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MINUTES
Meeting of the Investment Committee of the Board of Trustees of the
State Universities Retirement System Thursday, October 18, 2018, 9:00 a.m.
Northern Trust Global Conference Center – 1st Floor
50 S. LaSalle St., Chicago, Illinois The following trustees were present: Mr. Mark Cozzi, Chair; Mr. Tom Cross, Mr. Dennis Cullen, Dr. John Engstrom, Dr. Fred Giertz, Mr. Craig McCrohon, Dr. Steven Rock, Ms. Lisa Schumacher, and Mr. Collin Van Meter. Others present: Mr. Martin Noven, Executive Director; Mr. Doug Wesley, Chief Investment Officer; Ms. Ellen Hung, Deputy CIO; Ms. Kimberly Pollitt, Senior Investment Officer; Alex Ramos, Investment Officer; Ms. Kelly Carson and Ms. Annette Ackerman, Executive Assistants; Ms. Mary Pat Burns of Burke, Burns & Pinelli; Mr. Neil Rue, Mr. David Sancewich, Mr. Ted Fergusson, Mr. Brandon Ross and Ms. Judy Chambers of PCA; Mr. David Lerman of CME; Mr. Josh Deidesch of CalSTRS; Ms. Susan Long McAndrews and Mr. Tom Clarkson of Pantheon; Ms. Sally Haskins of Callan; Mr. Gregory Williams of Wellington Management; Mr. Anton Briton of Northern Trust; Ms. Angela Myers of Loop Capital Markets; Farzin Khan and Libby Teborck. Investment Committee roll call attendance was taken. Trustee Cozzi, present; Trustee Cross, present; Trustee Cullen, present; Trustee Giertz, absent; Trustee McCrohon, present; Trustee Rock, present; Trustee Schumacher, present. Trustee Antonio Vasquez joined the meeting via conference call at 9:15 a.m. Trustee Aaron Ammons joined the meeting via conference call at 9:45 a.m. Trustee Steven Rock made the following motion:
• That the trustees be allowed to participate via conference call for all meetings on October 18, 2018, pursuant to Section 7(a) of the Open Meetings Act due to their unavailability because of personal illness, employment purposes or family or other emergencies.
Trustee Dennis Cullen seconded and the motion carried with all trustees present voting in favor.
APPROVAL OF MINUTES
Trustee Cozzi presented the minutes from the Investment Committee meeting of September 13, 2018. Trustee Rock made the following motion:
• That the minutes from the September 13, 2018 Investment Committee meeting be approved as presented.
Trustee Cullen seconded and the motion carried with all trustees present voting in favor. Trustee Cullen made the following motion:
• That the closed minutes from the September 13, 2018 Investment Committee meeting be approved as presented and be opened.
Trustee Rock seconded and the motion carried with all trustees present voting in favor.
CHAIRPERSON’S REPORT Trustee Cozzi did not have chairperson’s report.
CHIEF INVESTMENT OFFICER REPORT Mr. Doug Wesley thanked those who attended the Senate hearing in Chicago, IL on October 17, 2018 and briefly updated the group on the focus of the Senate and the diversity goals they would like SURS to develop.
ASSET ALLOCATION IMPLEMENTATION Mr. Neil Rue of PCA discussed the long-term strategic allocation policy approved at the September meeting. Mr. Rue provided his perspective on major changes, implementation and growth changes for asset types. A copy of PCA’s memorandum titled “Asset Allocation Implementation” is incorporated as part of these minutes as Exhibit 1.
TREND FOLLOWING STRATEGY EDUCATION (Educational Topic)
Mr. Rue led the group in a discussion regarding the role of trend following strategies and the impact of CRO components. Mr. Rue provided examples of considerations, factors and history of trend following strategies for each asset. Mr. David Lerman of CME and Mr. Josh Deidesch of CalSTRS provided their perspective on current strategies at each institution.
Copies of the PCA presentation titled “Trend Following Strategy Education,” the CME presentation titled “Managed Futures Education” and the CalSTERS presentation titled “Risk Mitigating Strategies” are incorporated as part of these minutes as Exhibit 2, Exhibit 3, and Exhibit 4.
The educational topic lasted for 80 minutes ending at 11:20 a.m.
CLOSED SESSION
Trustee Rock moved that the Investment Committee go into closed session pursuant to §2(c)(7) of the Open Meetings Act to consider the sale or purchase of securities or investments or to consider an investment contract. Trustee Cullen seconded and the motion carried in a roll call vote.
Trustee Cozzi - aye Trustee Cross - aye Trustee Cullen - aye Trustee Giertz - absent Trustee McCrohon - aye
Trustee Rock - aye Trustee Schumacher - aye
RETURN TO OPEN SESSION
At the conclusion of discussion, Trustee Tom Cross moved that the meeting resume in open session. The motion was seconded by Trustee Cullen and carried with all trustees present voting in favor.
DIVERSITY GOALS/BROKERAGE REVIEW Mr. Alex Ramos provided the annual review of the Manager Diversity Program, noting the summary goals for the asset classes of U.S. Equity, Non-U.S. Equity and Fixed Income. Mr. Ramos provided results through June 30, 2018, stating that SURS has exceeded the goal for each asset class. A copy of SURS memorandum titled “Minority Brokerage Review 2018” is incorporated as part of these minutes as Exhibit 5.
TRANSITION MANAGER SEARCH UPDATE (Education Topic) Mr. David Sancewich provided educational information regarding transition management and how it is utilized. Transition managers can help preserve capital, maintain market exposure, implement benchmark changes and assist in managing risks. Discussion continued as Mr. Sancewich pointed out key factors to evaluate when choosing a transition manager and how transition managers will be utilized during the upcoming SURS transitions. The educational topic lasted for 20 minutes ending at 2:50 p.m. Mr. Ramos provided an update on the Transition Manager RFP that was approved by the board in June 2018. Mr. Ramos stated that twelve firms responded to the RFP, which was narrowed down to six finalist candidates. After conducting interviews of the finalists, staff and PCA recommend including all six firms on SURS’ transition manager bench. Mr. Ramos provided highlights of each firm. Trustee Rock made the following motion:
• That based on the recommendation from staff and PCA, the Investment Committee approve the selection of transition managers for the transition manager bench and /or interim management services:
o Black Rock o Citigroup o Loop Capital o Northern Trust o Penserra o Russell
Trustee Cullen seconded and the motion carried with all trustees present voting in favor. A copy of the PCA presentation titled “Transition Management Education Presentation” and a copy of SURS memorandum titled “Transition Manager Search Update” are incorporated as part of these minutes as Exhibit 6 and Exhibit 7. Also incorporated as part of these minutes are the appendixes titled “SURS Transition Manager Finalist Matrix,” “PCA Transition Manager Finalist Scorecard” and “Transition Manager Disclosures” as Exhibit 8, Exhibit 9, and Exhibit 10.
INVESTMENT COMMITTEE MATERIALS
Trustees raised concerns during prior meetings regarding the volume of materials provided to the trustees for their review in advance of each meeting, Mr. Wesley provided a few proposals to the trustees. Mr. Wesley suggested staff organize the materials into a main section and supplemental sections. This would ensure that all informational content is provided to the board while highlighting the most pertinent information for the trustees. Mr. Wesley welcomed feedback from trustees. A copy of SURS memorandum titled “Investment Committee Materials Proposal” is incorporated as part of these minutes as Exhibit 11. INFORMATIONAL ITEMS NOT REQUIRING COMMITTEE ACTION The following items were provided for reference and are incorporated as a part of these minutes:
1. Exhibit 12 – Non-US & Global Asset Class Review 2. Exhibit 13 – Deutsche Bank Review 2018 3. Exhibit 14 – Northern Trust Master Custodian Review 2018 4. Exhibit 15 – Parametric Review 2018 5. Exhibit 16 – SURS Summary Work Plan FY19 6. Exhibit 17 – SURS Schedule of 2019-2020 Meeting Dates
PUBLIC COMMENT
There were no public comments presented to the Investment Committee. There was no further business brought before the committee and Trustee Rock moved that the meeting be adjourned. The motion was seconded by Trustee Cullen and carried with all trustees present voting in favor.
Respectfully submitted,
Mr. Martin Noven
Secretary, Board of Trustees MMN/kc
M E M O R A N D U M
Date: September 30, 2018 To: Illinois State Universities Retirement System (SURS) From: Pension Consulting Alliance, LLC (PCA) CC: Doug Wesley, CFA – CIO RE: Implementation Plan for Newly Adopted 2018 Strategic Allocation Targets Background At its September meeting, the SURS Board approved a new long-term strategic allocation policy for its investment assets (see table below). Based on several projection statistics highlighted in the table, this new policy should increase the likelihood of providing improved outcomes for the System over its multi-year planning horizon.
Comparison of New Long-Term Allocation Policy with Current SURS Policy
From an allocation perspective, the major change is a reduction in growth-oriented assets (largely traditional equity mandates) to fund a new Crisis Risk Offset® (CRO®) class that is designed to help the SURS total asset portfolio (and, in conjunction, the overall system) better weather severe market outcomes. In addition, the increases in allocations to the Non-Traditional Growth and specific segments of the Stabilized Growth classes
Strategic ClassCurrent
Policy
New Long Term
Policy Difference CommentsBroad Growth 86.5% 66.0% -20.5% Significant reduction
Non-Traditional 9.0% 15.0% 6.0%Tradtional 54.0% 25.0% -29.0%Stabilized 23.5% 26.0% 2.5%
Inflation Sensitive 6.0% 6.0% 0.0%Principal Protection 7.5% 8.0% 0.5%Crisis Risk Offset 0.0% 20.0% 20.0% New fundingTotal 100.0% 100.0% 0.0%Proj. Return Stats.
Exp. LT Comp. Return 6.9% 7.0% 0.1% Improvement in returnExp. Annl. Volatility (SD) 12.9% 8.8% -4.1% Significant reduction
Exp. Best Cal. Yr. Ret. 27.0% 22.5% -4.5% Upside tail declinesExp. Worst Cal. Yr. Ret. -32.8% -19.4% 13.4% Downside tail improves
Proj. Funding Stats.Avg. Worst 10% FR in Yr 5 27.5% 31.4% 3.9% Improvement
Prob. of < Yr. 5 Lower FT 28.3% 23.9% -4.4% ImprovementExp. FR in Yr. 5 52.0% 51.7% -0.3% In-line
Prob. of > Lower FT in 2028-37 59.7% 64.3% 4.6% Improvement
Significant reduction in traditional strategies, coupled
with restructuring.
Exhibit 1
2
reflect increased commitments to (and reliance upon) private markets investments. These changes, as described in further detail below, will occur in a phased manner so as not to disrupt the portfolio’s return production capabilities in the near term. Implementation Timeline Based on the findings above, both PCA and Staff concur that full implementation of the New Long-Term Policy should occur by applying a phased approach over the next few years. Such phasing helps to diversify the Board’s funding decisions across time and market cycle(s). In addition, this approach allows for timely and deliberate due diligence on (and investigation of) specific strategies or sectors that might be considered at various sub-class/component levels. Based on these conclusions, PCA and Staff recommend to the Board a funding plan into the New Long-Term Policy in a step-by-step process (see table below). Over time, the Board and/or Staff may choose to modify these steps as a result of actual funding experience, unforeseen market dynamics, and/or other factors.
Proposed Phase-In Steps for SURS’ New Long-Term Policy
*Does not include Overlay assets/exposures. The schedule above suggests a process that would see SURS fully achieve its new policy allocation levels by 2022 and realize most of its implementation goals sometime during fiscal 2021. Actual results may differ and could result in realization of the allocation objectives sooner. However, particularly with the private markets classes (i.e., within the Non-Traditional component and specific segments within the Stabilized Growth component), it is important to pace into the increased allocations over a several-year period. The paragraphs below provide additional commentary and details for projected changes in three of the six major components/classes: Traditional Growth, Non-Traditional Growth, and CRO®.
Broad Growth Changes Overall, the New Long-Term Policy reduces SURS’ exposure to assets that rely heavily on equity-oriented growth for their return-generating success. Currently, nearly $9 of every $10 invested at SURS has such exposure, which can be highly
Current Actual (as of
8/31/2018) 7/1/2019 7/1/2020 7/1/2021 7/1/2022
Long-Term
Target
Broad Growth 87% 81% 76% 66% 66% 66%Non-Traditional Growth 8% 8% 9% 11% 13% 15%
Traditional Growth 57% 47% 41% 29% 27% 25%Stabilized Growth 22% 26% 26% 26% 26% 26%
Inflation Sensitive 6% 6% 6% 6% 6% 6%Principal Protection 7% 8% 8% 8% 8% 8%CRO 0% 5% 10% 20% 20% 20%
Total* 100% 100% 100% 100% 100% 100%
Exhibit 1
3
volatile. Over time, the Long-Term Policy contemplates reducing that proportion to approximately $7 of every $10. The most significant change comes from more than a 50% reduction in Traditional Growth (i.e., public equity) strategies – from a current 57% of total assets to 25% five years from now. A significant reason for this reduction is due to shifting from public markets allocations to private markets allocations. Over the next several years, the New Long-Term policy also contemplates shifting an additional 10% of its portfolio into private markets investments, resulting in an approximate doubling of this asset type. Traditional Growth Changes In order to pace into the above significant changes in a more deliberate manner, the proposed plan is to reduce the Traditional Growth asset portfolio from near 57% today to between 41% to 47% in approximately two years’ time. Traditional Growth portfolios have reasonably high levels of liquidity so transitional challenges are likely minimal. Importantly, the phased approach is used to help manage for any major changes in market dynamics that might occur during the policy transition period. In the initial phases, SURS will transition assets from the Traditional Growth component to meet two objectives: (i) begin funding the new CRO® class and (ii) fund additional diversifying strategies, in particular, within the Stabilized Growth component. In fact, nearly the same amount of assets is expected to flow from Traditional Growth to Stabilized Growth as from Traditional Growth to CRO®. After the first two years of implementation, SURS can then examine the merits of the implementation process and reassess the remaining steps moving toward the New Long-Term Policy. In the latter years of the implementation process, Traditional Growth assets are expected to be utilized as a funding source for the less-liquid Non-Traditional Growth assets. Non-Traditional Growth Changes Non-Traditional Growth strategies include both the broad private equity opportunity set as well as the broad non-core real asset investment universe. Private equity includes such sectors as buyouts, growth capital, venture capital, mezzanine debt, distressed debt, and other similar sectors. Non-core real assets include real assets requiring improvements (i.e., “value added” real assets), opportunistic real assets, distressed real assets, developmental real assets, highly-levered real assets, certain real asset debt strategies, and newly-evolving property types, among other sectors. Combining both private equity and non-core real assets into one strategic class indicates that, in general, most of these investments have similar return/risk profiles. More specifically, investments in the Non-Traditional Growth class seek relatively high compound returns by taking numerous
Exhibit 1
4
risks, including illiquidity risk, leverage risk, operational risk, development risk, early-stage idea risk, business transition risk, etc. Under the New Long-Term Policy, the proportional allocation to Non-Traditional Growth is expected to increase materially, from a current actual allocation of near 8% of total assets to 15% approximately five years from now. Given that Non-Traditional Growth consists largely of illiquid assets (assets that can be neither bought nor sold quickly at a reasonable price), it is critical that a phased, deliberate approach be taken to funding this class. Such paced funding (which translates into “vintage year” diversification) is a key risk mitigation tool utilized with these types of investments. Based on initial estimates, SURS will need to commit approximately $600 to $700 million/year to achieve the allocation objective. As contemplated in the allocation phase-in schedule highlighted earlier, the Non-Traditional Growth allocation is expected to remain near its current proportional level in the near term since new incremental commitments will not impact the value of the Non-Traditional class until a few years into their investment periods (i.e., new commitments are typically invested over a five-year investment period). Three-to-four years from now, today’s commitments should begin to have a material impact upon the dollar-value of the class and, as a result, begin to ratchet up its respective proportional allocation level. As discussed earlier, the primary funding source in the latter years of the phased allocation schedule will be Traditional Growth (i.e., public equity) assets. This funding mechanism simply shifts one similar-risk asset (public equity) for another (private equity) with the key difference being their respective liquid/illiquid profiles. Allocations to the New CRO® Class The New Long-Term Policy places significant emphasis on a long-term 20% allocation to a new CRO® class. The relatively high allocation level is needed so that it will be impactful to overall portfolio returns over time and help stabilize the portfolio in a material manner during extended crisis period(s). Over the next couple of years, the plan is to steadily grow the class by two annual 5% increments to achieve a 10% allocation by 2020 (likely close to a $2.5 billion allocation). Given that, by design, the CRO® class is highly liquid, once an initial allocation level is achieved with an appropriate manager structure, it should be relatively easy to simply provide additional funding into the existing manager structure. Along these lines, if the Board and Staff are comfortable with the initial $1 billion implementation phase of the class, a more aggressive funding pace could take place, achieving the 10% level before the 2020 milestone date. Funding of the CRO® class will derive from the scheduled downsizing of the Traditional Growth segment. As this occurs, it is important to recognize that the CRO® class is not a substitute for risk-oriented investments but is being funded to better diversify the overall portfolio. Therefore, any assessment of the CRO® class
Exhibit 1
5
should utilize comparisons to other diversifying classes in the SURS portfolio (e.g., Principal Protection and/or Inflation Sensitive). It is likely the CRO® class will utilize five to seven managers across its three underlying components. Long Duration is likely to be managed by one manager, while the other two more dynamic segments (Systematic Trend Following and Alternative Risk Premia) will likely require at least two managers each.
Diversity Considerations Through such a significant transition, manager diversity must be a key focus. PCA’s recommendations will likely also emphasize streamlining the manager structure while also prioritizing overall cost considerations. At the margin, these priorities often lead to larger, fewer manager accounts and mandates, where appropriate. This means there is reasonable likelihood that various manager(s) and/or their mandates will be eliminated. Given these tendencies, it will be a priority to increase the proportional participation of diverse managers from both the assets-under-management and number-of-managers measures during this process. Thus, the intended objective under this and any other future structural transition is to increase SURS’ exposure to diverse managers. Timeline for Implementation PCA and SURS Staff have developed an implementation timeline listing out the major tasks that will be required to shift the overall portfolio to its new strategic structure over the two years (see attached exhibit). Four major task groups make themselves evident in the exhibit: (i) reviews and education/deliberation on structural blueprints for the main newly-structured strategic classes, (ii) re-drafting and approval of policies and guidelines to implement the new class structures, (iii) conducting searches for the appropriate managers to execute new mandates, and (iv) as highlighted above, consideration and implementation of diversity considerations during the search process. The timeline lays out critical paths that are relatively rapid. The over-arching objective is to have the new strategic structure in place by the beginning of fiscal 2020. While all tasks may not be fully completed by exactly that date, the goal is to have relatively high confidence that the new structure will be largely in place for the bulk of the new fiscal year.
Exhibit 1
Nov Dec Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June1 Re-organize performance reporting across functional framework2 Re-draft SURS performance reports to account for new structure3 Draft initial outline of functional policy document4 Finalize Transition Manager line-up and contracts5 Determine v iability of Diverse managers - potential mandate usage6 Conduct Traditional Growth structural rev iew7 Reassess Diverse managers within Traditional Growth8 Re-draft Traditional Growth segment of investment policy9 Conduct necessary Tradtional Growth manager searches
10 Develop RA segment structural recommendations11 Re-draft RA segment of investment policy12 Review v iability of Diverse managers within Credit program13 Develop Credit v1.0 structure recommendations14 Draft new Credit segment of investment policy15 Conduct Private Growth structure/program rev iew16 Search for and retain Private Growth consultant/advisor (if approved)17 Re-draft Private Growth segment of investment policy18 Conduct necessary Private Growth manager searches19 Incorporate Diverse managers within Private Growth20 Review/develop Core/non-core RA pacing plan(s) with Callan21 Specialist consultants develop annual pacing plans for new segments22 Conduct structural rev iew and recommendations23 Draft new CRO segment of investment policy24 Conduct necessary CRO manager searches25 Develop risk management procedures for CRO class26 Determine v iability of Diverse STF and/or ARP managers27 Conduct rev iew of SURS fixed income managers, determine PP capabilit ies28 Develop structural recommendations for PP class29 Draft new PP segment of investment policy (similar to Fixed Income)30 Transition assets to select group of current fixed income manager(s)31 Focus on Diverse manager inclusion32 Develop structural recommendations for IS class33 Draft new IS segment of investment policy (must allow for privates)34 Conduct necessary manager searches
Principal Protection
Inflation Sensitive
2018 2019Class
Item Nbr. Item
2020
Strategic Level
Broad Growth
CRO
Preliminary 2019-2020 Investment Projects Time Line
Exhibit 1
DISCLOSURES: This document is provided for informational purposes only. It does not constitute an offer of securities of any of the issuers that may be described herein. Information contained herein may have been provided by third parties, including investment firms providing information on returns and assets under management, and may not have been independently verified. The past performance information contained in this report is not necessarily indicative of future results and there is no assurance that the investment in question will achieve comparable results or that the Firm will be able to implement its investment strategy or achieve its investment objectives. The actual realized value of currently unrealized investments (if any) will depend on a variety of factors, including future operating results, the value of the assets and market conditions at the time of disposition, any related transaction costs and the timing and manner of sale, all of which may differ from the assumptions and circumstances on which any current unrealized valuations are based. Neither PCA nor PCA’s officers, employees or agents, make any representation or warranty, express or implied, in relation to the accuracy or completeness of the information contained in this document or any oral information provided in connection herewith, or any data subsequently generated herefrom, and accept no responsibility, obligation or liability (whether direct or indirect, in contract, tort or otherwise) in relation to any of such information. PCA and PCA’s officers, employees and agents expressly disclaim any and all liability that may be based on this document and any errors therein or omissions therefrom. Neither PCA nor any of PCA’s officers, employees or agents, make any representation of warranty, express or implied, that any transaction has been or may be effected on the terms or in the manner stated in this document, or as to the achievement or reasonableness of future projections, management targets, estimates, prospects or returns, if any. Any views or terms contained herein are preliminary only, and are based on financial, economic, market and other conditions prevailing as of the date of this document and are therefore subject to change. The information contained in this report may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond the control of the Firm, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect PCA’s current judgment, which may change in the future. Any tables, graphs or charts relating to past performance included in this report are intended only to illustrate investment performance for the historical periods shown. Such tables, graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision. All trademarks or product names mentioned herein are the property of their respective owners. Indices are unmanaged and one cannot invest directly in an index. The index data provided is on an “as is” basis. In no event shall the index providers or its affiliates have any liability of any kind in connection with the index data or the portfolio described herein. Copying or redistributing the index data is strictly prohibited. The Russell indices are either registered trademarks or tradenames of Frank Russell Company in the U.S. and/or other countries. The MSCI indices are trademarks and service marks of MSCI or its subsidiaries. Standard and Poor’s (S&P) is a division of The McGraw-Hill Companies, Inc. S&P indices, including the S&P 500, are a registered trademark of The McGraw-Hill Companies, Inc. CBOE, not S&P, calculates and disseminates the BXM Index. The CBOE has a business relationship with Standard & Poor's on the BXM. CBOE and Chicago Board Options Exchange are registered trademarks of the CBOE, and SPX, and CBOE S&P 500 BuyWrite Index BXM are servicemarks of the CBOE. The methodology of the CBOE S&P 500 BuyWrite Index is owned by CBOE and may be covered by one or more patents or pending patent applications. The Barclays Capital indices (formerly known as the Lehman indices) are trademarks of Barclays Capital, Inc. The Citigroup indices are trademarks of Citicorp or its affiliates. The Merrill Lynch indices are trademarks of Merrill Lynch & Co. or its affiliates. FTSE is a trademark of the London Stock Exchange Group companies and is used by FTSE under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. No further distribution of FTSE data is permitted with FTSE’s express written consent.
