Rhode Island SIC Inflation Protection Class Policy & Structure - - PowerPoint PPT Presentation

Rhode Island SIC

August 23, 2017 John Burns, CFA

Inflation Protection Class Policy & Structure Discussion

2 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

I nfla tio n Pro te c tio n Cla ss Po rtfo lio :

• Ba c kg ro und
• Ob je c tive s
• Pro po se d Po lic y

Today’s Discussion

3 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

• E

RSRI , like a ll lo ng -te rm inve sto rs is vulne ra b le to spike s in infla tio n tha t re duc e the inve sto r’ s purc ha sing po we r a s no mina l a sse t re turns a re e ro de d b y infla tio n

• 2016 a sse t / lia b ility re vie w: a llo c a tio n to infla tio n pro te c tio n c la ss 10%
• Re c e ntly re duc e d to 8% po lic y we ig ht (b a nk lo a ns / sho rt-dura tio n hig h yie ld

mo ve d to I nc o me Cla ss)

• T

he re a re two prima ry fo rms o f infla tio n 1. Una ntic ipa te d / sha rp rise 2. Antic ipa te d / me a sure d rise

• I

ndividua l a sse ts b e ha ve diffe re ntly in diffe re nt infla tio na ry re g ime s

• T

I PS / na tura l re so urc e s / e ne rg y re so urc e s in g e ne ra l fa re we ll in una ntic ipa te d infla tio n re g ime s

• Co re Re a l E

sta te / I nfra struc ture (a sse ts tha t ha ve pe rio dic re se ts o f re nts / c o ntra c tua l inc o me – tie d to infla tio n) in g e ne ra l fa re we ll in a ntic ipa te d infla tio na ry re g ime s

Inflation Protection Class Portfolio:

4 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

a func tio nal c lass de sig ne d to pe rform we ll in infla tiona ry ma rke t e nvironme nts

I nve stme nt Ob je c tive s:

• L
• ng -te rm re a l re turn (CPI

+ ~3%) I nve stme nt Cha ra c te ristic s:

• Gro wth dive rsific a tio n
• Vo la tility lo we r tha n pub lic e q uity / hig he r tha n Co re fixe d inc o me

Risks:

• Re a l I

nte re st Ra te Risk

• Ac tive Ma na g e me nt Risk
• E

c o no mic Gro wth Risk

• L

iq uidity Risk

• Unde rwriting a func tio na l c la ss to pro vide infla tio n pro te c tio n is c ha lle ng ing
• T

he re is no pe rfe c t he dg e fo r infla tio n

• Asse ts tha t ha ve se nsitivity to infla tio n a lso ha ve se nsitivitie s to o the r fa c to rs tha t

c a n o ve rwhe lm the infla tio n impa c t in the ne a r to mid te rm

Inflation Protection Class Portfolio: Basic Construct

5 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Inve sta ble Unive rse

1. L iq uid F ixe d I nc o me

• I

nfla tio n-linke d b o nds (T I PS o r GI L Bs) 2. L iq uid Na tura l Re so urc e s

• Co mmo ditie s (o il future s, a g ric ulture future s)

3. Priva te Asse ts

• Co re Re a l E

sta te (fo c us o n inc o me / lo w le ve ra g e )

• I

nfra struc ture

• Ag ric ulture / F

a rmla nd

• T

imb e r

Inflation Protection Portfolio: Investable Universe

6 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

E RSRI Polic y Customiza tion

• Decrease inflation protection class allocation to 8% (≈ $640mn)

(fo rme rly 10%)

• Ra tio na le : inc re a se d I

nc o me Cla ss (b a nk lo a ns / sho rt-dura tio n HY mo ve d to I nc o me Cla ss)

• Struc tura l a llo c a tio n po lic y: inc lude re la tive ly wide a llo c a tio n b a nds fo r ma na g e me nt

fle xib ility

• Pro vide fle xib ility to de via te fro m po lic y we ig hts a s ma rke t c o nditio ns e vo lve
• Co nside r timb e r / a g ric ulture if ma rke t c o nditio ns wa rra nt
• Allo c a tio n to priva te a sse ts re q uire s so me po lic y we ig ht fle xib ility
• Ma ximum: 80% priva te a sse ts
• Pe rfo rma nc e fo r the infla tio n pro te c tio n c la ss e va lua te d o n ro lling 5 ye a r pe rio ds

Inflation Protection Portfolio: Policy

7 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Stra te g ic Alloc a tion Mode ling Proc e ss / Polic y De ve lopme nt

