Opportunistic Fixed Income Review February 15, 2018 All Data as of - - PowerPoint PPT Presentation

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Opportunistic Fixed Income Review February 15, 2018 All Data as of - - PowerPoint PPT Presentation

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Opportunistic Fixed Income Review February 15, 2018 All Data as of December 31, 2017 Unless Otherwise Stated Investment Management Division Role in the Portfolio Attractive Absolute Returns Long-term returns that are competitive with

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SLIDE 1

Opportunistic Fixed Income Review

February 15, 2018

All Data as of December 31, 2017 Unless Otherwise Stated

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SLIDE 2

Investment Management Division

Role in the Portfolio

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  • Long-term returns that are competitive with long-term public equities, after consideration
  • f lower downside risk, due to opportunistic investments, longer duration private

investments, restructurings, leverage, hedging, and trading skill

Attractive Absolute Returns

  • Achieve or exceed the return on the performance benchmark over a long period of time,

within reasonable risk parameters

Competitive Relative Returns

  • Enhance the diversification of the Fund relative to public equity and investment grade fixed

income

Diversification

  • Protect capital through credit-oriented investments and trading strategies that are designed

to minimize downside risk

Capital Preservation

  • The structure of certain fixed income assets may provide protection against the detrimental

effects of deflation

Deflation Protection

  • The asset class (N.C.G.S. § 147-69.2(b)(6c)) was approved for investment by the NC

General Assembly in June 2009.

Portfolio Launched June 2009

Source: Investment Policy Statement for North Carolina Retirement Systems, July 1, 2014

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SLIDE 3

Investment Management Division

Portfolio Components

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Direct Lending Relative Value Convertible Arbitrage Long/Short Credit Structured Credit High Yield Bonds Traditional Corporate Credit Distressed Credit Special Situations Hedge Funds Bank Loans High Yield Bonds Post-Reorg Equity Distressed Credit Components Strategies / Types of Investments Whole Loans Derivatives Mezzanine Debt Real Estate Loans Structured Credit Event-Driven Dislocation

Note: See slide 19 for details on the composition of the Opportunistic Fixed Income Benchmark.

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SLIDE 4

Investment Management Division

Portfolio Components

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Portfolio Component* Target* 12/31/17 +/- Maximum* Traditional Corporate Credit 15% 15% 0% 50% Distressed Credit 25% 9%

  • 16%

50% Hedged Fixed Income 45% 47% 2% 75% Special Situations 15% 29% 14% 75%

* Portfolio Components, Targets, and Maximums come from the Investment Policy Statement for North Carolina Retirement Systems, July 1, 2014

Note: See slide 19 for details on the composition of the Opportunistic Fixed Income Benchmark.

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Investment Management Division

Portfolio History

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Note: Fund count excludes liquidated investments.

Portfolio Market Value Timeline by Component

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%

  • 1,000

2,000 3,000 4,000 5,000 6,000 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 $ Millions Traditional Corporate Credit Distressed Credit Hedged Fixed Income Special Situations Opp FI % of Total Plan

Growth of Manager Relationships and Number of Funds

6 6 6 8 8 8 9 13 15 16 17 18 19 19 20 21 22 23 26 27 27 28 28 28 28 28 28 29 29 30 37 37 37 37 38 2 2 2 3 3 3 4 8 10 11 12 13 14 14 15 15 16 16 17 18 18 19 20 20 19 19 19 19 19 20 20 20 20 20 21 5 10 15 20 25 30 35 40 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 # of Funds (by Commitment) # of Managers

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Investment Management Division

Portfolio Performance

15.9% 2.2% 14.0% 16.6% 3.4%

  • 2.6%

7.1% 7.1% 9.5%

  • 4.0%

4.9% 5.3% 0.3%

  • 7.0%

14.0% 4.1%

  • 10%
  • 5%

0% 5% 10% 15% 20% 25% Opp FI Opp FI Benchmark

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Calendar Year Performance

7.1% 3.7% 6.1% 6.6% 10.1% 4.1% 3.3% 3.1% 2.3% 4.3% 0% 2% 4% 6% 8% 10% 12% 1 Yr 3 Yr 5 Yr 7 Yr Since June 2009 Opp FI Opp FI Benchmark

Annualized Performance

Note: See slide 19 for details on the composition of the Opportunistic Fixed Income Benchmark.

