R.B. RESOLUTION NO BASIC INVESTMENT POLICIES AND OBJECTIVES OF THE EAST BAY MUNICIPAL UTILITY DISTRICT EMPLOYEES' RETIREMENT SYSTEM

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1 R.B. RESOLUTION NO Introduced by: BASIC INVESTMENT POLICIES AND OBJECTIVES OF THE EAST BAY MUNICIPAL UTILITY DISTRICT EMPLOYEES' RETIREMENT SYSTEM Joe ~~'3 Seconded by: fra...n ~ \...la.,\~ WHEREAS, the voters of the State of California adopted Proposition 21, an amendment to the California Constitution, on June 5, 1984, to be effective January 1, 1985, and the amendment provides the prudent man rule as the investment standard for public agency retirement system programs; and WHEREAS, Chapter 1738 of the Statutes of the 1984 amended Municipal Utility District Act, thereby bringing the District's Employees' Retirement System into conformity with the provisions of Proposition 21; and WHEREAS, the Retirement Board has implemented an Investment Policy statement with the provisions of the Constitution and Statutes which accomplishes the following objectives: 1. Set forth investment policies and objectives which the Retirement Board judges to be appropriate and prudent, in consideration of the needs of the Employees' Retirement System; 2. Establish the criteria which the investment management organizations retained by the Retirement System are expected to meet and against which they are to be measured; 3. Communicate the investment policies and objectives and performance criteria to the investment managers; and 4. Serves as a review document to guide the Board's ongoing oversight of the investment of Retirement System's assets. WHEREAS, it is the practice of the Retirement Board to change its policies and objectives in accordance with changing regulatory, economic, financial and administrative conditions as they change over time: NOW, THEREFORE, BE IT RESOLVED, that the following investment policies and objectives of the Retirement System are revised and adopted as follows: Approved July 15,2010

2 A. General Investment Objectives The Retirement Fund shall be administered exclusively for the financial benefit of the members of the Retirement System. The long-term objective is to meet member benefit obligations and to minimize funding costs. Funding costs are measured by the ratio of member and District contributions to covered payroll. The following general objectives shall govern investments: 1. Minimize long-term funding costs by investment returns which exceed the actuarial interest rate assumption; 2. Achieve a real or inflation adjusted return of 4% or more above the nationwide Urban Consumers Price Index; 3. Recognize that the Retirement System is relatively risk averse and the System s capital should be preserved. Therefore, the goals of the Employees Retirement System are to be achieved recognizing safety of principal, liquidity and yield in that order. Assets must be diversified by type and issuer; 4. Achieve the above objectives within a time horizon of three to five years or approximately a full market cycle; 5. Financial derivatives may be used within prudent limits to manage risk, lower transaction costs, or augment returns. Derivative securities should not be utilized by portfolio managers to materially increase a portfolio s risk or duration as characterized by its stated investment style. Portfolio managers are prohibited from taking leveraged positions. Managers that invest in derivatives are required to make quarterly reports on the specific risk exposure to the System; and 6. Remain fully vested. Available cash within the combined portfolio style should not exceed 5%. (Fixed income managers may exceed this 5% for strategic purposes only). B. Asset Allocation 1. The Retirement Board shall designate multiple investment managers to manage the assets under their supervision subject to the laws of the State of California and the Investment Guidelines established by the Retirement Board. Allocation of assets to the investment managers shall be determined by the Retirement Board to accommodate changing conditions and laws. 2

