1

STATE INVESTMENT COUNCIL MEETING

Asset Allocation Discussion

July 22, 2020

Agenda Item 5

2

Capital Market Assumptions

Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, Hamilton Lane, and Horizon

Compound

ReturnVol

Compound

ReturnVol 1 2 3 4 5 6 7 8 9 10 11 12

1 U.S. Equity 6.14% 15.19% 6.12% 17.90% 1.00

2 Non-U.S. Developed Market Equity 6.83% 16.95% 6.71% 20.00% 0.78 1.00

3 Emerging Market Equity 7.77% 21.34% 7.64% 27.00% 0.72 0.75 1.00

4 Private Equity 9.40% 21.50% 9.00% 20.50% 0.70 0.73 0.70 1.00

5 Real Assets 8.05% 19.40% 7.90% 17.70% 0.55 0.63 0.58 0.50 1.00

6 Real Estate 8.60% 14.57% 7.61% 12.54% 0.30 0.27 0.18 0.55 0.54 1.00

7 High Yield 5.64% 8.11% 4.69% 12.00% 0.62 0.59 0.65 0.67 0.54 0.11 1.00

8 Private Credit 7.22% 8.99% 7.60% 8.35% 0.74 0.65 0.66 0.83 0.42 0.68 0.89 1.00

9 Investment Grade Credit 2.46% 6.54% 4.10% 5.60% 0.08 0.07 0.08 0.18 0.29 -0.07 0.37 0.49 1.00

10 Cash Equivalents 0.50% 0.00% 2.80% 0.00% 0.09 0.05 0.07 0.04 0.02 0.25 0.14 -0.11 0.50 1.00

11 U.S. Treasuries 1.81% 5.13% 2.61% 3.90% -0.06 -0.05 -0.05 -0.51 -0.15 -0.13 0.05 -0.16 0.83 0.61 1.00

12 Risk Mitigation Strategies 3.34% 3.46% 4.61% 3.68% 0.49 0.49 0.49 0.22 0.17 0.26 0.30 0.34 0.27 0.11 -0.15 1.00

FY21 FY20 Correlation Matrix Recommendation

3

Risk versus Return by Asset Class and Strategy

Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, Hamilton Lane, and Horizon

U.S. Equity

Non-U.S. DM Equity

Emerging Market Equity

Private Equity

Real Assets Real Estate

High Yield

Private Credit

Investment Grade Credit

Cash Equivalents

U.S. Treasuries

Risk Mitigation Strategies

0%

2%

4%

6%

8%

10%

12%

0% 5% 10% 15% 20% 25%

Retu

rn

Risk

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

1973 1978 1983 1988 1993 1998 2003 2008 2013 2018

Blo

om

be

rg B

arc

lays U

.S.

Tre

asu

ry In

de

x Y

ield

(%

)

U.S. Equity Non-U.S. DM Equity EM Equity Private Equity

Real Assets Real Estate High Yield Private Credit

IG Credit Cash U.S. Treasuries RMS

100%

75%

25%28%

13%

7%12%

3%

8%

2%

6%

10%

5%

5%3%

Asset Allocation With Expectations for Lower Investment Returns

4

Source: Aon, Bloomberg, and Division of Investment

In 1995, Treasuries yielded 7.8%

with a historical volatility of 8.3%.

Expected Returns Are Lower and Investment Portfolios Are More Complex

Historical Yields for Bonds

1995 – All Bond Portfolio 2020 – Stock and Bond Portfolio 2020 – Well Diversified Portfolio

Expected Return: 7.8%

Expected Vol: 8.3%

Expected Return: 5.3%

Expected Vol: 11.4%

Expected Return: 6.5%

Expected Vol: 10.8%

In 1995, an all-bond portfolio could

have been structured to earn an

attractive return for a pension plan.

Today, a portfolio comprised largely

of stocks is expected to fall short of

most plans’ actuarial assumptions.

A well diversified portfolio is

better positioned for higher

returns with less risk.

An important trade-off,

however, is less liquidity for

some of the highest yielding

asset classes.

Today, the average yield

for Treasuries is 0.5%.

1%

2%

3%

4%

5%

6%

7%

8%

2% 4% 6% 8% 10% 12% 14% 16%

Exp

ecte

d L

on

g-T

erm

Retu

rn

Expected Risk (Volatility)

The NJ Pension Fund Seeks To Earn the Highest Return Per Unit of Risk

5

The NJ Pension Fund’s well-diversified

structure is designed to earn an

attractive risk-adjusted return.

The Investment Frontier

Source: Division of Investment

Return Per Unit of Risk

Less

Diversification

More

DiversificationLess

Diversification

More

Diversification

Bonds in 1995

Current NJ Portfolio

Stocks and Bonds

Diversified Portfolio

0% 10% 20% 30% 40% 50% 60% 70% Current Targeted

Asset Allocation

80% 90% 100%

Expected Long-Term Return 2.06% 2.70% 3.32% 3.92% 4.51% 5.08% 5.63% 6.16% 6.52% 6.68% 7.18% 7.66%

Expected Risk 3.92% 3.26% 4.12% 5.28% 6.58% 7.96% 9.38% 10.83% 11.78% 12.29% 13.77% 15.25%

Return Per Unit of Risk 0.53 0.83 0.81 0.74 0.69 0.64 0.60 0.57 0.55 0.54 0.52 0.50

Expected Long-Term Return 1.81% 2.35% 2.87% 3.36% 3.83% 4.27% 4.69% 5.09% 5.35% 5.46% 5.81% 6.14%

