SURS fixed income assets are distributed among 13 external managers. The SURS total fixed income assets under management are distributed as follows:

Transcription

1 State Universities Retirement System of Illinois Serving Illinois Community Colleges and Universities 1901 Fox Drive Champaign, IL (217) (217) (FAX) Investment Department To: Investment Committee From: Douglas C. Wesley, CFA, Kimberly K. Pollitt, CFA, Joseph M. Duncan, Lou Ann Fillingham, CPA, & Gabriel Ayoroa Date: January 28, 2013 Re: Executive Summary of the Actively Managed Fixed Income Asset Class As of September 30, 2012, the SURS fixed income portfolio is valued at approximately $3.4 billion, or 24.3% of the total portfolio. The fixed income portfolio consists of four major components, as shown in the following chart. Actively managed core and core plus strategies comprise approximately 7 of the total fixed income portfolio while passively managed portfolio assets account for 15% of the fixed income investments. Treasury Inflation- Protected Securities (TIPS) make up the remaining 15% of the fixed income portfolio. The current portfolio contains a meaningful passive exposure for enhanced liquidity and a balanced structure between core, core plus and TIPS managers. Current Portfolio Structure as of September 30, 2012 Core 1 Core Plus 5 Passive 15% TIPS 15% SURS fixed income assets are distributed among 13 external managers. The SURS total fixed income assets under management are distributed as follows:

2 Account Mandate SURS Assets under Management in $MM As of September 30, 2012 PIMCO Total Return Core Plus $846 TCW MetWest Core Plus 399 Neuberger Berman Core Plus 287 Progress Investment Core Plus 98 Taplin, Canida & Habacht Core Plus 70 LM Capital Group Core Plus 57 Smith Graham Core Plus 55 Garcia Hamilton & Associates Core Plus 35 Total Core Plus $1,846 Chicago Equity Partners Core 277 Cash Flow Account Short-Term 194 Pugh Capital Core 86 Total Core/Short Term $556 State Street Global Passive 505 Total Passive $505 PIMCO U.S. TIPS TIPS 312 Longfellow Investment TIPS 125 New Century Advisors TIPS 96 Total TIPS $533 Total Fixed Income $3,440 The Progress Investment Management manager of emerging managers program will be reviewed at the April 2013 Investment Committee meeting. The State Street Global Advisors passive fixed income account was reviewed at the December 2012 Investment Committee meeting as part of the review of all index managers. Organizational Issues Listed below are organizational issues relating to investment managers in the SURS portfolio: On August 9, 2012, TCW management and The Carlyle Group announced a definitive agreement to acquire TCW from Société Générale. As a result of the transaction, TCW will again become an independent company and TCW employees will increase their ownership stake in the firm from 19% to approximately 4 on a fully diluted basis. The firm expects the transaction to close in the first quarter of TCW was placed on the Watch List in September 2012 as a precautionary measure due to the pending ownership change. Coinciding with the announcement that TCW management and funds managed by The Carlyle Group would acquire Société Générale s stake in TCW, David Lippman,

3 previously the Head of Fixed Income at TCW, was named President and CEO of TCW, succeeding Marc Stern, who remains Vice Chairman. Mr. Lippman previously served as CEO of the legacy firm, Metropolitan West Asset Management. In November 2011 Neuberger Berman announced that they intend to acquire the remaining 48% equity stake still owned by the Lehman Brothers Trust over the next 5 years. They will be 10 employee owned once the transaction is completed. Taplin, Canida & Habacht (TCH) added a senior investment professional to its team in November Daniela Mardarovici, CFA, joined TCH as a portfolio manager. Prior to joining TCH, Ms. Mardarovici was Director and Senior Fixed Income Portfolio Manager at Harris Investments in Chicago, now BMO Asset Management Corp. The addition of Ms. Mardarovici continues the expansion of the portfolio management team to five individuals. Also, BMO Financial Group, which currently owns 9 of the firm, continues to increase its ownership and is expected to own 10 of the firm by 2014, as provided in the 2008 purchase agreement. In January 2012, Smith Graham & Company reduced its staff by one Analyst/Portfolio Manager and one Trader. The staff reduction stemmed from an overlap in responsibilities resulting from the acquisition of the Fixed Income team at Ark Asset Management in February of There have been no changes in professionals assigned to the SURS account. Pugh Capital Management added Darius Cayetano as a Senior Credit Analyst in June Mr. Cayetano replaces Nancy McFadden who left the firm and relocated to Oregon in June He has more than 13 years of credit research experience and joined Pugh Capital from JPMorgan Chase, where he was a Credit Analyst and Portfolio Manager. David Seeley, lead portfolio manager at Longfellow Investment Management, will complete the five-year process of selling his ownership in the firm on December 31, He is sharing portfolio management responsibilities with Mr. John Villela, who will become the lead portfolio manager on January 1, Over the past year, New Century Advisors added two investment professionals. Chris Dirkes joined the firm in February 2012 with both trading and credit analysis responsibilities on the portfolio management team. Burak Tekes joined the firm in January 2013 as a sovereign analyst, a new position. Mr. Tekes will be responsible for macroeconomic research, modeling, and security valuations of developed and emerging markets for the firm. The additions increase the total investment team to six individuals. Staff has no organizational issues with any of the other fixed income managers in the SURS portfolio at this time.

