Members Present:

John Hammond, Howard Brown, William Brown, Dennis Callahan, Hunter Calloway, Jay Cuccia, Frank Marzucco, Jay Middleton, M. Kathleen Sulick, LeRoy Wilkison,

Members Absent:

Andrea Fulton, Jennifer Gilbert-Duran, Douglas Willis

Staff Present:

Karen Gerald, Tina Johnson, Brenda Minatee

Guests:

Greg Bussink, Peter R. Duffy, Stephen P. Fulton, Brian T. Hicks, Rhett Humphreys, Aaron Prince

Recorder: Laura C. Jackson, Audio Associates

The meeting of the Board of Trustees of the Anne Arundel County Retirement and Pension System (Board) was called to order at 12:17 p.m. by John Hammond, Chair.

Minutes

Mr. Brown moved to approve the minutes for the May 10, 2007, Board of Trustees meeting. The motion was seconded by Hunter Calloway and approved unanimously.

Investment Committee

Western Asset

Stephen P. Fulton and Aaron Prince of Western Asset provided a market and portfolio overview. They discussed Western Asset’s view on interest rates, inflation, the economy, housing prices, and mortgage lending standards. Although the economy is in good shape, a downturn in existing and new home sales signals that the housing boom has come to an end. Further, low rates and relaxed mortgage lending standards have led to a record number of

foreclosures. Because Western Asset recognized the signals of deteriorating purchase loan quality, it cut back on the amount of AAA rated sub prime origination purchases made each year.   

William Brown asked how Western Asset determines whether a subprime loan receives a AAA rating. Mr. Fulton explained that a certain amount of the loans in the subprime category can be considered AAA. Out of $100 million worth of loans, for example, the firm might feel good about the top 50 percent to 60 percent or $50 million of cash flow. Overall, however, Western Asset steered clear of this sector. 

Mr. Fulton reported that in 2006 various sectors saw better returns than the U.S. Treasury securities, including high yield, emerging markets, and commercial mortgages. In 2007, Treasury securities had better returns than most of Western Asset’s normal sectors. High yield and emerging markets showed strong returns as of May 31.

Overall, Anne Arundel County has hit its performance targets and actually exceeded them a bit during the past three years. The county’s portfolio includes, among other things, investment-grade credit, mortgages, and high-yield investments. 

Mr. Hammond questioned how much of the portfolios out performance of the index is due to the portfolio’s significant portion of high-yield funds. Mr. Fulton said high-yield funds were a decent contributor in 2006. Western Asset limits exposure to high yield and emerging markets to 25 percent of the portfolio.         

Penn Capital Management

Brian T. Hicks and Peter R. Duffy of Penn Capital Management reviewed with the county its defensive high yield fixed income portfolio. The presenters said the county’s portfolio is designed for consistency. The portfolio focuses on B rated companies; indeed, only 15 percent of the companies in the portfolio are rated BB. Further, the firm invests only in cash-pay securities.

The presenters discussed Penn’s view on inflation and the economy and explained the firm’s investment strategies. Penn, for example, relies on intensive research and analysis to speculate on individual companies. The defensive high yield portfolio has almost achieved the same return levels as the S&P 500 Index during the past 19 years.

During the past three months the county’s portfolio has outperformed the Merrill Lynch High Yield Cash Pay Constrained Index. The county’s returns are especially noteworthy as the Merrill Lynch index includes CCC rated and distressed firms, which have done well this year. The county’s portfolio also saw better returns than the Merrill Lynch High Yield BB-B Cash Pay Constrained Index.      

The portfolio has significant holdings in

• telecommunications
• gaming
• health care

In addition, the portfolio relies on a buy-and-hold strategy and generally is not designed for a lot of turnover.

Howard Brown asked how long Penn Capital will hold onto a particular company.

Mr. Duffy replied that Penn will hold onto a company for at least a year, although it might hold onto some for three to six months and others for as long as two years. The firm focuses on staying nimble enough to get out of a particular holding quickly if necessary.

New England Pension Consultants

Rhett Humphreys, a partner of New England Pension Consultants (NEPC), discussed the investment performance of the county’s pension and retirement system. The meeting materials included a preliminary May report, the county’s adjusted Investment Policy Statement, and a notification from Southeastern Asset Management. 

