How to Increase Investment Returns in Public Safety Health & - - PowerPoint PPT Presentation

2016 Public Safety Employees’ Pension & Benefits Conference

Jennifer Mink Principal Investment Performance Services Philadelphia, PA

How to Increase Investment Returns in Public Safety Health & Welfare Funds

• Asset Allocation for Health & Welfare Funds

is typically 75% ‐100% fixed income (bonds)

• Bond prices have an inverse

relationship with interest rates

• Interest rates are currently near all‐time lows

What We Know

Historical Perspective on Interest Rates

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0%

The Last Full Interest Rate Cycle 1958 - 2015 10-Year Treasury Rate

27 Years 35 Years

Source: Federal Reserve, Ibbotson, JPMorgan ‐ Market yield on Jan 1st of each year

• interest rate environment;

below long‐term average returns

• interest rate environment;

above long‐term average returns

Interest Rate Impact on Bond Returns

Classification Term Corporate Bond Returns Long‐term 1926‐2015 5.4% Rising Rates 1958‐1981 3.0% Declining Rates 1981‐2015 8.2%

Measuring Interest Rate Sensitivity Duration

Term used to describe the "average life" or maturity of the bonds in a portfolio

New Word!

Expressed in years

"Risk multiplier" used to mathematically measure interest rate sensitivity

A "duration of 5 years" means the risk multiplier is 5 times the change in interest rates

Measuring Interest Rate Sensitivity

A 1% increase in interest rates means the portfolio will lose 5% 1% x 5 =5% If rates increase by 2%, the portfolio will lose 10% (and so on) 2% x 5 =10%

Example: Portfolio Duration of 5 years

Measuring Interest Rate Sensitivity

12 Month Holding Period ‐Annualized returns as of 6/30/16 Yield Change

(basis points)

10 Yr Treasury Barclays Agg ML 1‐3 yr ML Defensive US HY BB/B ML Short Duration US HY BB/B

‐50 6.72 4.82 1.88 8.18 6.02 ‐25 4.19 3.36 1.42 7.02 5.59

1.66 1.90 0.95 5.87 5.15 25 ‐0.87 0.44 0.49 4.72 4.72 50 ‐3.4 ‐1.02 0.02 3.57 4.28 100 ‐8.45 ‐3.93 ‐0.91 1.26 3.41 150 ‐13.5 ‐6.85 ‐1.84 ‐1.05 2.54

Rates decrease Rates increase

Source: Penn Capital

Idea #1 –High Yield Bonds

Rating Agencies

Standard & Poor's Moody's AAA Aaa AA Aa A A BBB Baa BB Ba B B CCC Caa CC Ca C C

High Yield Investment Grade

Junk Bonds High Quality High Yield

High Yield Bonds

Annualized Corporate Returns by Credit Rating 1989 - 2015

Chart Source: Chartwell Investment Partners

Return %

Bond Rating

High Yield Bonds

Chart Source: Chartwell Investment Partners

High Yield Risk vs. Return

Standard Deviation (risk)

How Have High Yield Bonds Performed?

Calendar Year Returns

Index YTD Sept 2016 2015 2014 2013 2012 2011 2010 2009 2008

Barclays Agg

5.8% 0.6% 6.0% ‐2.0% 4.2% 7.8% 6.5% 5.9% 5.2%

Barclays High Yield Ba+B 2% Capped

12.0% ‐2.7% 3.5% 6.2% 15.0% 6.0% 13.9% 45.2% ‐22.0%

Barclays High Yield 15.1% ‐4.5% 2.5% 7.4% 15.8% 5.0% 15.1% 58.6% ‐26.2%

Source: Wilshire Compass

How Have High Yield Bonds Performed?

