asset allocation review - nebraska · 2017. 12. 27. · aon hewitt retirement and investment...
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Nebraska Investment Council
Asset Allocation Review
July 2017
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Overview
The A/L Study conducted last summer supported NIC’s existing 80% Return Seeking / 20% Risk
Reducing asset mix
– Please note that ≈2/3 of the 30% fixed income allocation is invested in core bonds
Given existing market conditions, meeting or exceeding the assumed rate of 7.5% is likely to prove
challenging
– That said, there are changes that can be made to the return-seeking portfolio to enhance long-
term return forecasts (and/or reduce portfolio volatility)….at least at the margin
Long-Term Policy
Allocation
Annualized Return (10
Year Forecast)**
Standard Deviation (10
Year Forecast)**
U.S. Equity 29.5% 6.5% 17.4%
Non-U.S. Equity 13.5 7.6 20.9
Global Equity 15.0 7.1 18.5
Fixed Income* 30.0 2.8 3.8
Private Equity 5.0 8.5 24.0
Real Estate 7.5 5.8 12.5
Total Fund 100.0% 6.1% 12.1%
*Modeled as 20% core bonds, 1.5% international bonds, 3.5% high yield bonds, and 5% bank loans
**Based on 3Q 2016 AHIC 10-year CMAs
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Asset Allocation – Peer Comparison
*Greenwich Associates – Institutional Investors Market Trends 2016 **Based on 3Q 2016 AHIC 10-year CMAs
37.0%
20.5%
30.0%
7.5%
5.0%
0.0% 0.0% 0.0%
26.2%
19.6%
26.2%
9.0%9.8%
4.1%
1.1%
4.0%
28.1%
19.0%
23.6%
8.6%
5.5%4.5%
0.8%
9.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
U.S. Stocks Non-U.S.Stocks
Core-PlusFixed
Income
Real Estate PrivateEquity
HedgeFunds
Cash Other
NIC Public Funds > $5 billion Public Funds $1-$5 Billion
NIC Public Funds > $5 Billion Public Fund $1-$5 Billion
Forecasted Return** 6.1% 6.1% 5.9%
Forecasted Volatility** 12.1% 11.5% 11.4%
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Other Asset Classes -- Worth Considering for NIC?
Asset Class
Forecasted
Return*
Forecasted
Volatility*
Worthy of
Further
Consideration? Comments
Hedge Funds 4.8% 9.0% Likely No
Can be a good diversifier, but high fees, ever
increasing competition, disappointing performance for
several years, and a poor fit with “Efficiency” approach
Infrastructure 6.3% 14.5% No
Intriguing in theory, but privatization has not taken hold
in the U.S. like some predicted. More of a Private
Equity sub-component than a standalone asset class
Commodities 3.5% 17.0% No
Makes sense for investors with extreme sensitivity to
inflation. For others, commodities offer low real returns
and high volatility
Multi-Asset /
TAAN/A N/A No
Timing markets is exceptionally difficult; very few
managers have shown an ability to add value with
tactical asset allocation
Risk Parity 5.6% 10.0% Likely NoSuccessful long-term track record, but track record
achieved during a secular decline in bond yields
Timber 5.4% 15.0% NoNiche asset class that can serve as a good diversifier;
long lock-up for middling returns, however.
Emerging
Market
Debt**
5.0% 12.0% Perhaps
High yields, some diversification potential, but relatively
volatile. Better as a part of a diversified credit
allocation than a standalone asset class in our view
Private
Credit***5.7% 9.0% Perhaps
High yields, compelling investment thesis; relatively
high fees and a give up in liquidity required
*Based on 3Q 2016 AHIC 10-year CMAs **Modeled as 50% USD EMD / 50% Local Currency EMD ***Modeled as 50% Direct Lending / 50% Multi-Asset Credit
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Three Changes to NIC’s Long-Term Target Asset Allocation Policy Worth
Considering
Constructing a realistic asset allocation policy with a better than average chance of meeting the
assumed rate is not possible in the current return environment, given our capital market assumptions
There are, however, changes that could increase forward looking return prospects and/or reduce
portfolio volatility