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Investment Management Division

Portfolio Performance

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Historical 5-Year Correlation

NCRS Pub Eq Priv Eq NC RE Opp FI IG FI Infl Sen Core RE M Strat NCRS 1.00 Pub Eq 0.95 1.00 Priv Eq 0.12 0.02 1.00 NC RE (0.21) (0.30) 0.39 1.00 Opp FI 0.49 0.58 0.28 0.02 1.00 IG FI 0.26 (0.02) 0.06 0.09 (0.34) 1.00 Infl Sen 0.56 0.48 0.20 (0.04) 0.59 0.05 1.00 Core RE 0.12 0.10 0.16 0.14 0.10 0.08 (0.21) 1.00 M Strat 0.89 0.97 (0.03) (0.33) 0.59 (0.15) 0.42 0.08 1.00

0% 5% 10% 15% 20% 25% Opp FI Opp FI Benchmark

Rolling 1-Year Volatility

1.3% 1.9%

Quarterly data as of 12/31/2017

Note: See slide 19 for details on the composition of the Opportunistic Fixed Income Benchmark.

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SLIDE 8

Investment Management Division

Portfolio Performance

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Portfolio Component Annualized Performance vs. Market Benchmarks

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 1 Year 3 Years 5 Years 7 Years Since June 2009* Opp FI Trad Corp Credit Opp FI Distressed Credit Opp FI Hedged Fixed Income Opp FI Special Situations Credit Suisse Leveraged Loan Index HFRX ED: Distressed Restructuring Index HFRX Relative Value Arbitrage Index ICE BofAML US High Yield Index

Note: See slide 19 for details on the composition of the Opportunistic Fixed Income Benchmark.

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Investment Management Division

Portfolio Characteristics

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Note: Information is based on market value *Level 1 Liquidity = T+3; Level 2 = T+3 to 12 Months; Level 3 = 12 to 24 Months; Level 4 = Greater than 24 Months

Allocation by Strategy

Traditional Corporate Credit 15.2% Distressed Credit 9.0% Hedged Fixed Income 47.3% Special Situations 28.5%

Liquidity by Level*

Level 1 9.6% Level 2 32.6% Level 3 21.4% Level 4 36.4% 81.7% 15.5% 0.7% 0.2% 0.8% 0.6% 0.7% 0% 20% 40% 60% 80% 100% North America Europe Asia (ex - Japan) Japan South America Australia/New Zealand Other

Capital Structure

Senior 47.9% Junior 32.9% Convertibles 3.1% Equity 16.1%

Allocation by Geography

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SLIDE 10

Investment Management Division

Portfolio Characteristics

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Allocation by GICS Sector

7.1% 3.6% 9.9% 14.8% 1.9% 5.6% 26.6% 7.4% 7.5% 1.6% 1.0% 3.1% 9.8% 0% 5% 10% 15% 20% 25% 30%

*Holdings that cannot be classified into any one particular sector, as self-reported by the investment manager

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Investment Management Division

Portfolio Characteristics

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Account Type by Count Account Type by Market Value Account Type by Commitment

Commingled, 26 Separately Managed, 11 Commingled, 48.1% Separately Managed, 51.9% Commingled, 58.2% Separately Managed, 41.8%

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Investment Management Division

Accomplishments since our last IAC update

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  • 1. Focused our efforts on high conviction fund managers
  • 2. Reduced exposure to hedge fund of funds
  • 3. Increased exposure to traditional corporate credit
  • 4. Opportunistically took advantage of the spread widening that took place

in early 2016

  • 5. Continue to negotiate favorable economic terms on new and existing

fund relationships

  • 6. Transitioned one credit manager to the Managed Account Platform
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Investment Management Division

Since we last spoke to the IAC

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Generally speaking, the market has experienced the following:

  • Credit spreads have continued to rally across many sectors and asset

classes (i.e., distressed, high yield, leveraged loans)

  • Decrease in volatility
  • Access to corporate credit as measured by new issue volumes
  • Default rates remained low
  • Recovery rates increased
  • Period of strong investment returns
  • Net inflows into credit-oriented mutual fund products
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SLIDE 14

Investment Management Division

Corporate Credit Spreads

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Source: BofA Merrill Lynch (accessed via Federal Reserve Bank of St. Louis). Used with permission. See disclaimer on slide 32.

0.00 2.50 5.00 7.50 10.00 12.50 15.00 17.50 20.00 22.50 25.00 27.50 30.00 32.50 35.00 37.50 40.00 42.50 45.00 Investment Grade High Yield CCC & Below

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SLIDE 15

Investment Management Division

High Yield Index Price Distribution

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Source: Bloomberg

10 20 30 40 50 60 70 80 90 100 % of Index

% of High Yield Index at Specified Trading Range or Below

Price[0 - 75] Price[75 - 90] Price[90 - 95] Price[95 - 100] Price[100 - 105] Price[105 - 110] Price[110 - 125] Price[ >=125]

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Investment Management Division

What does this mean for the investment pipeline?