Annualized Returns (as of September 30, 2016) Index 1 year 3 Year 5 year 7 year 10 Year

Barclays Agg

5.2% 4.0% 3.1% 4.1% 4.8%

Barclays High Yield Ba+B 2% Capped

11.7% 5.5% 8.0% 8.3% 7.3%

Barclays High Yield

12.7% 5.3% 8.3% 8.8% 7.7%

Source: Wilshire Compass

High Yield Bond Diversification

10 years + Annualized Expected Returns Asset Allocation #1 #2 #3

Core Fixed Income

100% 80% 65%

High Quality High Yield

0% 20% 35%

Return

3.3% 3.9% 4.3%

Risk

5.0% 4.8% 5.1%

Source: IPS Investment Committee Risk/Return Assumptions

Idea #2 –Real Estate

Forms of Institutional Real Estate Investments Type Form Primary Drawback Direct real estate (buy a building) Private Not liquid Limited Partnership Private Not liquid Real Estate Investment Trust (REIT) Public Volatility Institutional commingled fund Private Less liquid than stocks & bonds

How Real Estate Returns are Generated

Appreciation/Depreciation Total NFI‐ODCE return Income 4‐Qtr Rolling Return : Dec 1977 –Dec 2016

Types of Real Estate Investments

Geographic Location:

• Northeast
• Southeast
• Northwest
• West Coast

Property Type:

• Office
• Apartments
• Warehouse
• Hotel
• Retail

How Has Real Estate Performed?

Annualized Returns (as of June 30, 2016)

Index 1 year 3 Year 5 year 7 year 10 Year Barclays Agg 6.0% 4.1% 3.8% 4.6% 5.1%

NFI‐ODCE (equal weighted)

12.3% 13.0% 12.7% 10.6% 5.9%

Wilshire REIT

17.9% 14.3% 15.8% 15.7% 5.9%

Source: Wilshire Compass

How Has Real Estate Performed?

Calendar Year Returns

Index YTD June 30, 2016 2015 2014 2013 2012 2011 2010 2009 2008 Barclays Agg

5.8% 0.6% 6.0% ‐2.0% 4.2% 7.8% 6.5% 5.9% 5.2%

NFI‐ODCE (equal weighted)

4.7% 15.1% 12.4% 13.3% 11.0% 16.0% 16.1% ‐30.7% ‐10.4%

Wilshire REIT

11.1% 4.2% 31.8% 1.9% 17.6% 9.2% 28.6% 28.6% ‐39.2%

Source: Wilshire Compass

Public vs. Private Real Estate

Source: Wilshire Compass

Public vs. Private Real Estate

NFI‐ODCE US Bonds Barclays Agg US Large Cap S&P 500 US Small Cap Russell 2000 Wilshire REIT

Risk/Return December 31, 1978 –June 30, 2016

Source: Wilshire Compass

Real Estate Diversification

10 years + Annualized Expected Returns Asset Allocation #1 #2 #3

Core Fixed Income

100% 65% 60%

High Quality High Yield

0% 25% 25%

Real Estate

0% 10% 15%

Return

3.3% 4.5% 4.8%

Risk

5.0% 4.4% 4.2%

Source: IPS Investment Committee Risk/Return Assumptions

Idea #3 –Opportunistic Hedge Funds

Low Correlation to Barclays Agg (and equity indices) Provides downside protection during periods of credit (and equity) market stress

HFRI Credit Index Barclays US Aggregate MSCI World 3‐year Correlation ‐0.03 0.79 5‐year Correlation ‐0.12 0.83

The HFRI Credit Index is a composite index of strategies trading primarily in credit markets. It is an aggregation of following 7 HFRI substrategy indices. HFRI ED: Credit Arbitrage Index, HFRI ED: Distressed/Restructuring Index, HFRI ED: Multi‐Strategy Index, HFRI RV: Fixed Income‐Asset Backed Index, HFRI RV: Fixed Income‐Convertible Arbitrage Index, HFRI RV: Fixed Income‐Corporate Index, and HFRI RV: Multi‐Strategy Index. Source: HFRI