3 2. The long-range asset allocation goal is as follows: Fixed Income 25% Domestic Equity 50% International Equity 20% Real Estate 5% Allocation to Cash 0%* The composite asset allocation goal will be pursued by the Retirement System on a long-term basis and be revised if significant changes occur within the economic and/or capital market environment. Progress toward the goal will be reviewed at least annually. The Director of Finance is authorized to transfer assets from any asset class which exceeds the long-term asset allocation goal by more than 3% at the end of two or more consecutive quarters allocating the excess assets to a manager or group of managers with the exception of real estate managers. The Director of Finance is further authorized to withdraw assets from assigned managers as necessary to efficiently meet operating needs. The equity and fixed income asset allocations may range + 5% from the longrange asset allocation goals. The fixed income target allocation (25% of the total portfolio) will primarily consist of U.S. denominated fixed income securities. Individual managers may invest up to 20% of their assets in international fixed income securities. The domestic equity target allocation (50% of the total portfolio) will consist of approximately 45% in large cap strategies and 5% in small cap strategies. It is expected this allocation will allow for exposure to mid cap securities based on tactical decisions by the Retirement Fund s large cap and small cap domestic equity managers. The international equity target allocation (20% of the total portfolio) will consist of approximately 17% in international equities and 3% in emerging markets equities. The real estate target allocation (5% of the total portfolio) will consist of either equity (ownership) and/or fixed income participation in commercial, industrial, or residential properties. Investments may include interests in mortgages pools secured by loans of underlying properties. * The allocation goal recognizes that at any time equity and fixed income managers may have transactional cash on hand and the District will maintain enough cash as working capital to effectively meet cash flow demands on the 3

4 system. However, there is no specific allocation for cash as all investable cash is allocated to specific investment disciplines. C. Investment Category Objectives 1. Fixed Income Investments The objectives for investment of the fixed income portfolio are: a. Preserve capital and provide a high level of income on a consistent basis; b. Earn an average annual return from income and capital appreciation net of management fees which exceeds 50 basis points of the Barclay s US Universal Bond Index; c. Achieve performance results that will rank in the top third of fixed income results achieved by a peer group of investment managers and counselors; d. Achieve a minimum long-term rate of return which shall exceed the inflation rate as measured by the nationwide Urban Consumers Price Index by 3%; and e. Achieve the above objectives within a time horizon of a minimum of three to five years or approximately a full market cycle. Holdings of securities issued by the United States Government or any of its agencies need not be diversified. Securities of any one issuer with maturities of more than one year, other than the United States Government or any of its agencies, shall not exceed 5% of the value of the total portfolio. Securities of any one issuer of foreign government issues shall not exceed 10% of the value of the total portfolio at the time of purchase. Fixed income managers have the authority to make international investments, not to exceed 20% of their total portfolio. The use of futures and options in the fixed income accounts may be used as part of their portfolio management strategy and will be incidental to their securities trading activities. The resulting aggregate risk profile (volatility) of the portfolio will not be different from that permissible by using securities only. Short (sold) options positions will generally be hedged, either with current portfolio security holdings, other options or futures options. Mortgage derivatives with significant short option characteristics will not exceed 5% of the portfolio, and will generally be a) offset by positions in other mortgage derivatives, or b) offset by other portfolio positions. 4

5 No derivatives will be executed which will increase the value at risk of the portfolio by more than 25 basis points of the portfolio s market value. Structured notes with significant short options positions or increasing leverage will not be purchased, and in no case will structured notes exceed 5% of portfolio value. Structured Notes issued by the U.S. Government (Treasuries & Agencies) will be considered allowable investments, and are restricted to 25%. Fixed income managers are authorized to use futures and options contracts to supplement their investment capabilities to provide flexibility in managing the fixed income portfolios and reduce the cost of implementing strategies to respond to changing market conditions without incurring the higher transaction costs associated with buying and selling specific securities. These transactions are authorized to enable the manager to reduce the exposure of the portfolio to interest rate changes by reducing or increasing the duration of the portfolio without selling any of the actual holdings. No more than 5% of the portfolio will be invested in original futures margin and options premiums, exclusive of any in-the-money portion of the premiums. 2. Domestic Equity Investments The objectives for investment of the blended equity portfolios are: a. Achieve a total return net of management fees which exceeds the Russell 3000 Index; b. Achieve a minimum long-term rate of return which shall exceed the inflation rate as measured by the nationwide Urban Consumers Price Index by 4%; c. Achieve performance results which will rank in the top third of investment managers which utilize a similar investment style; and d. The use of futures and options in the domestic equity accounts may be used for hedging purposes as part of their portfolio management strategy and will be incidental to their securities trading activities. Each equity portfolio shall be diversified. When fully invested in equities or at its normal level of investment, a minimum of 20 securities should be held. At no time may a single equity investment exceed 5% of the value of the total retirement fund. 5