1. I de ntify inve sta b le unive rse

• E

xa mine c urre nt funda me nta ls a nd histo ric a l tra its/ b e ha vio r

2. De ve lo p a ssumptio ns (vo la tility / to ta l re turn / c o rre la tio ns) 3. Run o ptimiza tio n (with minima l c o nstra ints)

a ) Me a n-va ria nc e o ptimiza tio n e sse ntia lly o ptimize d e a c h po rtfo lio o n a risk/ re turn b a sis a nd ke pt the po rtfo lio CPI b e ta a t the 0.50 flo o r

4. Na rro w inve sta b le unive rse 6. Se le c t po te ntia l po lic y a llo c a tio ns a nd te st fo r re a so na b le ne ss

• T

e st fo r fide lity to a sse t / lia b ility mo de ling a ssumptio ns a nd o b je c tive s

NOT E : Mo de ling input / c o nstra ints in a ppe ndix

Inflation Protection Portfolio: Modeling Process

8 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Inflation Protection Portfolio: Modeling Output

CPI b e ta : “CPI Surprise Be ta s” a re b e ta s to une xpe c te d infla tio n (F ull de sc riptio n in a ppe ndix)

A/ L Mo de l Sta ff/ PCA Cho ic e 4.00% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 10.5% 11.0% Ge ome tric Re turn Vola tility

E ffic ie nt F r

• ntie r

| Ge ome tr ic Re tur n & Risk

#6 #2

Po rtfo lio # 1 Po rtfo lio # 2 Po rtfo lio # 3 Po rtfo lio # 4 Po rtfo lio # 5 Po rtfo lio # 6 Po rtfo lio # 7 Po rtfo lio # 8 Po rtfo lio # 9 Po rtfo lio # 10 A/ L Mo de l Sta ff/ PCA Cho ic e Ge o . Re turn 4.1% 4.3% 4.5% 4.8% 5.0% 5.2% 5.4% 5.6% 5.8% 5.9% 5.0% 5.3% Vo la tility 6.6% 6.7% 6.8% 7.0% 7.2% 7.5% 7.8% 8.2% 8.6% 10.0% 8.6% 8.5% Sha rpe Ra tio 0.31 0.34 0.37 0.39 0.41 0.42 0.43 0.44 0.45 0.41 0.36 0.40 CPI Be ta 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.43 0.61

#10 #9 #8 #7 #5 #4 #3 #1

9 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Inflation Protection Portfolio: Allocation Selection

• I

nfra struc ture + inc lude s infra struc ture / timb e r / a g ric ulture

• T

I PS / Na tura l Re so urc e s a re liq uid inve stme nt s

Po rtfo lio # 1 Po rtfo lio # 2 Po rtfo lio # 3 Po rtfo lio # 4 Po rtfo lio # 5 Po rtfo lio # 6 Po rtfo lio # 7 Po rtfo lio # 8 Po rtfo lio # 9 Po rtfo lio # 10 A/ L Mo de l Sta ff/ PCA Cho ic e Ge o . Re turn 4.1% 4.3% 4.5% 4.8% 5.0% 5.2% 5.4% 5.6% 5.8% 5.9% 5.0% 5.3% Vo la tility 6.6% 6.7% 6.8% 7.0% 7.2% 7.5% 7.8% 8.2% 8.6% 10.0% 8.6% 8.5% Sha rpe Ra tio 0.31 0.34 0.37 0.39 0.41 0.42 0.43 0.44 0.45 0.41 0.36 0.40 CPI Be ta 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.43 0.61

Po rtfo lio # 1 Po rtfo lio # 2 Po rtfo lio # 3 Po rtfo lio # 4 Po rtfo lio # 5 Po rtfo lio # 6 Po rtfo lio # 7 Po rtfo lio # 8 Po rtfo lio # 9 Po rtfo lio # 10 A/ L Mo de l Staff / PCA Cho ic e T IPs 54% 47% 40% 34% 27% 20% 13% 6% 0% 0% 30% 13% Natural Re so urc e s 11% 11% 11% 11% 12% 12% 12% 12% 11% 0% 0% 12% Co re RE 18% 21% 23% 25% 27% 28% 30% 32% 38% 67% 47% 45% Infrastruc ture + 16% 21% 25% 30% 35% 40% 45% 50% 52% 33% 23% 30%

