Members Present:  John Hammond,  Howard Brown, William Brown, Dennis Callahan, Jay Cuccia, Andrea Fulton, Dennis Howell, Frank Marzucco, Jay Middleton, M. Kathleen Sulick, LeRoy Wilkison, Douglas Willis

Members Excused: Hunter Calloway, Jennifer Gilbert-Duran

Staff Present:  John Peterson, Todd Green

Guests:  Timothy Costello, Chris Hecht, Rhett Humphreys, Geoff Lemieux

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 12:21 p.m. by John Hammond, Chair.

Minutes

The January 10, 2007, minutes should state that it costs the retirement system about $60,000 a month to provide benefits to about 23 surviving spouses. Mr. William Brown moved to accept the revised minutes. Mr. Cuccia seconded the motion. The board unanimously approved the minutes.

Investment Committee

HRJ Capital

HRJ is a West Coast alternative asset manager that focuses on private equity (buy-out and distressed), venture capital funds, real estate funds and hedge funds. With $2.2 billion in committed capital, HRJ has offices in San Francisco, New York, Zurich and other locations. The Chicago office handles the real estate funds.

Mr. Lemieux and Mr. Hecht discussed why a portfolio that concentrates on distressed markets makes sense in today’s market. The Special Opportunities Fund, put together in 2006/2007, targets managers who have some exposure to distressed securities. They are buying and trading publicly traded debt or buying troubled companies, conducting turnarounds and selling those companies.

Mr. Hecht said weakness in lower-quality mortgages has led to an unwinding of credit markets in general.  HRJ’s managers are adept at finding opportunities in this economic environment. They understand value, Mr. Hecht noted, and they want to take advantage of what’s available.

The Special Opportunities Fund is a fully committed $200 million distressed and special situations fund. The fund focuses on three areas of distress. Control/turnaround involves buying a company going through distress or operational difficulties, owning the company for three to five years then taking the company public or selling it. Control/turnaround is 38 percent of the portfolio. 

Opportunistic (54 percent of the portfolio) is similar to control/turnaround, but managers also are able to do a lot of investing elsewhere. The fund’s international exposure (8 percent) includes Avenue Asia, largely distressed liquid securities in Asia. The fund has only nominal exposure to mortgages. The fund is 42 percent drawn.

Mr. Lemieux said the Special Opportunities Fund provides a strong hedge to the more traditional S&P based equity strategies that are negatively affected by the market. Opportunistic and control areas did well in 2001 and 2002, and he hopes to see these kinds of returns in the future. 

Mr. Willis asked about PIK toggle bonds. Mr. Lemieux said that a lot of the leveraged buyouts that were done in the earlier half of 2007 were done with very generous capital structures. Part of the financing done on the buyouts was done with Paid in Kind toggle notes. Instead of paying interest on that debt, you can allow that interest to grow and pay it off at a later time. 

Newstone

Newstone Capital Partners is dedicated to being a leading provider of mezzanine capital to private equity sponsors pursuing leveraged transactions. Newstone has completed 13 transactions totaling $442 million with leading private equity sponsors. It has $865 million in committed capital. Since inception, the fund has realized approximately $59 million.

Newstone focuses on diversity in order to eliminate risk and reduce the possibility of being hurt by any single deal or industry. It targets larger, middle-market issuers and conducts extensive research to make sure companies can repay the principal and interest. 

Newstone has employees in Los Angeles and Dallas. As part of its “get the best athlete” mentality, the firm has hired a fourth vice president and two additional associates. With a surplus of staff, associates have time to conduct industry or company research. 

Costello said leveraged loan volume has declined in the current market and the subprime market has affected leveraged buyouts. Borrowers must pay more to borrow money due to the lack of capital. As a result, deals today are much more collaborative and relationship investing is vital.  Newstone often completes multiple transactions with the same firms, including nine deals with equity sponsor Texas Pacific Group and eight with GTCR. Although Newstone isn’t the cheapest form of capital, Costello noted that sponsors are familiar the firm.

