State Board of Administration
FRS Pension Plan Risk Management
and Asset Allocation
FGFOA Meeting
May 8, 2012
INVESTING FOR FLORIDA’S FUTURE
Presentation Outline
•
SBA Overview
•
SBA Enterprise Risk Management
•
FRS Pension Plan Case Study
– Pension Finance
– Asset Liability Modeling
– Asset Allocation
– Implementation and Business Model
•
Other Management Considerations
2
3
SBA Funds Under Management
April 23, 2012 Estimates
4
SBA’s Strategic Risks
1. Investment Management Risk
2. Governance/Management Risk
3. Communication/Public Affairs/Reputational Risk
4. Legislative/Political Risk
5. Compliance Risk
6. Fraud/ Misconduct/ Internal Controls Risk
7. Service Provider Risk
8. Client Relationship Risk
9. Operational Risk
10. Human Capital Risk
11. Security Risk
12. Business Continuity/Infrastructure Risk
13. Legal Risk
5
SBA Risk Management and Compliance
Residual Risk Assessment - Aggregated Strategic Risk Level
As of 6/30/11
4Highly
Likely
3 - Likely
10
4
12. Business Continu
3
2Unlikely
1
13. Legal Risk
2
13
7
9
5
8
11
12
6
1 - Highly
Unlikely
1 - Minor
6
2 - Moderate
1. Investment Mana
2. Governance/Mana
3. Communication/P
4. Legislative/Politic
5. Compliance Risk
6. Fraud/ Misconduc
7. Service Provider R
8. Client Relationship
9. Operational Risk
10. Human Capital R
11. Security Risk
3 - Major
SBA Investment Risk Components
–
Policy Risk
•
•
•
•
–
Implementation Risk
•
•
•
•
•
•
•
•
–
Policy Design Risk
Investment Objective Risk
Capital Market Assumption Risk
Liability Risk
Strategy Risk
Portfolio Under Performance Risk
Trading Risk
Asset Transition Risk
Model Risk
Due Diligence Risk
Leverage Risk
Aggregate Issuer/Counterparty Credit Risk
Inherent Risk
•
•
Market/Systematic Risk
Idiosyncratic/Unsystematic Risk
7
FRS Pension Plan Case Study
•
Pension Finance
•
Asset Liability Modeling
•
Asset Allocation
•
Implementation and Business Model
8
Millions of 2011 $
Pension Obligations – Future Benefit Cash Flows
D
C2
B
C1
A
A = benefits for current retirees
B = benefits already accrued/earned for current employees
C1+C2 = benefits yet to be earned for current employees
(C1 = portion allocated by actuarial method for past service)
D = benefits for future employees
9
FRS Pension Plan Investment Policy Objective
–
… provide investment returns sufficient for the plan to be maintained
in a manner that ensures the timely payment of promised benefits to
current and future participants and keeps the plan cost at a
reasonable level.
–
To achieve this, a long-term real return approximating 5% per annum
(compounded and net of investment expenses) should be attained,
consistent with the actuarial investment return assumption of 7.75%.
–
As additional considerations, the Board seeks to avoid excessive risk
in long-term cost trends.
–
To manage these risks, the volatility of annual returns should be
reasonably controlled.
10
Structure Of Asset-Liability Model
Economic Simulation
Asset
Returns
Interest
Rates
Inflation
Actuarial
Assump.
Asset
Growth
Asset
Smoothing
Actuarial
Methods
Plan Cost &
Funded Status
11
Liability
Growth
U.S. Equity Return
•
For the 2012 asset liability update we used an equity risk premium assumption
equal to 4.36%, the average of the assumptions used by the four SBA
investment consultants. The resulting expected average compounded return for
U.S. equities is equal to 7.4% (the U.S. bond expected return of 3.0% plus the
equity risk premium of 4.4%):
Price inflation
US bond returns
Risk premium for US equities
HEK
Callan
Wilshire
Mercer
Average
US equity returns
2010
AL Study
2011
AL Update
2012
AL Update
2.40%
4.60%
2.15%
4.20%
2.10%
3.00%
2.40%
4.00%
3.25%
3.80%
3.36%
7.96%
3.60%
4.25%
3.50%
3.80%
3.79%
7.99%
4.50%
4.50%
4.65%
3.80%
4.36%
7.36%
All returns are 15-year geometric average expected returns.