6 3. International Equity Investments a. Achieve a total return net of management fees which exceeds the Morgan Stanley Capital International (MSCI) ACWI x U.S. Index; b. Achieve a minimum long-term rate of return which shall exceed the inflation rate as measured by the nationwide Urban Consumers Index by 5%; c. Achieve performance results which will rank in the top third of a peer group of international investment managers; and d. Currency hedging will be permitted as part of a defensive strategy to protect an international equity portfolio. Each international equity portfolio shall be diversified. When fully invested in international equities or at its normal level of investment, a minimum of 20 securities should be held. At no time may a single international equity investment exceed 5% of the value of the total retirement fund. D. Investment Performance Evaluation 1. There shall be a continual review of the investments under management. The Board or its designated Administrative and Investment Committee shall confer with the investment managers) at least annually to review Fund investments and the current market environment. Each investment manager shall report pertinent data relating to the account on at least a quarterly basis. 2. Retirement System assets shall be reported at fair market value. Records of amortized cost shall also be maintained. Rates of return shall include net income, realized gains and losses and unrealized appreciation and depreciation. 3. Performance results for the total Retirement Fund, and for each investment manager shall be calculated and evaluated quarterly. A special target index will be created and utilized to measure the performance results of the portfolio and will be included in evaluation reports. The special target index will consist of and be weighted as follows: 50% Russell 3000 Index; 20% MSCI ACWI Index; 25% Barclay s US Universal Bond Index; and 5% NCREIF. This target benchmark index reflects the asset allocation goal established by the Retirement Board. 4. Performance results shall be presented to show: a. The degree to which portfolios and investment managers have achieved Retirement Board investment objectives; 6

7 b. That the investment managers strategy has been consistent with their stated philosophies; and c. How the total portfolio and the individual managers performed in comparison with other pension funds and peer managers. E. Monitoring The following procedures are intended to provide the Board with a decisionmaking framework to monitor its managers. The Board will continue to evaluate and to make decisions regarding its managers on a case-by-case basis. 1. Periodic Monitoring The Board has decided to review several qualitative aspects of an investment manager s investment management practices. Key qualitative indicators of possible inconsistency include, but are not limited to: a. Changes in investment strategy and style, b. Instability of investment manager personnel and organization c. Unusual portfolio activity, trading volume, and execution costs, d. Risk and performance characteristics not logically explainable in terms of the published style or out-of-step with manager s style peer group, and e. Failure to comply with all investment guidelines. None of these indicators may be taken as conclusive evidence of inconsistency. Such a finding would be based upon the facts and circumstances of each situation. 2. Ongoing Monitoring The Board has decided to evaluate investment performance on an ongoing basis using investment performance criteria relative to fund-specific benchmarks over varying periods of time by asset class. Performance criteria are applicable based on the length of the Retirement System s performance history (see table on next page). 7

8 Asset Class Active Domestic Equity Investment Performance Criteria by Asset Class All criteria are on an annualized basis. VRR Value Relative Ratio is calculated as: manager cumulative return / benchmark cumulative return. 3. Implementation of Monitoring Procedures A manager having performance that fails to meet the above criteria may be subject to a heightened level of monitoring. During this heightened level of monitoring, the Retirement Board may: i) instruct the manager to present in writing and/or before the Board reasons for the underperformance, and/or ii) have the investment consultant provide the Board with documentation that discusses the factors contributing to the manager s underperformance. Once the Board has considered these factors, it may want to consider placing the manager on probation. If a manager is placed on probation, three actions are then generally available to the Retirement Board: 1) to release a manager from probation, 2) to extend probation in order to determine whether any changes are improving performance, or 3) to terminate the manager if it has been unable to exhibit improvement in performance (generally within a time from of twelve to eighteen months, if not sooner). Any of these actions would be supported by additional documentation (produced by the investment consultant and/or Staff). This document would highlight the original reasons for placing the manager on probation and discuss how these issues have or have not been addressed. Underperformance would be evaluated in light of the manager's stated style and discipline. If the Retirement Board determines (with advice from the consultant) the manager is unlikely to meet the above performance criteria and/or one of the qualitative indicators of inconsistency is violated without signs of improvement (see Periodic Monitoring), the manager may be terminated. F. Commission Recapture Program Short-term (rolling 12 mth periods) Fd return < bench return - 3.5% Passive Domestic Equity Tracking Error >0.30% Active International Equity Fixed Income Fd return < bench return - 4.5% Fd return < bench return - 1.5% Passive Fixed Income Tracking Error >0.25% Medium-term (rolling 36 mth periods) Long-term (60+ months) Fd annlzd return < bench annlzd return -1.75% for 6 VRR < 0.97 for 6 consecutive months consecutive months Fd annlzd return < bench Tracking Error >0.25% for 6 annlzd return -0.40% for 6 consecutive months consecutive months Fd annlzd return < bench annlzd return -2.0% for 6 VRR < 0.97 for 6 consecutive months consecutive months Fd annlzd return < bench annlzd return -1.0% for 6 consecutive months Tracking Error >0.20% for 6 consecutive months VRR < 0.98 for 6 consecutive months Fd annlzd return < bench annlzd return -0.30% for 6 consecutive months The District has determined that investment managers should be encouraged to direct approximately 25% of their trades through brokers specified by the District. 8