4 Investment Performance Issues The table that follows highlights performance of the SURS fixed income portfolio for the past one- and ten-year periods. If a manager has less than ten years history with SURS, performance since inception is shown. 10 YR (1) Mgr 10 YR (1) Bmark September-12 Incep 1 YR Mgr 1 YR Bmark Excess Return Exces s Return Core Fixed Income Managers Chicago Equity Partners Oct % % 5.19% 5.25% -0.0 Pugh Capital Management Apr % Core Plus Fixed Income Managers Garcia Hamilton & Associates Feb % 7.17% 2.4 LM Capital Group Dec % 6.77% 0.98% Neuberger Berman Dec % % 7.88% 6.77% 1.11% PIMCO Total Return Oct % % 7.31% % Progress Investment May % % 6.99% % Smith Graham & Company Apr % % 6.39% Taplin, Canida & Habacht Apr % 7.55% % TCW MetWest Nov % % 7.11% % Active Fixed Income Oct % % 6.67% 5.67% 1.0 State Street Global Advisors Sep % -0.01% Passive Fixed Income Oct % 4.67% -0.07% Total Core Fixed Income Oct % % 6.45% 5.67% 0.79% Longfellow Investment Management Apr % 8.98% 9.53% -0.55% New Century Advisors Apr % % 9.59% 9.53% 0.07% PIMCO US TIPS May % Total TIPS Jul % % 7.11% % TOTAL FIXED INCOME TOTAL FIXED INCOME Oct % % 6.55% 5.68% 0.88% (1) or since inception, whichever is less TIPS Core/Core Plus Fixed Income Mandates The fixed income portfolio performed well relative to benchmark during the year ending September 30, Overall, the core fixed income portfolio, excluding TIPS, returned 7.73%, exceeding the 5.1 benchmark return by 257 basis points. Nine of the ten active managers outperformed the benchmark in the period. Managers outperforming the benchmark for the one-year period generally shared a common theme: an underweight to nominal Treasury securities and overweights to one or more of the spread sectors. Exposure to non-agency mortgages, corporate bonds (especially those in the financial sector), and TIPS benefited relative performance during the period as these bonds generally outperformed the broader market. Chicago Equity Partners, the lone manager to lag the benchmark for the year, underperformed due to a defensive posture in credit, quality and security selection and an emphasis on high quality, liquid assets. The firm believes that the portfolio is positioned to benefit from an environment characterized by a lower appetite for risk. Since inception the portfolio has returned 5.19% on an annualized basis versus 5.25% for the Barclays Capital Aggregate Bond Index.

