State Board of Administration Investment Advisory Council March 2011 Meeting Report
Mar 16, 2011
The State Board of Administration (“Board”) Investment Advisory Council (“Council”) met via teleconference on March 8, 2011 to discuss the performance of the Florida Retirement System (“FRS”) pension plan, review an asset liability and allocation study, and elect new officers. To view the meeting materials, click here.
The six-member Council provides independent oversight over the Board’s funds and major investment responsibilities, ranging from the FRS programs to the Florida Hurricane Catastrophe Fund and the Lawton Chiles Endowment Fund.
SBA Executive Director Ash Williams gave the opening remarks, focusing on the impact of having three new trustees on the Board, as well as the importance of reviewing and updating pertinent items to ensure that each new Board member is fully informed. The three new trustees are Florida Governor Rick Scott, chairman; Chief Financial Officer Jeff Atwater, treasurer; and Attorney General Pam Bondi, secretary.
The transfer of institutional knowledge is critically important because of the “unprecedented” and “100 percent” change in leadership, Mr. Williams said, adding that the new trustees need to fully understand the Board’s investment policies and practices.
“We will be visiting various processes,” he continued. “How we do asset liability analysis, how we derive from that analysis appropriate asset allocation and how we execute on that asset allocation to continue the long-term trends toward a good outcome.”
Mr. Williams advised that the Council will be revisiting its 2009 and 2010 actions and updating them to reflect some of the current Legislative activity that could affect the structure and liability side of Florida’s economy.
“We will probably be in a position to take some of the risk off the table once we know for sure what the Legislature has done in spring,” he said.
The Council will consider managing foreign equity in the same passive manner it manages domestic equity, Mr. Williams continued. Keen attention will also continue to be focused on enterprise risk management and compliance, as was started in 2009, he said.
The Council’s primary goals and objectives are listed below:
- Promote organizational values, including cost effectiveness and adherence to the highest ethical, fiduciary and professional standards
- Deliver superior investment performance
- Proactively manage human capital risk
- Maintain superior operational and technological infrastructures
- Deliver superior administrative and client services
SBA Deputy Executive Director Kevin SigRist gave the Performance and Major Initiatives Update, noting that a good economy and improving job growth in the job market has created some “headwinds” in the bond market, which has been very supportive for equity exposures.
“The outlook is pretty benign with three percent growth, perhaps more, perhaps less depending on what happens with the price of oil,” Mr. SigRist said. He requested Council members to let him know what type of reporting they would like to see in the future.
SBA assets have increased substantially, Mr. SigRist reported. In February 2011, the FRS Pension Plan totaled approximately $127 billon and its investment plan totaled $6,166 billion. The Florida Hurricane Catastrophe Fund totaled $10,575 billion and the Lawton Chiles Endowment Fund totaled $770 billion.
Mr. SigRist also reviewed the performances of nine different funds and compared the FRS pension plan attribution of managed versus benchmark funds over several periods ranging from three months to 10 years. In January and February, several transfers were made to complete rebalances, he said.
He summed up SBA strategic investments as follows:
- The SBA has $3.2 billion in market value, with total exposure to market value on all capital commitments equaling $5.2 billion.
- Corporate governance funds total $450 million.
- Hedge funds and related vehicles total $83 million.
Pension Plan Review; Regular Quarterly Performance Report
Mike Sebastian of Hewitt EnnisKnupp, an investment advisory services firm, gave the quarterly performance report on the FRS pension plan review. His report included commentary on the world market, other asset classes and allocations, and some comparison with peer groups, as well as detail on the various asset classes. He said performance news is good, and that the FRS plan is well-diversified with six broad asset classes. The FRS highlights are listed below:
- The pension plan performance has been strong over both long and short-term periods when measured against the performance benchmark and long-term target
- The performance relative to peers is competitive over both long and short-term periods
- The pension plan is well-diversified
- Hewitt EnnisKnupp and the Board staff revisit the plan annually through informal and formal asset allocation and asset liability reviews
- Adequate liquidity exists within the asset allocation to pay the monthly obligations of the pension plan consistently and on a timely basis
Mr. Sebastian discussed numerous measures of fund performance during his presentation, explaining that, over one, three, five, 10 and 15-year periods, the SBA’s Total Fund outperformed the Performance Benchmark. Return on the Total Fund, which is composed of cash, high yield, real estate, domestic stock, foreign stock, strategic investments and fixed income, exceeded the median fund in the Trust Universe Companion Service (“TUCS”) defined benefit plan during the fourth quarter and over the one and five-year periods. TUCS has been the standard used by plan sponsors to evaluate their investment performance since 1978.