  • 1. Continue to be disciplined about deploying capital
  • 2. Not overly excited about valuations
  • 3. Do not see a near term catalyst that would create a major dislocation in

credit

  • 4. Create investment capacity and prepare for the next large scale

investment opportunity

  • 5. Continue monitoring managers for strategy drift

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SLIDE 17

Investment Management Division

Forward Looking Opportunity Set

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More Attractive Less Attractive

  • On a select basis
  • Energy – Private Debt
  • Middle Market Lending
  • Senior Secured Debt
  • Real Estate Debt
  • US High Yield
  • CLOs

Sectors

  • Traditional Retail
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SLIDE 18

Investment Management Division

Strategic Considerations

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  • 1. Where are we in the credit cycle?
  • What is our risk tolerance in the current environment?
  • Should we maintain current underweight or close gap to target weight?
  • 2. What is the optimal structure for the portfolio?
  • Preference for SMAs vs. commingled structures
  • Preference for open-end funds vs. closed end funds
  • Large diversified platforms vs. smaller specialists
  • Reduce or increase the number of managers
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SLIDE 19

Investment Management Division

Portfolio Benchmark

15% 15% 20% 50% Credit Suisse Leveraged Loan Index BOAML US High Yield Index HFRX Relative Value Arbitrage HFRX Distressed

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Note: The BOAML US High Yield Index is from BofA Merrill Lynch and is used with permission. See disclaimer on slide 32.

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Investment Management Division

Appendix

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Investment Management Division

High Yield Bond and Loan Default Rates

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Investment Management Division

High Yield Bond and Loan Recovery Rates

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Investment Management Division

High Yield Bond and Loan Issuance

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Note: Values are in billions of U.S. Dollars.

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Investment Management Division

High Yield Bond and Loan Fund Flows

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High Yield Loans

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Investment Management Division

`Covenant-Lite Loan` New Issue Volume

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Note: Values are in billions of U.S. Dollars.

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Investment Management Division

High Yield Bond and Loan Index Volatility

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Rolling 12-Month Standard Deviation For 10 Years Ended December 31, 2017

Source: BofA Merrill Lynch and Credit Suisse (accessed via BNY Mellon Workbench). Used with permission. See disclaimer on slide 32.

0% 5% 10% 15% 20% 25% 30% High Yield Bank Loans

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SLIDE 27

Investment Management Division

Net Percentage of Domestic Banks Tightening Standards

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Source: Federal Reserve Bank of St. Louis

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SLIDE 28

Investment Management Division

Delinquency Rate by Product for Domestic Banks

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Source: Federal Reserve Bank of St. Louis

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Investment Management Division

Fixed Income Yield Landscape

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Source: Bloomberg, Federal Reserve Bank of St. Louis

  • 2.5%

0.0% 2.5% 5.0% 7.5% 10.0% 12.5% 15.0% 17.5% 20.0% 22.5% 10 Year Treasury German 10 Year JP Morgan EMBI US Agency MBS Non Agency CMBS IG Corporates HY Corporates

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Investment Management Division

Review of Rate Changes and Sensitivity

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U.S. Treasury Yield Curve

Source: Federal Reserve Bank of St. Louis, Bloomberg

0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25 Dec-17 Dec-16 Dec-15 Dec-14

Treasuries IG Credit Bank Loans HY Credit Relative Value Distressed S&P 500 10/20/94 2.54

  • 5.54
  • 5.67

12.88 0.30

  • 3.01

01/21/00 2.09

  • 2.95
  • 3.02

4.42 1.19 11.77 15.46 18.17 06/14/04 1.76

  • 4.95
  • 2.92

6.79 9.29 5.01 10.44 15.79 06/27/06 1.31

  • 2.16
  • 2.65

6.23 4.40 4.84 7.41 6.04 12/30/09 1.69

  • 4.19

19.45 45.35 58.70 37.28

  • 9.84

29.54 09/05/13 1.38

  • 4.59
  • 2.52

6.64 7.27 2.74 1.99 20.58 07/10/17 1.01

  • 3.59

0.74 7.11 10.92 4.28 11.29 16.36 Total Return (%) 10-Year UST Yield Rise (%) 12-Months Ending

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Investment Management Division

Notes:

All data presented are based on currently available information at time of publication and may be revised subsequently. The Opportunistic Fixed Income Benchmark is comprised of 50% HFRX Distressed Securities Index; 20% HFRX Relative Value Index; 15% Credit Suisse Leveraged Loan Index; and 15% BOAML US High Yield Index. The BOAML US High Yield Index is from BofA Merrill Lynch and is used with permission. See disclaimer on slide 32. The Opportunistic Fixed Income asset class (N.C.G.S. § 147-69.2(b)(6c)) was created by the General Assembly in June 2009. It included some investments that were previously authorized under other provisions of G.S. § 147-69.2.

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Investment Management Division

Disclaimer

BOFA MERRILL LYNCH IS LICENSING THE BOFA MERRILL LYNCH INDICES “AS IS,” MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE BOFAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THEIR USE, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND THE DEPARTMENT OF STATE TREASURER, OR ANY OF ITS PRODUCTS OR SERVICES.

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