Members Present:  John Hammond, Howard Brown, Dennis Callahan, Jay Cuccia,  Janelle Davis, Richard K. Drain, Jennifer Gilbert-Duran, Frank Marzucco,  Jay Middleton, M. Kathleen Sulick, LeRoy Wilkison

Members Excused: Andrea Fulton

Staff Present: John Peterson, Janet Morgan

Guests:  Stephen Hansen, Mike Hotchkiss, Rhett Humphreys, Susan Powers, Perry Williams, Cheryl Wyngarden

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 12:35 p.m. by John Hammond.

Minutes

Mr. Cuccia made a motion to approve the minutes of the February 12, 2009, Board of Trustees meeting.  The motion was seconded by Ms. Sulik and approved unanimously.

Investment Committee

ING Clarion Lion Properties Fund

This fund is a core style, diversified, investment real estate portfolio with $5.7 billion in real estate assets. Mr. Hansen reported no changes among ING senior management or with the Lion Properties Fund since his visit last year. 

The Lion Properties fund invests in 33 U.S. markets. The fund, which has 155 assets, focuses only on properties within the United States. Current occupancy is at about 91.1 percent. Due to changes in the real estate market, Mr. Hansen expects that occupancy rate to drop into the high 80 percent range.  

More than 170 shareholders invest in the fund. The average investment is $20 million. As part of the fund’s investment strategy, fund managers identify and exploit sectors of relative value, focus on sustainable cash flow and actively manage the fund to capture excess gain and avoid loss. ING works hard to keep this income-generating portfolio fresh because properties age and markets change over time, said Mr. Hansen. The fund has distributed out about $14 million in cash on a quarterly basis during the past four years.   

Mr. Hansen reported a dramatic fourth quarter of 2008, with returns of -12.50 percent versus a benchmark of -10.33 percent. For the previous seven or eight years, he said, the real estate asset class had performed spectacularly.

The firm focuses on such high-performing markets as the Baltimore-Washington, D.C. corridor, Los Angeles and Chicago. During recessions, these markets hold up much better than such secondary locations as Memphis or Kansas City, said Mr. Hansen.

The fund, which has borrowed money, has a leverage ratio of 40 percent of the total asset value, said Mr. Hansen. Fund borrowings are primarily fixed rate loans that are locked in for the next six years. 

In light of the market, the firm has had to seek new tenants due to the closures of about three or four Linens & Things and about two Circuit City stores. The closure of these stores offers the opportunity to find tenants for those spaces who can pay higher rents, said Mr. Hansen. Universal Music in Los Angeles is the highest-paying tenant for this fund.

To succeed during this turbulent economic market, ING will concentrate on protecting the income. This is an actively managed fund, and managers build increases into the leases, said Mr. Hansen. ING is willing to sell properties to reduce fund indebtedness; however, the firm won’t sell at unacceptable prices. The fund will use proceeds to pay down debt.   

ING also is underweight in the office sector, Mr. Hansen reported, with holdings down from 42 percent of the portfolio about 3 years ago to about 29 percent today. The firm prefers neighborhood convenience retail and seeks tenants that draw customers on a weekly basis.

Ms. Sulik asked about the frequency of property appraisals. Mr. Hansen said outside appraisers assess the properties each quarter.

Mr. Callahan wondered how the firm expected to see net operating income growth of 4.4 percent in 2009. Mr. Hansen said 2008 was a strong year for the fund. Operating income grew 6.7 percent. It is fading and will probably go negative in 2010, he said, but lease increases have been built into projections.  Noting that everyone might not meet their obligations, the overall budget for the 155 properties is higher than 4.4 percent, so managers have taken those concerns into consideration.

Mr. Hammond asked about withdrawals from the fund. Mr. Hansen said that the space is not liquid because selling properties in the current market is difficult. The firm is receiving more redemption requests than the fund can collectively convert to cash in a short period of time. Last year the fund paid out $521 million in redemptions. Frankly, this is not a good time to sell these long-term investments because the prices are low in just about every category, said Mr. Hansen. 

Sands Capital Management

Sands, an independent, staff-owned firm, has a 22-year track record of growth investing. The firm had $8.3 billion in assets under management as of December 31, 2008.

Sands invests in large cap U.S. global brands by focusing on “wealth-creating” businesses and a long-term investment horizon. Although this is an unprecedented time, Mr. Hotchkiss said he is optimistic about Sands’ investment sector, noting that stock selection is critical to surviving the current market.  The portfolio includes 25 to 30 businesses chosen because of their ability to establish a leading position in the market, maintain competitive advantage, set a clear mission and demonstrate financial strength.

Reviewing investment results through February 28, 2009, Mr. Hotchkiss said returns were terrible. In the fourth quarter, the county’s portfolio was -30.58 percent versus a benchmark of -22.79 percent. Even so, Mr. Hotchkiss said the board shouldn’t overreact to last year’s results, noting that in the first quarter of 2009, the portfolio was down but ahead of the benchmark. 

Because of the turbulence in the current market, Sands performed a stress test on each company in its portfolio and expanded that effort to include extreme conditions. Sands’ managers concluded that the firm’s portfolio included companies that will still profit during the economic crisis, a result that’s quite compelling for growth investors, said Mr. Williams.

