk of becoming overly competitive.
Capital markets are very strong with high valuations and high availability of debt. Purchase prices have increased, hovering at or exceeding long term averages. Unless we experience an economic slowdown or market correction, this trend will
likely continue, fueled by available debt at high leverage levels and high public market price multiples.
This type of market is ideal for sellers of private companies and many managers are already seizing the opportunity and liquidating portfolios to lock in gains.
Signs continue to point to an extended period of slow economic growth within the U.S. and European economies; this impedes the ability to generate value through normal course organic revenue growth and forces managers to implement cost reductions, operational efficiencies, and strategic initiatives.
Absent an economic disruption, we believe 2014 will be very active for buyout firms as new deal activity will be driven by the growing amount of dry powder to invest, ability to finance deals, and a large population of private equity-backed unrealized deals; however, we believe pricing will continue to increase given the hot capital markets and competition for new investments, especially in the large cap and upper middle market.
Venture capital is becoming increasingly attractive as the market has corrected over the past decade and funds have adjusted their strategy and approach in the post-Internet bubble era.
Structural changes, strong public markets, and significant disruptive technological innovation have paved the way for stronger venture capital returns.
We have already observed early indications of strong returns over the past few years, albeit too early to be meaningful.
New technology and healthcare companies have emerged that are truly disrupting the way enterprises and clinical trials operate.
o Technology and healthcare companies are flush with cash and continue to seek growth through acquisition. We expect these strategies to continue to work even closer to such innovation by becoming active financial partners with such companies, particularly on the healthcare side where there is a dearth of capital, however we are cautious about biotech venture capital despite the recent strength of such companies in the financial markets.
There are pockets of attractive investment strategies within all sectors of private equity. We favor investment in all sectors over multiple vintage years in order to avoid
overexposure to any one strategy or economic cycle, although it may be prudent to temper allocations to secondaries, credit related strategies and mega and large cap markets.
As always, manager selection will be the key to generating the best returns with a current focus on choosing managers with strong operational capabilities and high levels of valuation discipline on new deals.
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Real Estate Outlook
U.S. real estate returns remained stronger than anticipated during 2013 and we expect performance to continue to moderate through 2014 and beyond.
The overall recovery in core real estate is mature and in many coastal markets fully valued though not generally overheated; the Pension Real Estate Association’s consensus forecasts shows unlevered real estate return expectations of 7.8% in 2014.
The U.S. economy is still amidst a multi-year rebound with monetary policy expected to remain accommodative for now, which coupled with improving job growth and below average levels of new construction for most property types, should continue to provide a tailwind to the real estate sector.
Factors to consider in 2014 (and beyond) include: – Due to the slow pace of recovery to date in the fundamentals of the non-
residential sectors of commercial real estate, growth in net operating income has been modest, leaving plenty of room for improvement; above average performance should present itself as rental rate growth takes stronger hold and excess space continues to be absorbed—creating ongoing attractive yields.
– New supply is expected to rise across most property types, albeit still quite modestly with the exception of the apartment sector; while the demand/supply gap should remain favorable for most property types mid term, market selection will become even more important as the supply cycle ramps up.
– Vacancy and rental rates should continue to rebound more widely, helping to support and expand current pricing—especially aiding the rebound of non-core investments; metro areas significantly supported by technology, healthcare and energy sectors are expected to continue to outperform.
– Rising interest rates should be monitored; while gains in sector fundamentals will help offset rising rates, the offset is not expected to be complete, and portfolio structure and other long term risk mitigation measures are important to managing liquidity and interest rate sensitivities in the long run.
Globally, U.S. markets remain relatively attractive due to their current point in the real estate cycle, strength of the economy, corporate infrastructure, innovation of capital markets, and depth and breadth of investment opportunities.
With fundamental recovery ongoing, commercial real estate should prove attractive on a risk-adjusted basis relative to other asset classes.
Hedge Funds Outlook
We expect hedge funds to outperform traditional asset classes on a risk-adjusted basis in 2014 as they seek the best investment opportunities across financial markets.
Traditional asset class return assumptions are modestly lower going forward o Equity and credit market returns have been exceptionally strong in recent
years, resulting in higher price multiples, lower dividend yields, and narrower credit spreads which lessen the probability for above average future returns.
o Risk-free interest rates are suppressed by easy monetary policies from central banks globally—and are forecasted to remain at zero-bound levels for the foreseeable future—and broad inflation measures are muted.
Capacity has become a pertinent issue as several hedge funds are returning excess capital and many more are soft closed (subscriptions accepted only from existing
OPERS 2014 INVESTMENT PLAN Page 18
investors and those with reserved capacity) or hard closed (no longer accepting any new capital).
Leverage has increased as managers aim to maintain risk targets amid lower levels of volatility; we expect this to continue as long as volatility remains subdued.
Several product offering themes have emerged which we expect will continue into 2014. These include a growing number of long-only funds offered by long/short equity managers, more ‘40 Act and Undertakings for Collective Investment in Transferable Securities (“UCITS”) vehicles targeting defined contribution and retail investors, and continued interest in credit-oriented hedge funds as an alternative to traditional fixed income, including less liquid, opportunistic strategies with a multi-year investment time horizon.