12
FRS Pension Plan Return & Risk Assumptions
--- Expected Average Return --Current Policy
Targets*
Compounded
Single Year
Standard Deviation
Global Equity
52%
8.5%
10.6%
20.8%
Private Equity
5%
9.2%
13.2%
28.3%
Real Estate
7%
7.1%
8.4%
16.3%
Debt-oriented
3%
9.5%
10.1%
10.5%
HF - Absolute Return
2%
5.8%
6.3%
9.3%
HF - Equity Long/Short
2%
7.7%
8.4%
11.5%
HF - Open Mandate
2%
7.3%
7.8%
10.6%
Infrastructure
2%
8.5%
10.2%
18.3%
24%
3.0%
3.1%
3.5%
1%
2.2%
2.2%
1.3%
Risk Assets
Strategic
US Bonds
Cash
Inflation
Fixed Income
2.1%
Total Portfolio
Gross
Expenses
Net - Nominal Return
Net - Real Return
7.5%
8.4%
0.14%
0.14%
7.4%
5.3%
8.3%
13.0%
* Allocation targets based on "Expanded Authority" 13
policy, with typical diversification within the "Strategic" class
Range of Possible 15-Year Compound Returns -Nominal
Percentile:
95th
7.75% actuarial assump.
( 50% probability )
75th
50th
50% confidence range:
from 4.7% to 10.5%
50th %-tile = 7.8%
(median value)
Best estimate = 7.4%
(mean value)
25th
5th
14
90% confidence range:
from -0.1% to 13.8%
Range of Funded Ratios –
Current Asset Allocation Policy
220%
212%
200%
180%
160%
153%
140%
120%
100%
94%
86%
87%
80%
87%
87%
61%
60%
Trend line
40%
32%
24%
20%
0%
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21
FY22
FY23
FY24
FY25
FY26
FY27
84%
85%
86%
87%
87%
70%
84%
86%
87%
90%
61%
82%
86%
89%
94%
53%
80%
87%
91%
100%
44%
76%
86%
92%
104%
40%
72%
86%
95%
111%
38%
69%
86%
99%
121%
37%
67%
86%
101%
132%
33%
66%
87%
104%
142%
32%
63%
87%
107%
153%
30%
61%
87%
110%
161%
27%
59%
87%
116%
172%
25%
58%
86%
119%
183%
25%
56%
88%
122%
196%
24%
54%
87%
127%
212%
%-tile values:
5%
25%
50%
75%
95%
87%
87%
87%
87%
87%
Dark shaded area indicates the 50% probability zone, and light shaded area indicates the 90% probability zone.
15
Range of Employer Contribution Rates (DB Plan Only) –
Current Asset Allocation Policy
35%
30.9%
30%
28.0%
25%
Trend line
20%
15%
14.6%
10%
5%
10.3%
9.9%
9.3%
7.9%
4.1%
0%
FY12
0.0%
0.0%
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21
FY22
FY23
FY24
FY25
FY26
FY27
8.7%
8.7%
8.7%
8.7%
8.7%
8.6%
9.0%
9.2%
9.4%
9.9%
7.9%
8.8%
9.3%
9.9%
14.6%
6.9%
8.6%
9.7%
11.0%
18.5%
4.7%
7.6%
9.3%
11.5%
21.2%
4.7%
7.5%
9.8%
13.1%
23.8%
1.3%
6.6%
9.7%
14.3%
25.6%
0.0%
5.6%
9.9%
15.7%
26.5%
0.0%
4.7%
10.0%
16.4%
27.1%
0.0%
4.7%
9.9%
16.8%
28.0%
0.0%
3.8%
9.8%
17.7%
28.8%
0.0%
2.5%
9.9%
18.6%
29.9%
0.0%
0.0%
10.0%
19.3%
30.2%
0.0%
0.0%
10.5%
19.6%
30.7%
0.0%
0.0%
10.3%
20.2%
30.9%
%-tile values:
5%
25%
50%
75%
95%
4.1%
4.1%
4.1%
4.1%
4.1%
Dark shaded area indicates the 50% probability zone, and light shaded area indicates the 90% probability zone.