The Total Fund underperformed during the aforementioned three-year period and was level during the 10-year period. Mr. Sebastian added that the Total Fund return exceeded the median fund in the TUCS top-ten defined benefit plan during the fourth quarter, as well as over the one, three and five-year periods.
The overall investment of the FRS outperformed relative to the Performance Benchmark in many categories. For example, the Global Equity Asset Class, created in July 2010, approximated its Asset Class Target during the fourth quarter and has outperformed since inception, Mr. Sebastian said.
Over a one-year period, the net market value of the FRS plan increased from $6,368,816,867 over the last quarter ending in December 2010 to $10,660,353,058 over the entire year, Mr. Sebastian added.
Rowland Davis of Hewitt EnnisKnupp then presented the 2010 Asset Liability/Asset Location Study. He introduced the study by explaining that his role is to focus on how much risk is appropriate to take within the FRS fund.
“We do these studies every year, and then every three years we embed that in a bigger process of reviewing the whole allocation process,” Mr. Rowland said. He discussed the pension plan, finance concepts, cash flows and how liabilities are derived from cash flows.
“The pension plan is in most pure sense a series of cash flows. Cash flows out. All these numbers are rough estimates using rules of thumb,” he continued. “One of the first things I will do is to start to cut up these cash flows into different layers – in terms of measuring liabilities and measuring funding rates. Benefits are one of most front and center obligations.”
He explained that the second layer is composed of benefits for active employees based on current service and current pay levels. A third category includes benefits that have not yet been earned, and a fourth includes benefits for future employees who are not yet hired.
He further noted that liabilities can be determined in several ways. The most common way is to use the estimated future return of the funds. He said the actuarial firm of Milliman is currently using 7.75 percent as the discount rate.
“Think of liability as a funding target – something an actuary uses to guide investment, the way the corporate pension world is working right now,” he said. “This has evolved a lot over the past 25 years. It used to be about long term cost management. Balance sheet issues weren’t looked at.”
He said Florida’s retirement system is “among the best funded of plans in the country” with a good history of making contributions as required. He noted that the State’s investment policy is long-term oriented toward taking the highest risk return. The cost of the long-term plan is 12 percent of payroll, he said.
Some pending factors might slow the growth of liability, Mr. Davis remarked.
“If the plan is closed to new entrants and cost of living adjustment is phased out and employee contributions are added, it’s possible you could see the result of our model dialed down maybe 10 percentage points – that is the unknown,” Mr. Davis added.
Mr. Sebastian went on to say that the 2010 allocation to existing assets was within the optimal range. The focus now is how the risk reward asset plan can further be improved, he said. A risk level similar to the current policy with a higher rate of returns and more opportunistic diversification is what is being sought.
Mr. Sebastian went on to explain the SBA’s approach to hedge fund investing, and how it meets with service providers such as administrators, auditors and brokers.
“We generate sources through talking to folks in the industry, talking to analysts, and we try to assess a number of factors. What is the source of market inefficiency they are trying to take advantage of?” he added, saying that hedge fund investing makes sense because hedge fund managers typically look for the best opportunities for investment and return.
“Do your homework before making an investment and really understand what could go wrong if something goes wrong,” he said.
One Board member said the Council will reconvene after Florida’s 2011 Legislative Session concludes, and see if the new trustees are comfortable moving ahead with the existing plans.
“The overall plan is … to come back after the Legislative session with a more informed view,” one Council member said. “We want to see if we can get a feeling among the trustees if they are comfortable or uncomfortable going ahead and adjusting the statutory alternative cap.”
In conclusion, the Council chose two new officers, electing Robert Gidel chairman and David J. Grain as vice chairman. With no further business before the Council, the meeting was adjourned.
Should you have any comments or questions, please contact Colodny Fass.