Long/short equity managers have benefited from higher net exposure and greater concentration around best ideas; they will continue to generate interest among hedge fund strategies if equity markets sustain their advances, however short selling performance must improve in order to prevent investors from gravitating toward long-only strategies.
Macro funds have endured a challenging environment with a lack of pronounced trends, lower trading volumes, and sudden shifts attributable to political initiatives rather than economic fundamentals or price relationships. Increased volatility should renew interest in a strategy that historically has generated positive returns amid turbulent market conditions.
The “reach for yield” from investors has led to robust debt issuance which corporations are now using for acquisitions and operating leverage; some managers are investing opportunistically to fill the lending void as a result of financial regulations in Europe while others await further signs of recovery or more attractive pricing before committing capital.
Emerging markets were generally left behind in 2013 due to pressure on capital flows as investors weighed the threat of tightening monetary policies from developed markets; hedge funds may look to stronger, less sensitive emerging markets for investments with outsized return potential.
We expect fund of hedge funds (“FoHFs”) to experience further outflows, however the rate of redemptions has declined and most investors with the potential to enhance returns through direct hedge fund programs (i.e. those with sufficient assets and resources) have probably already begun to make the transition. FoHFs remain an efficient means of access and diversification for smaller investors and are able to customize offerings for more strategic investors.
Multi-strategy managers should be best positioned to dynamically rotate allocations to underlying hedge fund sub-strategies, and those with a global presence and large teams are competitively advantaged to identify the best investment opportunities.
OPERS 2014 INVESTMENT PLAN Page 19
Public Equity The Defined Benefit and Health Care Fund’s Public Equity allocations were decreased by 3.5% and 4.5% respectively, due to the change in the strategic allocation for both Funds approved by the OPERS Retirement Board (“Board”) at its October 2013 meeting. This transition is projected to be completed by March 2014 as Staff continues to source and fund the hedge funds managers and risk parity managers. The Public Equity allocation has transitioned to a global weighting between U.S. equity and Non–U.S. equity based on the MSCI All Country World Index-Investable Market Index (“MSCI ACWI-IMI”). The target weights will be reviewed/reset on a quarterly basis. The allocations within the Non-U.S. Equity asset class are currently in alignment with the custom strategic benchmark (“custom benchmark”) approved by the Board in July 2011. The custom benchmark includes an allocation to the Emerging Markets small cap segment (4%) and an explicit allocation to Developed Markets small cap securities (10%). The custom benchmark is composed of 55% MSCI World Index ex U.S. Standard Index; 10% MSCI World Index ex U.S. Small Cap Index; 31% MSCI Emerging Markets Standard Index; and 4% MSCI Emerging Markets Small Cap Index. This structure reflects a strategic overweight to Emerging Markets compared to the Emerging Markets allocation of MSCI All Country World Index ex U.S. Investable Markets Index (“MSCI ACWI ex U.S. IMI”). The following table shows the benchmarks and performance objectives for the Public Equity asset class. The benchmark for the U.S. Equity asset class is the Russell 3000 Index with an alpha target of 20 basis points, net of fees. The tracking error target is 50 basis points with a range of 0 to 100 basis points. The performance objective and target tracking error for Non-U.S. Equity are 60 basis points and 150 basis points, respectively.
Performance Target
Objectives Tracking Target
(net of fees) Error Information
Benchmark (bps) (bps) Ratio
U.S. Equity Russell 3000 20 50 0.40
Non-U.S. Equity Custom Benchmark 60 150 0.40
Public EquityExpected Performance and Tracking Error
A new tilt index investment strategy seeks to weight securities based on fundamental factors (such as sales and cash flow) or risk factors (such as volatility) as opposed to traditional indices, which are based upon market capitalization. The strategy, referred to as alternatively weighted indexing, is a systematic, rules-based approach for gaining cost-effective exposure to active management styles. It is implemented through the existing index management process leveraging the team’s expertise in index management, rules-based investing approaches, and quantitative modeling techniques. Staff expects this strategy to outperform its respective capitalization weighted indices over a market cycle of three to five years. Staff has already implemented a Non-U.S. equity developed markets small cap tilt portfolio and a U.S. equity small cap tilt portfolio. Staff plans to add two new tilt index investment strategies into the public equity asset class in 2014.
OPERS 2014 INVESTMENT PLAN Page 20
Fixed Income In order to complete the asset allocation recommendation approved by the OPERS Retirement Board (“Board”) at its January 2014 and October 2013 meetings, Staff plans to restructure the Fixed Income allocation. The Defined Benefit and Health Care Funds‘ Liquidity allocations will be liquidated (2% allocated for both Defined Benefit and Health Care Funds), to fund the TIPS (1.5% for Health Care Fund), and Emerging Markets Debt (2% for the Defined Benefit Fund and 1% for the Health Care Fund) sub-asset classes. The Health Care Fund will get additional 0.5% of High Yield, while Defined Benefit Fund’s High Yield allocation will be reduced by 2%. Global High Yield allocation will be reduced by 0.5% for both Funds. The allocations in the Internal Core Fixed portfolio will be transitioned to align the asset exposures with the new custom strategic benchmark (“custom benchmark”) approved by the Board in July 2011. Depending on market conditions, the performance benchmark will be transitioned to a custom benchmark using the Barclays Capital Aggregate Index weightings with a maximum allocation to Treasuries and government-related issues of 25%, along with corresponding pro-rata increases to the corporate and securitized bonds. The difference between the two benchmarks is that the custom benchmark holds a higher proportion of corporate and securitized bonds than government-related bonds. We are currently half way on this transition and the the timing of completion will depend on market conditions. Staff plans to implement one new portfolio in the Fixed Income asset Class in 2014. The Internal High Yield portfolio provides exposure to the BB rated US corporate bond market. The benchmark will be a Barclays BB High Yield Index. The following table shows the benchmarks and performance objectives for the Fixed Income asset class.