16
Risk / Reward Analysis
Based On Long-Term Economic Cost
Lower cost
Current Mix
Less risk
$0
-$5,000
More risk
Diagonal line = 3-to-1
risk/reward
benchmark
Higher cost
Avg. Cost Savings ($MM)
(All 500 scenarios)
$5,000
-$10,000
-$15,000
-$20,000
-$60,000
-$45,000
-$30,000
-$15,000
Avg. Risk Increase ($MM)
(Worst 100 scenarios)
Change in cost relative to
values using current mix
17
$0
$15,000
2011 Asset Liability Update: Diversification Impact
Diversification changes can improve the results.
Avg. Cost Savings ($MM)
(All 1,000 scenarios)
The Recommended policy offers long-term cost savings of $2.3 billion,
with no material change in risk profile
Recommended Policy
(with diversification)
Increased diversification shifts
curve in favorable direction
June 2010 Policy
(before diversification)
Avg. Risk Increase ($MM)
(Worst 200 scenarios)
18
Investment Policy Themes:
Enhancing diversification and taking risk more efficiently
•
Maintain or reduce the overall level of investment risk in the fund
– Reduction in the fund’s overall exposure to global stock markets
– Decrease in the fund’s use of active management in the public stock and bond
markets
•
Further increase diversification of investments
– Greater global diversification within the publicly traded stock investments
– Greater diversification into a broader array of investment types (i.e. alternative
investments) that do not necessarily fluctuate with stock markets
•
Increase flexibility to take investment risks more efficiently
– Downside protection from volatile markets through bond investments
– Participate in worldwide economic growth through stock investments
– Generate above market returns, with strong risk controls, through skillful
opportunistic investing
19
FRS Pension Plan Asset Allocation Policies
Asset
Class
Pre-July 2010
Policy
Current
Policy
Expanded
Authority Policy
Global Equity
58%
56%
52%
Fixed Income
28
26
24
High Yield Fixed Income
2
–
–
Real Estate
7
7
7
Private Equity
4
4
5
Strategic Investments
–
6
11
Cash
1
1
1
Total
100%
100%
100%
*Prior to July 2010, Global Equity was composed of two asset classes, Domestic Equities and Foreign Equities, with target allocations of 38% and
20%, respectively.
** Global Equity asset class includes existing Domestic Equity, Foreign Equity and Global Equity mandates; Strategic Investments includes existing
High Yield allocation.
*** In recognition of the dynamic nature of this asset class, there is no specific expected weight. Its actual allocation will vary within the policy range
depending on the mix of included strategies at any given time. When the actual allocation of Strategic Investments is greater than zero, all other
asset class target allocations shall be reduced pro-rata.
20
Strategic Investments Detail
Asset
Category
Recommended
(% of Total Fund)
Debt-Oriented Funds
3.0%
Infrastructure
2.0
Absolute Return Hedge Funds
2.0
Long/Short Equity Hedge Funds
2.0
Open Mandate Hedge Funds
2.0
Commodities
--
Timberland
--
Total Strategic Investments
11.0%
 Allocations reflect current expectations for future allocations in Strategic Investments for modeling
purposes. Actual allocations, including possible investments in commodities and timberland, will
vary dependent on identification of attractive opportunities.
21
FRS Pension Plan
Cumulative Performance History
Fiscal Years 1976 Through 2011
2000%
1500%
Cumulative Net Return on FRS Pension
Plan Assets
1000%
Actuarial Return Assumption (currently
7.75%)
500%
0%
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Fiscal Year Ending June 30
Returns are net of investment manager fees for periods after December 1984.
22
FRS Pension Plan Net Managed and Target Returns
18%
Managed
16%
7.98%
8.24%
3.15%
3.80%
4%
2.63%
2.93%
6%
5.62%
5.92%
6.68%
8.16%
8.55%
10.40%
8.46%
7.04%
8%
7.60%
10%
8.29%
Target
14%
12%
15.87%
16.51%
As of March 31, 2012
2%
0%
3
Months
1 Year
3 Years
5 Years
10 Years
15 Years
20 Years
25 Years
30 Years
23
FRS Results Relative to TUCS Top Ten Defined Benefit Plans
Periods Ending 12/31/2011
Total FRS (Gross)
Top Ten Median Defined Benefit Plan Fund (Gross)
15.0
11.2 11.0
10.0
Rate of Return (%)
5.0
4.5
5.4
5.5
3.9
2.8
2.0
2.2
0.0
-0.3
-5.0
-10.0
-15.0
Quarter
1-Year
3-Year
5-Year
Note: The TUCS Top Ten Universe includes $1.1 trillion in total assets. The median fund size was $112.5 billion
and the average fund size was $109.7 billion.