For the month of May the county earned between 2.7 percent and 3 percent. On the total equity composite, all managers except one met their benchmarks, making May a strong month for the county.

To offer the county a better assessment, NEPC added new information to its Flash Report. The firm reported the total composite, or the entire portfolio, for the county as well as the financial composite, which is 10 percent less because NEPC might not have updated information for all funds. When there is no updated information, the system assumes a 0 percent net asset value change. NEPC is marking 10 percent of the portfolio at 0. Ninety percent of the portfolio earned 3 percent.

Mr. Calloway asked if the county experiences political pressure about the industries it selects for its portfolio. Mr. Hammond said no one has expressed concerns about the county’s domestic or international investment choices. 

Mr. Wilkison moved to approve a change to Section B of the county’s policy statement to note the addition of a new fund manager, Newstone Capital Partners. The motion was seconded by Mr. Cuccia and approved unanimously.

The board discussed a notification from Southeastern Assets Management in Section 4 of the meeting materials. According to the pension system’s investment policy, investment firms are to notify the board if those firms hold more than a certain amount of stock in a particular company. The policy, which is meant to be a guideline and not an absolute restriction, helps alert the board to changes that could cause an investment firm to go out of business.

Action: Mr. Hammond will get back to Southeastern to determine how much stock the firm owns in Level 3 Communications Inc. and its future plans for the stock.

Action: Mr. Hammond will contact the firm to get some feedback on the pending retirement.

Mr. Hammond discussed another notification received from K2 regarding the long-planned retirement of one of the principals of the firm. Representatives from the firm did not discuss the pending retirement when they met with the board in April. 

Action: Mr. Hammond will have the Office of Law review the proposed changes to the partnership agreement.

Mr. Hammond also discussed a notification received from HRJ investment management firm regarding the approval of changes to its partnership agreement with the board.

Greg Bussink of the Clifton Gunderson accounting firm came before the board regarding the firm’s audit of the pension system’s financial statements for the year ended December 31, 2006. There were no significant accounting policies or their application that were either initially selected or changed during the year. There were significant accounting estimates of financial data, which would be particularly sensitive and require substantial judgments by management. There were no adjustments arising from the audit that could, in the firm’s judgment, either individually or in the aggregate, have a significant effect on the system’s financial reporting process.

During the audit Clifton Gunderson noted that a few nonvested former employees did not have their contributions refunded in a timely manner. The board then had a discussion on nonvested terminations. The discussion continued in the administration report.  

Administrative Report

Karen Gerald, Senior Personnel Analyst within the Benefits Division, came before the board in place of Judi Lohn. She provided an update on the unclaimed pension funds. A total of 28 people who left the county before 2002 still have pension funds remaining within the pension system. The total amount of those funds is about $42,000. The benefits division is working to contact those former employees regarding their unclaimed pensions.

Ms. Gerald also discussed several communication pieces, such as a newsletter, that will go out to employees and retirees. She shared a copy of a cover letter that will accompany a pension benefits statement that county employees will receive. The letter explained the county retirement systems earnings and assets for 2006 and encouraged county employees to evaluate their personal retirement goals and strategies regularly. The letter will be signed by the county executive.

Mr. Wilkison reported a complaint from a new retiree as to how his initial distribution was handled. He’s attempting to reach Ms. Fulton to discuss the issue with her.

Janet Morgan prepared the financial report for the first quarter. The documents included a statement of plan net assets, statement of changes in plan net assets, schedule of investment expense, and schedule of administrative expenses.

Action: Mr. Hammond said that he would look into the issue and give a report in July.

William Brown noted that Jennifer Gilbert-Duran has had a number of unexcused absences from board meetings.

Mr. Wilkison made a motion that the board should retain outside counsel with pension expertise to help the board clarify its role and legal authority and draft a trust agreement. The members briefly discussed the matter.

Action: Mr. Hammond said he would ask the Office of Law to meet with the board. If the board needs further clarification, the members can pursue outside legal counsel.

The meeting adjourned at 2:27 p.m. The next meeting is scheduled for July 12, 2007, at 12:00 p.m.