Performance Target
Objectives Tracking Target
(net of fees) Error Information
Benchmark (bps) (bps) Ratio
Core Fixed Barclays Aggregate/Custom Benchmark 30 75 0.40
Emerging Markets Debt EMD Custom Benchmark* 140 350 0.40
Floating Rate Debt Credit Suisse Leveraged Loan Index 60 150 0.40
Securitized Debt Barclays CMBS + 2% 200 500 0.40
High Yield Barclays U.S. High Yield 95 237 0.40
Global High Yield Barclays Global High Yield 100 250 0.40
TIPS Barclays TIPS 0 75 NA
Expected Performance and Tracking Error
Fixed Income
* 50/50 mix of the JP Morgan EM Bond Index Global & the JP Morgan Government Bond Index- Emerging Markets Global Diversified
Securities Lending
In the securities lending program, Staff utilizes multiple lending agents to maximize lending revenue. Staff strives to hire agents who provide competitive fee splits, while providing adequate risk controls and expertise in the asset class being loaned. There is a bias toward lending assets in an auction environment so borrowers are providing maximum revenue in a
OPERS 2014 INVESTMENT PLAN Page 21
competitive environment on a regular basis. In 2014, Staff will continue lending the Treasury and Agency assets in-house. This effort has increased revenues from Treasury lending. The collateral from the securities lending program is managed internally. The combination of lending revenue and investment income comprise the total securities lending performance.
Cash Management The cash portfolios are managed with a low-to-moderate risk profile that results in principal preservation, while exceeding the performance of the respective benchmarks. The benchmark for the OPERS Short Term Investment Funds (“STIF”) is the Merrill Lynch 3-month Treasury Bill Index. The benchmark for the Securities Lending STIF is the Fed Funds Open Rate. Staff is currently considering new portfolio guidelines and a new structure for the cash portfolios that would allow greater focus on the management of liquidity in the cash portfolios. The general structure will incorporate new liquidity buckets that will be unitized for purchase by the individual cash portfolios.
OPERS 2014 INVESTMENT PLAN Page 22
Alternatives
The Alternatives asset class is composed of Private Equity, Real Estate, Hedge Funds, Opportunistic, REITs, and Commodities investment strategies. The Defined Benefit and Health Care Funds invest differently in the Alternatives asset class to meet their unique investment objectives. The following table summarizes the benchmark, performance objectives and tracking error for the various alternative investment strategies utilized within the Fund.
Performance Target
Objectives Tracking Target
(net of fees) Error Information
Benchmark (bps) (bps) Ratio
Private Equity Custom Benchmark* 100 700 0.14
Real Estate Net NFI-ODCE + 0.85% 50 750 0.07
Hedge Funds Custom Benchmark** 50 400 0.13
Opportunistic Custom Benchmark*** 0 500 NA
REITs DJ U.S. Select RESI -5 10 NA
Commodities S&P GSCITR Index 0 400 NA
AlternativesExpected Performance and Tracking Error
* 60/40 weighted average of Russell 3000 and MSCI ACWI ex US IMI + 300 bps
** Higher of LIBOR + 4% or 7% in Q1. Effective from Q2 2014, performance benchmark will be switched to the weighted average of target strategy weights from Hedge Funds Policy. The following table shows strategy, Policy allocation strategy target, and its HFRI benchmark.
Strategy
Policy Allocation
Strategy Target Benchmark
Equity Hedge 25% HFRI Equity Hedge Index
Event Driven 20% HFRI Event-Driven Index
Credit/Distressed 15% HFRI Event Driven: Distressed/Restructuring Index
Relativel Value 5% HFRI Relative Value Index
Macro/Tactical 20% HFRI Macro Index
Multi-Strategy 15% HFRI Fund Weighted Composite Index
*** Market cap weighted average of underlying investments
OPERS 2014 INVESTMENT PLAN Page 23
Private Equity The Private Equity Program (“Program”) is slightly above its 10% target allocation in the Defined Benefit Fund and Staff expects the actual allocation to Private Equity to continue to rise slightly above the current level, but over the next three to five years the allocation should reduce to the long-term target of 10% due to the cash flow profile of the secondary investments as well as the currently robust environment to sell companies. The Program’s commitment pace will be slower than that of 2013, subject to finding attractive opportunities. Staff will focus on small to middle market private equity strategies in developed markets and will continue the build out of a diversified co-investment program. While secondary strategies continue to be attractive, Staff does not consider them as attractive as it was over the past three years. This market dynamic combined with the program being slightly above its target allocation will cause commitments to new secondary investments to represent a smaller portion of the total commitments than it has over the past three years. Although the fundraising environment has significantly improved, Staff will continue to negotiate improved terms for OPERS.