Three asset allocation changes that we believe are worthy of consideration
1) Constructing the equity portfolio such that it is more in-line with global equity market
capitalization
• i.e., reducing home country bias within equities
2) Separating the bond allocation into “risk reducing” and “return seeking” fixed income, and
establishing a target to less liquid fixed income opportunities within the return-seeking
component
3) Reducing the allocation to public equities, increasing the allocation to private equity and real
estate*Based on current AHIC CMAs
Core Fixed Income,
20%
Real Estate, 5%
Private Equity, 75%
Solving for 7.5%*
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Potential Asset Allocation Scenarios for Consideration
Current AA Policy
Scenario #1 –
50/50 U.S. / Non
U.S Equity
Scenario #2 – 10%
Credit
(Public/Private)
Scenario #3 –
Reduce Equity,
Increase Alts
Scenario #4 –
Combine
Scenarios 1&2
Scenario #5 –
Combine
Scenarios 1, 2 & 3
U.S. Equity 29.0% 19.5% 29.0 25.0% 19.5% 17.0%
Non-U.S. Equity 13.5 19.0 13.5 12.0 19.0 17.0
Global Equity 15.0 19.0 15.0 13.0 19.0 16.0
Core Fixed Income 20.0 20.0 20.0 20.0 20.0 20.0
HY Corp 3.5 3.5 -- 3.5 -- --
Bank Loans 5.0 5.0 -- 5.0 -- --
Int’l Bonds 1.5 1.5 -- 1.5 -- --
Public Credit* -- -- 5.0 -- 5.0 5.0
Private Credit** -- -- 5.0 -- 5.0 5.0
Private Equity 5.0 5.0 5.0 10.0 5.0 10.0
Real Estate 7.5 7.5 7.5 10.0 7.5 10.0
Total Fund 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Forecasted Return 6.1% 6.2% 6.2% 6.2% 6.3% 6.4%
Forecasted Volatility 12.1 12.3 12.2 11.9 12.4 12.1
Sharpe Ratio 0.40 0.41 0.41 0.42 0.41 0.43
Distribution (1 Year)
5th Percentile 27.8% 28.2% 28.0% 27.4% 28.5% 28.0
25th Percentile 14.5 14.7 14.7 14.4 14.9 14.8
50th Percentile 6.1 6.2 6.2 6.2 6.3 6.4
75th Percentile -1.7 -1.4 -1.6 -1.4 -1.6 -1.4
95th Percentile -11.9 -12.0 -11.9 -11.5 -12.0 -11.5
*Modeled as 50% HY bonds / 50% Bank Loans
**Modeled as 50% Direct Lending, 50% Multi-Asset Credit
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Cap-Weighted Equities – Why and Why Not?
Arguments for:
– Efficiency pick-up
– Current valuation picture
– Peer practice 6.4%
6.6%
6.8%
7.0%
7.2%
7.4%
7.6%
17.0% 18.0% 19.0% 20.0% 21.0% 22.0%
Exp
ecte
d N
om
inal
Geo
metr
ic R
etu
rn
Expected Risk (Volatility)
U.S. Equity Non-U.S. Equity Cap-Weighted
Current NIC Equity
Russell 1000 Forward P/E Ratio (Large-Cap U.S.
Stocks)
MSCI EAFE Forward P/E Ratio (Developed
Market International Stocks)Russell 2000 Forward P/E Ratio (Small-Cap
U.S. Stocks) MSCI Emerging Markets Forward P/E Ratio
56.7%
43.3%
0%10%20%30%40%50%60%70%80%90%
100%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
U.S. Stocks Non-U.S. Stocks
Composition of Equity Allocation: Public Funds >$5 Billion*
*Greenwich Associates – Institutional Investors Market Trends 2007-2016
Arguments against:
– Increased currency exposure (liabilities denominated in dollars)
– Higher fees (potentially)
– Current allocation provides most of the diversification benefit of international stock exposure
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Splitting the Bond Allocation and adding a Targeted Allocation to Private
Credit – Why and Why Not?
Benefits and Drawbacks of separating the fixed income allocation into “Risk Reducing” and “Return
Seeking”
Benefits Drawbacks
More control over asset allocation Complexity
More control over risk Higher cost
DiversificationTakes tactical decisions out of the hands of those
best positioned (in theory) to make them
Benefits and Drawbacks of establishing a targeted allocation to Private Credit within the “Return
Seeking” fixed income allocation
Benefits Drawbacks
Increased Return Potential Complexity
Understandable investment thesis Higher cost
Diversification potential Liquidity give up
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Increasing the Allocation to Real Estate and Private Equity / Reducing
the Allocation to Public Equities – Why and Why Not?