Exhibit 1
TREND FOLLOWING DISCUSSIONIllinois State Universities Retirement System
October 2018
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 2
Section
Asset-Liability Study Recap 3
Trend Following Discussion 7
Appendix 23
Agenda Items
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 3
Asset-Liability Study Recap
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 4
A/L Study Takeaways & Rationale
SURS approved a new strategic allocation at its September 2018 meeting
New targets improve the probabilities of achieving the System’s objectives
Ass
et O
nly
Stat
s
Median Comp. Return 6.9% 7.0%
Average Standard Deviation 12.9% 8.8%
Best Calendar Year 27.0% 22.5%
Worst Calendar Year -32.8% -19.4%
A/L
Sta
ts
Average Worst 10% FR Year 5 27.5% 32.8%
Scenarios < Lower FT Year 5 28.3% 21.9%
Median FR Year 15 52.0% 51.6%
Avg. Prob. > Lower FT 2028-37 59.7% 65.5%
Current Policy
New LT Targets
Non-Traditional Growth 9.0 15.0
Traditional Growth 54.0 25.0
Stabilized Growth 23.5 26.0
Hedged Strategies 3.0 0.0
EMD 3.0 0.0
Options Strategies 2.0 6.0
Credit Fixed Income 11.5 14.0
Real Assets 4.0 6.0
Inflation Protection 6.0 6.0
TIPs 4.0 6.0
Commodities 2.0 0.0
Principal Protection 7.5 8.0
Crisis Risk Offset 0.0 20.0
Long Duration 0.0 5.0
Trend Following 0.0 10.0
Alternative Risk Premia 0.0 5.0
Current Policy
New LT Targets
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 5
Impact of Adjusting CRO® Components
Sources: PCA, GRS
Ass
et O
nly
Stat
s
Median Comp. Return 7.0% 6.9% 6.9% 6.9%
Average Standard Deviation 8.8% 8.8% 8.8% 12.9%
Best Calendar Year 22.5% 22.2% 21.8% 27.0%
Worst Calendar Year -19.4% -20.2% -20.2% -32.8%
A/L
Sta
ts
Average Worst 10% FR Year 5 32.8% 32.6% 32.5% 27.5%
Scenarios < Lower FT Year 5 21.9% 22.2% 22.8% 28.3%
Median FR Year 15 51.6% 51.6% 51.3% 52.0%
Avg. Prob. > Lower FT 2028-37 65.5% 64.6% 64.1% 59.7%
Adopted Alternate #1 Alternate #2 SURS
Non-Traditional Growth 15.0 15.0 15.0 9.0
Traditional Growth 25.0 25.0 25.0 54.0
Stabilized Growth 26.0 26.0 26.0 23.5
Inflation Protection 6.0 6.0 6.0 6.0
Principal Protection 8.0 8.0 8.0 7.5
Crisis Risk Offset 20.0 20.0 20.0 0.0
Long Duration 5.0 7.0 10.0 0.0
Trend Following 10.0 7.0 5.0 0.0
Alternative Risk Premia 5.0 6.0 5.0 0.0
• Equivalent expected returns and risk measures
• Similar A/L-focused statistics as well
• Each structure represents an improvement from current policy
• Significant potential volatility and downside risk improvement
• Reasonable increases in chances to match funding plan
• CRO® structure not bound by A/L model; initial structure will seek balance
• CRO® component structure is a near-term priority; may evolve over the next two-to-three years
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 6
CRO® Portfolio Structural Considerations
Weightings within CRO® should not drive its efficacy Forecast errors lead to unreliable weighting schemes Weighting scheme should, at a minimum, reflect role orientations PCA prefers weightings that are less reliant on any one component, similar to Structure 3
Long Duration
Systematic Trend Following Alternative
Risk Premia
Structure 1
Long Duration
Systematic Trend Following
Structure 2
Long Duration
Systematic Trend Following
Alternative Risk Premia
Structure 3
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 7
Trend Following Discussion
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 8
Systematic Trend Following
Alternative Risk Premia
Long Treasury DurationRole: “First Responder”Utilize default-free long-duration assets to capture “flight to quality” returns during deflationary crises.
Role: “Second Responder”Capitalize on continuing market trends, particularly during extended market declines. Approach buys what’s going up and sells what’s going down.
Role: Complementary real returnsProven non-traditional risk premiums that exhibit positive long-term value and are often unrelated to well-known traditional premia. Examples: value, momentum, carry, volatility, etc.
Long Duration & STF: “Crisis Capture”
ARP: “Return Sustainer”
Long Duration & STF are long-short portfolios
Role of Trend Following and Other CRO® Components
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 9
• Momentum and Trend Following are somewhat interchangeable terms
• Buy what is going up; sell what is going down
• Long and short positions in futures and forwards
• Derivatives-based leverage utilized to set strategy volatilities (see appendix)
• Investable universe includes all liquid investments across the globe: Equities, Fixed Income, Currencies, Commodities
• Systematic = rules-based implementation
• Related terms = managed futures, CTAs (commodity trading advisors)
Trend Following Considerations
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 10
• Moving average crossovers are an example of trend following
• Loses money when trends reverse and makes money as they continue
Example
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 11
Why Does it Work?
Behavioral Factors
• Under/Over Reaction to News
• Feedback Loops
• Herding
Economic Factors
• Companies hedging price risks
Sources: Brian Hurst et Al., “Demystifying Managed Futures” Journal of Investment Management, 3rd Quarter 2013Trend Following with Managed Futures, Alex Greyserman, PhD and Kathryn Kaminski, PhD
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 12
• Trend Following strategies have been utilized for decades
• Historic 2%/20% hedge fund strategy What was once thought to be “alpha” can now be obtained as “beta” Managers are primarily hired due to strategy design and implementation
• Multitude of reasons/underlying factors contributing to strategy success:1. Behavioral Factors (i.e., humans are involved in markets)
Under Reactiono When news is announced, market participants do not extrapolate full impacto Price does not immediately increase/decrease to appropriate level
Feedback Loops o Investors often follow news/recent returns and invest accordingly
Herding o Market participants often buy/sell what others have done
History and Justification
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 13
2. Economic Factors (i.e., risk premium based, logical) Price Risk
o During the course of business, companies hedge their sales/purchases– Ex: food company that needs wheat in six months will buy futures to
guarantee a price, even if it is too high– Ex: cattle rancher that will be harvesting in six months will sell futures to
guarantee a price, even if it is too low– Investors on the other side of the trade serve a vital economic role and
thus will be paid a premiumo Willingness to accept lower prices (for sales) and higher prices (for purchases)
increases during volatile times– One of the reasons trend following often performs best during crises
3. Combination of Economic and Behavioral Factors Market Regimes
o As markets shift from one regime to another, prices go from A to Bo Assets trend in various directions as the markets reset to a new regime
Time Varying Risk Premia
History and Justification
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 14
• Trend Following works across nearly every asset
Individual Assets: 1985-2009 Sharpe Ratios for 12-Month Trend Following
Source: Brian Hurst et Al., “Demystifying Managed Futures” Journal of Investment Management, 3rd Quarter 2013
• Sharpe Ratio = (Strategy Return – Cash Return) / Volatility
Historical Results – Across Asset Classes
Commodities Currencies Equities Fixed Income
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 15
Recent Historical Returns
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
Growth of $1 Since 2000
SG Trend Index S&P 500
Year SG Trend Index S&P 500
2000 11.7% -9.1%2001 -0.1% -11.9%2002 26.1% -22.1%2003 11.9% 28.7%2004 2.7% 10.9%2005 0.7% 4.9%2006 8.2% 15.8%2007 8.6% 5.5%2008 20.9% -37.0%2009 -4.8% 26.5%2010 13.1% 15.1%2011 -7.9% 2.1%2012 -3.5% 16.0%2013 2.7% 32.4%2014 19.7% 13.7%2015 0.0% 1.4%2016 -6.1% 12.0%2017 2.2% 21.8%
Sources: Societe Generale, Bloomberg, AlphaSimplex
• SG Trend Index = Manager index/composite of 10 largest trend followers
• Equities and SG Trend Index provide portfolio diversification
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 16
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
Rolling 12-Month Performance Since 2000
SG Trend Outperformed S&P 500 SG Trend Index S&P 500
Sources: Societe Generale, Bloomberg
Recent Historical Returns
• Trend following can underperform for long periods of time relative to equities
• Performance can be episodic but is often negatively correlated to equities
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 17
Source: AQR
Hypothetical Performance During 10 Largest Market DrawdownsJanuary 1880 – June 2018
Trend Following often provides material offset when traditional portfolios decline
Long-Dated Historical Returns
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 18
Trend Following Performance During the 10 Worst Quarters of Equity PerformanceJanuary 2000 – June 2018
• Even during quarterly drawdowns, Trend Following tends to offset equity declines
Sources: Societe Generale, Bloomberg, AlphaSimplex, CME Group
Relevant Historical Returns
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 19
• Trend Following tends to perform poorly in range bound markets (i.e., flat-to-marginal returns in major asset classes)
• Sharp reversals negatively impact Trend Following strategies
Equity Performance During the 10 Worst Quarters of Trend Following PerformanceJanuary 2000 – June 2018
Relevant Historical Returns
Sources: Societe Generale, Bloomberg, AlphaSimplex, CME Group
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 20
• Trend following is prevalent throughout public funds
Public Funds with Trend Following Allocations
Example Plans AllocationCalSTRS $8.7bnFlorida State Board of Administration $1.0bnHawaii ERS $1.0bnNew Jersey Division of Investment $0.8bnOregon PERF $0.8bnMaryland State Retirement & Pension System $0.7bnOhio Public Employees Retirement System $0.6bnIllinois Teachers $0.5bnIowa PERS $0.3bn
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 21
• PCA seeks managers/strategies that exhibit the following criteria: Biased towards medium- and longer-term trends
o Short ≈ <3 months | Medium ≈ 3-9 months | Long ≈ 9-12+ monthso Medium- to long-term trends provide most robust return patterns1
i.e., optimal combination of Sharpe Ratio and crisis protection
Systematic implementation | quantitatively -oriented firmso Graduate (PhD, Masters) backgrounds in mathematics, physics, computer scienceo Straight-forward strategy design (i.e., humility)
Focus on global futures markets (i.e., utilize forwards on limited basis)
Strong focus on risk management and diversification
High volatility (≈ 15-20% annual standard deviation)o Required in order to meaningfully impact portfolio
PCA’s Manager Preferences
1Source: Brian Hurst et Al., “Demystifying Managed Futures” Journal of Investment Management, 3rd Quarter 2013Trend Following with Managed Futures, Alex Greyserman, PhD and Kathryn Kaminski, PhD
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 22
• Benchmarking Trend Following strategies is imperfect Primarily due to volatility targets and markets traded
• Benchmarks: Primary benchmark: Credit Suisse Managed Futures Liquid Index
o CS produces variants of the index based on volatility targets
Alternative benchmark: Mount Lucas Management Global Index EV Alternative benchmark: SG Trend Index
• Benchmark pros/cons: Credit Suisse
o Highest degree of complexity but best aligned with manager universe
MLM Global Index EVo Straight-forward but volatility methodology is inconsistent with manager universe
SG Trend Index o Manager composite, uninvestable
Benchmarking
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 23
Appendix
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 24
$0.10
$1.00
$10.00
$100.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
$ Va
lue
-Log
Sca
le
Year
Current vs. Recommended Comparisons: Asset Growth*
Median long-term compound return: 7.0%
*Based on PCA’s 2018 capital market assumptions
8.9%
5.0%
$0.10
$1.00
$10.00
$100.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
$ Va
lue
-Log
Sca
le
Year
Median long-term compound return: 6.9%
9.8%
4.0%
Current
Recommended
• Improvement in long-term expected return
• Much tighter range of return paths
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 25
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045
Stochastic Funding Ratio
Current vs. Recommended Comparisons: Funding Ratio*
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045
Stochastic Funding Ratio
Current
Recommended
• Funding ratio paths bunched more toward planned path
• Trade-off: reduction of both extreme high and low funding paths
*Based on PCA’s 2018 capital market assumptions Sources: PCA, GRS
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 26
Sources: Societe Generale, Bloomberg, AlphaSimplex
Recent Historical Returns
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
Best 20% ofS&P 500Returns
2 3 4 Worst 20%of S&P 500
Returns
Ave
rage
Qua
rterly
Ret
urn
Quintiles
Average Quarterly Trend Following Return Sorted By Equity Quintiles
-20%
-10%
0%
10%
20%
30%
40%
-30% -20% -10% 0% 10% 20%
Qua
rterly
S&
P 50
0 Re
turn
s
Quarterly SG Trend Returns
Quarterly SG Trend Performance versus S&P 500
SG Trend Index
S&P 500 Index
• Trend following can be an important portfolio diversifier
• Best periods of performance are when equities are strongly positive or negative
• Performance suffers during choppy / sideways markets with no trends
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 27
-60%
-50%
-40%
-30%
-20%
-10%
0%
Dec
-99
May
-00
Oct
-00
Mar
-01
Aug
-01
Jan-
02
Jun-
02
Nov
-02
Apr
-03
Sep-
03
Feb-
04
Jul-0
4
Dec
-04
May
-05
Oct
-05
Mar
-06
Aug
-06
Jan-
07
Jun-
07
Nov
-07
Apr
-08
Sep-
08
Feb-
09
Jul-0
9
Dec
-09
May
-10
Oct
-10
Mar
-11
Aug
-11
Jan-
12
Jun-
12
Nov
-12
Apr
-13
Sep-
13
Feb-
14
Jul-1
4
Dec
-14
May
-15
Oct
-15
Mar
-16
Aug
-16
Jan-
17
Jun-
17
Nov
-17
Apr
-18
Sep-
18
Historical Drawdown Comparison (2000 to Sept. 2018)
S&P 500 60/40 SG Trend Index
Recent Historical Returns
Percent of Time Spent in a Drawdown
Maximum Drawdown
Maximum Length of
Drawdown (months)
Average Length of
Drawdown (months)
StandardDeviation
S&P 500 74% -51% 73 19 14%
60/40 64% -32% 49 9 9%
SG Trend Index 85% -18% 42 11 14%
• Must withstand extended and frequent periods of tough performance to capture diversification benefits
Sources: Societe Generale, Bloomberg
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 28
• Futures contain embedded leverage
• Trend Following strategies leverage ≈ 1x-10x Average/full-cycle leverage ≈ 3x-5x
• Without leverage (i.e., 1x), strategy volatility ≈ 6% (i.e., bond-like)
• Leverage/risk oversight is key component of strategy selection
• Leverage protections: Futures have daily price limits and daily settlement
o Price limit = maximum change in contract priceo Exchanges will close out positions if failed settlement
Long and short positions partially offset leverage risks
Leverage in Trend Following Strategies
Exhibit 2
Illinois SURS • 2018 AL Study Follow-up 29
DISCLOSURES: This document is provided for informational purposes only. It does not constitute an offer of securities of any of the issuers that may be described herein. Informationcontained herein may have been provided by third parties, including investment firms providing information on returns and assets under management, and may not have beenindependently verified. The past performance information contained in this report is not necessarily indicative of future results and there is no assurance that the investment inquestion will achieve comparable results or that the Firm will be able to implement its investment strategy or achieve its investment objectives. The actual realized value of currentlyunrealized investments (if any) will depend on a variety of factors, including future operating results, the value of the assets and market conditions at the time of disposition, anyrelated transaction costs and the timing and manner of sale, all of which may differ from the assumptions and circumstances on which any current unrealized valuations are based.
Neither PCA nor PCA’s officers, employees or agents, make any representation or warranty, express or implied, in relation to the accuracy or completeness of the informationcontained in this document or any oral information provided in connection herewith, or any data subsequently generated herefrom, and accept no responsibility, obligation orliability (whether direct or indirect, in contract, tort or otherwise) in relation to any of such information. PCA and PCA’s officers, employees and agents expressly disclaim any and allliability that may be based on this document and any errors therein or omissions therefrom. Neither PCA nor any of PCA’s officers, employees or agents, make any representation ofwarranty, express or implied, that any transaction has been or may be effected on the terms or in the manner stated in this document, or as to the achievement or reasonablenessof future projections, management targets, estimates, prospects or returns, if any. Any views or terms contained herein are preliminary only, and are based on financial, economic,market and other conditions prevailing as of the date of this document and are therefore subject to change.
The information contained in this report may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond thecontrol of the Firm, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect PCA’s current judgment,which may change in the future.
Any tables, graphs or charts relating to past performance included in this report are intended only to illustrate investment performance for the historical periods shown. Such tables,graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision.
All trademarks or product names mentioned herein are the property of their respective owners. Indices are unmanaged and one cannot invest directly in an index. The index dataprovided is on an “as is” basis. In no event shall the index providers or its affiliates have any liability of any kind in connection with the index data or the portfolio described herein.Copying or redistributing the index data is strictly prohibited.
The Russell indices are either registered trademarks or trade names of Frank Russell Company in the U.S. and/or other countries.
The MSCI indices are trademarks and service marks of MSCI or its subsidiaries.
Standard and Poor’s (S&P) is a division of The McGraw-Hill Companies, Inc. S&P indices, including the S&P 500, are a registered trademark of The McGraw-Hill Companies, Inc.
CBOE, not S&P, calculates and disseminates the BXM Index. The CBOE has a business relationship with Standard & Poor's on the BXM. CBOE and Chicago Board Options Exchangeare registered trademarks of the CBOE, and SPX, and CBOE S&P 500 BuyWrite Index BXM are servicemarks of the CBOE. The methodology of the CBOE S&P 500 BuyWrite Index isowned by CBOE and may be covered by one or more patents or pending patent applications.
The Barclays Capital indices (formerly known as the Lehman indices) are trademarks of Barclays Capital, Inc.
The Citigroup indices are trademarks of Citicorp or its affiliates.
The Merrill Lynch indices are trademarks of Merrill Lynch & Co. or its affiliates.
Exhibit 2
© 2018 CME Group. All rights reserved.
The Compelling Case for Managed Futures
David LermanSenior Director, Asset ManagersCME [email protected]
Exhibit 3
© 2018 CME Group. All rights reserved.
The Futures Ecosystem
2
Source: Brian Solis and JESS3
Exhibit 3
© 2018 CME Group. All rights reserved.
The Investor’s Dilemma
3
Is there an investment Strategy that incorporates many of the elements above?
Non-correlation
Global diversification
LiquidityRegulated & now central
clearing
Long and short
strategiesTransparency
Passive/Active/LDI Strategies
GTAASAA
Via cash futures/swaps or
funds
Equities
Fixed Income
Cash
AlternativesCommoditiesReal Assets
TimberInfrastructure
Private Equity
Real Estate
And remember that 1986 paper by Brinson, Hood and Beebower?
Exhibit 3
© 2018 CME Group. All rights reserved.
Making sense of managed futures industry…
• 1st managed account attributed to noted technician Dick Donchian who secured power of attorney to trade retail customer accounts in 1948
• Commodity Trading Advisors (CTAs) - Professional commodity traders registered with National Futures Association (NFA) for purposes of
trading decisions on behalf of customers
- They may trade on behalf of separately managed accounts or pooled funds
• Commodity Pool Operators (CPOs) - Registered with NFA to create and administer managed futures funds, commodity funds,
commodity pools
- CPOs usually retain services of CTAs to trade all or part of fund
- CPOs concentrate on fund raising, accounting, evaluation and monitoring of CTA performance
• Originally a retail product, managed futures are widely accepted as institutional investment tool ... often classified as a type of hedge fund
• And now we have 40 Act mutual funds and ETFs that allow one to allocate to managed futures strategies with the click of a mouse on various platforms
4
Managed Futures Overview
Exhibit 3
© 2018 CME Group. All rights reserved.
(billions USD) 1980-2018
Managed Futures: Growth in Assets Under Management
5
$-
$50.00
$100.00
$150.00
$200.00
$250.00
$300.00
$350.00
$400.00
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3
201
4
201
5
201
6
201
7
201
8 (6
/30)
Exhibit 3
© 2018 CME Group. All rights reserved.
A sampling of Plan Sponsors/Endowments/SWFs that allocate to managed futures
6
Pensions Plan Sponsors
Endowments Others
• Alberta Investment Management
• Ontario Teachers Pension Plan
• California State Teachers Retirement System
• IL Teachers Retirement System
• Teachers Retirement System of Texas
• Florida State Board of Administration
• Northwestern University
• University of Texas Investment Management
• University of Oregon Endowment
• University of Toronto Asset Management
• Foundations such as R. Woods Foundation
• Sovereign Wealth funds—ADIA
• Registered Investment Advisors (RIAs)
• HNW Investors
Exhibit 3
© 2018 CME Group. All rights reserved.