Real Estate Private market real estate has a target allocation to the Defined Benefit (“DB”) Fund of 10.0%. The portfolio began 2013 with an estimated net asset value of $6.8 billion or 10.2% of the DB Fund, and ended the year with an estimated value of $7.4 billion or 10.1% of the DB Fund. The Health Care (“HC”) Fund has a target real estate allocation of 6.0%, and this exposure is obtained through passively managed investments in publicly traded real estate securities known as Real Estate Investment Trusts or REITs. The value of the REIT portfolio was $750.6 million or 5.9% of the HC Fund at the beginning of 2013, and $765.8 million or 5.9% at year-end. In 2014, Staff will continue the strategy of seeking and exploiting underserved niches in the commercial real estate capital markets. Over the past three years, OPERS invested in secondary funds, opportunistic equity, distressed and transitional debt, apartment development, and open-end fund exit queues. In the coming year, Staff will search for niche opportunities such as the development or redevelopment of the hotel, industrial and retail property types. Intensive portfolio management of the existing assets is another priority for 2014. Staff will focus on remaining in compliance with the risk parameters specified in the Real Estate Policy, maintaining the DB Fund allocation target, and realizing gains on mature investments. In 2013, Staff worked on the following projects with Hewitt Ennis Knupp (“HEK”) to follow industry best practices:
Revised the valuation procedures for the separate account portfolio, which will be implemented in the first quarter of 2014,
Refined performance reporting to include occupancy rates as well as core and non-core percentages by channel, and
Maintained target allocations.
OPERS 2014 INVESTMENT PLAN Page 24
Staff and HEK will continue to work collaboratively to implement best practices in portfolio construction, monitoring, and reporting. Hedge Funds
In 2013, the OPERS Retirement Board increased the target allocation to the Hedge Funds sub asset class to 8% in the Defined Benefit Fund, and 6% in the Health Care Fund. Staff anticipates increasing the allocation to the new target at the end of the first quarter of 2014. Based on the current size of the Funds, the total size of the Hedge Funds sub–asset class would be $6.6 billion, an increase from the current size of $5.0 billion. The increase will be achieved through additional contributions to existing funds, and investments in new direct hedge funds identified by Staff with the assistance of OPERS’ Due Diligence Consultant, Cliffwater.
Opportunistic
The Opportunistic sub-asset class is intended to permit investments in assets or strategies not presently contemplated in the respective Defined Benefit or Health Care Funds. In this regard, assets or strategies used in the Opportunistic sub-asset class must have the potential to be mainstreamed into OPERS investment program over time, or be opportunistic based on either valuation or circumstance. Strategies are developed based on their individual merit and circumstances and are assessed as to their scalability and feasibility for a potentially larger allocation. The maximum size for any single benchmarked strategy is 0.5% of the total fund. The Opportunistic allocation contains the Emerging Markets currency portfolio as of November 30, 2013.
Staff plans to create one new portfolio in the Opportunistic sub-asset Class in 2014. The Interest Rate and Volatility portfolio provides exposure to the U.S. interest rate and volatility markets using a combination of Treasuries, futures and options. The benchmark will be the Barclays U.S. Treasury Index with a duration of approximately five years.
Commodities
The Commodity asset class provides exposure to both the Defined Benefit and Health Care Funds as shown in the Fund Strategies sections. Enhanced commodity index strategies were introduced in the sub-asset class in 2013. Additional strategies will be evaluated for inclusion in 2014.
Risk Parity
Risk parity is an alternative approach to investment portfolio management, which focuses on allocation of risk rather than allocation of capital. The risk parity approach asserts that when asset allocations are adjusted to the same risk level, the risk parity portfolio can achieve a higher Sharpe ratio and can be more resistant to market downturns than the traditional portfolio. Initially, Staff implemented the risk parity strategy through hiring external managers in 2012 under Opportunistic sub-asset class. As of the fourth quarter of 2013, the Risk Parity asset class is at its target allocation of 2% for the Defined Benefit and Health Care Funds. The Board approved the new strategic allocation of 5% exposures to the Risk Parity asset class for the
OPERS 2014 INVESTMENT PLAN Page 25
Defined Benefit and the Health Care Funds at its October 2013 meeting. Staff will complete the additional funding through the existing managers.
The performance benchmark for the Risk Parity asset class is the weighted average of underlying managers’ performance benchmarks. Knowing that risk parity managers are trying to construct diversified balanced portfolios and not trying to outperform a benchmark, the Risk Parity asset class has an expected alpha target of zero.
Global Tactical Asset Allocation
Global Tactical Asset Allocation, or GTAA, is a top-down investment strategy that attempts to exploit short-term mis-pricings among a global set of assets. This strategy focuses on general movements in the markets rather than on performance of individual securities. Staff started implementing the GTAA strategy through hiring external managers and target allocations of 2% for the Defined Benefit and Health Care Funds were completed April 1, 2013. NEPC recommended an alpha target of 160 basis points with a target tracking error of 400 basis points. The performance benchmark for the GTAA asset class would be the weighted average of underlying managers’ performance benchmarks.