Opportunistic Credit HFoFs

• Bank deleveraging and increased

regulatory requirements for banks have led to new opportunities: Distressed asset sales New loan origination Orphaned markets

Credit HFs vs. Core Bonds

Source: Wilshire Compass

Credit HFs vs. Core Bonds

Source: Wilshire Compass

Opportunistic Credit HFoFs Characteristics

Diversified, high yielding credit portfolio Dynamically allocate across credit classes Niche situations; Global markets Nimble fund size Medium to low duration Premium ‐ Target returns 8‐10%+ Open‐ended fund structure

Hedge Fund Diversification

10 years + Annualized Expected Returns Asset Allocation #1 #2 #3

Core Fixed Income

100% 55% 50%

High Quality High Yield

0% 25% 25%

Real Estate

0% 15% 15%

Opportunistic HFoF

0% 5% 10%

Return

3.3% 5.1% 5.4%

Risk

5.0% 4.5% 4.8%

Source: IPS Investment Committee Risk/Return Assumptions

The Power of Diversification

Source: IPS Investment Committee Risk/Return Assumptions

10 years + Annualized Expected Returns Asset Allocation #1 #2 #3 #4 #5 #6 #7

Core Fixed Income 100% 80% 65% 65% 60% 55% 50% High Quality High Yield 0% 20% 35% 25% 25% 25% 25% Real Estate 0% 0% 0% 10% 15% 15% 15% Opportunistic HFoF 0% 0% 0% 0% 0% 5% 10% Return

3.3% 3.9% 4.3% 4.5% 4.8% 5.1% 5.4%

Risk

5.0% 4.8% 5.1% 4.4% 4.2% 4.5% 4.8%

Risks/Drawbacks

High Yield Increased credit risk Risk of defaults Real Estate Less liquidity than bonds Depreciation Hedge Funds Less Liquidity than bonds Poor investment thesis

Next Steps

Define your investment goals Know your Fund's liquidity needs Understand risk exposures/risk tolerance Establish meaningful asset allocation guidelines Work with experienced professionals

Questions?

Jennifer Mink Principal | Senior Consultant jmink@ips‐net.com

Equity Asset Class Return Risk Fixed Income Asset Class Return Risk Alternatives Asset Class Return Risk

U.S. Large Cap 7.50% 17.00 Cash Equivalents 2.00% 0.50 Multi-Strategy Hedge Fund of Funds 6.00% 7.00 U.S. Mid Cap 7.75% 19.00 Short-term Gov /Credit 2.50% 2.50 Opportunistic Hedge Fund of Funds 9.00% 12.00 U.S. Smid Cap 7.75% 22.00 Intermediate Investment Grade 3.00% 4.00 Long Short Equity Hedge Fund of Funds 7.00% 10.00 U.S. Small Cap 8.00% 25.00 Core Investment Grade 3.25% 5.00 Global Tactical Asset Allocation 7.25% 12.50 International 8.00% 20.00 Mortgages 4.00% 4.00 Core Real Estate 7.75% 9.00 International Small Cap 8.50% 26.00 Short Duration High Quality High Yield 5.50% 6.25 Value -Add Real Estate 9.00% 11.00 Emerging Markets 10.00% 27.50 High Quality High Yield 6.00% 9.00 Private Equity 10.00% 25.00 Global Equity 7.75% 17.50 Opportunistic Fixed Income 4.50% 6.00 Infrastructure 7.00% 13.00 Short Duration Global Bonds 3.50% 5.00 Risk Parity 7.25% 16.00 Commodities 3.75% 18.50

• IPS Investment Committee (06/16).
• Inflation expectation 2.50%.
• The above chart represents an annualized return forecast for different asset classes using index returns (net of fees). These forecasts are forward-looking

assumptions based on reasonable beliefs of the IPS Investment Committee, but are not a guarantee of future performance. Actual results may differ from the forecast above.