1 Trend Following/Countertrend Strategies
2 Arbitrage
3 Options Writing
4 Fundamental Global Macro
5 Intermarket / Intramarket Spreading
Major CTA Strategies
Exhibit 3
© 2018 CME Group. All rights reserved.
CTA’s use more than just commodities
A Commodity Trading Advisor (CTA) is an individual or organization which, for
compensation or profit, advises others as to the value of or the advisability of buying or
selling futures contracts, options on futures, or retail off-exchange forex contracts.
What does this mean?
A CTA registers with the National Futures Association (NFA) so that it is regulated by the U.S. Commodity Futures Trading Commission.
WHY IS THIS SO CONFUSING?!
The word “commodity” in CTA doesn’t reflect what the strategies are trading! The CTA’s are trading any futures contracts including ones on stocks, currencies, interest rates, fixed income, and commodities.
8
Commodities/Commodity Trading Advisors and some Myths:
Exhibit 3
© 2018 CME Group. All rights reserved.
The Product mix is changing rapidly…
9
Managed Futures Space
“40 Act funds” gaining momentum
(PIMCO/AQR)
CTAs/CPOSeparately Managed
Accounts
ExchangeTradedFunds
Exhibit 3
© 2018 CME Group. All rights reserved.
Diversification of futures markets
10
FXAustralian DollarBritish PoundCanadian DollarEuro FXIndian Rupee
Japanese YenRussian RubleSwiss Franc
EquitiesE-mini Nasdaq 100E-mini S&P 500E-mini S&P MdCap 400
Nikkei 225 MiniS&P CNX Nifty IndexE-mini Russell 2000
…and now Bitcoin futures
Interest Rates30-Year Treasury Bond2-Year Treasury Note
5-Year Treasury Note10-Year Treasury Note
CommoditiesSoy Oil
Soy MealSoybeans
Wheat
CornLean HogsLive Cattle
Brent Crude OilHeating Oil
Henry Hub Swap
EnergyLight Sweet Crude Oil
Natural GasMetalsCopper PlatinumGold PalladiumSilver
SteelZinc
Exhibit 3
© 2018 CME Group. All rights reserved.
10 Compelling Reasons to Invest in Managed futures
11
1. Diversify beyond the traditional asset classes.Managed Futures are an alternative asset class that has achieved strong performance in both up and down markets, exhibiting low correlation to traditional asset classes, such as stocks, bonds, cash and real state.
2. Reduce overall portfolio volatility.In general, as one asset class goes up, some other asset class goes down. Managed Futures invest across a broad spectrum of asset classes with the goal of achieving solid long-term returns.
3. Increase returns and reduce volatility.Managed Futures, as well as commodities, when used in conjunction with traditional asset classes, may reduce risk, while at the same time potentially increasing returns.
4. Returns evident in any kind of economic environment.Managed Futures may generate returns in bull and bear markets, boasting solid long-term track records despite economic downturns. Moreover, they often do so with less volatility and smaller drawdowns than other asset classes (see chart above).
5. Strong performance during stock market declines.Managed Futures may do well in down markets because they employ short-selling and options strategies that allow them to profit in such markets.
Exhibit 3
© 2018 CME Group. All rights reserved.
10 Compelling Reasons to Invest in Managed futures
12
6. Successful institutions use them.Pension Plan Sponsors, Endowments and Foundations have long used Managed Futures to generate returns in excess of the S&P 500.
7. Commodity Trading Advisors (CTAs), Pool Operators (CPOs), and Managed Futures Mutual Funds have access to a wide variety of global futures products that are liquid and transparent.These are more than 150 liquid futures products across the globe, including stock indexes, fixed income, energies, metals, and agricultural products.
8. The CTA/CPO/Managed Futures Mutual Fund community is regulated.Trading in a regulated marketplace builds the credibility and trustworthiness of the CTA/CPO/Managed Futures Mutual Fund community.
9. Risk Management and Clearing.CME Clearing institutes some of the most sophisticated risk management practices in the financial world. For more than 100 years, CME Clearing has provided services that substantially mitigate the risk of clearing member failure. CME Clearing has provided the resources to ensure the performance of every contract on our exchanges for more than a century.
10. Overall industry growth has been exceptional.In the last 35 years, assets under management for the Managed Futures industry have grown 1000 fold. Current assets under management stand at over $310 billion.
Exhibit 3
© 2018 CME Group. All rights reserved.
Two styles of trading in the managed futures industry.
The Two Major Trend Following Trading Styles of CTAs:
13
Systematic CTAs, on the other hand, do not transact trades and are conducted based on a trading signal that is generated by a computer program or algorithm.
Discretionary CTAs are traders who use their own decision-making skills to determine whether to enter or exit a trade. For example, a discretionary CTA might focus on economic reports and technical analysis to determine if they will Treasury or Stock index futures.
Exhibit 3
© 2018 CME Group. All rights reserved.
Comparing Discretionary and Systematic Strategies
14
Source: Modern Trader November 2017 issue
Systematic Discretionary
Models need to be reworked at times Yes No
Relies primarily on Computerized models Human decision making based on research
Emotional Swings Largely non-existent Yes
Requires technology Yes Less dependent on tech
Number of practitioners according to Barclays CTA Over 400 Over 100
Performance advantages N/A Slight advantage according to some studies
Investment Performance
Exhibit 3
© 2018 CME Group. All rights reserved.
Trend and Carry in Lots of Places—A PIMCO Study
15
Investors acknowledge two fundamental principles
1) Don’t fight the trend2) Don’t pay too much to hold an investment (carry)
PIMCO studied 20 major markets from 1960-2014 and the resultsOverwhelmingly support the thesis that having trend AND carry in yourFavor lead to significantly better returns.
https://www.pimco.com/en-us/insights/viewpoints/in-depth/carry-and-trend-in-lots-of-places
Exhibit 3
© 2018 CME Group. All rights reserved.
Trend and Carry in Lots of Places—a PIMCO Study
16
Exhibit 3
© 2018 CME Group. All rights reserved.
Is Trend “underallocated”?
17
A meaningful Trend allocation would have provided indisputable benefits to mostinvestors over almost any extended period of time. The impact on skew, crisisalpha, and other relevant metrics has been well documented and supports largeallocations to Trend in any portfolio context. Trend Following strategies havedisplayed compelling portfolio benefits for decades; since 1987, the BTOP CTAindex has delivered returns of 7.5% annually, with a -0.04 correlation to the S&P500.In a simple two asset portfolio of S&P500 and Trend, the optimal allocation to Trendwould have been on the order of 50%, and even in multi-strategy portfolios, theoptimal allocation to Trend ranges from 15% to 55%. Numerous academic andindustry studies have demonstrated the value of the addition of systematic TrendFollowing to almost all portfolios. An ISAM whitepaper “All Portfolios Need Trend”evaluated 1 million variations of traditional portfolios and documented thebenefits of significant Trend allocations under a variety of different circumstances.1
Despite overwhelming evidence of the portfolio benefits, actual investorallocations to Trend Following strategies are typically 5% or less.
Why?
Exhibit 3
© 2018 CME Group. All rights reserved.
Is Trend “Underallocated”?
18
Trend Following’s long performance history shows that a meaningful allocationwould have benefitted any portfolio, and yet typical investments remain at orbelow 5%. Some investors have no exposure. The strategy’s quantitative nature,positive skew, and frequent but small losses act in concert to trigger loss aversion,recency bias, and the ambiguity effect. We call the combination of the three TrendAversion.
--Alex Greyserman, PhD—ISAM
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
19
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
20
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
21
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
22
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
23
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
The Transactional Costs of Trend Following
24
Source: Crabel Capital Mgt
Exhibit 3
© 2018 CME Group. All rights reserved.
E-mini S&P 500 Cost to Trade: CME Liquidity Tool
25
Exhibit 3
© 2018 CME Group. All rights reserved.
E-mini S&P 500 Cost to Trade: CME Liquidity Tool
26
Exhibit 3
© 2018 CME Group. All rights reserved.
10 Yr Treasury Note Cost to Trade: CME Liquidity Tool
27
Exhibit 3
© 2018 CME Group. All rights reserved.
Gold futures Cost to Trade: CME Liquidity Tool
28
Exhibit 3
© 2018 CME Group. All rights reserved.
So, which depth of order book is correct….?
They are BOTH Correct.
However, one is a snapshot in time. The depth of order book changes CONSTANTLY
The other is a massive data crunch of millions of data points YTD. CME Liquidity Tool allows capture of all the depth of order book and bid/offer spread data over a given time
I wanted robustness for larger orders (and larger CTAs), hence the 500 and 1000 lot studies.
29
Exhibit 3
© 2018 CME Group. All rights reserved.
Important Points:
• As John Bogle from Vanguard used to preach; “Cost Matter”
• Transactional costs will have an impact on Trend following. Larger orders might exacerbate those costs depending on the markets traded
• Negotiate execution fees and ruthlessly eliminate costs
• Regarding exchange fees try to take advantage of incentive fee programs
• Speed matters, so infrastructure, co-location and networks play a key role in
speed
• Every tick matters, especially when spread over an average of 1000 RT/year
30
Exhibit 3
© 2018 CME Group. All rights reserved.
Margins/Leverage in Managed futures
31
Contract Margin Req
Notional Val Margin as %
Bitcoin futures $13,814 $32,500 42.5%E-mini S&P 500 futures $6,000 $145,000 4.1%
Gold futures $3,000 $120,000 2.6%Crude Oil futures $3,000 $72,000 4.3%
30-Yr T-Bond futures $2,300 $100,000 2.3%10-Yr T-Note futures $1,050 $100,000 1.1%
Exhibit 3
© 2018 CME Group. All rights reserved.
4Futures Exchanges
• Board of Trade of the City of Chicago (CBOT)
• Chicago Mercantile Exchange (CME)• New York Mercantile Exchange
(NYMEX)• Commodity Exchange Inc. (COMEX)
1Clearing Houses
• CME Clearing
32
Exhibit 3
© 2018 CME Group. All rights reserved.
CME Clearing process and monitor all trades, and ensure the financial integrity of every trading party and transaction in their respective markets.
33
Exhibit 3
© 2018 CME Group. All rights reserved.
Trade workflow mechanics
Cleared Globex Exchange Traded Futures and Options
34
Credit Controls
Order is Placed
BUY
Max Order Quantity
Price Banding
Trade Rejection
Orders must pass all market protections in order to get matchedCentral
Limit Order BookPASS PASS PASS
FAIL FAIL FAIL
Single Market Data Feed
Market & Stop Order
Velocity Logic
PASS
FAIL
Market Pause
FAIL
CME Clearing
CLEARED PASS
Exhibit 3
© 2018 CME Group. All rights reserved.
Pre-Trade Risk Controls:
35
Credit Controls: between clearing firm and customer accounts. CME Clearing provides the mechanism but the clearer sets the limits.
Max Order Quantity: individual order cannot be greater than “x.” Designed to reduce “fat finger” errors prevalent in earlier versions of electronic trading. Product specific, determined by CME Group BLM and GCC leadership.
Exhibit 3
© 2018 CME Group. All rights reserved.
Pre-Trade Risk Controls: Price Banding
$60.00
$59.40
$60.60
Customers can enter buy orders up to $60.60
Customers can enter sell orders down to $59.40
Crude Oil has $ 0.60 price banding.
The trading engine dynamically updates the “banding start price” or fair value based on market data –trade, bids, asks.
Additionally TIPS (Theoretical Intraday Pricing Server) sends FV updates every one minute.
Greatly reduces trade entry “fat finger” errors.
36
Exhibit 3
© 2018 CME Group. All rights reserved.
Risk Controls: Velocity Logic (VL)Velocity Logic prevents excessive price movements measured by a combination of price and time- Too far too fast.
Engine checks incoming orders against highs and lows for the past second.
If an incoming order has a price that exceeds the pre-defined range, VL is triggered.
Market pauses for 5-20 second pre-open period.
Market resumes trading.
$2600.00$2595.00
$2590.00
$2585.00
$2582.00
E-mini S&P 500 Index (ES) VL = $18.00 index points per second
37
Exhibit 3
© 2018 CME Group. All rights reserved.
CME Group Provides Extensive Risk Management Tools
38
Available risk management tools to be considered for use in Bitcoin futures contract
Price Limits (previously mentioned)• +/- 7, 13 and 20 percent. • 7 and 13 percent limits are “soft limits”• 20 percent is hard limit except at final expiration
Position Limits• Spot Position Limits are set at 1,000 contracts. • A position accountability level of 5,000 contracts will be applied to positions in single months outside the spot month and in all
months combined.• The reportable level will be 25 contracts. • Block minimum = 5 contracts
Performance bond margins set in line with volatility and contract notional value• 47% initial. 43% maintenance subject to change (as of December 12, 2017)
In Line Credit Controls (ICC)• Pre-trade position control enforced at the account/product level. Calculation is done prior to orders reaching the matching engine.• Access can be granted to risk managers at both the legal clearing entity and the account ownership level. This allows them to set
limits on accounts registered to each individual.• Risk managers can see account activity in real-time through dashboards and email alerting systems, similar to those already in
place in Globex Credit Controls and Account Manager
Globex Credit Controls• Allows risk manager to set pre-execution credit control limits for futures and options on Globex
Risk Management Interface• Allows clearing firms to programmatically block/unblock order entry and cancel working orders at the account level via API or UI
Exhibit 3
© 2018 CME Group. All rights reserved.
CME Managed Futures Initiatives
39
Managed Futures Initiative Institutional Retail
Investor’s Roundtable √
Industry Experts Interviews on iPod √
Participation at industry conferences √ √
Written collateral √ √
Website √ √
Webinars/Seminars √ √
Pinnacle Awards √ √
Phone Campaigns to Endowment, Foundations √
Calling programs / Direct mail programs √ √
Exhibit 3
© 2018 CME Group. All rights reserved.
More on Trend Following
40
Exhibit 3
© 2018 CME Group. All rights reserved.
More CME Group Resources for Pension Plan Sponsors
41
Exhibit 3
© 2018 CME Group. All rights reserved.
Visit our Managed Futures Resource Center to access:
42
• Podcasts: interviews on topics centered around risk management and managed futures strategies. Each interview provides a unique perspective from leading industry participants and range from 5 to 30 minutes in length.
• Managed Futures Research Digest: An aggregate of abstracts to help navigate the vast world of research papers. Topics include:
- General managed futures
- Performance and portfolio management
- Trend following
- Liquidity and volatility
- Performance measurement
- Performance in varying interest rate
• Lintner Revisited: A Quantitative Analysis of Managed Futures: an update to Dr. John Lintner's seminal paper, which describes the diversification benefits that managed futures strategies can bring over the long-term to an equity/fixed income/hedge fund portfolio.
Learn more at cmegroup.com/managedfutures
Exhibit 3
© 2018 CME Group. All rights reserved.
Contact info:
Managed Futures Contact Information
43
David Lerman
Senior Director, [email protected]
Colby Borders
Director, Alternative Investment [email protected]
Exhibit 3
© 2018 CME Group. All rights reserved.
Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.
The Globe Logo, CME®, Chicago Mercantile Exchange®, and Globex® are trademarks of Chicago Mercantile Exchange Inc. CBOT® and the Chicago Board of Trade® are trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange, and ClearPort are trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. CME Group is a trademark of CME Group Inc. All other trademarks are the property of their respective owners.
The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Although every attempt has been made to ensure the accuracy of the information within this presentation, CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.
All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT, NYMEX and CME Group rules. Current rules should be consulted in all cases concerning contract specifications.
Copyright © 2018 CME Group. All rights reserved.
Disclaimer
Exhibit 3
Exhibit 3
CalSTRS Risk Mitigating Strategies October 18, 2018
Exhibit 4
• Approx. $227B NAV (As of 8/31)
• Current actuarial discount rate: 7%
• Current funded status: 63%
CalSTRS Overview
0% 20% 40% 60%
Cash
RMS
Fixed Income
Inflation Sensitive
Real Estate
Private Equity
Total Public Equity
2
Exhibit 4
RMS at CalSTRS
• Why RMS? –Mature plan –New funding plan –Equity / growth risk
• Timing –Approved November 2015 (9% target allocation) –Fully Implemented early 2018
3
Exhibit 4
RMS Allocation (As of 8/31)
Current Allocation (billions)
Allocation % Strategic Target
Long Treasury 8.9 45% 40%
Trend Following 8.7 44% 45%
Global Macro 2.2 11% 10%
Systematic Risk Premia 0 0% 5%
Total 19.8 - -
4
Exhibit 4
RMS Strategies
-1%
0%
1%
2%
3%
4%
5%
-20% -15% -10% -5% 0% 5% 10% 15%
RMS
Stra
tegi
es M
onth
ly R
etur
ns
S&P 500 Monthly Returns
UST Trend Macro SRP RMS
5
Exhibit 4
Exhibit 4
To: Investment Committee From: Investment Staff Date: October 2, 2018 Re: Annual Review of Minority-, Female- and Persons with a Disability- Owned
Broker/Dealer Usage by SURS Investment Managers
A brokerage usage policy was instituted by SURS at the December 9, 2005, Board of Trustees meeting when approved as a component of the Investment Policy. Annual revisions have been approved by the Board beginning in 2007, providing modifications to brokerage expectations. Standard investment reports prepared quarterly for the Board include brokerage cost reviews by asset class that summarize the total usage of minority-, female- and persons with a disability-owned (MFDB) brokerage firms over the prior four quarters by investment managers in SURS defined benefit portfolio.
A brokerage review is presented to the Board of Trustees on an annual basis to summarize results of the previous fiscal year and to identify investment managers facing challenges in achieving the established expectation levels of usage of MFDB firms over the previous fiscal year. Based on information included in the quarterly reports and annual reviews, investment managers may be invited to participate in a presentation to the Board to assist in explaining current brokerage compliance issues. An investment manager that is continually unable to attain the expected level of usage of MFDB firms may be potentially terminated. In 2013, one manager was terminated due to the continued inability to achieve the expected level of utilization of MFDB firms.
Fiscal Year 2018 Results
SURS Summary Goals
Utilization of Minority-, Female- and Persons with a Disability- Owned Broker/Dealer Firms
Asset Class Goal U.S. Equity 30.0% Non-U.S. Equity 15.0% Fixed Income 20.0%
The table above lists the minority-, female- and persons with a disability-owned brokerage goals by asset class included in SURS Investment Policy, as approved at the Board Meeting on March 9, 2018.
Exhibit 5
The following table summarizes the utilization of MFDB broker/dealers in each of the major asset classes for the one-year period ending June 30, 2018.
The summary table indicates that total commissions paid by SURS equity investment managers declined from 2010 through 2018 while utilization of MFDB brokerage firms has been steady since 2012.
Commissions Actual MFDBto MFDB Firms Utilization Goal Variance
U.S. Equity, Active 274,977$ 41.47% 30.00% 11.47%U.S. Equity, Passive 17,944$ 88.95% 35.00% 53.95%U.S. Equity, Enhanced Active 175,386$ 66.92% 20.00% 46.92%U.S. Equity, Total 468,307$ 49.54% 30.00% 19.54%
Non-U.S. Equity, Active 573,213$ 51.18% 15.00% 36.18%Non-U.S. Equity, Enhanced Active 72,197 19.36% 15.00% 4.36%Non-U.S. Equity, Total 645,410$ 43.23% 15.00% 28.23%
Global Equity 203,443$ 29.77% 20.00% 9.77%
Total Equity 1,317,160$ 42.19%
Fixed Income 1 N/A 27.20% 20.00% 7.20%
1
Asset Class
Commissions are not applicable to fixed income. Percentage calculation is based on percent of total market
Trading with Minority-, Female- and Persons with a Disability- Owned Broker/Dealer FirmsYear Ending June 30, 2018
Total Commissions ($) Actual MFDBTotal Commissions Actual MFDB Commissions to MFDB Firms Utilization
Fiscal Year Commissions * to MFDB Firms Utilization Increase(Decrease) Increase(Decrease) Increase(Decrease)2010 5,081,540$ 1,622,970$ 31.94%
2011 4,299,700$ 1,483,763$ 34.51% -15.39% -8.58% 8.05%
2012 3,871,797$ 1,556,867$ 40.21% -9.95% 4.93% 16.52%
2013 4,266,669$ 1,658,716$ 38.88% 10.20% 6.54% -3.32%
2014 3,982,710$ 1,518,156$ 38.12% -6.66% -8.47% -1.95%
2015 4,035,852$ 1,565,431$ 38.79% 1.33% 3.11% 1.76%
2016 3,750,457$ 1,437,702$ 38.33% -7.07% -8.16% -1.17%
2017 3,963,115$ 1,577,682$ 39.81% 5.67% 9.74% 3.85%
2018 3,121,626$ 1,317,160$ 42.19% -21.23% -16.51% 5.99%
* Total commissions exclude electronic trades and emerging market trades.
Equity Commissions Summary Results
Exhibit 5
Commissions totaled $3.1 million on equity trades for the year ended June 30, 2018. As the table above indicates, commissions to MFDB broker/dealer firms were approximately $1.3 million, representing 42.2% of total commissions paid on equity trades for the period.
In aggregate, all asset classes exceeded the brokerage goals set forth in the Investment Policy for trading with minority-, female- and persons with a disability-owned firms.
As a component of the annual compliance process, SURS’ staff communicates with each of the investment managers, to remind them of SURS commitment to the MFDB brokerage utilization initiative adopted by the Board at the March 19, 2004 meeting. This initiative was created to develop a strategy for increasing the utilization of minority- and women-owned broker/dealers. Since January 2006, SURS has been formally communicating quarterly with investment managers that are not attaining the desired levels of utilization. The evaluation is based on a rolling four-quarter period. Due to the inherent seasonality embedded in the reporting process, managers may occasionally fall below levels of utilization for truncated periods of time while consistently reaching overall utilization goals over the longer term. SURS domestic equity, non-U.S. equity, and global equity managers submit brokerage information quarterly that is reconciled to data provided by SURS custodian, Northern Trust.