OPERS 2014 INVESTMENT PLAN Page 26
POLICIES, COMMITTEES AND RESOURCES
OPERS Retirement Board Policies Governing Investment Activities The following exhibit illustrates the structure and relationship of the Policies within the total System and its two investment Funds.
Staff Committee Structure
The Chief Investment Officer (“CIO”) utilizes a variety of committees, working groups and meeting structures to govern the Investment Division’s activities. This internal governance arrangement enhances collective inputs, retains institutional knowledge, provides documentation of the due diligence process and other processes, promotes transparency and accountability, and formalizes decision-making processes. These committees are designed to combine structure and flexibility to efficiently bring the appropriate decision makers together on a timely basis and maintain a controlled environment to minimize operational risk.
Broker - Dealer Policy Corporate Governance
Derivatives Policy Leverage Policy
External Investment Managers’ Insurance Policy Iran and Sudan Divestment Policy
Material Nonpublic Information Policy DC Fund Policy
Ohio-Qualified & Minority-Owned Manager Policy Personal Trading Policy Proxy Voting Guidelines
Responsible Contractor Policy Securities Lending Policy
Soft Dollar/Other Commission Arrangements Policy
OFAC Policy
INVESTMENT-WIDE POLICIES
Cash Policy Commodity Policy
Hedge Funds Policy Opportunistic Fund Policy
GTAA Policy
Public Equity Policy Fixed Income Policy Private Equity Policy
Real Estate Policy Risk Parity Policy
ASSET/SUB-ASSET CLASS POLICIES
OPERS FUNDS
FUND POLICIES
HEALTH CARE FUND
Investment
Objectives and Asset Allocation Policy
DEFINED BENEFIT FUND
Investment
Objectives and Asset
Allocation Policy
OPERS 2014 INVESTMENT PLAN Page 27
The following provides an outline of the Investment related committees.
Committee/Meeting Purpose and Description Investment Committees – Approvals and Decisions
Broker Review* Monitor/Approve and Evaluate Brokers, Complete ORSC Reports
Counterparty* Set Counterparty Limits and Monitor Counterparty Exposures
Fund Management* Implement Asset Allocation and Investment Strategies, Cash Forecasting, Fund and Portfolio Exposure Metrics, and Set Quarterly Fund Target Benchmark Allocations During Transition, Liquidity Management
DC Funds Staff Investments Committee*
Review/Monitor Defined Contribution Fund's Allocation and Rebalancing Activities
Operational Risk* Identify and Monitor Operational Risks
Risk Steering Risk Assessments and Prioritization
Investment Meetings – External Portfolio Management External Public Markets*
Private Equity* Review External Public Managers and Manager Searches for CIO Approval
Review PE Opportunities for CIO Approval
Real Estate* Review RE Opportunities for CIO Approval
Investment Meetings – Internal Portfolio Management Active Equity Sector Reviews/Outlooks, Portfolio Composition and Risk Management
Global Bonds Sector Reviews/Outlooks, Portfolio Composition and Risk Management
Derivatives Portfolios Review Markets, Strategies, and Internally Managed Index Portfolios
Transition Management Transition Assets Between Managers and Conduct Rebalancing
Internal Equity Index/Tilt Strategy and Tactics
Portfolio Progress Meeting New Portfolio – Planning and Implementation
Non-Investment Division Committees – Committees with Investment Staff Involvement Iran/Sudan Divestiture* Leadership Team*
Corporate Governance*
* Committee has a charter and maintains minutes
The committees and working groups vary in both the frequency of meetings and the degree of structure and formality - some provide informal information sharing and some have formal written charters. The CIO, Deputy CIO and the CIO-designated Chairperson provide leadership to the committees, working groups, and formal meetings. The CIO and Deputy CIO are informed of all committee activities.
OPERS 2014 INVESTMENT PLAN Page 28
Staffing
Recruiting and retaining the best and most talented Staff is a critical priority for the Investments Division. The following table shows the anticipated full staffing for 2014.
Office Total
of the Fund Internal External Invest.
CIO Management Funds Funds Division
2013 Investment Plan Projected Staffing 6 6 33 16 61
Current Staffing 6 6 29 15 56
Vacant Positions - To be filled in 2014 0 0 4 1 5
Year End 2014 Target Staffing 6 6 33 16 61
Target Staffing for Year End 2014
Status of New and Current Positions
Position Vacant
Internal Management Senior Portfolio Manager - Active Equity 1
Internal Management Portfolio Manager - Active Equity 2
Internal Management Senior Investment Analyst - Active Equity 1
External Management Associate Investment Analyst - External Public Markets 1
Total 5
Staffing Costs Assuming full staffing levels in 2014, the chart below details the estimated $13.12 million of salaries, benefits, and incentive compensation for the Investments Division. This represents approximately 1.57 basis points of cost, a decrease of 0.09 basis points from the 2013 projection.
