Members Present: John Hammond, Howard Brown, Dennis Callahan, Jay Cuccia, Janelle Davis, Richard K. Drain, Andrea Fulton, Jennifer Gilbert-Duran, Jonathan Hodgson, Jay Middleton, LeRoy Wilkison
Members Excused: M. Kathleen Sulick
Staff Present: John Peterson, Janet Morgan
Guests: Joseph Carieri, Peter Duffy, Tom Heseltine, Rhett Humphreys, Stephen H.D. Loizeaux,
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 12:20 p.m. by John Hammond.
Minutes
Mr. Hammond said that the minutes for the May 14, 2009, meeting should have indicated that Ms. Sulick had an excused absence. Mr. Cuccia made a motion to approve the minutes as corrected. Mr. Callahan seconded the motion and the board approved the minutes unanimously.
Investment Committee
New England Pension Consultants
Mr. Humphreys reviewed the “flash” report for the period ending May 31, 2009, as well as updated policy statements. The financial composite was up 4.5 percent last month and showed returns of 15.2 percent for the past 3 months, he said. That performance washes out the negative months of January and February. Year to date, the total equity composite is up almost 9 percent.
Two managers carried the domestic equity returns, he said. Buckhead, a small cap value manager, had positive results even when the market reported negative returns. Southeastern was up 25 percent year to date when the large-cap market was down. In emerging markets equity, Marvin and Palmer had returns of 19.4 percent for the month, 53.5 percent for the last 3 months and 33 percent year to date.
Returns on the bonds side showed a bit of a return to normalcy, at least year to date, said Mr. Humphreys. Both Western and ING outperformed the benchmark’s returns of 2.6 percent during the last 3 months.
Reviewing high-yield fixed income, Mr. Humphreys noted returns of 3.3 percent for the first month of the Loomis Sayles bank loan. Bridgewater, which was flat for the month, has transitioned about 60 percent of county’s portfolio out of safe mode and back into a long-term, all-weather portfolio. Wellington had year-to-date returns of 13.2 percent versus a benchmark of 7.5 percent. Mr. Humphreys also expected to receive good reports from K2 and Mariner.
In the pension system’s investment policy statement, the actuarially required return for the pension system’s fund is 8 percent annually, net of fees and operating expenses. To achieve a buffer and have a somewhat higher likelihood of meeting the fund’s objectives, the board has approved a net total return in excess of 9.75 percent. Considering an assumed inflation rate of 3 percent, the long-term real return target is 6.75 percent.
The board also has approved a target asset allocation. NEPC included recommended minimum and maximum exposures.
Section B of the policy statement now includes investment manager guidelines for Loomis Sayles and Co., said Mr. Humphreys. NEPC has removed guidelines for terminated fund managers.
NOTE: Mr. Wilkison made a motion to approve the revised investment policy statement. Mr. Cuccia seconded the motion. The board passed the motion unanimously.
In light of the strong returns in the flash report, Mr. Hodgson asked if board members should anticipate similar results in the near future. Mr. Humphreys said he expects market volatility to continue. The past three months will have little effect on NEPC’s seven-year assumptions and strategies for the pension system.
Penn Capital
Penn Capital, an employee-owned firm, has managed high-yield portfolios for 22 years. Penn Capital is financially stable with no debt and no layoffs to report. The firm has $3.4 billion in assets under management, including $1.8 billion in high-yield strategies.
The value of the county’s portfolio is $55.5 million net of fees.
Although the market has experienced a low-quality rally during the last several months, Mr. Duffy said Penn Capital tends to stay in the middle lane and avoid risky investments. As a result, the firm trailed the market for the last three months, although for the last year Penn has been right in line with the index. He added that Penn Capital’s defensive style and sell discipline help the firm avoid problems. In fact, the firm has experienced only one default during the past 20 years.
Penn Capital has acted as a double B firm during the last year and has no triple C investments. Mr. Loizeaux noted that 50 percent of triple C bonds default. A bond’s downgrade to triple C triggers an automatic sell, although Penn typically gets rid of those investments well beforehand. Further, Penn Capital has avoided GM, GMAC and any other government bailout situations. The firm has begun to rotate out of defensive sectors such as telecom and health care and into cyclical sectors and convertible bonds.
