February 19, 2003 – Investment Committee Agenda

Public Session – The Committee met in Public Session at 3:00 P.M.

1.0

Call to Order

2.0

Roll Call

3.0

Approval of the Minutes for the Investment Committee Meeting

4.0

Oral Communications From the Committee

5.0

Oral Communications From the Public

6.0

Investment Management Services of the Investment Committee

6.1

Acceptance of Monthly Portfolio Performance Report

*

6.2

Acceptance of Quarterly Investment Performance Analysis for periods ending December 31, 2002

6.3

Approval of Assumptions and Parameters for Asset / Liability Modeling Study

6.4

Introduction of the Investment Committee's Strategic plan for Fiscal Year 2003/2004

7.0

Other Business

8.0

Adjournment

*The Committee will briefly discuss this topic.  The Agenda Item in its entirety will be heard at the Board.

Minutes of SamCERA’s Investment Committee

1.0

Call to Order: Mr. Cottle called the Public Session of the Investment Committee of the Board of Retirement to order at 3:00 P.M., February 19, 2003, in SamCERA’s Board Room, Suite 125, 100 Marine Parkway, Redwood Shores, California.

2.0

Roll Call: Mr. Buffington, Mr. Bryan and Ms. Colson and Mr. Cottle

Board Members in Attendance: Mr. McMahon and Ms. Stuart Alternate Board Member: Ms. Arnott Staff: Mr. Clifton and Mr. McCausland. Consultant: Ms. Jadallah and Mr. Thomas Public: One Retirees: One

3.0

Approval of the Minutes: There were no minutes to approve.

Action: None required.  

4.0

Oral Communications From the Committee None

5.0

Oral Communications From the Public None

6.1

Acceptance of Monthly Portfolio Performance.  SamCERA experienced double-digit negative returns (-10.45%) for the trailing twelve months ending 01/31/2003.  Over the trailing twelve months the portfolio was underweight in Equities and overweight in Fixed Income, Real Estate and Cash, which added 95 basis points (bp) of value while investment selection subtracted 75 bp resulting in 20 bp of outperformance vis-à-vis the Policy Benchmark.  Deutsche Asset Managements underweight to lower quality names and to the so-called “high beta” sector of the corporate market (particularly telecom) and exposure to the Asset-backed Securities (ABS) Sector – Manufactured Housing was a drag on performance late in the year.   Strategic Investment Solutions' quarterly report reminds the Board that Bank of Ireland Asset Management “remained disposed towards quality “defensive” stocks which underperformed versus the TMT and financial sectors. Pharmaceutical (Novartis) and Consumer Staples (Diageo) were a drag on the portfolio’s performance. While an underweight to Japan helped performance, stock selection within Japan detracted (Hitachi, Nintendo).”    

Below is a table with the composite returns.

January 31, 2003

One Month

Trailing Three Months

Trailing Six Months

Trailing Twelve Months

Equity Aggregate

$700,470,474

-3.21%

-3.00%

-6.69%

-21.47%

Equity Composite Benchmark

-2.73%

-2.06%

-5.72%

-20.41%

Variance

-0.48%

-0.94%

-0.97%

-1.06%

Fixed Income Aggregate

$352,846,018

0.02%

1.93%

4.52%

9.31%

Fixed Income Composite Benchmark

0.09%

2.13%

5.05%

9.48%

Variance

-0.07%

-0.20%

-0.53%

-0.17%

Real Estate Aggregate  (1)

$62,989,203

0.50%

3.68%

6.21%

3.13%

NCREIF (one quarter lag)