Total 2013
Internal External Invest. Projected
Mgmt. Mgmt. Division Total
Salaries 5.78 2.03 7.81 7.94
Benefits 2.84 1.02 3.86 3.18
Incentive Compensation 1.40 0.60 2.00 2.00
Total Compensation 10.02 3.65 13.67 13.12
Average Assets ($ billions) 29.19 57.81 87.00 79.00
Compensation (Basis Points) 3.4 0.6 1.57 1.66
Estimated 2014 Total Compensation Costs
($ millions)
OPERS 2014 INVESTMENT PLAN Page 29
Operating Budget The Investments Division’s 2014 operating budget (excluding compensation) is $7.57 million. This operating budget reflects a decrease of $0.27 million, or 3.4% percent, from the 2013 budget and, as a percentage of assets, is 0.87 basis points as compared to 0.99 basis points in 2013.
Total
Internal External Invest.
Mgmt. Mgmt. Division
2013 Operating Budget 4.27 3.57 7.84
2014 Operating Budget 4.27 3.30 7.57
Percent Change 0.0% -7.6% -3.4%
Percent of Total 56.4% 43.6% 100.0%
Average Assets ($ billions) 29.19 57.81 87.00
Operating Budget (Basis Points) 1.46 0.57 0.87
Operating Budget less Total Compensation
($ millions)
Management Cost The expected annual external management fees by asset class for the Investments Division are in the table below. The estimate of fees is based on the projected average market value for the Defined Benefit and Health Care Funds, as shown by sub-asset class in the average assets column below.
OPERS 2014 INVESTMENT PLAN Page 30
Total for 2014
Average Annual Annual Average Annual Annual
Assets Cost Cost Assets Cost Cost
($ millions) ($ millions) (bps) ($ millions) ($ millions) (bps)
Public Equity 16,534 2.7 1.6 20,206 83.7 41.4
U.S. Equity 13,723 2.0 1.4 5,179 23.6 45.6
Non-U.S. Equity 2,811 0.7 2.5 15,027 60.1 40.0
Public Fixed Income 11,779 1.3 1.1 9,681 36.4 37.6
Core Fixed 9,512 1.0 1.0 111 0.5 42.0
Emerging Market Debt 0 NA NA 3,612 15.1 41.8
Floating Rate Debt 0 NA NA 870 3.9 45.0
Securitized Debt 870 0.1 1.3 0 NA NA
High Yield 0 0.1 NA 3,717 11.9 31.9
Global High Yield 0 NA NA 1,371 5.0 36.7
TIPS 1,397 0.1 0.7 0 NA NA
Alternatives 878 0.1 0.9 21,831 318.5 145.9
Private Equity 0 NA NA 7,448 104.3 140.0
Real Estate 0 NA NA 7,382 61.3 83.0
REITs 791 0.0 0.4 0 NA NA
Hedge Funds 0 NA NA 6,000 153.0 255.0
Opportunistic 87 0.1 5.7 0 NA NA
Commodities 0 NA NA 1,002 1.6 16.0
Risk Parity 0 NA NA 4,350 22.6 52.0
GTAA 0 NA NA 1,740 15.4 88.3
Total 29,191 4.0 1.4 57,809 476.6 121.3
Custody 2.1 1.3
Total Fund 29,191 6.1 2.1 57,809 477.9 82.7
Estimate of External and Internal Management Costs
Internal Management External Management
There is a significant cost advantage of internal management versus external management. Within U.S. Equity, the proportion of passive assets contributes to the lower internal management costs, reducing them by more than half over what they would be for active assets. Another source of cost savings is that it is less costly to manage assets internally (i.e. lower salaries and incentives, lower rent, less travel, no marketing costs, no stand-alone business expenses and no profit margin). Total Costs The total costs of the investment program in 2014 are projected to be $501.24 million, or 57.6 basis points of assets under management. In 2012 (the latest year for which figures are available), OPERS actual cost of 46.6 basis points was below the CEM benchmark average cost of 57.1 basis points. CEM Benchmarking, Inc. is an independent firm that provides an
OPERS 2014 INVESTMENT PLAN Page 31
assessment of pension plans and it evaluates OPERS investment program relative to the peer group of comparable size.
Total
Internal External Invest. % of
Mgmt. Mgmt. Division Total
Total Compensation 10.02 3.65 13.67 2.7%
Operating Budget less Compensation 4.27 3.30 7.57 1.5%
Manager Fees 476.60 476.60 95.1%
Custody 2.10 1.30 3.40 0.7%
Total Costs 16.39 484.85 501.24 100.0%
Percent of Total 3.3% 96.7%
Average 2013 Asset Size ($ billions) 29.19 57.81 87.00
Costs in Basis Points 5.6 83.9 NA
Costs in Basis Points to Total Fund 1.9 55.7 57.6
Estimated 2014 Total Costs
($ millions)
OPERS 2014 INVESTMENT PLAN Page 32
Peer Group Comparison
The following chart compares the OPERS asset size and Investment staff to its peer group as of June 30, 2013. The chart and table below indicate that the OPERS asset size per Investment Staff is slightly above average among the public plan peer group. The focus of the management team continues to be on increasing productivity and improving results without significantly increasing staff size, except when new responsibilities, investment strategies, or sub-asset classes are added to the investment program.
$0
$50
$100
$150
$200
$250
$300
0 50 100 150 200 250 300 350 400
Ass
et S
ize
($b
illio
ns)
Investment Staff
Public Plan Peer Group
Asset Size and Investment Staff
6/30/2013
The following table lists the public pension peer group referenced in the chart.