One of the firm’s largest weights is Amazon, which has been one of Sands’ best performers. The company reported 18 percent revenue growth in the 4^th quarter. Amazon is uniquely positioned in this economic environment and the competition has not been able to keep up, said Mr. Williams. 

With nearly $30 billion in cash, Apple is another successful company in Sands’ portfolio. Apple has more cash than Google, Cisco or Microsoft due to its industry-leading innovations in portable computing. The company sold 22 million Ipods in the 4^th quarter during the worst consumer environment in our lifetimes, said Mr. Williams. Sands expects these and other businesses to do well during the next 5 to 10 years.

Although these companies have had successful returns, Mr. Callahan noted that the county’s portfolio lost 5 percent on an absolute basis, and that loss was in addition to a 30 percent decline during the 4^th quarter.

Mr. Hotchkiss said basic rules of investing fell apart during 2008. Nevertheless, he expects the absolute number will get better and strong companies will get stronger. Over the next five years, the companies in the portfolio could earn an average of 20 percent, he added.

Mr. Middleton asked about Sands’ outlook for Starbucks. Mr. Williams said the company grew at an unsustained rate throughout 2007. Sands doesn’t expect Starbucks to open any more U.S. stores during the next five years than it opened throughout all of 2007. Even so, the company hasn’t lost its relevance to consumers, Mr. Williams added.

New England Pension Consultants

Mr. Hammond reported that board members are reviewing bank loan managers, including Loomis, Sayles & Company and Eaton Vance Management. Bank loans are senior secured loans that banks make to provide liquidity to businesses. Those loans are then sold off, he said.  The senior secured loans get paid before anything else, he said. The trick is to make sure the loans have been underwritten properly.

The investment committee recommends Loomis Sayles, a smaller firm. NEPC brought that asset class to the board’s attention at a very opportune time, Mr. Hammond said. Mr. Humphreys said the board is considering a $50 million allocation. 

>> Mr. Callahan made a motion to select Loomis, Sayles & Company as the pension system’s bank loan manager. Mr. Middleton seconded the motion. The board passed the motion without further discussion

Mr. Humphreys reported that the pension system has increased its target allocation to private equity from 4 percent to 7 percent. Further, the 2009 private equity plan calls for $25 million in commitments to 2009 vintage year funds, $10 million to secondaries and $15 million to mezzanine. 

NEPC recommends the pension system invest $10 million in Lexington Capital Partners VII and $15 million in Newstone Capital Partners II. Both of these firms have performed well,  Mr. Humphreys reported. The pension system would transfer money over a period of time as the firms find good investments.  

>>  Mr. Callahan made a motion to select Loomis, Sayles & Company as the pension system’s bank loan manager. Mr. Middleton seconded the motion. The board passed the motion without further discussion

Mr. Humphreys discussed a memo regarding HRJ Capital and HRJ Special Opportunities. The sponsor of HRJ Special Opportunities, HRJ Capital, is experiencing financial difficulty. HRJ Capital is a separate entity that provides monitoring and investor reporting services to the fund. Mr. Humphreys said the issues associated with HRJ Capital should have minimal impact upon HRJ Special Opportunities.

Mr. Humphreys also provided an update to the 2009 asset allocation analysis, which the board reviewed during the February meeting. In general, NEPC urges all of its clients to reduce their equity ratios to reduce risk and improve diversification.

For Anne Arundel County, NEPC recommends a total equity ratio of 35 percent. Mr. Humphrey also suggests that the ratio of high yield/opportunistic credit increase to 10 percent. The risk parity ratio also would increase from 4 percent to 15 percent. The expected return would increase to 9.9 percent, said Mr. Humphreys, while expected risk would drop to 12.7 percent.

To rebalance the portfolio, the investment committee recommends liquidating the Sands account. Sands has underperformed the market, Mr. Humphreys said, and because the structure of the pension system’s strategy has changed, the portfolio has less tolerance for Sands’ investment strategy. Mr. Humphreys also said the pension system should take roughly $24 million from Southeastern. 

In the international equity sector, Mr. Humphrey recommends liquidating the Globeflex account. In bonds, the pension system would take $48 million from Western and use those funds for the new bank loans. Bridgewater would receive a $90 million allocation from equities. $10 million would go to cash.

Mr. Brown asked about the length of time needed to sell the equities. Mr. Humphreys said the pension system could receive money from Globeflex by the end of the month. The other funds could require about two weeks as fund managers seek to get the best price for the equities.

In reviewing the “flash” report for the period ending February 28, 2009, Mr. Humphreys said every single active manager beat the market except for the international small cap fund. On the bonds side, Western has been positive for the last three months due to a credit rebound. For the month, Western’s performance was -1.8 percent. Penn Capital showed positive year-to-date returns of 5.6 percent. Under global asset allocation, Bridgewater was down 0.5 percent. Wellington had a year-to-date return of -8 percent against a benchmark of -11.9 percent.

Administrative Report

Mr. Peterson said the administrative staff has been busy with the pension audit as well as with interest in the DROP program. He reported 49 estimates or actual DROP entries. 

Mr. Wilkison noted that Mr. Peterson has been quite responsive to retirees.                   

Mr. Hammond mentioned a piece of pending legislation to modify the process for electing pension system board members. The legislation will expand the pool of candidates to include retirees. As part of this change, prospective candidates would have to be “participants” of a classified service rather than “members.”       

The meeting adjourned at 2:45 p.m. The next meeting will take place April 9, 2009.