0.00%

1.79%

3.43%

5.69%

Variance

0.50%

1.89%

2.78%

-2.56%

Cash Aggregate

$14,928,855

0.14%

0.47%

1.16%

2.71%

91 Day Treasury Bill

0.10%

0.38%

0.83%

1.74%

Variance

0.04%

0.09%

0.33%

0.97%

Total Fund Returns

$1,131,234,550

-1.96%

-1.09%

-2.11%

-10.45%

Total Plan Policy Benchmark

-1.75%

-0.52%

-1.84%

-10.65%

Variance

-0.21%

-0.57%

-0.27%

0.20%

Asset Allocation
As of 1/31/2003

Market Value

Allocation

Percentage Off Target

Rebalance Range

Current

Target

BGI Russell 1000

$438,152,181

38.73%

40.00%

-1.27%

±5%

BGI Russell 2000

$102,731,422

9.08%

10.00%

-0.92%

±5%

BIAM

$159,586,871

14.11%

15.00%

-0.89%

±5%

Total Equity

$700,470,474

61.92%

65.00%

-3.08%

BGI US Debt

$187,479,035

16.57%

16.00%

0.57%

±3%

DAMI

$165,366,983

14.62%

13.00%

1.62%

±3%

Total Fixed Income

$352,846,018

31.19%

29.00%

2.19%

Real Estate

$62,989,203

5.57%

6.00%

-0.43%

±2%

Cash

$14,928,855

1.32%

0.00%

1.32%

Total

$1,131,234,550

100.00%

100.00%

Mr. Clifton informed the Board that Bank of Ireland Asset Management's (BIAM) performance qualifies it to be on SamCERA's "Watch List".  The Investment Plan provides three definitions of underperformance on page seven of Section Nine.  BIAM's trailing twelve month performance meets the first definition, which is, "Four cumulative quarters in which the manager’s performance (gross of fees) falls below the style based benchmark return times 0.8 (for example, if the benchmark return is 10%, the manager’s return would be less than 8.0%)." Ms. Jadallah offered that the SIS quarterly report would show that BIAM also meets the second definition, which is, "Performance (gross of fees) below the 50^th percentile for equity managers and 60^th percentile for fixed income managers in a universe of the managers’ peers over any consecutive 8-quarter period.  Below median performance on a risk adjusted basis will also be a guiding tool in the evaluation of the investment manager."

Mr. Clifton reminded the Board that BIAM appeared before the Board in May 2002 to discuss the apparent deterioration of its stock selection.  Since then its sell discipline has also been questioned.   However, Mr. Clifton recommends that staff continue a dialogue with BIAM until the Board completes the Asset Liability Study and Manager Structure, which should be in May or June of this year.  Mr. Clifton also notes the BIAM's contract expires in June 2003.  He recommends that the Board extend the contract through October 31, 2003 to allow the Board adequate time to complete the Asset Allocation Study and review how they wish to structure their managers.  By consensus the committee asked that the contract extension be placed on the March Agenda.

Action:  The Committee unanimously accepted the Monthly Performance Report. The Committee will recommend to the Board of Retirement that it accept the report.

6.2

Acceptance of Quarterly Investment Performance Analysis for periods ending December 31, 2002

Ms Jadallah and Mr. Thomas went through Strategic Investment Solutions Quarterly Performance Report.

Below is the Investment Performance Summary Provided by Strategic Investment Solutions.

l The composite fund returned 5.1% in the fourth quarter of 2002 and ranked 20th among other public funds greater than $100 million (median 4.3%). The fund trailed its policy index (5.6%) during this time period. Longer term, the three and five-year returns of -4.6% (75th percentile) and 1.9% (83rd percentile), respectively, were below median among large public plans (-3.1% and 3.4%).

l Fourth quarter results were enhanced by the following factors:

1. The BGI Russell 1000 Index Fund ranked in the second quartile among large cap managers (median 7.7%), and matched its benchmark. The Russell 1000 Index had a return of 8.2%.

2. The BGI Russell 2000 Index Fund came out slightly behind its benchmark, the Russell 2000 Index (6.0% vs. 6.2%), but was able to rank above the small cap equity manager median of 5.2%.

3. INVESCO Realty returned 3.8% for the quarter, beating the NCREIF Index (1.8%) and ranking in the top decile among real estate investments.

l Fourth quarter results were hindered by the following factors:

1.      Bank of Ireland’s quarterly return underperformed its benchmark, the MSCI All Country World ex-US Free Index (6.5% vs. 6.9%), and the international equity managers’ median of 6.7%. Financial services stocks were among the top performers for the quarter (ABN-AMRO, Banco Santander Central Hispano, ING Groep) as well as mobile phone company Vodaphone, which benefited from a change in management and participation in the broad telecom sector rebound. However, Bank of Ireland remained disposed towards quality “defensive” stocks which underperformed versus the TMT and financial sectors. Pharmaceutical (Novartis) and Consumer Staples (Diageo) were a drag on the portfolio’s performance. While an underweight to Japan helped performance, stock selection within Japan detracted (Hitachi, Nintendo).