Asset Size
($ millions)
California Public Employees' Retirement System $257,876 376 $686
California State Teachers' Retirement System $165,820 122 $1,359
State Board of Administration of Florida $132,383 87 $1,522
New York State Teachers' Retirement System $94,895 69 $1,375
State of Wisconsin Investment Board $94,442 148 $638
Ohio Public Employees Retirement System $81,820 61 $1,341
North Carolina Retirement System $79,994 26 $3,077
New Jersey Division of Investment $79,400 69 $1,151
Employees Retirement System of Georgia $72,873 52 $1,401
Washington State Investment Board $67,903 84 $808
Ohio State Teachers Retirement System $67,982 113 $602
Average $108,672 110 $1,269
Peers
Investment
Staff
Public Plan Peer Group (as of 6/30/2013)
Assset Size per Investment
Staff
Appendix
OPERS 2014 INVESTMENT PLAN Page 34
OPERS 2014 INVESTMENT PLAN Page 35
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OPERS 2014 INVESTMENT PLAN Page 36
Department/Title Department/Title
Name
Education/Designation/
License OPERS Total Name
Education/Designation/
License OPERS Total
Investment
Experience
Investment
Experience
Steven Barker Teresa Black
John Blue David Buchholz
Erik Cagnina Lincoln Carnam
Bradley Carr Jennifer Cassidy
Jennifer Chichka Greg Cotterman
Lorie Davie David Dury
1 14
14 18
5 8
Fixed Income
Senior Cash/Securities Lending
Analyst
BS, The Ohio State University
Passed Level I of the CFA Program
Fixed Income
Investment Analyst
BS, Wright State University
CFA Charterholder
Risk Management Oversight
Senior Operational Risk Analyst
MBA, William & Mary Mason School
of Business
BA, Muhlenberg College
CFA Charterholder
Private Equity
Investment Analyst
BS, Franklin University
BMus, Capital University
2013 Level I Candidate in the CFA
Program
Fund Management
Fund Management Analyst
BS, Xavier University
2014 Level III Candidate in the CFA
Program
16
Private Equity
Associate Investment Analyst
BS, The Ohio State University
CFA Charterholder
19
Active Equity
Senior Investment Analyst
MBA, The Ohio State University
BS, The Ohio State University
External Public Markets
Portfolio Manager
MBA, The Ohio State University
BS, The Ohio State University
CFA Charterholder
CAIA Charterholder
Fixed Income
Portfolio Manager
MBA, Case Western Reserve
BS, Miami (OH) University
CFA Charterholder
Office of the CIO
Executive Assistant
MA, The Ohio State University
BS, Ohio University
Trading
Trader I
BA, Ashford University
CP (Certified Paralegal)
Series 63
14 14
11
20 22
1 1
8
4 12
Fixed Income
Associate Cash/Securities Lending
Analyst
BS in Accounting, Salve Regina
University
1 162 5
2 5
OPERS 2014 INVESTMENT PLAN Page 37
Department/Title Department/Title
Name
Education/Designation/
License OPERS Total Name
Education/Designation/
License OPERS Total
Investment
Experience
Investment
Experience
Mark Ehresman Tony Enderle
Dan German Paul Greff
Xinyang Gu Chad T. Hamberg
Alex Hamilton Sajjad S. Hussain
Ryan Khoury Nick Kotsonis
Prabu Kumaran Jack Lake
Fund Management
Fund Management Analyst
MBA, Wright State University
BS, Wright State University
2013 Level I Candidate in the CFA
Program
Index/Quantitative
Senior Quantitative Analyst
BS, Ohio State University
Passed Level III of the CFA Program
Fixed Income
Senior Investment Analyst
BA, Northwestern University
CFA Charterholder
6
6
Fund Management
Fund Manager
MBA, Asian Institute of Management
B Eng (Mech), Anna University
CFA Charterholder
Risk Management Oversight
Senior Risk Analyst
MBA, Case Western Reserve
University
BS, Marist College
CFA Charterholder
20
9154
Active Equity
Senior Investment Analyst
BS, University of Minnesota,
Twin Cities
CFA Charterholder
4 16
5 16
5 24
Fixed Income
Senior Portfolio Manager
MBA, University of Detroit
BA, Kalamazoo College
CFA Charterholder
Fixed Income
Senior Investment Analyst
BS, Bowling Green State University
CFA Charterholder
Fixed Income
Senior Investment Analyst
BS, Miami (OH) University
CFA Charterholder
12 12
2 11
1 6
13 13
12 12
15
Index/Quantitative
Quantitative Analyst
MS, The Ohio State University
BS, Southeast University, China
6
Fixed Income
Portfolio Manager
MBA, Case Western Reserve
BS, Miami (OH) University
CFA Charterholder
Risk Management Oversight
Investment Risk Officer
MBA, University of Pittsburgh
BS, Allegheny College
CFA Charterholder
OPERS 2014 INVESTMENT PLAN Page 38
Department/Title Department/Title
Name
Education/Designation/
License OPERS Total Name
Education/Designation/
License OPERS Total
Investment
Experience
Investment
Experience
John C. Lane J.G. Lee
Michelle Lewis DeAnne B. Mannion
Zachary Martin Dustin Matthiessen