Managers Not Achieving Desired Expectation Levels For the rolling four-quarter periods ended during Fiscal Year 2018, the level of MFDB usage was above the expectations established by SURS for all managers. SURS Monitoring Process If a manager fails to meet the minimum brokerage expectations, a letter of non-compliance is sent, with a response requested to address the reason(s) for not attaining the expected level of MFDB utilization. All managers are aware of the importance of the initiative as well as the goals set forth in the Investment Policy, with some acknowledging challenges in achieving both best execution and the established MFDB utilization levels. The September 2010 revision to the Investment Policy that allows credit only for direct, rather than indirect, trading with MFDB firms proved initially challenging for several non-U.S. and global equity managers. The universe of MFDB firms capable of providing direct international trade execution at competitive rates is relatively small at this time, hindering the efforts of some investment managers to meet expectations. However, during FY 2018, managers have taken steps to comply with the more rigorous requirements. Staff is regularly communicating with managers in an effort to achieve the MFDB utilization goals without compromising best execution.
When selecting a broker, the manager must consider several factors, including achieving best price, commission rate, liquidity and willingness to commit capital, trade flow, transaction size, confidentiality, technology infrastructure, operational capabilities, broker research, and expertise in particular markets, and the use of local desks in global markets.
Exhibit 5
Compliance Enforcement Measures Managers must adhere to Minority-owned Broker/Dealer Utilization Goals set forth in Appendix 7 and Appendix 8 of the current Investment Policy, approved by the Board on March 9, 2018. Failure to meet these expectations will lead to the following:
1. Staff notification to the non-compliant Manager; 2. Placement of the Manager on Reassessment status; 3. Staff examination of reasons for non-compliance; and 4. Remediation plan acceptable to the Staff or recommendation to the Board to Terminate.
SURS On-line Brokerage Reporting System An on-line brokerage reporting system, developed by SURS staff in 2010, has been used by investment managers since the first quarter of calendar year 2011 to enter quarterly data. Staff uses information in the system to complete various reports, including quarterly brokerage cost reviews, annual reports of the utilization of the Chicago Stock Exchange, and the annual utilization of Illinois broker/dealers. The data in the system is available for ad hoc purposes as well. The system has provided significant time savings for staff by eliminating cumbersome, labor-intensive tasks involved in reconciling, recording and reporting brokerage information. Additional annual cost savings were realized by eliminating the need for a $35,000 contract to monitor and report manager utilization of the Chicago Stock Exchange. The system is enhanced to address specific needs as they arise.
Summary Appendix 1 includes a comparison of SURS desired usage levels of MFDB broker/dealer firms versus other Illinois large public pension funds. Appendix 2 lists the brokerage expectation levels stated in the Investment Policy approved by SURS Board on March 9, 2018.
Staff continues to expand its knowledge regarding the brokerage oversight function. SURS does not identify broker/dealers to be used by investment managers; however, when SURS becomes aware of a MFDB broker/dealer, the firm’s information is shared with SURS investment managers. The investment managers are expected to communicate with the prospective broker/dealer firm to assess the feasibility of establishing a relationship. SURS has increased awareness of the brokerage community as a result of the Board initiative and the Senate Pensions and Investments Committee hearings.
Staff will continue to monitor investment manager utilization of MFDB broker/dealers on a quarterly basis. In addition, staff will continue to encourage managers to enhance efforts in achieving the expected levels of direct trading with MFDB broker/dealers while maintaining best execution practices.
Exhibit 5
Appendix 1
Teachers Retirement System of Illinois (TRS) Domestic Equity 23% International Equity 13.5% Fixed Income (based on volume) 15%
Illinois Municipal Retirement Fund (IMRF) (All trade levels must be directly executed) U.S. Equities 25% U.S. Large-Cap Equities 30% U.S. Micro-Cap Equities 7% International Equities 20% Fixed Income 22% High-Yield Bonds 5% International Small-Cap Equities 5% Emerging Market Equities 5% Bank Loans Best efforts Opportunistic Strategies Best efforts Emerging Market Debt Best efforts
State Universities Retirement System (SURS) (All trade levels must be directly executed) Active U.S. Equity Separate Accounts 30% Passive U.S. Equity Separate Accounts 35% Structured Active Domestic Equity Separate Accounts 20% Non-U.S. Equity Separate Accounts 15% Structured Active Non-U.S. Equity Separate Accounts 15% Global Equity Separate Accounts 20% Fixed Income Separate Accounts 20% Real Estate Investment Trusts (REITS) 15%
Illinois State Board of Investment (ISBI) Domestic Equity 30% International Equity 20% Fixed Income 20% International Fixed Income 0 - 5% Hedged Equity 0 - 5%
Public School Teachers' Pension & Retirement Fund of Chicago (CTPF) (All trade levels must be directly executed unless otherwise noted) Active Domestic Managers and Manager-of-Managers All Cap, Large Cap Equity 50% Active Domestic Small Cap Equity and Passive Domestic Equity 35% Active International Managers and Manager-of-Managers All Cap, Large Cap Equity and Passive International Equity 25% Active International Small Cap Equity 5% Active and Passive fixed income managers (goal is based on volume traded) 25% Active REIT managers 10%
County Employees' Annuity & Benefit Fund of Cook County Domestic Equity 35% International Equity 10% International Small Cap 3% Emerging Markets 3% Fixed Income (based on volume) 10% Transition Management 40%
Municipal Employees' Annuity and Benefit Fund of Chicago Domestic Equity 40% International Equity - Developed 20% International Equity - Emerging 10% Fixed Income (based on volume) 25%
Minority-, Female- and Persons with a Disability- Owned Broker/Dealer Usage
October 2018Expectation Levels
Exhibit 5
Appendix 2
XIII. Emerging Investment Managers, MFDB Managers and Minority-
Owned Broker/Dealers
SURS is committed to providing opportunities for Emerging Investment Managers and Minority Owned Broker/Dealers. SURS is also committed to providing ongoing opportunities for minority-, female-, and persons with a disability-owned (“MFDB”) Managers that have advanced beyond the statutory definition of Emerging Investment Managers. In determining the status of a business enterprise, SURS will use the definitions found in the Business Enterprise for Minorities, Females, and Persons with Disabilities Act, 30 ILCS 575/2(A), (B).
The Illinois Pension Code, in 40 ILCS 5/1-109.1, encourages the Board to use Emerging Investment Managers in managing the System’s assets to the greatest extent feasible within the bounds of financial and fiduciary prudence, and to take affirmative steps to remove any barriers to the full participation of Emerging Investment Managers in investment opportunities afforded by the System. Furthermore, in accordance with the Illinois Pension Code, SURS encourages its Fund-of-Fund Managers to use Emerging Investment Managers as subcontractors when the opportunity arises.
A. Goals for Utilization of Emerging Investment Managers and MFDB Managers
Beginning January 1, 2016, the Illinois Pension Code, in 40 ILCS 5/1-109.1, established aspirational goals of 20% for pension funds, with respect to assets under management by Emerging Investment Managers and the percentage number of MFDB Managers.
Since late 2014, the Board (subject to its fiduciary responsibility) has established goals for both the percent of assets under management and actively managed assets under management by Emerging Investment Managers. Furthermore, with the intent of having MFDB Managers significantly represented in each broad Asset Class and not concentrated in any particular Asset Class, the Board has established additional goals for actively managed assets specific to Minorities, Females, and Persons with Disabilities.
A summary of the Board’s goals are set forth in Appendix 6. These goals shall be reviewed annually.
B. Goals for Utilization of Minority-Owned Broker/Dealers The Board has set minimum expectations for the use of qualified Broker/Dealers that meet the definition of a minority-owned business, female-owned business or a business owned by a person with a disability (“Minority-owned Broker/Dealer”) by the System’s Managers. Only trades executed directly with Minority-owned Broker/Dealers will be considered in the achievement of these goals.
Exhibit 5
Summary goals for Minority-owned Broker/Dealer Utilization have been established for the aggregate U.S. equity, Non-U.S. Equity and Fixed Income Asset Classes as set forth in Appendix 7. SURS seeks to have its Managers consistently meet or exceed these goals, while achieving best execution. In order to achieve the aggregate U.S. Equity, Non-U.S. Equity and Fixed Income goals, minimum expectations have been established for individual Managers within a number of Sub-Asset Classes. Subject to best execution, SURS requires its Managers to meet the minimum expectations set forth in Appendix 8 for each rolling twelve (12) month period. Reporting Guidelines Each Manager will submit a compliance report within 30 days after March 31, June 30, September 30 and December 31 of each year. Reporting will be monitored over a rolling twelve-month period.
Consequences of Non-Compliance Failure to meet Minority-owned Broker/Dealer Utilization Goals will lead to the following:
1) Staff notification to the non-compliant Manager;
2) Placement of the Manager on Reassessment status;
3) Staff examination of reasons for non-compliance; and 4) Remediation plan acceptable to the Staff or recommendation to the Board to
Terminate.
C. Manager Diversity Program
Program Description SURS has implemented a Manager Diversity Program (“MDP”) to identify highly successful MFDB firms. The process used for selection of investment managers is set forth in the SURS Investment Procurement Policy. Manager Benchmarks are identified in the Manager Guidelines for each Manager in the program. Benchmarks and Performance Targets for the MDP for each applicable Asset Class are the same as those set forth in the applicable Appendix. Managers in the MDP will be evaluated in the same manner as that set forth in Section VII (‘Selection and Retention’). Managers will be placed on Reassessment status as described in Section VII. Termination decisions will follow the guidelines set forth in Section VIII (‘Investment Manager Termination Guidelines’). An evaluation of each Manager shall be conducted annually.
Exhibit 5
D. Manager-of-Managers Program
Program Description SURS utilizes a Manager-of-Managers program, overseen by SURS Staff. The program’s primary goal is to identify MFDB Managers that will be initially awarded smaller allocations within the program. Staff may recommend, for the Board’s approval, one or more Manager-of-Managers to play an active role in identifying emerging MFDB Managers and maintain an ongoing involvement in the evaluation and performance oversight of such Managers. Staff shall work with the Manager-of-Managers to identify, recruit, and monitor Managers in the program.
Graduation Program
On an annual basis, SURS Staff and the Manager-of-Managers will identify one underlying Manager to be considered for a meaningful, direct allocation. The following factors are considered in determining when an underlying Manager should be awarded a larger allocation in the SURS Portfolio:
• Acceptable measure of performance over a three year period; • Stability in Manager’s organization; • Institutional quality infrastructure; • Growth in Assets Under Management; • Confidence in Manager’s investment process; • Meeting its Performance Target; and • Product Fit.
In addition to the factors mentioned above, the needs of the overall SURS investment program will be considered.
Notwithstanding this provision, the Board, in its sole discretion, may decide not to make any award in any given year, if it determines that such an allocation would not be in the best interests of the Members.
Initially adopted December 8, 2006; Revised April 26, 2007; September 21, 2007; September 12, 2008; April 23, 2009; September 11, 2009; December 2, 2009; September 3, 2010; September 16, 2011; October 25, 2012; September 13, 2013, September 19, 2014; September 11, 2015; December 9, 2016; June 9, 2017; December 8, 2017; March 9, 2018.
Appendix 7
System Utilization Goals for Minority-owned Broker/Dealers
Asset Class Goal U.S. Equity 30.0% Non-U.S. Equity 15.0% Fixed Income 20.0%
Exhibit 5
Appendix 8
Manager(1) Utilization Goals for Minority-owned Broker/Dealers
ASSET CLASS
MINIMUM
EXPECTATION
ELIGIBLE TRADE
VOLUME
ELIGIBLE
COMMISSIONS Equity: Active U.S. Equity 30.0% X (1)(2) Passive U.S. Equity 35.0% X (1)(2) Structured Active U.S. Equity 20.0% X (1)(2) Non-U.S. Equity 15.0% X (1)(2)(3) Global Equity 20.0% X (1)(2)(3) REITS 15.0% X (1)(2)(3) Fixed Income: Fixed Income (including TIPS) 20.0% X
(1)(2)(3)
‘(1) Separate account managers. ‘(2) Exception for electronic trading. ‘(3) Exception for emerging markets, as defined by Morgan Stanley Capital International.
Exhibit 5
Illinois State Universities’ Retirement System • Transition Management 1
Ma
TRANSITION MANAGEMENTOVERVIEW
State Universities Retirement System
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 2
Table of ContentsSection Slide
What is Transition Management? 3
Liquidity Sources 6
T-Standard 7
Transition Costs 8
Pre/Post-Trade Reports 9
Selecting a Transition Manager 10
SURS Transition Events 11
Appendix 14
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 3
What is Transition Management?
Utilized for: Portfolio liquidation Portfolio restructuring Rebalancing Manager changes Benchmark changes Direct withdrawal to raise cash
Transition Management isthe movement of assetsfrom a “legacy portfolio”to a “target portfolio” TA
RGET
Cash
Fund A Fund BFund A
Fund CFund B
Fund AFund C
Fund B
Fund A
LEG
AC
Y
Fund A; BM2
Fund A; BM1
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 4
What is Transition Management?
Why use a Transition Manager?
Transition Managers help preserve capital by:
Strategic Planning & Orchestration
Managing Risks
Providing Transparency / Monitoring
Trading / Execution
Mitigating Implicit Costs (Spread, Market Impact, Opportunity Cost, etc.)
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 5
Key Responsibilities of TM
Discuss objectives
of tradeFormulate Strategy/ Timeline
Develop Pre Trade
Report
Operational Preparations
Execute Trade
Reconcile positions
Corporate Actions /
Proxy Voting
Post Transition Analysis
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 6
Liquidity Sources
Foreign Exchange (FX)
Competitive Bidding Process Electronic Trading Platforms
Over-the-Counter Electronic Platforms Direct Counterparty Engagement
Cash / In-Kind Transfers Principal Bids Dark Pools
Internal/ External Crossing
Smart Algorithms
Electronic Networks
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 7
T-Charter & T-Standard
• T-Charter: Established in 2007, the T-Charter represents a set of 10 principles drawn up by thetransition management industry to provide greater transparency into how transitions should bemanaged, resourced and measured.
• T- Standard: Established in 2003 by Russell Investments and adopted as industry standardmethodology for treatment of the critical factors that drive portfolio performance during atransition.
• T-Standard Implementation Shortfall is the arithmetic difference between the return on thelegacy portfolio and the return on the new portfolio, performed on a daily basis. Compares the difference in performance between the target portfolio (with no transaction costs) vs. the
return of the portfolio in transition (which includes all transaction costs)
(Exa
mpl
e ev
ent f
rom
Citi
RFP
Res
pons
e)
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 8
Transition Costs
EXPLICIT COSTS
Commission Fee
Custodian Fees
Regulatory Fees, Taxes, and Exchange Fees
IMPLICIT COSTS
Market Impact
Opportunity Costs
Information Leakage
Bid/Ask Spread
Impl
emen
tatio
n Sh
ortfa
ll
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 9
Pre/Post Trade Reports
Pre-Trade Report Post-Trade Report
Report issued prior to transition event that includes: Estimate of the total cost of the trade,
represented by implementation shortfall Bell curve illustrating the range of
expected cost in standard deviations fromthe estimated implementation shortfall
Explicit Costs (commission, taxes, fees) Potential sources of illiquidity Proposed trade strategy
Report issued after the event is complete that: Summarizes the event in detail Compares actual costs to pre-trade
estimates Breaks down trade costs by sector /
market cap / region Analyzes why the cost is higher/lower than
original pre-trade report
Comparison of these two reports determineseffectiveness of the transition manager
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 10
Selecting a Transition Management Provider
• Why utilize a bench? Different strengths/experiences in various asset classes/market capitalizations
• ability to identify suitable provider for each event Space changes quickly, providers may exit unexpectedly
• Factors to Evaluate When Choosing a TM: Experience
• Amount of transitions executed, with attention to size and experience across assetclasses
Organization• Legal/regulatory issues• Dedication to business• Team size and experience
Transition Program• Comprehensive order management and trade execution systems• Strategy• Sources of liquidity• Competitive advantages• Technology / platforms• Reporting
Cost Internal Monitoring
• Compliance program• Conflicts of interest
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 11
SURS Transitions 2015-2018
• Since 2015, SURS has undergone 11 transition eventsrepresenting $4.0 billion
$0
$200,000,000
$400,000,000
$600,000,000
$800,000,000
$1,000,000,000
$1,200,000,000
U.S. Equity Non U.S.Equity
GlobalEquity
FixedIncome
REITs TIPs Multi AssestClass
Recent Transitions By Asset Class
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 12
SURS Transitions 2015-2018
Recent Transitions by Purpose & Provider
Total Events: 11Avg. Impl. Shortfall: -13.5
Terminations (8)
73%Rebalance (1)
9%
Elimination of Mandate (1)
9%
Retention of New Manager (1)
9%
Recent Events by Purpose
Northern Trust (4)36%
BlackRock (7)64%
Recent Events by Provider
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 13
Upcoming SURS Transitions
• SURS new asset allocation Beginning in 2019:
Assets will be allocated away from traditional growth
Various components of stabilized growth will see sizeable movements ofcapital
Principal Protection and Inflation Protection will also see changes to thecurrent targets
• Transition managers will be utilized during some of these events: To help reduce/increase market exposure
Manage trading costs
Liquidate portfolio holdings
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 14
Appendix
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 15
Glossary of TermsTerm Definition
Agency vs. Principal Providers Agency: Acting as a broker, the transition manager executes the trade without committingfirm capital (i.e., without taking the other side of the trade). This minimizes potential conflictsof interest but may hinder timely executions in illiquid securities.
Principal: Acting as a dealer, the transition manager executes the trade by using firm capital(e.g., buys the security themselves when the client is seeking to sell). This imposes certainconflicts of interest but has the potential to be advantageous when trading illiquid securities.
Electronic Communication Network (ECN)
An automated system that matches buy and sell orders for securities.
Dark Pools Type of alternative trading system that provides investors with the opportunity to place orderand make trades without publicly revealing intentions during the search for a buyer or seller.
DOL Exemption Exemption granted by the Pension & Welfare Benefits Administration, Dept. of Labor,permitting cross-trades of securities among Index and Model-Driven Funds
Fiduciary Duty Transition manager who fall under the Investment Advisor Act of 1940 are required to actsolely in the interest of the transition client as well as handle many administrative tasks of atransition including processing corporate actions, voting proxies, reconciling assets andmonitoring cash positions.
Implementation Shortfall Difference in returns between the actual portfolio held through the transition period and atheoretical, perfect transition in to the target portfolio without commission, taxes or fees atclosing prices the day before trading started.
In-Kind Transfers Securities that the legacy and target portfolios have in common.
Internal Crossing Utilizing internal trading business units for liquidity. The transition manager tries to matchtrades from the transition with trades from other clients.
Market Impact Difference between the price the investor pays and the price that would have prevailed inthe absence of the investor’s trade.
Exhibit 6
Illinois State Universities’ Retirement System • Transition Management 16
Glossary of Terms (Cont.)Term Definition
Opportunity Cost During the transition event, there is a difference in performance between what isactually held and the performance of the portfolio you are trading into, thedifference in performance attributable to the overall movement of the market isopportunity cost. Can be considered the cost of time in a transition.
Order Management System (OMS) An electronic system developed to execute securities orders in an efficient and cost-effective manner. Brokers and dealers use order management systems when fillingorders for various types of securities and are able to track the progress of each orderthroughout the system.
Smart Order Router (SOR)
Software used by banks and brokers to optimize execution by using advancedrouting rules and algorithms when directing orders to multiple trading venues
Volume Weighted Average Price(VWAP)
Used as a benchmark for trading. Calculated by adding up the dollars traded forevery transaction and then dividing by the total shares traded for the day. If theprice of a buy trade is lower than the VWAP, it is a good trade.
Exhibit 6
To: Investment Committee From: Investment Staff Date: October 3, 2018 Re: Transition Manager Search Update Search Update At the June 2018 Investment Committee meeting, the Board approved the recommendation to conduct a search for transition management services. The Request for Proposal (RFP) was developed by SURS staff, posted to the SURS website beginning June 20, advertised on the website of Pensions & Investments and in its June 25 print edition, and noticed as required in the State newspaper. Twelve firms responded to the RFP, which staff and PCA narrowed down to six finalist candidates after extensive review of the RFP responses. At the September 2018 Investment Committee meeting, the Board directed staff and PCA to return with a recommendation of firms for SURS’ transition manager bench at the October Board meeting. In-person interviews of the finalist firms were conducted by staff and PCA on October 2, 2018 in Champaign. Background SURS has historically utilized the transition management services provided by either the Fund’s custodian, or one of the index managers. The implementation of the newly adopted 2018 strategic allocation policy will result in changes to multiple asset classes within the investment portfolio. Having a bench of diversely qualified transition managers in place will allow staff to implement portfolio changes approved by the Board in a timely manner. In accordance with Illinois statute (40 ILCS 5/1-113.14), transition managers retained by the Fund would be required to act as fiduciaries on behalf of the Fund. Transition managers act as short-term asset managers in an effort to minimize both risk and cost. They may be utilized to assist in the implementation of shifts in asset allocation, portfolio liquidations/restructuring, and benchmark/guideline changes.
The transition manager bench would consist of multiple transition managers, each with different strengths/experiences in various asset classes/market capitalizations. Transition managers retained by SURS will be required to meet minimum expectation levels for their use of minority-, female-, and persons with a disability-owned brokerage firms. Firms from the bench, based on specialty and experience, will be selected and asked by staff and PCA to submit bids for each transition event.
Exhibit 7
Timeline: The timeline for the search is as follows:
Schedule of Events Quiet Period Begins June 8, 2018 RFP Issued June 20, 2018 Deadline for Responder Questions July 6, 2018 Response to Questions July 11, 2018 RFP Responses due 4:30pm CT July 20, 2018 Evaluations July/August 2018 Candidate Interviews October 2, 2018 Approval by Board October 18, 2018
Conclusion & Recommendation After conducting interviews of the six finalist candidates, staff and PCA recommend including all six firms on SURS’ transition manager bench. There are several reasons for increasing the bench from the initial thought of five to six.
• Some firms are known to be better transition managers for certain asset classes than others. • Some firms have capacity constraints as to the optimal number of transitions that can be
done at any one time. This may become an issue if SURS does multiple transitions at a time.
• The transition manager space has changed over recent years and providers may exit unexpectedly.