10 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Po lic y Guide line s

Infla tion Pr

• te c tion Cla ss

Compone nts L

• ng - te r

m T a r g e t L

• ng - te r

m Polic y R a ng e s T IPs

13% 0-25%

Na tur a l R e sour c e s

12% 0-25%

Cor e R e a l E sta te

45% 30-60%

Infr a str uc tur e +

30% 15-45% 100%

• Po lic y g uid e line s a llo w ma na g e me nt

fle xib ility a s ma rke t c o nd itio ns e vo lve

Inflation Protection Portfolio: Allocation Selection & Policy

• PCA a nd Sta ff re c o mme nd po lic y b e lo w
• Ro unde d/ na ïve a llo c a tio ns a re inc o rpo ra te d to re fle c t humility
• T

his struc ture is lo g ic a l, imple me nta b le , a nd b a la nc e s the risk/ re turn tra de o ff

• I

lliq uid infla tio n pro te c tio n a sse t mo ve to lo ng -te rm po lic y we ig ht a t a me a sure d pa c e

11 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Po lic y Be nc hma rk:

• Ble nd o f individua l a sse t c la ss indic e s

I ndividua l a sse ts’ b e nc hma rks:

• Co re Re a l E

sta te NF I

• ODCE

I nde x

• I

nfra struc ture CPI +4%

• T

I PS Blo o mb e rg Ba rc la ys 1-10 Ye a r T I Ps I nde x

• Na tura l Re so urc e s

Blo o mb e rg Co mmo dity I nde x (T

• ta l Re turn)

Dive rsific a tio n

• T

he infla tio n pro te c tio n c la ss is e xpe c te d to pro vide dive rsific a tio n o f e q uity (g ro wth risk).

• T

he po rtfo lio will b e dive rsifie d a c ro ss nume ro us so urc e s o f re a l re turn

Inflation Protection Portfolio: Benchmarks & Diversification

Appendix

13 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Re turn/ Risk Assumptio ns Co rre la tio n Ma trix

Inflation Protection Class Portfolio: Modeling Inputs

Str ate gy Ar ithme tic Re tur n Ge ome tr ic Re tur n Volatility CPI Be ta

T IPs 3.00% 2.80% 7.00% 0.25 Na tura l Re so urc e s 4.25% 2.25% 22.00% 2.00 Co re Re a l E sta te 6.30% 5.55% 13.33% 0.75 Infra struc ture 6.30% 5.55% 13.33% 0.00 T imb e r 6.30% 5.55% 13.33% 0.00 Ag ric ulture 6.30% 5.55% 13.33% 0.00

T I Ps Co mmo ditie s Co re I nfra struc ture T imb e r Ag ric ulture T I Ps 1.00 Co mmo ditie s 0.30 1.00 Co re 0.15 0.30 1.00 I nfra struc ture 0.25 0.15 0.35 1.00 T imb e r 0.10 0.00 0.05 0.15 1.00 Ag ric ulture 0.05 0.00 0.15 0.15 0.35 1.00

14 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Inflation Protection Class Portfolio: Terminology

• Arithme tic (a ve ra g e ) Re turn
• T

he re turn e xpe c te d in a ny sing le g ive n ye a r

• Ge o me tric / Co mpo und (a ve ra g e ) Re turn
• T

he a ve ra g e / a nnua lize d re turn e xpe c te d o ve r a multi-ye a r (e .g ., 10) ho rizo n

• Ge o me tric re turn = c o mpo und re turn
• Due to vo la tility impa c ts, the g e o me tric / c o mpo und a ve ra g e re turn is a lwa ys le ss tha n the a rithme tic

a ve ra g e re turn

• Vo la tility/ Sta nd a rd De via tio n
• A me a sure tha t b ro a d ly d e sc rib e s ho w wid e / na rro w a d istrib utio n o f re turns is
• Ro ug hly 2/ 3 o f a ll o utc o me s/ o b se rva tio ns fa ll within +/ - o ne SD
• Annua l Yie ld
• T

he a nnua l c a sh d istrib utio n

• Ma y b e d istrib ute d mo nthly, q ua rte rly, b i-a nnua lly, o r a nnua lly
• CPI Be ta
• “CPI Surprise Be ta s” - b e ta s to une xpe c te d infla tio n. If the ma rke t e xpe c ts infla tio n o f 3% in a g ive n

q ua rte r (a nnua lize d ) a nd we a c tua lly g e t 4%, the n yo u c a n multiply the 1% “surprise ” b y e a c h b e ta fig ure a nd tha t will g ive yo u the e xtra re turn tha t a sse t wo uld pro d uc e c o mpa re d to if the re we re n’ t a n infla tio n surprise . T his is a pa rtia l b e ta c o e ffic ie nt; the re a re multiple fa c to rs tha t a re d riving the se c la sse s’ re turns b ut the y d o ha ve a pa rtia l se nsitivity to surprise infla tio n.