Mr. Hammond asked about the impact of new bankruptcy rules and the government’s involvement in company bailouts. One result, said Mr. Duffy, is more senior claims. In the GM and Chrylser situation, for example, the union took most of what could have been the bondholders’ claim, he said.
Reviewing the county’s portfolio holdings, Mr. Duffy said Penn has begun to reposition itself but wants to wait for the right time to make extremely aggressive moves. The firm has moved away from telecom and is significantly underweight in financials. Penn has put money in energy, capital goods, industrials and firms with an international footprint. Health care has been a huge outperformer during the past three years, Mr. Duffy said, but health care reform raises concerns.
Western Asset
Western Asset, founded in 1971, serves as a fixed-income specialist. The firm has $473.4 billion in assets under management. Following a round of layoffs among back-office/administrative staff, the firm has added 6 to 7 senior-level colleagues in the past two months.
Mr. Carieri said the firm is now headed in the right direction after a period of great difficulty.
The firm, he said, has always underweighted the treasury portion of the fixed-income markets and focused on credit, mortgages, high yield and so on. Unfortunately, those who owned treasuries experienced the most success during the past two years, he said, noting that 2008 was the worst period on record for fixed income relative to treasuries. The financial markets, however, seem to have turned a corner.
Western Asset managers see opportunities in the nonagency marketplace, said Mr. Carieri. The firm also has been very involved in the Treasury Department’s Public Private Investment Program and the Term Asset Loan Facility program. These programs will focus on buying legacy and new origination loans in the asset backed, commercial backed, CMBS and residential (nonagency) marketplace.
The county’s portfolio showed year-to-date returns of 5.6 percent versus the benchmark’s 1.3 percent. From November 30, 2008, to May 31, 2009, the county’s performance has been 10 percent against the benchmark’s 5.1 percent. Allocation to credit (investment grade and high yield) has driven the rebound, he said.
The firm has been reducing its exposure to Ginnie Mae, Freddie Mac and Fannie Mae mortgages and buying more credits. Western is particularly interested in the industrial sector. Noting that the yield in the portfolio is almost 6 percent more than the benchmark, he encouraged board members to stick with their strategy.
Administrative Report
Mr. Heseltine of Clifton Gunderson gave an update on the audit of the pension system’s financial statements. He reported no audit adjustments related to the numbers presented by management.
In light of such a difficult year, auditors had to look at the investment portfolio differently than they have in the past, he said. The firm focused on valuations, particularly the valuations surrounding alternative investments because that area can be difficult to value due to lack of transparency. Auditors also closely examined compliance procedures to make sure any changes to fund allocations were approved and reported properly.
The firm recommends that the pension system request that all fund managers certify the December 31 balance at the end of January and assess whether any significant changes have occurred between the recorded December 31st valuation and the certified valuation date that require adjustment to the financial statements. Additional monitoring and keeping financial records open a bit longer will ensure that estimates are accurate, he said.
Mr. Heseltine also reminded board members that for the year ended December 31, 2008, the pension system experienced an investment loss of 30.4 percent. The system must absorb that loss over the next five years, which could have an impact on the funding ratio in future years.
In other administrative business, Mr. Peterson reported receiving one nomination to represent fire services. Nominations have closed.
Further, administrative staff will mail letters to employees regarding cost-of-living adjustments. Mr. Cuccia reported that he received lots of inquires about the COLAs this year. Although few people expected a cost-of-living increase, he said, they were unaware that they could experience a decrease and receive $8 to $10 less in their pension checks each month. He did note, however, that retirees were pleased with how the Office of Personnel Management responded to their concerns.
All the pension plans allow the reduction by law. Mr. Hammond said he would determine the total cost of the reduction so board members could decide whether they should make a recommendation to county legislators to change the law regarding negative cost-of-living adjustments.
The meeting adjourned at 2:15 p.m. The next meeting will take place July 9.