Rather than trying to time the market, Newstone focuses on sticking to its knitting and conducting extensive research to identify the best deals. Newstone’s portfolio generates about $43 million of income per year, and the current deal flow and pipeline remain strong. The average investment size is $34 million. 

Regarding the weighted average equity contribution of 28 percent, Mr. Middleton asked how Newstone has weighted average total leverage of 5.6x. Mr. Costello said Newstone is junior capital.  Of the 72 percent of any given deal, the first 50 percent is bank debt or senior debt. The other 22 percent is Newstone.    

The investment portfolio includes Jacuzzi Corporation, Alltel Corporation, CompBenefits Corporation and Petsmart. When making selections, Newstone focuses on spread by issuer, industry and equity sponsor. 

Committee Investment Report

The board reviewed the minutes of the February 7, 2008, investment committee meeting.  Rhett Humphreys of New England Pension Consultants reviewed the fourth quarter 2007 executive performance report. The portfolio experienced a negative return of 0.2 percent compared to the 2.2 percent decline in the equity allocation index and the 1.6 return of the fixed income allocation.

For the calendar year, the portfolio returned 11.2 percent. The long-term (five-year) performance continues to be above average, earning a compound annual rate of 13 percent.

Specific issues discussed during the investment committee meeting included an update on the residual W.R. Huff holdings in response to a February 4 meeting that included Mr. Huff, Mr. Hammond and Mr. Humphreys. The report noted that all managers are in compliance with the ongoing exceptions of Southwestern and WR Huff, which have been previously noted and approved. The committee is not recommending any changes in asset allocation.

Action: The Investment Committee will meet on May 2, 2008 at 11:00 a.m.

New England Pension Consultants

Mr. Humphreys reported negative returns on the equity side during the period ending January 31. Total equity was down almost 9 percent. In emerging markets, Marvin and Palmer was down 14.6 percent.  Reviewing the fixed income report, Mr. Humphreys said investment grade bonds ING and Western Asset Management were up 1.6 percent and 1.5 percent respectively. Bridgewater was up 1.7 percent.  

Board members briefly discussed the Deferred Retirement Option Program. Mr. Callahan noted for the record that he didn’t think the DROP program was healthy for the retirement system’s financial position because it guarantees a minimum of 8 percent and this month the retirement system is losing 5.7 percent. Mr. Wilkison pointed out that the board shouldn’t target one month. Tom Lowman of Bolton Partners said the DROP program isn’t as big a driver as people might think. Some programs try to tie the rate to what the fund actually earns instead of paying a fixed amount, he added, but other issues can arise from that decision.

Experience Study Report

Mr. Lowman presented the Anne Arundel County Experience and Assumption Study for the employees’ retirement plan, the detention officers’ and deputy sheriffs’ retirement plan, the fire service retirement plan and the police service retirement plan.

The report reviews the experience of the Anne Arundel County retirement plans over the period of 2002 to 2006 to determine potential changes in actuarial valuation assumptions. The prior experience study was prepared in 2003 and covered experience for the years 1998-2002.

Among other things, the study revealed greater than expected retirements at ages below 60 and lower that expected retirements at ages greater than 65. Under the fire service plan, the study showed much lower than expected retirements at ages 50 and above. Under the police service plan, fewer retired than expected. Mr. Lowman recommended changes to the assumed retirement rate of the fire service plan and police service plan.

Regarding termination assumptions, this year's study showed greater than expected terminations at older ages. Detention officers had fewer that expected terminations above age 25, and many of the terminations at older ages are short service employees. Under the police service plan, terminations generally follow expected terminations. Under the disability assumption, the number of disabilities (all plans combined) has increased from 14.6 per year to 21.5 per year. The disability experience for the detention plan changed from a 93 percent actual-to-expected ratio in the prior study of 359 percent and saw the most dramatic change.

Mr. Lowman recommended no changes to the DROP plan or the Cost of Living Adjustment.

Administrative Report