9 This may allow the Retirement System to recapture some of the commission costs. It should be understood that the trades should be executed on a competitive basis to ensure best execution and to limit commission costs. Investment managers should also recognize that it is the intent of the District to encourage the growth and development of M/WBE firms when prudently possible. Investment managers are encouraged to execute trades through M/WBE firms. Such trades must be executed on a competitive basis to ensure best execution and to limit commission costs. All investment managers are invited to participate in the development and review of evaluation criteria. The Retirement Board invites comments on any of its policies or practices and considers this a communication responsibility of the managers. RULE NO. B-14 Disclosure of Placement Agent Retention Adopted by motion Res. Prior to contract execution, investment managers retained by the EBMUD Retirement Board and its investment advisors, must disclose the following in accordance with Sections 20098, 31528, , , and of the Government Code: 1) Retention of placement agents defined as any person or entity hired, employed, or engaged by or acting on behalf of an external manager as a finder, solicitor, marketer, consultant, broker or other intermediary to raise money or investments from or to obtain access to the EBMUD Retirement Board. 2) The fees or compensation paid to placement agents, or person or entities as described above and the services they performed. 3) The resume for each officer, partner, or principal of the placement agent detailing the person s education, professional designations, regulatory licenses, and investment and work experience. 4) A statement as to whether the placement agent, or any of its affiliates, is registered with the Securities and Exchange Commission or the Financial Industry Regulatory Association, or any similar regulatory agent in a country other than the United States, and the details of that registration, or an explanation as to why no registration is required. 5) A statement as to whether the placement agent, or any of its affiliates, is registered as a lobbyist with any state or national government. 9

10 6) All campaign contributions and/or gifts made by placement agents, or any of its affiliates to EBMUD Employees' Retirement System (EBMUDERS) Board Members during the prior 24-month period, and any subsequent campaign contributions to the Board or its Members during the time the placement agent is receiving compensation in connection with providing an investment to the EBMUDERS. All investment managers must provide written confirmation that they are in compliance with this Policy and complete forms as required by the EBMUDERS. An external investment manager who violates this policy is prohibited from soliciting new investments from EBMUDERS for five years from the date of violation. However, the Retirement Board may reduce this prohibition, by majority vote, at a public session upon a showing of good cause that such action is consistent with the Board's fiduciary duties. Retirement Board Members, and employees of the Board including investment officers, retirement administrators, and legal counsel are prohibited from selling investment products to EBMUDERS or any other public retirement system while they are Members ofthe EBMUDERS Board or staff to the Board, and for two years after leaving the Board or employment with the Board. BE IT FURTHER RESOLVED that RB Resolution No and any resolution or parts of resolutions in conflict herewith are rescinded. President ATTEST: Secretary W:\ES\RETIREMENT SYSTEM - ORG 366 FILES\RET. BOARD MTGS\lnvestment Policv\ERS Investment Policv Julv 2010 FINAL.doc Approved July 15,