All six finalist firms had strong RFP Responses, presented well during the interviews including responding to a case study, and had good references. Highlights of each firm are listed below:
BlackRock – BlackRock is currently used by SURS for transition management services. They have a large transition team, with capabilities across all asset classes, and are particularly strong in executing fixed income transitions. In addition, as one of SURS’ passive providers there are possible synergies when using them for transition services. Citigroup – Citi generally caters to larger plans (greater than $10 billion). They are known to be particularly strong in global equities transitions. Loop Capital – Loop is a Chicago based, MFDB owned firm and has worked with other Illinois plans. They are strong in global equities transitions, and transition management is an integral part of their business. Given the size of their team, they may have some capacity constraints. Northern Trust – Northern Trust is currently used by SURS for transition management services and has broad asset class capabilities. As SURS’ Custodian and one of our passive providers, there are possible synergies when using them for transition services. Penserra – Penserra is an MFDB owned firm. Their experienced transition management team is relatively large compared to other smaller transition managers. They are strong in
Exhibit 7
US equities transitions. Given the size of their team, they may have some capacity constraints. Russell – Russell has broad capabilities and a large transition management team. The firm is known to be particularly strong in complex portfolio transitions and has capabilities to serve as an interim manager, if needed.
Motion That the board approve, based on the recommendation of staff and PCA, selection of the following transition managers for the transition manager bench and/or interim management services: Recommendations:
• BlackRock • Citigroup • Loop Capital • Northern Trust • Penserra • Russell
Quiet Period Policy Guidelines The Quiet Period Policy is intended to establish guidelines by which Board Members and Staff will communicate with prospective service providers during the search process. The objectives of the policy are to ensure that prospective service providers competing to become employed by SURS have equal access to information regarding the search parameters; communications related to the selection are consistent and accurate; and the process of selecting service providers is efficient, diligent, and fair. The following guidelines will be instituted during a search process for a service provider:
1. A Quiet Period will commence upon Board authorization and end once a selection has been made by the Board and the completion of successful contract negotiations with a respondent;
2. Initiation, continuation and conclusion of the Quiet Period shall be publicly communicated to prevent inadvertent violations;
3. All Board members, and Staff other than the Chief Procurement Officer or their designee, shall refrain from communicating with respondents regarding any product or service related to the search in process. All Board members and Staff shall refrain from accepting meals, travel, hotel, or other value from such respondents;
4. Throughout the Quiet Period, if any Board member is contacted by a respondent, the Board member shall refer such party to the Chief Procurement Officer;
5. All authority related to the search process shall be exercised solely by the Investment Committee or Board as a whole, and not by individual Board members;
6. The Quiet Period does not prevent Board approved due diligence, client conference attendance or communications with an existing vendor; provided, however, that discussions related to the procurement and pending selection shall be avoided during those activities;
Exhibit 7
7. The provisions of this Policy shall apply throughout the Quiet Period and shall be
communicated to respondents in conjunction with any search; and 8. A respondent may be disqualified from a search process for a violation of the Quiet Period
or any portion of this Policy.
Exhibit 7
Appendix
Search Process Managers are being recommended to be contracted for transition management services. The search process was conducted consistent with legislative requirements and SURS’ normal practice as defined in the Investment Policy: Staff developed a Request for Proposal (RFP) for the search process. The minimum
qualifications required to respond to the RFP included:
• The proposing firm must be SEC-registered or exempt from registration with the nature of the exemption provided.
• The responder must agree to serve as a “fiduciary” to the Fund within the meaning of Illinois legislation and to act in accordance with all requirements and standards of conduct applicable to fiduciaries.
• Proposing firm and its proposed team must have all authorizations, permits, licenses and certifications required by federal and state laws and regulations to perform the services specified in this RFP at the time responder submits a response to the RFP. Responder’s audited financial statements will be made available for review.
• The proposing firm comply with all legislation regarding investment restrictions, applicable State fiduciary, ethics, and diversity laws, including any additional disclosure requirements.
• The proposing firm must not have been the subject of material litigation or claims or censured by the SEC or subject to regulatory action within the last three years
• One or more principals of the proposing firm have five years or more experience transitioning assets for institutional clients.
• The proposing firm must be directly responsible for the management of the transition, and all personnel responsible for the transition must be employees of the firm.
• The proposing firm must have been in operation as an investment management organization and/or broker/dealer for at least five years, as of December 31, 2017. (MFDB forms exempt)
• The proposing firm must be able to comply with SURS Minority, Female, Disable-owned Business (MFDB) brokerage goals.
• The Request for Proposal (RFP) was advertised on the website of Pensions & Investments and in its June 25 print edition, along with being noticed as required in the State newspaper, and posted to the SURS website beginning June 20.
• RFP responses were due no later than July 6, 2018. Staff and PCA received 12 responses from transition management providers by the July 6 deadline.
• The initial list of respondents was narrowed to six firms using the following criteria: o Transition experience o Transition activity o Costs
Exhibit 7
o Organizational structure o Personnel qualifications o Services offered o Reporting and compliance capabilities
• At the September 13 Investment Committee meeting, SURS Staff and PCA requested the board direct staff to return with a recommendation of firms to hire for the Board’s consideration at the October Board meeting.
• SURS and PCA conducted interviews with key personnel from the six finalists October 2, 2018, at SURS headquarters in Champaign, IL. David Sancewich and Kristen Chase of PCA, and Doug Wesley, Ellen Hung, Alex Ramos, Brian DeLoriea, and Akshay Patel of SURS staff attended the interviews.
Upon conclusion of finalist interviews, staff and PCA determined that the six finalist firms would be recommended for inclusion in the SURS bench of transition managers. The firms being recommended to the Board at the October 18 Investment Committee Meeting are:
BlackRock Citigroup Loop Capital Northern Trust Penserra Russell
Exhibit 7
SURS Transition Manager SearchSummary of Finalist RFP Responses
October 2018
Firm Name Penserra Capital Management, LLC Northern Trust BlackRockLocation Orinda, CA Chicago, IL Various; Chicago, IL; San Francisco, CAContact Person Connie Kreutzer Mike Terzich Joe Hernandez and Azim Hilmy
Ownership Structure Privately held company Publicly Listed Company Publicly Traded Company
Minority Owned Firm Yes, Latino-Owned No No
Total Number of Employees 76 21188 7075
Anticipated Material Organizational Changes None None None
Recent / Pending Litigation None None Yes, not related to Transition Management
Key Transition Management Employees
Team of 14 across three offices in CA, NY, Chicago; Head of Transition, Zlatko Martinic Team of 16 Group of 55
Transition Group Inception 2009 1987 1993Subcontract? No No No
Personnel Changes One in risk management and added one in Operations; no losses in Traders Gained 12 traders over last three years Gained 11 and lost 6 trading coordinators over the last five
years
Number of Clients 12 Public DB clients with 59 transitions; include IMRF and TRS 104 Public DB clients with 146 transitions 111 Public DB clients with 177 transitions, ISBI included
Type of Transitions Mostly US Equity transitions; 3 Managed Futures/Trend Following Across the traditional asset classes Across the traditional asset classes plus 95 multi-asset
transitions
Strengths and Weaknesses Small firm size No proprietary trading; May not be lowest cost provider They say no weaknesses
MFDB Goals MFDB firm itself 8 MFDB firms selected from an RFI search Mentions Emerging Broker Initiative
Outside Broker usage None On occasion Unclear
Systems Newport, Indigo, Bloomberg, Insight, Intex, The Yield Book, Fxall, proprietary Charles River, Eagle, Bloomberg, various risk management Aladdin
Fee Rate 0.5 - 1 cents per share up to $500 million, then negotiable for US equity; 4-8bps for non US equity; 1-5bps for fixed
0.8-0.9 cents per share for US equity; 4-8 bps for nonUS equity; 4-9 bps for fixed
0-1.25 cents per share for US equity; 0-8.0 bps NonUS; 0-6 bps for fixed
Illinois Offices Yes Yes Yes
Oth
er CIO Magazine TM Survey Ratings No highs or lows
Lowest Extremely Satisfied Rating for Global; Tied for Lowest Extremely Satisfied Rating for US; Lowest Project
Mgt RatingNo highs or lows
Oth
er
Misc Managed Futures/Trend experience Did not fill out firm diversity spreadsheet; Currently used for Transition Management
Currently used for Transition Management; Transition Manager Director recently arrested due to past with State
Street case
Oth
er
Status Recommended for bench Recommended for bench Recommended for bench
Term
s / F
ees
Org
aniz
atio
nSt
rate
gy /
Proc
ess
Exhibit 8
SURS Transition Manager SearchSummary of Finalist RFP Responses
October 2018
Firm NameLocationContact Person
Ownership Structure
Minority Owned Firm
Total Number of Employees
Anticipated Material Organizational ChangesRecent / Pending Litigation
Key Transition Management EmployeesTransition Group InceptionSubcontract?
Personnel Changes
Number of Clients
Type of Transitions
Strengths and Weaknesses
MFDB Goals
Outside Broker usage
Systems
Fee Rate
Illinois Offices
Oth
er CIO Magazine TM Survey Ratings
Oth
er
Misc
Oth
er
Status
Term
s / F
ees
Org
aniz
atio
nSt
rate
gy /
Proc
ess
Citigroup Loop Capital RussellNY, NY Chicago, IL and NY, NY Seattle, WA
Sarah Kirschbaum Will Greene Graham Seagraves, Brittany Meisner
Publicly Traded Company LLC majority owned by James Reynolds, Jr. Majority stake held by funds managed by TA Associates
No Yes, African-American-Owned No
2817 165 767
None None None
Yes, not related to Transition Management None None
Team of 17 Team of 4; Will Greene, Andre Adams, Angela Myers, Lazarus Goosby Group of 27
1996 2003 1992No No No
Unclear Gained 4 and lost two over the last five years Gained 11 and lost 9 over the last five years
181 Public DB clients with 613 transitions, TRS included 22 Public DB clients with 53 transitions; including TRS, Chicago Teachers, and ISBI 36 Public DB clients with 90 transitions
Across the traditional asset classes plus Options strategies Mostly Domestic and Global equity Across the traditional asset classes with one options transition
Could improve dedicated systems for fixed income trading Does not use short term discretionary investment manage but will use ETFs Explicit costs may appear higher
No issue meeting other clients' MFDB goals MFDB firm itself Reasonable efforts language, Expect a range of 20-25% for MFDB in developed asset classes
MFDB requirements Global Markets Yes
BECS Kompass, Fidessa, TOMS, Market Access, TradeWeb PAR plus multiple others
up to 2 cents per share for US equity; up to 10 bps for NonUS; up to 8 bps for fixed
0.6-1.5 cents per share for US equity, 4-10 bps for NonUS, 4-10 bps for fixed
up to 1 cent per share for US equity, 4-9 for NonUS, 1.5-9 for fixed
Yes Yes Yes
Lowest Perf Disclosure Did not receive enough survey responses No highs or lows
Largest client list; Options Strategies experience MFDB Firm, Chicago Based MFDB usage stated in RFP is slightly below SURS targets
Recommended for bench Recommended for bench Recommended for bench
Exhibit 8
TRANSITION MANAGER SCORECARD - PCA
Questions Indiv Wtd
Avg Score BlackRock Citi Loop Northern
Trust Penserra Russell
I. Quantitative CharacteristicsTransition activity, fiduciary status, size of transitions 25, 52-53 5 3.5 5.0 5.0 3.5 4.0 3.0 5.0Experience across asset classes 25,51 5 3.5 5.0 5.0 3.5 4.0 3.0 4.5
Section Weighting 10 7 10.0 10.0 7.0 8.0 6.0 9.5
II. CostsTotal Transition costs 70-76 10 7 9.0 6.0 7.5 7.5 7.5 7.5
Section Weighting: 10 7 9.0 6.0 7.5 7.5 7.5 7.5
III. Organization/PersonnelOwnership control, structure and/or changes, insurance coverage 1-13, 21 5 3.5 4.0 4.0 5.0 4.5 4.5 2.5Litigation/regulatory issues 10-13 5 3.5 3.5 3.5 4.5 3.5 5.0 5.0Met all Minimum Qualifications MQ 2 1.4 2.0 2.0 2.0 2.0 2.0 2.0
MFDB Participation 5,19,32-33 2 1.4 2.0 2.0 2.0 1.7 2.0 1.7Management and personnel (resources & changes). Dedication to TM business.
14-23,48-49,84 16 11.2 11.0 15.0 15.0 15.5 15.0 13.0
Section Weighting: 30 21 22.5 26.5 28.5 27.2 28.5 24.2
IV. Services and ClientsCompetitive Advantage, enhancements to model/systems 28-29, 34 10 7 7.0 7.0 7.0 8.0 7.0 8.0
Overall transition program30-31,35-37,42-45, 51, 54-57 9 6.3 8.0 9.0 7.0 9.0 7.5 9.0
Fixed Income Capabilities 38-39 1 0.7 1.0 1.0 0.5 1.0 0.7 1.0Approach (Agency, Principal) 46 3 2.1 3.0 3.0 2.0 3.0 3.0 2.0Use of crossing strategies 35,40-41 2 1.4 2.0 2.0 1.7 2.0 1.0 2.0
Risk management (financial & operational)47,
50,58,59,61 10 7 8.0 9.0 6.0 8.0 7.0 8.0
Clients, type of clients, reference check 24-27 5 3.5 4.0 4.5 5.0 3.0 5.0 3.5Section Weighting: 40 28 33.0 35.5 29.2 34.0 31.2 33.5
V. Compliance, Reporting, and OtherCompliance 58-65 1 1 1.0 1.0 0.8 1.0 0.7 1.0Reporting (Pre- and Post-trade) 66-69 5 3.5 4.5 5.0 4.0 4.5 4.0 4.0
Letter of agreement 79 / Exhibit 1 0.5 1.0 1.0 1.0 1.0 1.0 1.0Placement Agents 80 1 0.5 1.0 1.0 1.0 1.0 1.0 1.0Campaign Contributions 82-83 1 0.5 1.0 0.5 1.0 0.5 1.0 1.0Offices located in State of Illinois 81 1 0.5 1.0 1.0 1.0 1.0 1.0 1.0
Section Weighting: 10 6.5 9.5 9.5 8.8 9.0 8.7 9.0
Total Score: Section1-2: 20 14 19.0 16 14.5 15.5 13.5 17Total Score: Section 3-4: 70 49 55.5 62 57.7 61.2 59.7 57.7Total Score: Section 5: 10 6.5 9.5 9.5 8.8 9 8.7 9Total Score: All Sections: 100.0 69.5 84.0 87.5 81.0 85.7 81.9 83.7
Exhibit 9
Page 1 of 2
APPENDIX B-1
Disclosures Pursuant to Illinois Pension Code Section 1-113.21
Beginning January 1, 2015, Section 1-113.21 of the Illinois Pension Code requires the following disclosures from an investment advisor, consultant or private market fund prior to the awarding of a contract with such entity:
Name of Firm:
BlackRock Institutional Trust Company, N.A (“BTC”)
1. The number of its senior staff and the percentage of its senior staff who are (i) a minority person (ii) a female, and (iii) a person with a disability;
(If none, state “none”) Staff Classification Number of Investment and
Senior Staff Who Are
% Percentage of Investment
and Senior Staff Who Are
Minority 430 30.0% Female 403 29.0%
Person with a Disability 2 0.10%
2. The number of contracts, oral or written, for investment services, consulting services and professional and artistic services that the investment advisor, consultant, or private market fund has with (i) a minority owned business, (ii) a female owned business, or (iii) a business owned by a person with a disability; and
Statutory compliance requires numeric responses. Contracts Number Contracts
Minority 20 Female 47
Person with a Disability 6
3. The number of contracts, oral or written, for investment services, consulting services, and professional and artistic services the investment advisor, consultant, or private market fund has with a business other than (i) a minority owned business, (ii) a female owned business or (iii) a business owned by a person with a disability, if more than 50% of services performed pursuant to the contract are performed by (i) a minority person, (ii) a female, and (iii) a person with a disability.
Statutory compliance requires numeric responses. Contract Number Contracts
Minority 0 Female 0
Person with a Disability 0
Exhibit 10
Page 2 of 2
INVESTMENT ADVISOR / CONSULTANT/ PRIVATE MARKET FUND:
Company Name: BlackRock Institutional Trust Company, N.A
Signature:
Printed Name Joe Hernandez
Title: Managing Director
Dated: 20 July 2018
Exhibit 10
Exhibit 10
Exhibit 10
Page 1 of 2
APPENDIX B-1
Disclosures Pursuant to Illinois Pension Code Section 1-113.21
Beginning January 1, 2015, Section 1-113.21 of the Illinois Pension Code requires the following disclosures from an investment advisor, consultant or private market fund prior to the awarding of a contract with such entity:
Name of Firm: Loop Capital Markets
________________________________________________________________________ 1. The number of its senior staff and the percentage of its senior staff who are (i) a minority person (ii) a
female, and (iii) a person with a disability; (If none, state “none”)
Staff Classification Number of Investment and
Senior Staff Who Are
% Percentage of Investment
and Senior Staff Who Are
Minority 13 65% Female 8 40%
Person with a Disability 0 0
2. The number of contracts, oral or written, for investment services, consulting services and professional and artistic services that the investment advisor, consultant, or private market fund has with (i) a minority owned business, (ii) a female owned business, or (iii) a business owned by a person with a disability; and
Statutory compliance requires numeric responses. Contracts Number Contracts
Minority 61 Female 12
Person with a Disability 0
3. The number of contracts, oral or written, for investment services, consulting services, and professional and artistic services the investment advisor, consultant, or private market fund has with a business other than (i) a minority owned business, (ii) a female owned business or (iii) a business owned by a person with a disability, if more than 50% of services performed pursuant to the contract are performed by (i) a minority person, (ii) a female, and (iii) a person with a disability.
Statutory compliance requires numeric responses. Contract Number Contracts
Minority 40 Female 19
Person with a Disability 0
Exhibit 10
Page 2 of 2
INVESTMENT ADVISOR / CONSULTANT/ PRIVATE MARKET FUND:
Company Name: Loop Capital Markets
Signature:
Printed Name Kourtney Gibson
Title: President
Dated: July 20, 2018
Exhibit 10
Page 1 of 2
APPENDIX B-1 Disclosures Pursuant to Illinois Pension Code Section 1-113.21 Beginning January 1, 2015, Section 1-113.21 of the Illinois Pension Code requires the following disclosures from an investment advisor, consultant or private market fund prior to the awarding of a contract with such entity:
Name of Firm:
Northern Trust Investments, Inc.
1. The number of its senior staff and the percentage of its senior staff who are (i) a minority person (ii) a female, and (iii) a person with a disability;
(If none, state “none”) Staff Classification Number of Investment and
Senior Staff Who Are % Percentage of Investment
and Senior Staff Who Are Minority 82 17.7% Female 123 26.6%
Person with a Disability 0 0
2. The number of contracts, oral or written, for investment services, consulting services and professional and artistic services that the investment advisor, consultant, or private market fund has with (i) a minority owned business, (ii) a female owned business, or (iii) a business owned by a person with a disability; and
Statutory compliance requires numeric responses. Contracts Number Contracts Minority 43 Female 95
Person with a Disability 2
3. The number of contracts, oral or written, for investment services, consulting services, and professional and artistic services the investment advisor, consultant, or private market fund has with a business other than (i) a minority owned business, (ii) a female owned business or (iii) a business owned by a person with a disability, if more than 50% of services performed pursuant to the contract are performed by (i) a minority person, (ii) a female, and (iii) a person with a disability.
Statutory compliance requires numeric responses. Contract Number Contracts Minority 0 Female 0
Person with a Disability 0
Exhibit 10
Page 2 of 2
INVESTMENT ADVISOR / CONSULTANT/ PRIVATE MARKET FUND:
Company Name: Northern Trust
Signature:
Printed Name Mike Terzich
Title: Senior Vice President
Dated: 10/4/18
Exhibit 10
Page 1 of 2
APPENDIX B-1
Disclosures Pursuant to Illinois Pension Code Section 1-113.21
Beginning January 1, 2015, Section 1-113.21 of the Illinois Pension Code requires the following disclosures from an investment advisor, consultant or private market fund prior to the awarding of a contract with such entity:
Name of Firm: Penserra Capital Management LLC
________________________________________________________________________
1. The number of its senior staff and the percentage of its senior staff who are (i) a minority person (ii) a female, and (iii) a person with a disability;
(If none, state “none”) Staff Classification Number of Investment and
Senior Staff Who Are
% Percentage of Investment
and Senior Staff Who Are
Minority 3 30% Female 1 10%
Person with a Disability 0 0%
2. The number of contracts, oral or written, for investment services, consulting services and professional and artistic services that the investment advisor, consultant, or private market fund has with (i) a minority owned business, (ii) a female owned business, or (iii) a business owned by a person with a disability; and
Statutory compliance requires numeric responses. Contracts Number Contracts
Minority 1 Female 0
Person with a Disability 0
3. The number of contracts, oral or written, for investment services, consulting services, and professional and artistic services the investment advisor, consultant, or private market fund has with a business other than (i) a minority owned business, (ii) a female owned business or (iii) a business owned by a person with a disability, if more than 50% of services performed pursuant to the contract are performed by (i) a minority person, (ii) a female, and (iii) a person with a disability.
Statutory compliance requires numeric responses. Contract Number Contracts
Minority 0 Female 0
Person with a Disability 0
Exhibit 10
Page 2 of 2
INVESTMENT ADVISOR / CONSULTANT/ PRIVATE MARKET FUND:
Company Name: Penserra Capital Management LLC
Signature:
Printed Name George Madrigal
Title: CEO
Dated: July 19, 2018
Exhibit 10
Page 1 of 2
APPENDIX B-1
Disclosures Pursuant to Illinois Pension Code Section 1-113.21
Beginning January 1, 2015, Section 1-113.21 of the Illinois Pension Code requires the following disclosures from an investment advisor, consultant or private market fund prior to the awarding of a contract with such entity:
Name of Firm:
Russell Investments: (Data disclosures removed as requested by IL SURS 10/11/18).