5 Over longer time periods, the fixed income portfolio continues to perform well. For the threeyear period, the SURS fixed income portfolio returned 7.38%, exceeding the benchmark return by 119 basis points annually. For the five-year period, the portfolio returned 7.6 compared to the benchmark return of 6.53%. The performance charts following the review are from Callan s September 30, 2012 performance book. The first chart compares the SURS fixed income portfolio s performance and peer ranking over various time periods. For the periods ending September 30, 2012, the portfolio ranked in the 70 th percentile for the one-year and in the 75 th and 52 nd percentiles, respectively, for the three- and five-year periods. The second chart displays the fixed income portfolio s relative quarterly performance for the past five years, as well as a cumulative fiveyear return versus the benchmark. The next two charts illustrate the portfolio s risk-adjusted statistics. The SURS portfolio has a lower risk and a higher risk-adjusted return than the majority of other funds in the universe. TIPS Mandates The TIPS portfolio returned 10.27% for the year ending September 30, 2012, exceeding the benchmark return by 117 basis points. Performance was mixed among the three active managers. In the twelve-month period ending September 2012, the PIMCO TIPS portfolio returned 11.6, exceeding the 9.1 benchmark return by 254 basis points. The excess return was driven by an emphasis on financials in the investment grade and high yield corporate sectors and exposure to non-agency mortgages amid increased investor demand for spread sectors. The portfolio has exceeded the benchmark in the threeand five-year periods by 109 basis points and 86 basis points, respectively. From the inception of the actively managed portfolio, performance has exceeded the benchmark by 75 basis points. Longfellow Investment Management returned 7.8, net of fees, for the one-year period ending September 30, 2012, trailing the benchmark return by 128 basis points. Performance was negatively affected by duration, curve positioning and being underweight TIPS versus nominal securities in a risk-on environment that favored TIPS during the twelve-month timeframe. Since inception, the portfolio has returned 8.98%, trailing the benchmark by 55 basis points annually. The New Century Advisors portfolio returned 8.88% for the one-year period ending September 30, 2012, net of fees, trailing the benchmark return by 23 basis points. The underperformance was due to term structure positioning that anticipated a flattening in the yield curve. Specifically, the portfolio was overweight in longer dated TIPS, which would benefit the most from a decline in long-term real rates. In reality, the real yield curve steepened over the course of the year, negatively impacting relative performance. Since inception, the portfolio has returned 9.59%, exceeding the benchmark by 7 basis points annually. The performance charts following the review are from Callan s September 30, 2012 performance book. The first chart compares the SURS TIPS portfolio s performance and peer ranking over various time periods. For the periods ending September 30, 2012, the portfolio ranked in the 8 th percentile for the one-year and in the 9 th and 7 th percentiles, respectively, for the three- and five-year periods. The second chart displays the TIPS portfolio s relative

6 quarterly performance for the past five years, as well as a cumulative five-year return versus the benchmark. The next two charts illustrate the portfolio s risk-adjusted statistics. The SURS portfolio has a higher risk and a higher risk-adjusted return than most other funds in the universe. Recommendations SURS staff and Callan Associates jointly recommend: That PIMCO be retained as a core plus fixed income manager. That PIMCO be retained as a TIPS fixed income manager. That TCW MetWest be retained as a core plus fixed income manager. That Neuberger Berman be retained as a core plus fixed income manager. That Taplin, Canida & Habacht be retained as a core plus fixed income manager. That LM Capital Management be retained as a core plus fixed income manager. That Smith Graham be retained as a core plus fixed income manager. That Garcia Hamilton & Associates, L.P. be retained as a core plus fixed income manager. That Chicago Equity Partners be retained as a core fixed income manager. That Pugh Capital be retained as a core fixed income manager. That Longfellow Investment Management be retained as a TIPS fixed income manager. That New Century Advisors be retained as a TIPS fixed income manager.

7 SURS Fixed Income Portfolio Excluding TIPS Performance vs Lg Fund Sponsor - Domestic Fixed (Gross) % (70) (75) (52) (92) (81) (91) (92) (59) Last Quarter Last Year Last 3 Years Last 5 Years 10th Percentile th Percentile Median th Percentile th Percentile Fixed-Income Custom Benchmark Cumulative and Quarterly Relative Return vs Custom Benchmark Relative Returns 1 8% () () () (8%) (1) Fixed-Income Lg Fund Spnsr - Dom Fixed

8 Returns % () Lg Fund Sponsor - Domestic Fixed (Gross) Annualized Five Year Risk vs Return Fixed-Income Custom Benchmark () Standard Dev iation Risk Adjusted Return Measures vs Custom Benchmark Rankings Against Lg Fund Sponsor - Domestic Fixed (Gross) Five Years Ended September 30, (0.5) (1.0) (1.5) (36) (20) Information Sharpe Excess Return Ratio Ratio Ratio 10th Percentile th Percentile Median th Percentile (0.25) th Percentile (0.85) 0.85 (0.19) Fixed-Income (41) SURS TIPS Portfolio Performance vs CAI Real Return (Gross) 1 1 (50) (8) (53) (9) (7) 8% (63) (56) (13) Last Quarter Last Year Last 3 Years Last 5 Years 10th Percentile th Percentile Median th Percentile th Percentile TIP S Custom Benchmark

9 Cumulative and Quarterly Relative Return vs Custom Benchmark 5% Relative Returns 3% 1% (1%) () TIPS CAI Real Return Returns % % % % % CAI Real Return (Gross) Annualized Five Year Risk vs Return TIPS Custom Benchmark Standard Dev iation Risk Adjusted Return Measures vs Custom Benchmark Rankings Against CAI Real Return (Gross) Five Years Ended September 30, (0.5) (1.0) (34) (14) (15) Information Sharpe Excess Return Ratio Ratio Ratio 10th Percentile th Percentile Median th Percentile (0.01) 1.30 (0.37) 90th Percentile (0.24) 1.18 (0.66) TIP S