24
10-Year
Comparison of Asset Allocation
As of 12/31/2011
FRS Pension Plan vs. Top Ten Defined Benefit Plans
FRS TOTAL FUND
Strategic Investments
4.1%
TUCS Top Ten
Cash
2.1%
Cash
0.7%
Private Equity
4.9%
Alternatives
17.6%
Real Estate
7.4%
Real Estate
6.3%
Global
Equity*
Global
Equity**
46.8%
56.9%
Fixed Income
26.0%
Fixed Income
27.3%
**Global Equity Allocation: 28.9% Domestic Equities; 17.9% Foreign
Equities.
*Global Equity Allocation: 25.5% Domestic Equities; 28.7% Foreign
Equities; 2.8% Global Equities. Percentages are of the Total FRS Fund.
Note: The TUCS Top Ten Universe includes $1.1 trillion in total assets. The median fund size was $112.5 billion
and the average fund size was $109.7 billion.
25
Hedge Fund Return and Risk Attributes
Outperformance
Lower Risk
Growth of a Dollar
Jan 1994 – Dec 2010
Annualized Volatility
Jan 1994- Dec 2010
5.0
25%
4.5
4.0
20%
3.5
15%
3.0
2.5
10%
2.0
1.5
5%
1.0
0%
0.5
DJ/CS
Hedge Fund
Index
HFR Fund Weighted Composite
S&P 500 Index
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
Dec-93
0.0
Tbill
26
HFR Fund
Weighted
Index
Dow Jones
U.S Total
Stock Market
Index
S&P 500
Index
MSCI All
Country
World Index
Barclays
Aggregate
Bond Index
Goldman
Sachs
Commodity
Index
FRS Pension Plan Cost Comparison to
CEM Peer Group
60.0
Cost in Basis Points
50.0
40.0
SBA Total Costs
Peer Group Median Total Costs
30.0
20.0
10.0
0.0
2005
2006
2007
2008
Calendar Year
2009
2010
Cost Effectiveness Measurement (“CEM”) maintains a global database of detailed cost information provided by public and
corporate pension plans. The SBA’s 2010 CEM Peer Group included 16 U.S. plan sponsors with assets from $22.5 billion to
$225.6 billion.
27
27
High Level Investment Guidelines
•
Public market asset classes shall be well diversified with respect to their
benchmarks and have a reliance on low cost passive strategies scaled
according to the degree of efficiency in underlying securities markets,
capacity in effective active strategies, and ongoing total fund liquidity
requirements.
•
Private Equity, Real Estate and Strategic Investments asset classes shall
utilize a prudent process to maximize long-term access to attractive riskadjusted investment opportunities through use of business partners with
appropriate:
–
–
–
–
Financial, operational and investment expertise and resources;
Alignment of interests;
Transparency and repeatability of investment process; and
Controls on leverage.
28
FRS Pension Plan Asset Class Allocations
February 2012
29
FRS Pension Plan Active Risk Budget Monitoring Standards
Active Risk
Active
Share
Monitoring
Standard
Current Market
Standard
Tactical Asset Allocation
0.20%
0.40%
--
Global Equity
1.00%
1.50%
[40%, 60%]*
Fixed Income
0.75%
1.25%
[25%, 75%]
Real Estate
5.00%
8.00%
--
Private Equity (secondary
benchmark)
6.00%
10.00%
--
Strategic Investments
4.00%
6.00%
--
Cash
0.10%
0.20%
--
Total Fund
1.00%
1.50%
TAA/ Asset Class
30
31
32
Looking Forward: 2012 FRS Pension Plan Asset
Liability Update
• Supports continuation of the current multi-year implementation of
increased allocations to real estate, private equity, and strategic
investments, but identifies changes to be considered
– Conflicting indicators on best portfolio risk target – some supporting an
increase in risk and some supporting a decrease in risk
– Growing importance of liquidity management over intermediate-term
– Re-emphasizes the value of diversification
• The funding policy has a direct impact on some of the investment
policy risk-reward analysis
–
–
–
–
Deferring actuarially recommended contributions (“UAL”)
Treatment of 2011 benefit changes
Actuarial assumptions
Amortization and other actuarial cost methods
33