_______________________________________________________________________ 1. The number of its senior staff and the percentage of its senior staff who are (i) a minority person (ii) a
female, and (iii) a person with a disability; (If none, state “none”)
Staff Classification Number of Investment and
Senior Staff Who Are
% Percentage of Investment
and Senior Staff Who Are
Minority 11 9% Female 33 26%
Person with a Disability 0 0
2. The number of contracts, oral or written, for investment services, consulting services and professional and artistic services that the investment advisor, consultant, or private market fund has with (i) a minority owned business, (ii) a female owned business, or (iii) a business owned by a person with a disability; and
Statutory compliance requires numeric responses. Contracts Number Contracts
Minority 0 Female 0
Person with a Disability 0
3. The number of contracts, oral or written, for investment services, consulting services, and professional and artistic services the investment advisor, consultant, or private market fund has with a business other than (i) a minority owned business, (ii) a female owned business or (iii) a business owned by a person with a disability, if more than 50% of services performed pursuant to the contract are performed by (i) a minority person, (ii) a female, and (iii) a person with a disability.
Statutory compliance requires numeric responses. Contract Number Contracts
Minority 0 Female 0
Person with a Disability 0
Exhibit 10
Page 2 of 2
INVESTMENT ADVISOR / CONSULTANT/ PRIVATE MARKET FUND:
Company Name: Russell Investments Implementation Services, LLC
Signature: Printed Name Steve Kirschner
Title: Managing Director, Trading and Transition Management
Dated: July 20, 2018 (Updated 10/11/18)
Exhibit 10
To: Investment Committee From: Investment Staff Date: October 5, 2018 Subject: Investment Committee Packet Proposal Background The investment program has gotten increasingly complex over the past several years and the material provided to the Investment Committee has grown commensurately. At the September 2018 Investment Committee meeting, and occasionally at prior meetings, the committee voiced concerns over the voluminous amount of material provided. Over the past 12 months the investment committee packet has averaged 431 pages long, with the shortest book at 316 pages. Staff proposes to organize the volume of material into a main section and a supplemental section. This would ensure all informational content is still provided to the Board while highlighting the more pertinent section. Staff also proposes to enhance the summary information currently provided to the Board. Current Material Each quarterly meeting contains detailed performance reports from the general consultant, specialty consultant(s), and manager specific dashboards. Over the past five quarterly meetings the defined benefit performance books and manager dashboards have averaged 73 and 98 pages, respectively. The September 2018 materials included the following performance information:
• Pages 35-91 – SMP Due Diligence Report • Pages 306-389 – PCA Performance Report • Pages 390-417 – Manager Performance Dashboards • Pages 418-473 – Manager Qualitative Dashboards
The investment packet is further increased when complex or infrequent topics (e.g. asset allocation) are introduced. Background information for the topics have been included as additional appendix material. Over the past 8 meetings, appendix material was included four times and averaged 37 pages. Proposals
1. We propose to include the following in the main section of the investment packet: economic updates, high level (total fund and class level) portfolio performance and market risk metrics. The only performance detail included in this section would be for any
Exhibit 11
underperforming managers. All current material not included in the main section will be in a separate packet marked supplemental. This change would eliminate, from the main section, approximately 140 pages out of 221, reducing the main packet from 501 to 358 pages.
2. We propose to keep the additional information for complex and new topics provided in
appendices with the related subject matter. To help the Board get a handle on the appendix material provided, we propose adding a one-page summary. This would be similar to the summary document describing each agenda topic that is currently emailed to the Board prior to each meeting. This would result in an email to the Board that included a summary of each agenda topic, a summary of any appendix material and a page guide of all material being provided.
Conclusion Staff and consultant will continue to consider this issue. We would also appreciate any suggestions from Trustees as this will likely be an iterative process that is solved over time.
Exhibit 11
Non-U.S. & Global Equity Asset Class Review
Year Ending June 30, 2018
Exhibit 12
Non-U.S. Equity
Exhibit 12
Non-U.S. Equity Portfolio Overview• SURS Actual vs. Target Non-U.S. Equity Allocation:
• Actual Allocation (ex-overlay) = 18.6%• Actual Allocation (with overlay) = 18.3%• Strategic Policy Target = 19.0%
• SURS Non-U.S. Equity Exposure = $3.6 billion:• Active Non-U.S. Equity = $1.167 billion or 32.8%• Structured Active Non-U.S. Equity = $1.116 billion or 31.4%• Passive Non-U.S. Equity = $1.276 billion or 35.9%
Data as of June 30, 2018
Manager TypeExpected
Value-AddedExpected
Tracking Error
Active 2.00% 3% - 5%
Structured Active 1.50% 1% - 3%
Passive N/A N/A
33%
31%
36%
Active Structured Active Passive
Exhibit 12
MSCI ACWI ex-U.S. Index
Japan17%
United Kingdom
12%
France8%
China8%Canada
7%
Other 50%
Country Weights• MSCI ACWI ex-U.S. captures large and mid cap representation across 22 of 23 Developed Market Countries and 24 Emerging Markets around the world, excluding the U.S.
• Covers approximately 85% of the global equity opportunity set outside of the U.S.
• Average Market Cap is $9.7 billion.• Top 10 Holdings:
1. Nestle2. Tencent Holdings3. Samsung Electronics4. Taiwan Semiconductor5. Alibaba Group HLDG ADR6. Novartis7. Roche8. HSBC Holdings (GB)9. Total10. Royal Dutch Shell A
Source: MSCI
Exhibit 12
Portfolio CharacteristicsPortfolio Benchmark
Wtd. Avg. Mkt. Cap ($M) 53,057 65,831Median Mkt. Cap ($M) 7,219 8,122Price/Earnings ratio 13.0 14.0Price/Book ratio 2.2 2.25 Yr. EPS Growth Rate (%) 15.7 11.9Current Yield (%) 3.2 3.1Beta (5 Years, Monthly) 1.0 1.0Number of Stocks 2,360 2,154Debt to Equity 0.3 -0.2
Top Ten Equity HoldingsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)Roche Holding AG 1.0 0.7 0.3 -3.4Samsung Electronics Co Ltd 0.9 1.0 -0.1 -8.8Nestle SA 0.8 1.1 -0.3 0.7SAP AG 0.7 0.5 0.2 11.9Total SA Oil & Gas 0.7 0.7 0.0 8.4Alibaba Group Holding Ltd 0.7 1.0 -0.3 1.1Novartis AG 0.6 0.8 -0.2 -6.5Allianz SE 0.6 0.4 0.2 -4.8Nippon T&T 0.6 0.2 0.4 -1.5Sanofi 0.6 0.4 0.2 4.2
% of Portfolio 7.2 6.8 0.4
Sector Weights (%)
Total Non US Equity
MSCI AC World ex USA
0.0 5.0 10.0 15.0 20.0 25.0 30.0
UtilitiesTelecommunication Services
Real EstateMaterials
Information TechnologyIndustrials
Health CareFinancials
EnergyConsumer Staples
Consumer Discretionary
2.4
4.0
3.8
8.6
10.8
13.3
9.0
20.2
7.7
8.5
11.8
3.0
3.7
3.2
8.2
11.9
11.6
8.1
21.9
7.4
9.7
11.2
Distribution of Market Capitalization (%)
Total Non US Equity MSCI AC World ex USA
0.0
10.0
20.0
30.0
40.0
>100 Bil 75 Bil - 100 Bil
25 Bil - 75 Bil
15 Bil - 25 Bil
2 Bil - 15 Bil
0 - 2 Bil
18.6
6.6
33.4
13.8
27.2
0.5
14.2
6.1
30.6
16.0
31.1
2.0
Non-U.S. Equity Portfolio CharacteristicsAs of June 30, 2018
State Universities Retirement System of Illinois (SURS) 51
Exhibit 12
Region
Total Non US Equity
MSCI AC World ex USA
0.0 10.0 20.0 30.0 40.0 50.0
OtherFrontier Markets
Middle EastUnited Kingdom
Europe ex UKJapan
Pacific ex JapanEM Mid East+Africa
North AmericaEM Latin America
EM EuropeEM Asia
0.3
0.0
0.5
10.8
37.6
18.0
10.6
1.5
5.0
1.8
1.3
12.6
0.4
0.0
0.4
10.2
33.1
16.4
11.5
2.1
6.7
2.6
1.5
15.2
Top Ten ContributorsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)Kering 0.3 0.2 0.1 27.7Macquarie Group Ltd 0.4 0.1 0.3 18.9Royal Dutch Shell PLC 0.6 0.7 -0.1 12.1Aristocrat Leisure Ltd 0.3 0.0 0.3 24.3SAP AG 0.6 0.5 0.1 11.9Equinor ASA 0.4 0.1 0.3 13.7Safran SA 0.3 0.2 0.1 16.4CSL Ltd 0.3 0.3 0.0 19.2Lundin Petroleum AB 0.2 0.0 0.2 28.8Repsol SA 0.4 0.1 0.3 13.3
% of Portfolio 3.8 2.2 1.6
Top Ten DetractorsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)Taiwan Semiconductor 0.9 1.0 -0.1 -13.3Deutsche Post AG 0.5 0.2 0.3 -25.4Samsung Electronics Co Ltd 1.0 1.0 0.0 -8.8Danske Bank As 0.4 0.1 0.3 -16.1Itau Unibanco Holding SA 0.2 0.2 0.0 -33.7Itausa Investimentos Itau Sa 0.2 0.1 0.1 -38.1ING Groep NV 0.4 0.3 0.1 -14.8Be Semiconductor Industries NV 0.1 0.0 0.1 -42.9WH Group Ltd 0.2 0.0 0.2 -21.5KB Financial Group Inc 0.3 0.1 0.2 -17.0
% of Portfolio 4.2 3.0 1.2
Sector Allocation
Sector Number ofAssets
Market Value($000)
PortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)Consumer Discretionary 297 389,036 11.8 11.2 0.6Consumer Staples 193 281,103 8.5 9.7 -1.1Energy 109 252,397 7.7 7.4 0.2Financials 401 664,587 20.2 21.9 -1.8Health Care 141 295,468 9.0 8.1 0.8Industrials 370 439,177 13.3 11.6 1.7Information Technology 200 355,734 10.8 11.9 -1.1Materials 232 282,464 8.6 8.2 0.4Real Estate 153 126,035 3.8 3.2 0.6Telecommunication Services 72 131,333 4.0 3.7 0.3Utilities 108 79,624 2.4 3.0 -0.6Total 2,276 3,296,958 100.0 100.0 0.0
Non-U.S. Equity Portfolio CharacteristicsAs of June 30, 2018
State Universities Retirement System of Illinois (SURS) 52
Exhibit 12
Non-U.S. Equity Portfolio Overview• SURS Actual vs. Target Non-U.S. Equity Allocation:
• Actual Allocation (ex-overlay) = 18.6%• Actual Allocation (with overlay) = 18.3%• Strategic Policy Target = 19.0%
• SURS Non-U.S. Equity Exposure = $3.6 billion:• Active Non-U.S. Equity = $1.167 billion or 32.8%• Structured Active Non-U.S. Equity = $1.116 billion or 31.4%• Passive Non-U.S. Equity = $1.276 billion or 35.9%
Data as of June 30, 2018
Manager TypeExpected
Value-AddedExpected
Tracking Error
Active 2.00% 3% - 5%
Structured Active 1.50% 1% - 3%
Passive N/A N/A
33%
31%
36%
Active Structured Active Passive
Exhibit 12
Active Non-U.S. Equity
24%
28%19%
29% Ativo
GlobeFlex
Progress
SGA
Manager Mandate Assets ($MM)
Ativo ACWI Ex-US $285
GlobeFlex ACWI Ex-US $327
Progress EAFE $223
Strategic Global
AdvisorsEAFE $333
$1,167
Data as of June 30, 2018
Active Managers:• Make active stock, sector and country selection decisions in an attempt to add
significant value relative to a passive benchmark over time.• Pros: provides opportunity for excess return.• Cons: managers may lag benchmark; higher fees relative to passive
management.
Exhibit 12
Structured Active Non-U.S. Equity
48%
52%
BTC Int'l Alpha Tilts Fidelity
Manager Mandate Assets ($MM)
BTC International
Alpha TiltsEAFE $537
Fidelity ACWI Ex-US $579
$1,116
Data as of June 30, 2017
Structured Active Managers:• Make active stock and sector selection decisions in a more risk-controlled
framework in an attempt to add modest value relative to a passive benchmark over time.
• Pros: provides opportunity for excess return in a risk-controlled manner.• Cons: managers may lag benchmark; higher fees relative to passive management.
Exhibit 12
19%
81%
BTC Emerging Markets BTC International
Passive Non-U.S. Equity
Manager Mandate Assets ($MM)
BTC Emerging Markets
Emerging Markets
$237
BTC International
ACWI Ex-US $1,039
$1,276
Data as of June 30, 2018
Passive Managers:• Attempt to replicate the risk-return profile of the benchmark, in this case the
MSCI All Country World ex-US Index. • Pros: cost, liquidity, reliability.• Cons: no opportunity for excess return.
Exhibit 12
19%
24%57%
African American Latino Woman
Non-U.S. Equity Portfolio Overview
• SURS Diverse Manager Exposure ~ $1.168 billion or 33% of Total Non-U.S. Equity:
Data as of June 30, 2018
Managers: Ativo, GlobeFlex, Progress, Strategic Global Advisors
33%
67%
Diverse Other
Exhibit 12
Total Non-U.S. Equity Performance(as of June 30, 2018)
7.35%
5.46%
6.70%
2.81%
7.28%
5.07%
5.99%
2.54%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
1 Year 3 Years 5 Years 10 Years
Net of Fees
Total Non-U.S. Equity MSCI ACWI Ex-US
Exhibit 12
Global Equity
Exhibit 12
Global Equity Portfolio Overview• SURS Actual vs. Target Global Equity Allocation:
• Actual Allocation (ex-overlay) = 9.3%• Actual Allocation (with overlay) = 8.2%• Strategic Policy Target = 8.0%
• SURS Global Equity Exposure = $1.8 billion:• 100% Active Global Equity• Benchmarked to MSCI ACWI Index
Data as of June 30, 2018
Manager TypeExpected
Value-AddedExpected
Tracking Error
Active 2.00% 3% - 5%
Exhibit 12
Active Global Equity
31%
37%
32%
Mondrian T. Rowe Price Wellington
Manager Mandate Assets ($MM)*
Mondrian ACWI $543
T. Rowe Price ACWI $658
Wellington ACWI $576
$1776
Data as of June 30, 2018
Active Managers:• Make active stock, sector and country selection decisions in an attempt to add
significant value relative to a passive benchmark over time.• Pros: provides opportunity for excess return.• Cons: managers may lag benchmark; higher fees relative to passive
management.
*Totals may not add due to rounding
Exhibit 12
MSCI ACWI Index
United States55%
Japan7%
United Kingdom
5%
France3%
China3%
Other25%
Country Weights• MSCI ACWI captures large and mid cap representation across 23 Developed Markets and 24 Emerging Markets countries.
• Covers approximately 85% of the global investable opportunity set.
• Average Market Cap is $16.8 billion.
• Top 10 Holdings:1. Apple2. Amazon.com3. Microsoft4. Facebook A5. JP Morgan Chase6. Alphabet C7. Alphabet A8. Johnson & Johnson9. Exxon Mobil Corp10. Bank of America Corp
Source: MSCI
Exhibit 12
Portfolio CharacteristicsPortfolio Benchmark
Wtd. Avg. Mkt. Cap ($M) 142,070 65,831Median Mkt. Cap ($M) 19,785 8,122Price/Earnings ratio 19.5 14.0Price/Book ratio 3.1 2.25 Yr. EPS Growth Rate (%) 18.0 11.9Current Yield (%) 2.0 3.1Beta (5 Years, Monthly) 0.8 1.0Number of Stocks 444 2,154Debt to Equity -1.4 -0.2
Top Ten Equity HoldingsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)Amazon.com Inc 2.3 0.0 2.3 17.4Facebook Inc 2.1 0.0 2.1 21.6Microsoft Corp 1.9 0.0 1.9 8.5Alphabet Inc 1.8 0.0 1.8 8.9Visa Inc 1.7 0.0 1.7 10.9Unitedhealth Group Inc 1.3 0.0 1.3 15.0Allergan PLC 1.2 0.0 1.2 -0.5Becton, Dickinson and Co 1.2 0.0 1.2 10.9Alibaba Group Holding Ltd 1.1 1.0 0.1 1.1Tencent Holdings LTD 1.0 1.4 -0.4 -3.6
% of Portfolio 15.6 2.4 13.2
Sector Weights (%)
Global Equity
MSCI AC World ex USA (Net)
0.0 6.0 12.0 18.0 24.0 30.0
OtherUtilities
Telecommunication ServicesReal Estate
MaterialsInformation Technology
IndustrialsHealth Care
FinancialsEnergy
Consumer StaplesConsumer Discretionary
0.5
3.0
3.1
2.3
3.7
24.3
11.3
15.8
14.1
5.0
4.7
12.3
0.0
3.0
3.7
3.2
8.2
11.9
11.6
8.1
21.9
7.4
9.7
11.2
Distribution of Market Capitalization (%)
Global Equity
MSCI AC World ex USA (Net)
0.0
10.0
20.0
30.0
40.0
>100 Bil 75 Bil - 100 Bil
25 Bil - 75 Bil
15 Bil - 25 Bil
2 Bil - 15 Bil
0 - 2 Bil
18.6
6.6
33.4
13.8
27.2
0.5
33.7
6.9
25.7
11.0
21.4
1.3
Global Equity Portfolio CharacteristicsAs of June 30, 2018
State Universities Retirement System of Illinois (SURS) 53
Exhibit 12
Region
Global Equity
MSCI AC World ex USA (Net)
0.0 15.0 30.0 45.0 60.0 75.0
OtherFrontier Markets
Middle EastUnited Kingdom
Europe ex UKJapan
Pacific ex JapanEM Mid East+Africa
North AmericaEM Latin America
EM EuropeEM Asia
0.3
0.0
0.1
7.3
16.4
8.0
4.4
0.4
56.8
0.0
0.1
6.2
0.4
0.0
0.4
10.2
33.1
16.4
11.5
2.1
6.7
2.6
1.5
15.2
Top Ten ContributorsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)Amazon.com Inc 1.7 0.0 1.7 17.4Facebook Inc 1.1 0.0 1.1 21.6Netflix Inc 0.7 0.0 0.7 32.5Canada Goose Holdings Inc 0.3 0.0 0.3 76.1Unitedhealth Group Inc 1.2 0.0 1.2 15.0Visa Inc 1.6 0.0 1.6 10.9Microsoft Corp 1.9 0.0 1.9 8.5salesforce.com Inc 0.9 0.0 0.9 17.3Alphabet Inc 1.6 0.0 1.6 8.9Tesla Inc 0.4 0.0 0.4 28.9
% of Portfolio 11.4 0.0 11.4
Top Ten DetractorsPortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)
QuarterlyReturn
(%)PERSOL HOLDINGS CO LTD 0.6 0.0 0.6 -23.5New York Community Bancorp Inc. 0.9 0.0 0.9 -14.0Philip Morris International Inc 0.7 0.0 0.7 -17.6WH Group Ltd 0.5 0.0 0.5 -21.5Taiwan Semiconductor 0.9 1.0 -0.1 -13.3Honda Motor Co Ltd 0.8 0.3 0.5 -14.1Nintendo Co Ltd 0.4 0.2 0.2 -26.0Mitsubishi Electric Corp 0.6 0.1 0.5 -17.0AMS AG 0.3 0.0 0.3 -28.8IQE PLC 0.4 0.0 0.4 -25.3
% of Portfolio 6.1 1.6 4.5
Sector Allocation
Sector Number ofAssets
Market Value($000)
PortfolioWeight
(%)
BenchmarkWeight
(%)
ActiveWeight
(%)Consumer Discretionary 50 207,633 12.3 11.2 1.0Consumer Staples 28 79,157 4.7 9.7 -5.0Energy 28 84,266 5.0 7.4 -2.4Financials 65 237,847 14.1 21.9 -7.9Health Care 60 267,074 15.8 8.1 7.7Industrials 61 190,885 11.3 11.6 -0.4Information Technology 82 410,876 24.3 11.9 12.4Materials 36 63,254 3.7 8.2 -4.4Real Estate 11 38,959 2.3 3.2 -0.9Telecommunication Services 10 52,255 3.1 3.7 -0.6Utilities 7 51,096 3.0 3.0 0.0Total 438 1,683,302 99.5 100.0 -0.5
Global Equity Portfolio CharacteristicsAs of June 30, 2018
State Universities Retirement System of Illinois (SURS) 54
Exhibit 12
Total Global Equity Performance(as of June 30, 2018)
13.59%
10.47%11.47%
6.83%
10.73%
8.19%9.41%
6.01%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
1 Year 3 Years 5 Years 10 Years
Net of Fees
Total Global Equity MSCI ACWI
Exhibit 12
Recommendations
Manager Org Issues? Manager Status Recommendation
Ativo No Enhanced Review Retain
GlobeFlex No Good Standing Retain
Strategic Global Advisors No Enhanced Review Retain
Active Non-US Equity Managers
Structured Active Non-US Equity Managers
Manager Org Issues? Manager Status Recommendation
BTC International Alpha Tilts No Enhanced Review Retain
Fidelity No Enhanced Review Retain
Active Global Equity Managers
Manager Org Issues? Manager Status Recommendation
Mondrian No Enhanced Review Retain
T. Rowe Price No Good Standing Retain
Wellington No Enhanced Review Retain
Exhibit 12
Appendix -Active Scorecards
Exhibit 12
1Active versus PassiveKnowledge. Experience. Integrity.
Fee Hurdle 0.25% 0.30% 0.35% 0.40% 0.45% 0.50% 0.55% 0.60% 0.65% 0.70%Median 51% 49% 46% 40% 40% 36% 31% 30% 29% 29%45th Percentile 61% 61% 60% 59% 59% 55% 54% 49% 41% 39%40th Percentile 66% 65% 65% 65% 64% 64% 64% 61% 60% 59%35th Percentile 79% 75% 71% 69% 69% 68% 68% 66% 65% 65%30th Percentile 85% 84% 84% 80% 79% 79% 78% 76% 73% 70%25th Percentile 95% 94% 93% 89% 86% 85% 83% 83% 81% 79%
Average Annualized 3-Year Excess Return (gross) – Median Manager: 0.18%
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
for 20 Years ended June 30, 2018Rolling 3-Year Gross Excess Return relative to S&P 500
Gro
ss E
xces
s R
etur
n
Callan Large Cap Core Style (10th to 90th) Median S&P 500
A Guide to Our Active versus Passive Data
This data point indicates that managers in the 40th percentile beat the benchmark by at least 0.35% in 65% of the rolling 3-year periods over the last 20 years.