Jerry May Mike Parker
Gerry Peters Vincent Pettiti
Mac Price Chris Rieddle
Active Equity
Associate Equity Analyst
BBA, University of Kentucky
33
2
U.S. Equity
Investment Analyst
MBA, Boston University
JD, University of Chicago
BA, James Madison University
CFA Charterholder
10 22
Fixed Income
Portfolio Manager
MBA, Ashland University
BA, Abilene Christian University
CTP
1
Active Equity
Senior Investment Analyst
BS, Wharton, University of
Pennsylvania
CFA Charterholder
7
Fixed Income
Portfolio Manager
MBA, Indiana University
BS, Indiana University
CFA Charterholder
7 24
11
Risk Management Oversight
Associate Risk Analyst
MBA, Capital University
BS, The Ohio State University
CFA Charterholder
Index/Quantitative
Sr. Portfolio Manager
MBA, Drexel University
BS, Lafayette College
3 27
12 17
3
Office of the CIO
CIO
MBA, LaSalle University
BS, LaSalle University
Fund Management
Quant Manager
PhD, The Ohio State University
CFA Charterholder
FRM Charterholder
PRM Charterholder
Fund Management
Fund Management Analyst
MBA, University of Phoenix
BA, Wright State University
2013 Level I Candidate in the CFA
Program
4
13 203
External Public Markets
Lead Portfolio Manager
MBA, The Ohio State University
BA, The Ohio State University
BA, Mt. Holyoke College
2014 Level II Candidate in the CFA
Program
2 4
Fund Management
Investment Analyst Trainee
MAFM, Keller Grad. School of Mgt
BS, Wright State University
2014 Level III Candidate in the CFA
Program
1 3
5
4
OPERS 2014 INVESTMENT PLAN Page 39
Department/Title Department/Title
Name
Education/Designation/
License OPERS Total Name
Education/Designation/
License OPERS Total
Investment
Experience
Investment
Experience
Christy Ruoff Daniel J. Sarver
A.J. Sayers Rick Shafer
Matthew Sherman Samir Sidani
Todd Soots Joan Stack
Stephen Stuckwisch Bradley Sturm
Timothy J. Swingle Roger Tong
Trading
Equity Trader
AS, Franklin University
Series 63
2931
External Public Markets
Portfolio Manager
MBA, The Ohio State University
BS, Marietta College
CFA Charterholder
29
18
8
15 15
20
11
5
External Management
Deputy CIO
BA, Dartmouth College
CFA Charterholder
Private Equity
Lead Portfolio Manager
BA, University of Rochester
CFA Charterholder
CAIA Charterholder
19
31
Private Real Estate
Portfolio Manager
MBA, The Ohio State University
BA, Hanover College
CFA Charterholder
CAIA Charterholder
Active Equity
Senior Investment Analyst
BSBA, The Ohio State University
CFA Charterholder
CMT Charterholder
CPA (Inactive)
CMA
Private Real Estate
Associate Investment Analyst
BA, The Ohio State University
Passed Level III of the CFA Program
Level I Candidate in the CAIA
Program
1 1
38
19
Fixed Income
Senior Investment Analyst
MBA, The Ohio State University
BS, The Ohio State University
CFA Charterholder
12
40
Trading
Senior Equity Trader
MBA, Otterbein College
BA, The Ohio State University
Series 63
Trading
Trading Manager
MBA, Fordham University
BA, Mt. Holyoke College
Private Real Estate
Lead Portfolio Manager
MBA, The Ohio State University
MA, University of Cincinnati
MAIR, University of Cincinnati
BA, University of Cincinnati
CAIA Charterholder
Index/Quantitative Equity
Quantitative Analyst
MBA, The College of Insurance
MS, New Jersey Institute of
Technology
Passed Level I of the CFA Program
20
10
8
18
1412
OPERS 2014 INVESTMENT PLAN Page 40
Department/Title Department/Title
Name
Education/Designation/
License OPERS Total Name
Education/Designation/
License OPERS Total
Investment
Experience
Investment
Experience
Lewis Tracy Andrew Urban
Xiaoling Wang Erick Weis
Joyce Williams Cheri Woolsey
Brian H. Wright JoAnn Yocum
34 6
Private Equity
Portfolio Manager
MBA, Baylor University
BA, Baylor University
CFA Charterholder
Index/Quantitative Equity
Portfolio Manager
MBA, The Ohio State University
BBA, University of Toledo
CFA Charterholder
External Public Markets
Senior Investment Analyst
BSBA, Auburn University
CFA Charterholder
CPA (Inactive)
28
22
2010
3 9
Private Equity
Portfolio Manager
PhD, The Ohio State University
MBA, The Ohio State University
BA, University of California at
Berkeley
CAIA Charterholder
Active Equity
Investment Analyst
MS, Columbia University
M Phil, The Chinese University of
Hong Kong
BA, Southwestern University of
Finance and Economics
CFA Charterholder
External Management
Portfolio Assistant
BS, Franklin University
Candidate for the Claritas Investment
Certificate
19
Fixed Income
Investment Assistant
AS, Bliss Business College
13 13
External Public Markets
Investment Analyst
BBA, Ohio University
2014 Level III Candidate in the CFA
Program
Passed Level I of the CAIA Program
4
4 7 14