15 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

T he I nfla tio n Pro te c tio n Po rtfo lio is a func tio na l / purpo se -drive n stra te g ic c la ss

• De sig ne d to pe rfo rm we ll in infla tio na ry ma rke t re g ime s c o mpo se d o f pub lic a nd priva te a sse ts

/ fixe d inc o me a nd e q uity se c uritie s

Asse t / L iability Mode ling Assumptions: Inflation Pr

• te c tion Class Mode ling Compone nts:

Mo de ling a nd po rtfo lio struc ture / unde rwriting ma y diffe r a s ma rke t c o nditio ns e vo lve

Note : Se pte mbe r 28, 2016 SIC Mate r ials

Inflation Protection Class: Asset / Liability Review Inputs

Composition: E xpe c te d R e tur n Vola tility Ba nk L

• a ns

21% 5.79% 15.60%

Cor e R e a l E sta te

37% 5.49% 12.00%

Cor e Infr a str uc tur e

18% 6.39% 9.25%

T IPS

24% 3.49% 6.00%

E xpe c te d Re tur n (ge o) Volatility

I nfla tio n Cla ss 5.6% 5.9%

US Equity NonUS Equity Private Growth Income Class Crisis Risk Offset Inflation Protection IG Fixed Income Absolute Return Cash 0% 2% 4% 6% 8% 10% 12% 0% 5% 10% 15% 20% 25% 30% C o m p o und Re turn Sta nda rd Devia tio n

R isk Vs. R eturn

Infla tio n Pro te c tio n Cla ss

16 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Proposed Portfolio Rebalancing Policy: Asset / Liability Review

Str ate gic Class F

• c us Por

tfolio % Re balanc ing Bands

Global E quity

40 +/ - 2%

Private Growth *

15 +/ - 4%

Inc ome Class

6 +/ - 2%

Crisis Risk Offse t

8 +/ - 2%

Inflation Prote c tion *

10 +/ - 3%

IG F ixe d Inc ome

11.5 +/ - 2%

Absolute Re turn

6.5 +/ - 2%

Cash

3 +/ - 2%

T

• tal

100% 100%

• Wide r re b a la nc ing b a nds fo r func tio na l c la sse s with illiq uid a sse ts --- minimize s

de no mina to r e ffe c t in ma rke t c risis

• Will pro mo te smo o the r inve sting o f a dditio na l a llo c a tio ns to illiq uid a sse ts a nd

pro mo te vinta g e ye a r dive rsific a tio n

• Curre nt po lic y is to re b a la nc e mo nthly

* F

unc tio na l Cla ss inc lude s illiq uid a sse ts Note : Se pte mbe r 28, 2016 SIC Mate r ials

No te : Curre nt re b a la nc ing po lic y is +/ - 2% fo r a ll c la sse s

17 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n

Review: Portfolio Structure for Optimization Purposes

Nine Asse t / F unc tio na l Cla sse s to b e Optimize d

Note : Se pte mbe r 28, 2016 SIC Mate r ials

Strate gic Classe s Classe s/ Asse ts fo r O ptimizatio n Purpo se s Co mpo ne nts o f O ptimizatio n Classe s/ Asse ts

Glo bal E quity

= 100% Glo bal E

quity

=

75% Priv ate E quity

= 15% No n-Co re Re al E

state 10% Oppo rtunistic Priv ate Cre dit 25% RE IT s 25% Hig h Y ie ld Infrastruc ture 25% Hig h Y ie ld 25% Priv ate Cre dit 50% T re asury Duratio n 50% Syste matic T re nd F

• llo w ing

21% Bank L

• ans

37% Co re Re al E state 18% Co re Infrastruc ture 24% T IPS IG F ixe d Inc o me

= 100% IG F

ixe d Inc o me Abso lute Re turn

= 100% Abso lute Re turn

Cash

= 100% Cash

Gro w th Class Priv ate Gro w th Inc o me Class Inc o me Class

=

Risk Re duc tio n Class Crisis Pro te c tio n

=

Inflatio n Pro te c tio n

=