This publication contains two charts for each category of active managers. The top table shows the percentage of rolling 3-year periods in which managers in various percentiles beat their benchmark by more than a certain fee hurdle. Percentages 50% and above are shaded in green.
The bottom chart displays the gross excess return for all the managers in Callan’s database for specific asset class categories across the distribution spectrum, from the 10th percentile to the 90th percentile.
This data point shows that in the 4th quarter of 2004, the median manager in Callan’s database reported gross excess returns over the benchmark of -0.25%, with returns ranging from 1.94% for managers in the 10th percentile to -3.95% for those in the 90th percentile.
How often Manager Beat Benchmark by more than Fee Hurdle in Rolling 3-Year Periods over last 20 Years
Large Cap Core Equity Style versus S&P 500
Exhibit 12
32Active versus PassiveKnowledge. Experience. Integrity.
How often Manager Beat Benchmark by more than Fee Hurdle in Rolling 3-Year Periods over last 20 Years
Global Broad Equity Style versus MSCI ACWI
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18-10.0
-5.0
0.0
5.0
10.0
15.0
for 20 Years ended June 30, 2018Rolling 3-Year Gross Excess Return relative to MSCI ACWI
Gro
ss E
xces
s R
etur
n
Callan Global Broad Equity Style (10th to 90th) Median MSCI ACWI
Fee Hurdle 0.45% 0.50% 0.55% 0.60% 0.65% 0.70% 0.75% 0.80% 0.85% 0.90%Median 66% 61% 60% 55% 55% 53% 48% 48% 48% 48%45th Percentile 90% 88% 86% 86% 84% 78% 76% 71% 68% 65%40th Percentile 99% 98% 96% 95% 95% 93% 93% 90% 90% 89%35th Percentile 100% 100% 100% 99% 98% 98% 98% 98% 98% 98%30th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 98% 98%25th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Average Annualized 3-Year Excess Return (gross) – Median Manager: 1.31%
Exhibit 12
34Active versus PassiveKnowledge. Experience. Integrity.
How often Manager Beat Benchmark by more than Fee Hurdle in Rolling 3-Year Periods over last 20 Years
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
for 20 Years ended June 30, 2018Rolling 3-Year Gross Excess Return relative to MSCI ACWI ex USA
Gro
ss E
xces
s R
etur
n
Callan Non-U.S. Equity Style (10th to 90th) Median MSCI ACWI ex USA
Non-U.S. Equity Broad Style vs MSCI ACWI ex USA
Fee Hurdle 0.45% 0.50% 0.55% 0.60% 0.65% 0.70% 0.75% 0.80% 0.85% 0.90%Median 66% 65% 65% 65% 64% 64% 64% 58% 58% 56%45th Percentile 74% 73% 73% 73% 71% 70% 69% 69% 69% 64%40th Percentile 85% 85% 84% 84% 80% 79% 79% 79% 79% 78%35th Percentile 94% 94% 93% 91% 90% 90% 88% 86% 84% 84%30th Percentile 99% 99% 99% 99% 99% 99% 99% 99% 98% 96%25th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Average Annualized 3-Year Excess Return (gross) – Median Manager: 1.67%
Exhibit 12
35Active versus PassiveKnowledge. Experience. Integrity.
How often Manager Beat Benchmark by more than Fee Hurdle in Rolling 3-Year Periods over last 20 Years
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18-5.0
-1.0
3.0
7.0
11.0
15.0
for 20 Years ended June 30, 2018Rolling 3-Year Gross Excess Return relative to MSCI EAFE
Gro
ss E
xces
s R
etur
n
Callan Non-U.S. Dev Eq Style (10th to 90th) Median MSCI EAFE
Non-U.S. Developed Broad Equity Style versus MSCI EAFE
Fee Hurdle 0.45% 0.50% 0.55% 0.60% 0.65% 0.70% 0.75% 0.80% 0.85% 0.90%Median 95% 94% 93% 90% 89% 89% 86% 85% 84% 81%45th Percentile 99% 99% 99% 99% 96% 96% 95% 95% 94% 91%40th Percentile 100% 100% 100% 100% 100% 100% 100% 99% 98% 98%35th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%30th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%25th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Average Annualized 3-Year Excess Return (gross) – Median Manager: 1.72%
Exhibit 12
38Active versus PassiveKnowledge. Experience. Integrity.
How often Manager Beat Benchmark by more than Fee Hurdle in Rolling 3-Year Periods over last 20 Years
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18-10.0
-5.0
0.0
5.0
10.0
15.0
for 20 Years ended June 30, 2018Rolling 3-Year Gross Excess Return relative to MSCI Emerging Markets
Gro
ss E
xces
s R
etur
n
Callan Emerging Markets Style (10th to 90th) Median MSCI Emerging Markets
Emerging Mkts Broad Equity Style vs MSCI Emerging Markets
Fee Hurdle 0.70% 0.75% 0.80% 0.85% 0.90% 0.95% 1.00% 1.05% 1.10% 1.15%Median 65% 65% 63% 63% 61% 59% 58% 56% 55% 49%45th Percentile 76% 71% 71% 71% 70% 69% 69% 68% 68% 64%40th Percentile 84% 84% 81% 80% 80% 78% 78% 75% 74% 73%35th Percentile 93% 93% 91% 91% 89% 88% 86% 86% 86% 86%30th Percentile 99% 99% 99% 98% 96% 96% 96% 96% 96% 95%25th Percentile 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Average Annualized 3-Year Excess Return (gross) – Median Manager: 1.31%
Exhibit 12
Glossary of TermsExhibit 12
Glossary of TermsBARRA GEM World Predicted Beta- Systematic risk coefficient that expresses the expected response of the portfolio excess return to excess return on the market portfolio.
BARRA GEM Financial Leverage- Indicates the financial leverage of a company. Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity.
BARRA GEM Growth - Reflects historic and implies future growth expectations. This index is a predictor of future growth of a company and not simply a measure of historic growth. Thus it emphasizes retained earnings rather than measures of historic growth. The Growth index includes descriptors of payout, asset growth and historic growth in earnings, the level of earnings to price, and variability in capital structure.
BARRA GEM Liquidity- Describes return differences of stocks based on their relative trading activity. The factor is calculated using monthly, quarterly, and annual share turnover
BARRA GEM Momentum - Indicator of Stock Price Momentum. The Momentum index identifies stocks that have been recently successful mainly in terms of stock price, but also in terms of earnings. The relative strength of a stock, shown by the stock price, is the chief indicator of how well the stock has done. The Momentum index measures the success of the company over both the last year and the last five years. It does this in two ways: First, as measured by earnings growth; and second, as measured by price behavior in the market over the last five years and the last year. In addition, the frequency of dividend cuts is used as a negative indication.
BARRA GEM Size - A measure indicating the relative size of the companies in the portfolio.
BARRA GEM Size Non-Linearity- A measure that captures non-linear relationships between returns and log of market capitalization.
BARRA GEM Value - Book to price- The extent to which the portfolio stocks are priced inexpensively in the market.
BARRA GEM Volatility - Predictor of the relative volatility of a stock's price-This risk index is a predictor of the volatility of a stock based on its behavior, and the behavior of its options in the capital markets. Unlike beta, which measures only the response of a stock to the market, BARRA Volatility measures a stock's overall volatility, with its response to the market being but one source of volatility.
BARRA GEM Total Fund Beta- Total Fund Beta shows the rate at which your equity holdings plus cash rate of return will change relative to the broad equity market.
BARRA GEM Historical Beta- Historical Beta is a historic measure of a company's return to the market return, ordinarily computed as the slope coefficient in a 60-month historical regression. This version of Beta does not attempt to "predict" the Beta of a company from the fundamental characteristics of a company.
Source: Northern Trust
Exhibit 12
To: Investment Committee From: Investment Staff Date: October 5, 2018 Subject: Deutsche Bank Securities Lending Annual Review and Proposed Investment
Guideline Addition
Background SURS participated in the securities lending program offered by the master custodian, The Northern Trust Company, starting in the 1980's. In 2007, SURS opted to retain a third-party (non-custodian) securities lending provider, Credit Suisse. In September 2011, the Board of Trustees approved a search for master trust and custody services, and securities lending. The securities lending search concluded with the selection of Deutsche Bank in April 2012. Revenue Commentary Total revenue for the FYE 2018 period was $4.3 million. This represented a 20% decrease over the FYE 2017, an amount of approximately $1.1 million.
Profile and Performance Overview Average Lendable Market Value $10.6 Billion Average on Loan $866 Million Average Utilization Rate 8.1% Earnings $4.3 Million Top 5 Securities (as % of Total Earnings) 15%
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
FYE 2013 FYE 2014 FYE 2015 FYE 2016 FYE 2017 FYE 2018
Revenue
Revenue
Exhibit 13
The top five earning securities for FYE 2018 were:
• Visa Inc Class-A • Tesla Inc • SPDR S&P 500 ETF • IQE PLC • iShares Russell 2000
Minimum Weighted Average Gross Spread Restriction The securities lending strategy with Deutsche Bank includes a restriction requiring a 50 bps minimum weighted average gross spread across all activity ("hurdle"). This hurdle was not written into the investment guidelines but was implemented in practice at the start of the program to ensure a more risk-adverse approach. During our annual review process, Deutsche Bank brought to our attention that, on average, the loan spread on “specials” (the securities in greatest demand where fees are > 20 bps) has trended downward such that DB has had to either unwind some loans or forego a number of attractive loan opportunities that would otherwise have caused the weighted average gross spread across all activity to drop below the 50 bps hurdle. This began happening in the 4th quarter of 2017. SURS staff, PCA and Deutsche Bank have agreed to officially include the threshold in the investment guidelines and to reduce the hurdle to 25 bps. It is estimated that this change will increase loan balances by approximately $390 million at an average loan spread of 32.6 bps and thereby increase SURS’ revenue (after fees) by approximately $1.2 million per year. In terms of forward outlook, DB believes the spread at the program level will average closer to 40 bps. The new hurdle maintains a conservative risk profile, optimizes revenues to SURS, and accommodates trends in loan demand. There is no downside to SURS with the reduction in hurdle rate because of the dual indemnity provided by Deutsche Bank. Organization Deutsche Bank AG, founded in 1870, is a banking company with limited liability incorporated under the laws of the Federal Republic of Germany. The Bank consists of three Business Divisions: Corporate Banking & Investment Banking, DWS (Formerly Deutsche Asset Management) and Private, Wealth & Commercial Clients. The Agency Securities Lending ("ASL") team resides within the Corporate & Investment Banking group. The ASL g r o u p has lending desks in New York, London, Frankfurt, Dubai, Sydney and Hong Kong. The securities lending business is run on a global basis with the global head located in New York. The non-US business is managed in London by two co-heads. Each office has the capabilities and the training to handle all aspects of the securities lending product. Staffing Tim Smollen, Global Head of the securities lending business, oversees all aspects of the ASL group. Anthony Toscano, Head of US Agency Lending, is currently responsible for US operations
Exhibit 13
and risk & liability management. Joseph Santoro, Director, is Head of Product Sales in the US. Amy Dunn, Director, is Head of Client Service in New York. The following chart shows the organization of the ASL team.
The staffing of the ASL group has been stable over time, with five members having worked together continuously for more than 20 years, including Tim Smollen and Anthony Toscano in the U.S. Clients/Assets Deutsche Bank has 70 clients worldwide with total lendable assets of approximately $600 billion as of December 31, 2017. Total lendable assets have increased by approximately $100 billion from December 31, 2016. SURS assets account for $10.6 billion of the lendable base. Over the past three years, Deutsche Bank has added 16 new accounts to the securities lending program and 2 clients have left the program (Texas Municipal Retirement System and Kentucky Retirement System). Client Service Amy Dunn, Director of Client Service, and Gustave Christakos, Vice President are the daily client service contacts for the relationship. Deutsche Bank provides excellent service and is responsive to requests from SURS staff. Due Diligence Visit to Deutsche Bank On August 17, 2018, Ellen Hung and David Sancewich of PCA did an on-site due diligence meeting with the Deutsche ASL group. Attendees from Deutsche Bank included:
• Tim Smollen, Managing Director, Global Head of Agency Securities Lending • Anthony Toscano, Managing Director, Head of US Agency Securities Lending • Joseph Santoro, Director, Head of Product Sales
Exhibit 13
• Thomas Ryan, Director, Head of US Trading • Gustave Christakos, Vice President, Client Relationship Manager
The topics covered included organizational update, regulatory landscape, effect of securities lending, future of the repo market and program review. There was an extensive discussion on the financial stability of Deutsche Bank AG and the Federal Reserve’s announcement of the 2018 Comprehensive Capital Analysis and Review (CCAR) results for Deutsche Bank’s US subsidiary and intermediate holding company, Deutsche Bank’s US Corporation (DBUS). DBUS received positive quantitative results but the Federal Reserve objected to their capital plan submission for qualitative reasons. Deutsche Bank continues to address regulatory concerns by reducing expenses. The ASL group lost two positions as part of the reduction in force. Further discussion focused on Deutsche Bank’s ability to fully indemnify SURS against counterparty insolvency risk with respect to loans of securities and investments of cash collateral in repos. In addition to Deutsche Bank’s financial strength (€1.6 trillion balance sheet, €280 billion liquidity reserves), on March 1, 2018, ASL put in place a custom New York State domicile insurance policy written by a AA rated insurer. This policy covers a period of three years and has been paid in full. Staff asked Deutsche Bank to determine the time it would take to unwind all SURS outstanding loans and investments. Upon further analysis, Deutsche Bank feels comfortable that the program can be completely unwound, if need be, within 30 days with 83% of the balance returned within the first week. Consultant Comments PCA recommends that SURS continue to retain Deutsche Bank as its securities lending provider, with a 25-bps intrinsic hurdle added to the investment guidelines. DB has taken the extra step of adding indemnification insurance to further protect SURS from financial impairment. PCA and SURS staff will continue to monitor the securities lending program with DB and report back to the Board as needed. Conclusion and Recommendation SURS staff and PCA jointly recommend that Deutsche Bank be retained as a securities lending provider. Rationale for recommendation include:
• Risk averse securities lending program. • SURS is fully indemnified against counterparty insolvency risk and loss from investments
of cash collateral in repos. • The full indemnification is backed by Deutsche Bank AG’s financial strength. • In the event that Deutsche Bank is unable to meet its indemnification obligation due to
financial impairment, there is an insurance policy from an AA rated insurer with a coverage for three years that has been paid in full.
Exhibit 13
To: Investment Committee From: Investment Staff Date: October 5, 2018 Re: Northern Trust Master Custodian Review
Overview The Northern Trust Company (Northern Trust) has served as SURS global custodian since 1984. As SURS custodian, Northern Trust provides a variety of services, including securities safekeeping, trade execution and settlement, valuation, foreign exchange, income collection, tax withholding and reclamation, corporate actions, class action filings, performance analytics, investment risk monitoring, accounting and reporting. The Board of Trustees retained Northern Trust as SURS custodian at the conclusion of a global custody provider search in March 1997. In September 2002, the Board approved retention of Northern Trust without conducting a search. Two subsequent searches for custodial services were initiated, with requests for proposals issued in November 2006 and in October 2011, and resulted in the retention of Northern Trust. The most recent global custody provider search conducted by SURS concluded at the April 26, 2012 Board of Trustees meeting when Northern Trust was again retained as SURS master custodian. At the March 10, 2017 meeting, the Board of Trustees approved continued utilization of Northern Trust as master custodian. Organization Northern Trust Corporation is a publicly listed company that operates as a financial holding company and provides administration, asset management, and servicing solutions. The Northern Trust Company, the principal subsidiary of Northern Trust Corporation, is comprised of three core business segments. The Corporate & Institutional Services (C&IS) business unit, which furnishes custody services to SURS, provides asset administration, fund administration and information services to corporations and institutions worldwide. The Wealth Management (WM) business unit delivers trust, investment management and banking services to high net worth individuals and families. Asset Management (AM), currently provides U.S. equity index investment management services to SURS, is a global, multi-asset class investment manager serving institutions and individuals worldwide. These three business units are supported by Enterprise Enablement (E2). Northern Trust has not been involved in any large-scale corporate restructurings that have affected the organization’s personnel, systems, or ability to service clients. Northern Trust has engaged in acquisitions to expand the organization’s current product capability or geographical presence rather than to gain the clientele of competitors. This approach contributes to the long-term advantages of a strong brand and culture, a disciplined and client-centric strategic focus, an
Exhibit 14
integrated operating platform, and an experienced and stable management team. On October 2, 2017, Northern Trust announced the closing of its acquisition of UBS Asset Management, a leading fund administrator in Luxembourg and Switzerland. The acquisition positions Northern Trust as a leading administrator by assets in Switzerland and a top 10 asset servicing provider in Luxembourg. Northern Trust currently does not anticipate any significant organizational changes in the near future that would impact the organization’s business model, organizational structure or ability to deliver on commitments to clients. In 2009, Northern Trust Global Investments joined the United Nations’ Principles for Responsible Investing (PRI), an initiative that aligns with Northern Trust’s values of transparency, accountability and continuous improvement. Northern Trust supports a philosophy of developing internal talent levered by occasional external staffing additions. This practice assures continuity for the organization and maintains a diversity of thought in setting strategy and managing execution. The success of this philosophy is apparent in the tenure of the rank and file employees, of whom 31% have worked at Northern Trust for ten years or more. In 2017, Northern Trust made the following strategic leadership changes.
Announced/Effective Name Current Role New Role July 2016 / October 2017
Steve Potter President of Asset Management
Vice Chairman
July 2017 / October 2017
Shundrawn Thomas
Head of the Funds and Managed Acct
President - Asset Management
July 2017 / N/A David Wicks Head of Enterprise Enablement
Head of Continental Europe
October 2017 / January 2018
Mike O’Grady President CEO
As of March, 31, 2018, Northern Trust Corporation had total corporate assets of $124.5 billion and a capital base of approximately $9.6 billion. Northern Trust had $8.1 trillion in assets under custody and $1.2 trillion in assets under management. Unchanged from the prior year, Northern Trust derived 64% of corporate revenues from fee-based, non-interest activities and the remaining 36% of revenues from net interest income in 2017. The current long-term unsecured debt ratings from national credit rating agencies for the Corporation are AA- from Fitch, A2 from Moody’s, and A+ from Standard & Poor’s.
Exhibit 14
Client Service Northern Trust had 18,494 total active employees as of December 31, 2017. This total includes 471 client servicing staff and 13,372 individuals supporting the organization’s worldwide institutional asset servicing business. Northern Trust relationship managers have an average of approximately 19 years of service at the organization and oversee an average of five client relationships. Northern Trust has assigned a back-up relationship manager and a back-up account manager who have been cross-trained to ensure consistent client servicing to SURS. Northern Trust has assembled a team of client service professionals whose background and experience support the needs of SURS account in the areas of asset services, information services, decision support and asset management. In early 2018, SURS was assigned a new client executive, Anton Britton. The team servicing SURS account is listed in the organizational chart below.
Global Custody As of March 31, 2017, of the $8.1 trillion in assets under custody, $5.0 trillion are global custody assets and $3.1 trillion are US custody assets. Institutional clients totaled 2,409, of which 1,573 are US-domiciled and 836 are non-US domiciled.
Exhibit 14
In 2017, Northern Trust gained 57 and lost 19 custody clients, resulting in a net gain in assets of $20.17 billion. The primary reason clients transition away from Northern Trust is the consolidation of assets with another provider, often due to a merger or acquisition. Other reasons include plan terminations, Northern Trust’s unwillingness to provide credit support, and minimum fees for small clients. As of March 31, 2018, the mean custody account size at Northern Trust is $3.7 billion and the median custody account size is $354.3 million. The five largest public fund master trust/custody services clients have market value ranging from $43.62 billion - $209.91 billion. Performance Measurement/Analytics The internally developed performance system is sourced directly from Northern Trust’s accounting database. Monthly rates of return are dollar-weighted, based on fully accrued, trade-dated transactions and asset positions. Returns for periods longer than one month are time-weighted rates, calculated by linking the monthly dollar-weighted rates together. For investments structured as partnerships, Internal Rate of Return (IRR) returns are used for periods longer than one month. Improvements Processing operations and technology are at the center of Northern Trust’s business, with planned priorities indicating its importance to the organization. The key initiatives identified below demonstrate how Northern Trust has incorporated industry priorities into its own business development priorities in the product and service areas to benefit clients.
• Continued emphasis on web-based applications enabling clients and their investment
managers with technological solutions through Passport, Northern Trust’s online system.
• Data delivery warehouse to extend capabilities that further enhance the production of consolidated reporting based upon data collected from third parties for asset servicing clients.
• Increased attention on special and alternative assets and developments to service them effectively.
• Enhanced range of investment risk and performance tools available via Passport. • Straight-through-processing (STP) initiatives to improve the infrastructure of local
markets and promote settlement efficiency. Northern Trust operates one integrated technology platform, allowing enhancements to be provided to all clients at the same time, as each enhancement is developed and implemented only once. In order to meet varied client demands, Northern Trust uses and supports a combination of third-party and internally-developed software products which are integrated into a single global platform. Periodic concept testing sessions are held where Northern Trust asks clients in-depth questions regarding the solutions that clients consider imperative. Based on direction and input received during these sessions, Northern Trust designs new features and applications.