Arguments for:
– Increased Returns (Private Equity), Reduced Volatility (Real Estate)
– Performance persistence (i.e., past outperformers outperforming in the future) is stronger in alternative
asset classes than it is in public markets
– Reduced equity risk
– Leverages NIC’s liquidity advantage
0%
20%
40%
60%
80%
100%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%C
on
trib
uti
on
to
To
tal R
isk
Alternatives as % of Return-Seeking Assets
Equity Diversifying Assets* Alternatives Bonds
Contribution to Risk at Varying Levels of
Alternatives Allocations
Net Outflow Analysis: (Benefit Payments less Contributions) / MVA
School Retirement System
Arguments against:
– Costs in private equity and real estate are substantially higher than in public equity
– Additional complexity
– Private equity yet to “prove itself” for NIC
– Reduced liquidity
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NIC’s Private Equity Allocation – Pacing Considerations
0%
1%
2%
3%
4%
5%
6%
Current 2016 2017 2018 2019 2020 2021 2022
Projected NAV of Private Equity as a Percent of Total Program
2.1% Asset Growth 3.6% Asset Growth
5.1% Asset Growth Target Policy Allocation
2016 2017 2018 2019 2020 2021 2022
Private Equity NAV @ Beginning of Year $559.0 $567.8 $625.8 $678.1 $721.5 $754.8 $781.0
Capital Called (23.4) (112.4) (123.3) (128.2) (129.0) (130.7) (130.9)
Capital Called - Existing Commitments (23.4) (95.6) (79.1) (54.5) (34.2) (19.1) (8.6)
Capital Called - New Commitments 0.0 (16.7) (44.2) (73.7) (94.8) (111.6) (122.3)
Distributions 36.0 153.3 173.1 190.4 197.5 211.2 218.7
Distributions - Existing Commitments 36.0 152.6 169.4 179.9 173.7 164.3 143.2
Distributions - New Commitments 0.0 0.7 3.7 10.5 23.8 46.9 75.4
Net Cash Flow 12.5 40.9 49.8 62.2 68.5 80.5 87.8
Appreciation 21.3 98.9 102.1 105.6 101.8 106.7 107.6
Appreciation - Existing Commitments 21.3 99.9 102.9 101.2 85.0 73.6 58.3
Appreciation - New Commitments 0.0 (0.9) (0.7) 4.4 16.8 33.1 49.3
Private Equity NAV @ End of Year $567.8 $625.8 $678.1 $721.5 $754.8 $781.0 $800.8
Private Equity as % of Total Program (1) 4.6% 4.8% 5.1% 5.2% 5.3% 5.2% 5.2%
Annual Commitment Pace
In $ Millions
Year Investment
2017 150.0
2018 150.0
2019 150.0
2020 150.0
2021 150.0
2022 150.0
• Based on current
pacing, 5% PE
target should be
reached in 2018
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NIC’s Real Estate Allocation – Pacing Considerations
Forecast
6.2%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 Q42016
2017 2018 2019 2020 2021 2022
Core Allocation Non-Core Allocation Target Policy Allocation 6.0% Total Program Growth Actual Net Asset Value
$ in millions
Inception to
Q4 2016 2016 2017 2018 2019 2020 2021 2022
Commitments 870 80 50 50 20 20 20 20
- Core 60 30 30 - - - -
- Non-Core 20 20 20 20 20 20 20
Capital Calls (945) (18) (177) (82) (28) (23) (27) -
Distributions 536 26 43 40 50 56 64 -
Annual Net Cash Flows (409) 8 (134) (41) 22 32 37 -
Real Estate NAV 775 775 966 1,079 1,137 1,189 1,240 1,305
Total Plan Value 12,471 12,471 13,219 14,012 14,853 15,744 16,689 17,690
RE Value as a % of Total 6.2% 6.2% 7.3% 7.7% 7.7% 7.5% 7.4% 7.4%
Real Estate program is maturing, commitment pace will slow in upcoming years
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Efficient Execution in Core Portion of Real Estate Portfolio
Notes: Average Fund Tracking Error includes the 16 NFI-ODCE funds which have a greater than 10 year history as of 12/31/2016, “Largest” portfolio scenarios take a weighted
average approach starting in Q1 2016 and rebalancing every three years to account for changes in index components
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Annual Average (2007 - 2016) Trailing 10-Year Ending12/31/16
NFI-ODCE Dispersion of Return (Top to Bottom Quartile)
0.00%
0.25%
0.50%
0.75%
1.00%
1.25%
1.50%
1.75%
2.00%
2.25%
2.50%
2.75%
3.00%
3.25%
3.50%
3.75%
4.00%
4.25%
4.50%
4.75%
5.00%
Tracking Error (Rolling 3-Year)
Average Fund Largest 2 Largest 3 Largest 4 Largest 5
While short-term dispersion between Core funds can be wide, long-term dispersion is relatively tight
Some investors have difficulty avoiding flipping in and out of Core funds during periods of short term
underperformance
Efforts are best spent taking a “passive” approach in Core and spending more time on manager selection in
the Non-Core portion of the portfolio
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Appendix: AHIC Medium-Term Views
MTVs are shown against strategic benchmark weights. Fundamental, valuation and near-term columns convey the
positives and negatives that build up to the aggregate MTV for an asset class.
MTV May 2017
May 2017 April 2017 Fundamental Valuation Near Term
Global Equity (ACWI) = = = = =
US LC Equity = = = - =
US SC Equity = = = - =
EAFE Equity + + + + ↑+
EM Equity + + + + +
High Yield = = = - =
Bank Loans + + + + +
USD EMD = = = - =
Local EMD + + + + =
Hedge Funds + + N/A N/A N/A
Commodities = = = = +
Direct Real Estate = = = = N/A
IG Credit - - = - =
US Government Bonds -- -- -- - -
Cash = = = -- =
USD = = = - ↓ -
Key:
“+++++/- - - - -” = max over / underweight, “=” = neutral. Currency “+” scores indicate a stronger USD and “-” scores indicate a weaker USD.
↑ / ↓ = positive /negative change in view or component of view from last update.
Reg
ion
al
Equ
ity v
iew
s
rela
tive
to
AC
WI E
qu
ity