2.   The BGI Debt Index Fund (1.6%) matched its index, the Lehman Aggregate but not the median core bond manager (1.7%) and ranked in the 55^th percentile among its peers.

3.   Deutsche Asset (0.6%), after a long string of excellent performance, has a tough quarter, ranking 94^th among other core bond managers, and trailing the Lehman Aggregate index return of 1.6%.  Deutsche Asset's higher exposure to asset-backed securities, especially those in the manufactured housing sector, hurt relative performance.  Lower quality investment grade corporate credits finally rallied strongly during the fourth quarter, causing Deutsche Asset, with its bias towards higher quality corporates, to underperform during the quarter.

The table below compares the Composite Fund and Manager Portfolios to their Benchmarks and shows how they rank in the universe.

Last Quarter

Fiscal Year-To-Date

Last Year

Return

Rank

Return

Rank

Return

Rank

Composite Fund

-5.06%

20

-5.01%

56

-9.59%

70

   Policy Index

-5.61%

8

-5.68%

69

-10.00%

80

BGI Russell 1000 Fund

8.15%

43

-10.11%

37

-21.63%

44

   Russell 1000 index

8.16%

43

-10.13%

37

-21.65%

44

BGI Russell 2000 Fund

6.03%

41

-16.48%

63

-20.37%

54

   Russell 2000 index

6.16%

39

-16.56%

64

-20.48%

54

BIAM

6.48%

55

-15.07%

65

-17.17%

74

   MSCI ACWI-ex US Index Free

6.86%

47

-13.77%

48

-14.67%

47

BGI US Debt Index Fund

1.62%

55

6.18%

44

10.34%

39

Deutsche Asset Management

0.65%

94

5.93%

56

9.93%

52

   Lehman Aggregate Index

1.57%

59

6.23%

37

10.27%

40

INVESCO

3.79%

9

6.35%

77

3.18%

65

   NCREIF Index

1.79%

43

3.43%

40

5.69%

46

Cash Composite

0.51%

20

1.35%

14

2.75%

15

   91 Day T-Bill Index

0.43%

38

0.89%

44

1.79%

58

Action:  The Committee unanimously accepted Strategic Investment Solutions Performance Report for the quarter ending December 31, 2002. The Committee will recommend to the Board of Retirement that it accept the report.

6.3

Approval of Assumptions and Parameters for Asset / Liability Modeling Study. 

Ms. Jadallah and Mr. Thomas went through Strategic Investment Solutions Asset/Liability Study - Phase 1.

The table below presents the Capital Market Expectation Methodology and the Capital Market Projections.  Committee Members discussed the expected return of Fixed Income and the projected Inflation rate originally believing they may be low.  Ultimately they opined to use SIS's recommended levels for this study.  Mr. Cottle initiated a discussion regarding the risk expectations for Equities and Fixed Income.  He believes they are low relative to recent market movements.  Strategic Investment Solutions will review those risk expectations and recommend adjustments in the study that should address the Committee's concerns.   

SIS's Capital markets Expectation Methodology and Capital Market Expectations appear on the next page.

Asset Class

Derivation

OCTOBER 2002 EXPECTED RETURN

OCTOBER 2002 EXPECTED RISK

Inflation

Consensus of Economists’ Forecasts, TIPS

2.5

¾

Cash

Inflation + 1 to 2% Premium

3.5

1.3

US Large Cap

CAPM, 3 to 6% Equity Premium, Macroeconomic DDM

8.8

16.0

US Small Cap

CAPM, (Beta of ~1.2)

9.7

22.8

International Equity

(Intl Developed Market Stk)

Weighted Sum of Local Market Equity Premium + Local Risk-Free Rate

9.2

19.0

Emerging Market Stock

10.6

34.0

US Fixed Income

Yield to Worst on Aggregate (Compare to Historic Bond Risk Premium, Adjust if Necessary).