Exhibit 14
Northern Trust is committed to enhancing the functionality and ease-of-use of its global platform to improve the client online reporting experience. The goal of the current strategic initiatives is to enhance the integration of information, details and features. The initiatives include an enhanced mobile user interface, an iPad application with a high-level view of data, an expanded exposure dashboard, an enriched accounting experience, and a Fund Accounting dashboard. Recent enhancements include the integration of eVestment universe comparison capabilities on Investment Risk and Analytical Services (IRAS), the addition of multiple capabilities to the IRAS dashboard to improve transparency, the enhancement to fund accounting reporting, and the introduction of fair value reporting to support clients with fair value leveling disclosures. Technology spending by Northern Trust totaled approximately $2.3 billion for systems support, development and enhancements over the past three years. The organization has budgeted approximately $2.7 billion for the next three years (2018-2020). Devoting all technology spending to one integrated platform has been a major benefit to the organization, as each enhancement is only developed and implemented once. For the past eight years, members of the Northern Trust client service team and SURS investments staff have met on a regular basis to review and discuss current service issues and planned enhancements or changes. The meetings have proven to be an effective means to collectively address and resolve issues and to remain current on recent and upcoming changes. Account Review Meeting SURS staff had an account review meeting with representatives from Northern Trust on September 25, 2018 in Champaign. The topics covered included updates on SURS and Northern Trust, accounting and regulatory accounting, class actions, corporate actions, performance reporting for public and private markets, and technology updates. Consultant Comments Northern Trust is a well-regarded custodial bank that is utilized by various clients, including SURS. PCA does not have any concerns with the organization or the staff overseeing the SURS relationship and does not recommend any changes at this time. However, as part of ongoing monitoring, PCA and SURS staff will update the Board should any changes occur. Conclusion and Recommendation SURS staff and PCA jointly recommend that Northern Trust Corporation be retained as the master custodian. Rationale for recommendation include:
• Continues to hold credit ratings of AA-, A2 and A+ from Fitch, Moody’s and Standard & Poor’s respectively.
• Provides a reliable and satisfactory level of service to SURS staff.
Exhibit 14
• The team of client service professionals assigned to SURS account has remained relatively stable, experiencing only moderate turnover from the prior year and in recent years.
• Headquartered in Chicago, Illinois.
Exhibit 14
To: Investment Committee From: Investment Staff Date: October 4, 2018 Re: Parametric Portfolio Associates LLC (“Parametric”) Manager Annual Review Background SURS hired Parametric Portfolio Associates LLC (“Parametric”) as a cash overlay manager in September 12, 2014. Parametric also helps SURS maintain policy targets with regard to overweight or underweight of various asset classes. Organization The Parametric Group was founded in 1972 in Minneapolis, MN, now the Minneapolis Investment Center. Parametric obtained its first protection assignment in 1979 and its first traditional overlay assignment in 1986. A year later, in 1987, Parametric Portfolio Associates LLC was founded and headquartered in the Seattle Investment Center. Other first assignments followed throughout the next two decades, including custom indexing in 1990, the first tax-managed assignment in 1992, the initiation of the Parametric Emerging Markets Strategy in 1994, liability driven investing in 1996, the first commodities assignment in 1999, the Centralized Portfolio Management assignment in 2000, defensive equity in 2011, and first proprietary factor strategies in 2015. In 2014 Parametric established its Sidney Office. Parametric has been a majority-owned subsidiary of Eaton Vance Corp. since 2003. In 2007, Parametric formed Parametric Risk Advisors LLC, now the Westport Investment Center, and in 2013, Parametric acquired the Clifton Group. Currently, through its wholly-owned subsidiaries, Eaton Vance Acquisitions and EVA Holdings LLC, maintains voting control of Parametric and Profit and Capital interests of 94.5% and 99.2% respectively. Employees of Parametric and its subsidiary Parametric Risk Advisors LLC, through ownership in Parametric Portfolio LP, maintain an indirect Profit and Capital ownership interest in Parametric of 5.3% and 0.8%, respectively. Client Service Parametric utilizes a team approach for portfolio management which expands client coverage through shared responsibilities. The team approach assists in broadening the investment perspective by incorporating the expertise and experience of the entire group on each investment decision. The team approach is a key aspect in the continuity plan as it mitigates the risks involved with the departure of key personnel. A team of analysts is also available to help with clients. The team is responsible for coordinating with custodial banks to receive client account information and producing daily tracking reports used by the portfolio management team to implement the strategy program. The main contact for the SURS account is Dan Wamre, CFA, Senior Portfolio Manager.
Exhibit 15
Staffing Parametric has a total of 421 employees, 94 of whom are investment professionals, as shown in the table below:
Zach Olsen joined the firm in January 2017 as an Associate Portfolio Manager and is directly involved with the SURS strategy. In addition to Zach, there were 12 investment professional additions and three departures during the same time period. These additions and departures are not directly involved with the SURS strategy. Oversight of the SURS account is provided by the following key investment professionals: Dan Wamre, CFA Senior Portfolio Manager Anthony Moti, CFA Portfolio Manager Jan Mowbray, CFA Associate Portfolio Manager James Thorson, CFA Associate Portfolio Manager Portfolio Managers assigned to the SURS account have not taken any additional responsibilities in the past year. Currently, each portfolio manager has primary responsibilities on approximately 18 relationships, one up from a year ago. No additional material information related to staff reassignments of responsibility, committee changes, and prospective additions was reported as of June 30, 2018. Succession planning is a key element integrated in various functions of Parametric. The firm supports open communications and a collaborative environment between team members and with other departments at the firm. Parametric does not rely on the investment perspectives of a single individual. Instead, they use a team format to manage its strategies, with representatives from four areas collaborating to determine all aspects of the product. Employment contracts at Parametric are confidential and the firm does not disclose terms. Additionally, there have not been any changes in management or ownership structure in the past year nor there are any anticipated changes in the coming year. Clients/Assets Assets under management for Parametric are shown in the following table: (asked for clarification)
Number of Total Staff Number Involved with SUR’ Product
Portfolio Managers 66* 29* Analysts 15 15 Traders 39* 29* Total Investment Professionals 94 30 Other 330 70 Total Staff 421 114 * Portfolio Managers in Minnesapolis, MN (currently 29) perform dual roles in trading and portfolio management. Data as of June 30, 2018
Exhibit 15
From July 1, 2016 through June 30, 2018, Parametric gained 287 accounts with assets totaling $9.7 billion and lost 52 accounts with assets totaling $3.2 billion. During the same period of time, 31 accounts were gained in the SURS strategy with initial assets of approximately $3.5 billion and 22 accounts were lost with total assets at termination of $18 million approximately. Investment Process A Daily Tracking Report is used to track the status of the SURS portfolio. Investment Guideline parameters are coded into an internal system and are utilized to calculate the asset allocation, initial overlay positions, required daily trades, cash flows, fund rebalancing thresholds, margin, and other variables as delineated in SURS Investment Policy. Each day, a new Daily Tracking Report is generated and reviewed by analysts for accuracy and completeness. Analysts verify changes between target and actual overlay positions based on market and cash flow data, and calculate the required trades to maintain account compliance with guidelines. Data used to create the Daily Tracking Report is accessed beginning at 5 a.m. central time to ensure the report can be posted by 10:30 a.m. central time for client viewing via a secure website. The Portfolio Management Team will establish a process for communicating information regarding anticipated cash inflows and outflows. This cash flow management system enables Parametric to implement SURS’ predetermined Investment Policy Guidelines efficiently and anticipate any margin requirement changes. A trade may be entered into the system only by an authorized trader. The trade is subject to passing all pre-coded compliance checks before it may be submitted for approval. An authorized trader other than the individual who created the trade must also approve the trade before execution. This trading process significantly reduces the risk of error in implementing an overlay program. Upon approval, the vast majority of trades are sent for execution to the electronic trading platform via FIX protocol (an industry standard messaging protocol). The electronic trading platform gives Parametric access to several trading algorithms which are used to minimize the trading cost of implementing a particular trade. Upon execution, the details of the order fill are returned to Parametric via FIX, the fill details are affixed to the trade and booked to the general ledger, and positions are recorded in Parametric’s proprietary system, Investment Management System (IMS). Managing transaction costs while factoring in tracking error considerations is important in the implementation of an overlay program. Parametric seeks to minimize transaction costs on both an explicit and implicit basis. Parametric maintains several Futures Commission Merchant (FCM) relationships which facilitates competitively negotiated commission schedules. Schedules are renegotiated on an ongoing basis to ensure that fair and competitive pricing is in place (Parametric does not trade with any affiliates and earns no revenue from trading). Additionally, transaction costs can be minimized by having a thoughtful framework for the overlay program. The use of tolerance bands, under which trading commences only after a band has been breached can significantly reduce the number of trades. This reduction favorably affects the level of transaction
Strategy # of Account AUM (MM) Overlay (SURS strategy) 208 $82,670 Total 37,014 $231,470 As of June 30, 2018
Exhibit 15
costs without sacrificing the core benefits of an overlay program. Finally, by understanding the objectives and constraints of SURS, Parametric tailors the overlay program to employ instruments that best serve the SURS portfolio while minimizing transaction costs. For example, if SURS experiences numerous cash flows that require position adjustments, Parametric will use a set of futures contracts and cash tolerance bands that are different when compared to a portfolio with a more stable cash position. Parametric’s overlay investment management process has been continually enhanced over the last 30 years. Parametric continues to make ongoing improvements to the current investment process with a focus on reducing the risk of managing an overlay program and improving client outcomes. Recent advancements in technology have allowed Parametric to enhance and automate much of the daily investment process. Through policy driven system controls, the overlay program has become more scalable while simultaneously improving risk controls. Performance Over the past 12 months, the overlay strategy has performed in line with program objectives at 5 basis points below the custom benchmark. There are three main sources of tracking error for the overlay strategy. The first is the timing difference between Non-US and global benchmarks and the futures used to replicate these benchmarks. While the benchmark closes as the constituent markets close around the globe, the futures continue to trade in the US market. This timing mismatch can at times show tracking error that is optical in nature. The second source of tracking error is due to the overlaying of cash flows. The overlay is adjusted during the current day market hours and is benchmarked against the previous day market close. Therefore, buying into an up market or selling into a down market can result in underperformance to the benchmark. The third source of tracking error is due to the lack of credit exposure in the fixed income replication. Because the benchmark is the Barclay Capital Aggregate which contains credit, a replication using treasury futures will generally outperform the index as credit spreads widen and underperform as they tighten. Overall, futures provide return expectations that are relatively consistent with benchmark returns. Risk Control and Monitoring Systems Risk management is Parametric’s highest priority, and is not viewed as a discrete function. Instead, it is an integral part of the firm’s business model and is woven through all functions including trading, operations, investment technology, and accounting. Senior management and investment staff meet at least monthly to discuss risk management issues within the firm. Kip Chaffee, Managing Principal, is responsible for managing Parametric’s overall operations risk and enhancing internal controls in Minneapolis. Mr. Chaffee does not have trading responsibilities, nor does he have day-to-day operations or accounting tasks. His attention is solely focused on firm management. The Parametric’s proprietary Investment Management System (IMS) provides a process that facilitates portfolio monitoring seeking to ensure compliance with client specific Investment Policy Guidelines. IMS, which includes portfolio management, order management systems, accounting, operations, and compliance platforms, plays a critical role in Parametric’s back-office. Some of IMS’s functions include: Validation - Thousands of data quality checks are conducted in real time. These checks prevent invalid data from entering the system and provide immediate notifications to the necessary group.
Exhibit 15
For example, the portfolio management platform will not allow trading of restricted instruments and the accounting platform includes automatic checks and balances to ensure that the sum of debits equals the sum of credits, greatly reducing the opportunity for error. Compliance Rules - Client-specific and global rules enforce compliance with client Investment Policy Guidelines and external regulations, respectively. For example, a Portfolio Manager may not trade an instrument for a client unless it has been entered as an allowable contract in IMS. Other examples include disallowing short positions for an account, setting client level maximum exposure limits, and ensuring that firm-wide exchange position limits are not exceeded. By coding client specific Investment Policy Guideline rules into IMS, appropriate controls are in place. Trade Instruction/Workflows - Workflows are defined to enforce business processes. For example, each trade must pass all validation checks before becoming available for approval and must be approved by two separate Portfolio Managers (the first enters the trade; the second independently verifies the trade before execution). System Warnings - Hundreds of system rules are tightly integrated with specific business processes and are implemented via workflows. Rules may be hard, in which the user cannot proceed until the warning is resolved, or soft, in which case the user may enter an explanation for an exception. For a client account that has predefined rebalancing thresholds, for instance, the system will issue a warning if a threshold is breached. System Notifications - Predefined global checks within the system search in real time for invalid data or conditions that may require action. Examples include: a missing closing price for a security with active positions, a negative cash balance in a non-futures brokerage account, or a significant difference between the trade price and closing price for a same-day close. Automated Processes - Most business processes are fully automated in order to increase productivity and eliminate duplicate entry. Automated processes include trade/position/mark-to-market/collateral reconciliation, trade execution, client policy rules processing, and entries generated on the system’s investment calendar. Authentication and Authorization - Access to our systems is restricted to authorized users only through robust password rules. Furthermore, the system is configured to allow read/write/delete access only to user groups that are responsible for specified areas, allowing the Parametric to segregate responsibilities of each user or group of users. Audit Trail - IMS tracks all changes including field level auditing (e.g. old value, new value, user, date, time). Comprehensive internal audits are conducted on a regular basis by investment staff not directly associated with the account The chart below describes the risks involved in an overlay strategy and how Parametric monitors and controls them:
Types of Risk Definitions and Monitoring Market Risk The risk that the market performs in a way that was not
anticipated. For example, cash outperforms capital markets.
Exhibit 15
Systematic market risk is an inherent part of the PIOS® program and can neither be diversified away nor mitigated. Client specific policy guidelines are established to clearly define desired market risk based on client asset allocation targets.
Data/Communication Risk The risk that information received from outside sources is inaccurate, incomplete, or stale. Parametric establishes an electronic link to the custodial bank, third-party, and other custody providers on a daily basis. Fund data is downloaded into IMS. Automation reduces the potential for human error in data transmission.
Margin/Liquidity Risk The risk that market movements will result in the need for the posting of incremental variation margin or the accumulation of excess collateral in the margin pool. A section of the DTR is dedicated to margin required, the excess amount available and an estimate of the magnitude of an adverse market move which would require additional funds. Investment staff monitor this report daily. When market moves dictate, a Portfolio Manager will attempt to notify the client and/or consultant that either additional margin is needed or that excessive margin collateral exists. Parametric will work proactively with all parties to maintain adequate liquidity for the program.
Cash Flow Risk The risk that unexpected cash flows result in sub-optimal overlay execution. Parametric will work with the client and consultant to establish a communication system to track anticipated cash flow moves into and out of the fund along with any reallocation of manager positions.
Tracking Error Risk The risk that synthetic exposure of an index has tracking error to the cash index. Parametric seeks to minimize tracking error by utilizing optimized futures baskets of very liquid futures contracts. All derivative contracts will have some tracking error that cannot be mitigated by an overlay manager.
Trading Risk The risk that an error is made in the execution of a trade on behalf of the client. Parametric’s first step in minimizing trading risk is to accurately collect and analyze data. Investment staff then enter and review trades for compliance. The review process helps to ensure that trades executed comply with Investment Guidelines and no errors have been made. Trades are settled by back office staff within hours using continuously updated electronic trade reconciliation systems. Parametric has limited the number of brokers it works with to help maintain strong relationships which, in turn, promote back office accuracy, trading capabilities, and timely pricing. Through the institution of multiple levels of risk management, Parametric seeks to ensure that trade executions are correct. Trading activity is a relatively low risk area for an overlay program because of the infrequency and size of trades relative to total portfolio size. No trades are executed until two separate Portfolio Managers review the trade. Investment staff members
Exhibit 15
physically sit next to each other in the trading room so communication flows are frequent and direct.
Usage of Minority-, Female-, and Persons with a Disability-Owned Brokerage Firms SURS encourages the utilization of the services of minority- and female-owned brokerage firms, subject to best execution. In line with this effort, Parametric is currently able to trade to minority-owned brokerage firms, complying with the firm’s best execution policy and fiduciary responsibility. In selecting a counterparty, the primary objective shall be to obtain the most favorable overall price and execution, consistent with fiduciary duties and applicable law. In addition to overall price, best execution requires analysis of factors such as research capabilities, credit worthiness, settlement procedure and confidentiality. Other factors include size of the transaction, nature of the market for the security, timing of the transaction, experience of the broker involved and the quality of the ideas, information and service provided by the broker. Trading activity is periodically monitored by a Best Execution Committee. Parametric seeks to utilize derivative security focused brokers who provide efficient execution, superior operational, and administrative support to Parametric. Most often, Parametric can work with brokers of the clients choosing (including minority-owned brokerage firms) assuming they meet fair market standards. Our due diligence has not found minority-owned, female-owned or people with a disability owned brokerage firms with whom to execute futures trades as part of the overlay program. Consultant Comments In addition to cash overlay and providing incremental return to the portfolio, Parametric helps SURS maintain its target allocation by adjusting its allocation relative to over/underweights of the various asset classes. As SURS moves into its new asset class framework, PCA and SURS staff will be working closely with the firm to maintain target exposures as the portfolio is rebalanced. PCA does not have any concerns with the organization or the portfolio management team overseeing the SURS relationship. However, PCA and SURS staff will continue to monitor the portfolio and the organization and update the Board as needed. Conclusion and Recommendation SURS staff and PCA jointly recommend that Parametric be retained as an overlay manager. Rationale for recommendation include:
• Provides a team approach and environment of open communications and collaboration to consistently mitigate risks.
• A proven internal system to calculate and track asset allocation, initial overlay positions, required daily trades, cash flows, fund rebalancing thresholds, margins and other variables to ensure compliance with SURS Investment Policy.
• Overlay strategy has performed in line with program objectives.
Exhibit 15
Fiscal Year 2019-20 Summary Work Plan
Investment Committee Schedule State Universities Retirement System
Denotes recurring items - Denotes non-recurring items
FISCAL YEAR 2019 October 18, 2018 Annual Broker/Dealer Review Annual Global/International Equity Asset Class Reviews Annual Review of Securities Lending, Cash Overlay Program and Custodian - Consideration of Finalists for Transition Manager Search - Educational Topic (TBD)
December 6, 2018 Receipt of Annual Report to the Governor and General Assembly on Utilization of Emerging
Investment Managers Annual Real Estate Asset Class Review Annual Review of Investment Policy and Minority Brokerage Goals - Educational Topic (TBD) January 31, 2019 Annual Fixed Income & Emerging Market Debt Asset Class Reviews - Educational Topics – Trustee Educational Forum (TBD) March 7, 2019 Annual Hedged Strategies Asset Class Review Annual Commodities Asset Class Review - Educational Topic (TBD) April 18, 2019 Annual U.S. Equity Asset Class Review - Educational Topic (TBD) June 6, 2019 SURS FY ’20 Budget
Exhibit 16
Annual Private Equity Asset Class Review Annual Opportunity Fund Asset Class Review - Educational Topic (TBD)
FISCAL YEAR 2020 September 12, 2019 Annual Review of SURS Portfolio Consideration of SURS Fiscal Year 2020 Investment Plan Annual Investment Review of Self-Managed Plan (SMP) - Educational Topic (TBD) October 17, 2019 Annual Broker/Dealer Review Annual Global/International Equity Asset Class Reviews Annual Review of Securities Lending, Cash Overlay Program and Custodian - Educational Topic (TBD)
December 10, 2019 Receipt of Annual Report to the Governor and General Assembly on Utilization of Emerging
Investment Managers Annual Real Estate Asset Class Review Annual Review of Investment Policy and Minority Brokerage Goals - Educational Topic (TBD) January 30, 2020 Annual Fixed Income & Emerging Market Debt Asset Class Reviews - Educational Topics – Trustee Educational Forum (TBD) March 5, 2020 Annual Hedged Strategies Asset Class Review Annual Commodities Asset Class Review - Educational Topic (TBD) April 16, 2020 Annual U.S. Equity Asset Class Review - Educational Topic (TBD) June 4, 2020 SURS FY ’21 Budget Annual Private Equity Asset Class Review Annual Opportunity Fund Asset Class Review - Educational Topic (TBD)
Exhibit 16
Memorandum To: SURS Board of Trustees From: Martin Noven – Executive Director Date: September 4, 2018 Re: Schedule of 2019-2020 Meetings Dates Thursday, January 31, 2019 9:00 a.m. – 5:00 p.m. Investment Committee Friday, February 1, 2019 9:00 a.m. – 1:00 p.m. Investment Forum Chicago Thursday, March 7, 2019 9:00 a.m. – 5:00 p.m. Committee Meetings Friday, March 8, 2019 9:00 a.m. – 12:00 p.m. Committee Meetings Champaign Board Meeting Thursday, April 18, 2019 9:00 a.m. - 5:00 p.m. Investment Committee Chicago Thursday, June 6, 2019 9:00 a.m. - 5:00 p.m. Committee Meetings Friday, June 7, 2019 9:00 a.m. - 12:00 p.m. Committee Meetings Chicago Board Meeting Thursday, September 12, 2019 9:00 a.m. - 5:00 p.m. Committee Meetings Friday, September 13, 2019 9:00 a.m. - 12:00 p.m. Committee Meetings Chicago Board Meeting Thursday, October 17, 2019 9:00 a.m. - 5:00 p.m. Investment Committee Chicago Tuesday, December 10, 2019 9:00 a.m. - 5:00 p.m. Committee Meetings Wednesday, December 11, 2019 9:00 a.m. - 12:00 p.m. Committee Meetings Chicago Board Meeting
Exhibit 17
Thursday, January 30, 2020 9:00 a.m. – 5:00 p.m. Investment Committee Friday, January 31, 2020 9:00 a.m. – 1:00 p.m. Investment Forum Chicago Thursday, March 5, 2020 9:00 a.m. – 5:00 p.m. Committee Meetings Friday, March 6, 2020 9:00 a.m. – 12:00 p.m. Committee Meetings Champaign Board Meeting Thursday, April 16, 2020 9:00 a.m. - 5:00 p.m. Investment Committee Chicago Thursday, June 4, 2020 9:00 a.m. - 5:00 p.m. Committee Meetings Friday, June 5, 2020 9:00 a.m. - 12:00 p.m. Committee Meetings Chicago Board Meeting Thursday, September 10, 2020 9:00 a.m. - 5:00 p.m. Committee Meetings Friday, September 11, 2020 9:00 a.m. - 12:00 p.m. Committee Meetings Champaign Board Meeting Thursday, October 15, 2020 9:00 a.m. - 5:00 p.m. Investment Committee Chicago Thursday, December 3, 2020 9:00 a.m. - 5:00 p.m. Committee Meetings Friday, December 4, 2020 9:00 a.m. - 12:00 p.m. Committee Meetings Chicago Board Meeting
Exhibit 17