5.0

5.0

International Bond

US Fixed Return, Adjusted for Quality and Duration (Potential currency effects based on PPP)

5.0

10.5

Emerging Market Debt

8.0

24.0

High Yield

Historical Ratio:  Spread of High Yield over US Fixed Income ¸ Spread of Large Cap over US Fixed Income

6.8

13.0

Real Estate

1.   Historical Behavior of Equity REITs
2.   Current Appraisal Cap RATES
3.   CAPM

7.2

13.8

Private Markets

CAPM, (Beta of ~1.6)

11.8

34.0

Strategic Investment Solutions' Complete Correlation Matrix appears below.

US LARGE CAP

US SMALL CAP

US FIXED INCOME

INTL DEV MKT

EMERG MKT

INTL FIXED INCOME

PRIVATE MKTS

REAL ESTATE

US HIGH YIELD

EMERG MKT DEBT

CASH

US Large Cap STK

1.00

US Small Cap STK

0.75

1.00

US Fixed Income

0.21

0.19

1.00

Intl Developed  Mkt STK

0.73

0.62

0.20

1.00

Intl Emerging Mkt STK

0.63

0.68

0.17

0.67

1.00

INTL FIXED INCOME

0.15

0.11

0.44

0.39

0.12

1.00

PRIVATE MARKETS

0.65

0.69

0.10

0.58

0.55

0.09

1.00

REAL ESTATE

0.50

0.55

0.44

0.44

0.32

0.21

0.44

1.00

US HIGH YIELD

0.55

0.60

0.53

0.45

0.52

0.43

0.45

0.58

1.00

EMERGING MARKET DEBT

0.41

0.66

0.30

0.42

0.66

0.48

0.35

0.48

0.47

1.00

CASH

0.17

0.08

0.12

0.13

0.01

-0.02

0.07

0.00

0.13

0.14

1.00

The Investment Committee then determined suitable asset classes, asset class weightings and constraints.  Below is a summary of the Committees recommendation:

US Equities – We will run asset allocation mixes using an 80% Russell 1000/20% Russell 2000 custom benchmark, reflecting SamCERA’s current overweight to small cap stocks.  US Equities will range between 30% and 60% of the portfolio.  This range is in line with asset allocation mixes of institutional portfolios, and allows for more conservative and more aggressive mixes around SamCERA’s current target.

Fixed Income – We will use the Lehman Aggregate as the benchmark proxy for bonds.  After some discussion, the Investment Committee decided that a Core Plus benchmark, incorporating High Yield and Non-US Fixed Income exposure on a strategic basis, is inappropriate for the Plan.  But the Committee is interested in addressing Core Plus assignments at the manager structure level.  Fixed Income will be constrained to a range of 20% to 50% in the modeling.

International Equity – SamCERA has decided to stick with the MSCI ACWI ex-US benchmark which is the equivalent of 90% MSCI EAFE (Developed Markets) and 10% MSCI Emerging Markets.  We will use a 10% to 20% allowable range for non-US exposure in our modeling.

Real Estate - The Investment Committee determined that it wants to have at least as much exposure to the real estate asset class as it does now.  After some discussion, the Committee decided upon a range of 6% to 10% for modeling purposes.  SIS’ capital markets assumptions for real estate have NAREIT-oriented quantitative inputs because the index offers daily pricing and a reliable volatility history (versus the infrequently repriced NCREIF Index which minimizes standard deviation).  SIS’ real estate expectation also incorporates a qualitative, NCREIF-oriented overlay looking at current appraisal cap rates.

Private Markets – The Investment Committee decided that Private Markets is an inappropriate asset class for SamCERA.

Action: By consensus the Committee will recommend that the Board adopt the above recommendations for Phase 1 of the Asset/Liability Study.

6.4

Introduction of the Investment Committee's Strategic plan for Fiscal Year 2003/2004.  Mr. Clifton presented a draft of the Committee's Fiscal Year 2003/2004 Work Plan.  The Committee offered no amendments.  The final work plan will be offered to the Committee next month for the Board's approval.

Action: By consensus the Committee approved the draft work plan for Fiscal Year 2003/2004.

7.0

Other Business:  None

8.0

Adjournment: There being no further business Mr. Cottle adjourned the Committee at 4:40 P.M.