Expected Risk 5.13% 4.77% 4.96% 5.63% 6.64% 7.87% 9.22% 10.65% 11.69% 12.13% 13.65% 15.19%

Return Per Unit of Risk 0.35 0.49 0.58 0.60 0.58 0.54 0.51 0.48 0.46 0.45 0.43 0.40

Allocation to Return Seeking Investments

Well Diversified

Portfolio

Stocks and Bonds

6 6

Lessons From the Asset-Liability Study Still Apply

Source: Aon

30 year Economic Cost (in $ billions)

30 year Ending Funded Ratio (MVA / AL)

Base

Case

Downside

Risk

Base

Case

Downside

Risk

0% Return-Seeking $170.6 $183.2 45% 28%

10% Return-Seeking $166.2 $180.5 49% 30%

20% Return-Seeking $161.4 $179.0 54% 31%

30% Return-Seeking $156.4 $178.2 61% 32%

40% Return-Seeking $151.4 $178.0 68% 32%

50% Return-Seeking $146.2 $178.3 75% 32%

60% Return-Seeking $140.7 $179.0 82% 32%

70% Return-Seeking $135.7 $179.7 89% 31%

Current Targeted Asset Allocation $132.9 $180.2 93% 30%

80% Return-Seeking $130.8 $180.8 97% 29%

90% Return-Seeking $126.2 $182.0 104% 28%

100% Return-Seeking $121.9 $183.3 112% 27%

Present Value of Fund Contributions

Present Value of Terminal Funding

ECONOMIC COSTS OF PENSION FUND

7 7

Home Country Bias within the Global Equity Allocation Has Benefited the Pension Fund

Source: Bloomberg

Global Public Equity Returns

March 9, 2009 – February 19, 2020

18.38

10.55 11.07 10.4011.22

23.86

0.0

5.0

10.0

15.0

20.0

25.0

30.0

MSCI USAIMI

MSCI EAFE& Canada

MSCI EAFE& Canada

MSCIEmergingMarkets

MSCIEmergingMarkets

MSCI USATechnology

Tota

l R

etu

rn (

%)

(US $)(local

currency) (US $)(local

currency)

59.6% 58.3% 55.0%44.0%

26.6% 30.3% 33.1%

43.0%

13.8% 11.5% 11.9% 13.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

USA Non-US DM Emerging Markets

8

Global Equity Allocation

Source: Division of Investment and MSCI

NJ Global Equity Allocation vs ACWI

NJ Targeted

Asset Allocation

ACWI

Now One Year Ago Ten Years Ago

9

The COVID Pandemic Has Halted the Global Economy

Source: International Monetary Fund

3.602.90

1.90

4.50

6.70

2.902.30

1.30

3.70

6.10

-4.90

-8.00

-10.20

-3.00

1.00

5.404.50

6.00 5.90

8.20

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

World US Euro Area EM China

GD

P G

row

th (

%)

2018 2019 2020E 2021E

10

Global Equity Market Valuations

Source: Factset

U.S. Equity Valuations

6

8

10

12

14

16

18

20

22

24

26

2000 2004 2008 2012 2016 2020

Price /

Earn

ing

s M

ultip

le (

X)

S&P 500 12M Forward PE Ratio Average

6

8

10

12

14

16

18

20

22

24

26

2000 2004 2008 2012 2016 2020

Price /

Earn

ing

s M

ultip

le (X

)

MSCI EAFE 12M Forward PE Ratio Average

6

8

10

12

14

16

18

20

22

24

26

2000 2004 2008 2012 2016 2020

Price /

Earn

ing

s M

ultip

le (

X)

MSCI EM 12M Forward P/E Ratio Average

Non-U.S. DM Equity Valuations

Emerging Market Equity Valuations

-4

-2

0

2

4

6

8

10

12

14

2000 2004 2008 2012 2016 2020

Rela

tive

Price/E

arn

ing

s M

ultip

le (

X)

S&P 500 less EAFE P/E S&P 500 less EM P/E Avg Avg

Global Equity Valuation Comparisons

Higher U.S. valuations

Lower U.S. valuations

11

Private Equity versus Public Equity

Source: Cambridge and Aksia TorreyCove

Note: Private Equity returns are global and include buyout, growth equity, and venture

9.13

7.28

4.79

2.57

14.1113.42

9.03

6.39

13.27

14.25

12.54

10.53

18.68

20.33 20.28

18.33

0.0

5.0

10.0

15.0

20.0

25.0

5 Year 10 Year 15 Year 20 Year

To

tal R

etu

rn (

%)

MSCI World Russell 3000 Private Equity Private Equity Top Quartile

Returns For Periods Ending

December 31, 2019

12

There Has Been A Wide Range of Returns in Private Equity

Source: Cambridge and Aksia TorreyCove

-11% -10%

-16%

4%6%

0%

12% 12%

9%

20%19% 19%

41%

34%

48%

Small and Mid-Cap Large and Mega-Cap Growth and Venture Capital

Inte

rnal R

ate

of

Retu

rn (

IRR

) sin

ce in

cep

tion

(%

)

Bottom 5% Lower Quartile Median Upper Quartile Top 5%

Private Equity Quartile Returns By Vintage

Vintage YearMedian-Lower

Spread

Upper-Median

SpreadTotal Spread

2000 8.0% 8.9% 16.8%

2001 8.6% 11.3% 19.9%

2002 9.0% 12.0% 21.0%

2003 8.5% 8.5% 17.0%

2004 7.7% 6.7% 14.4%

2005 6.1% 5.1% 11.2%

2006 6.7% 5.8% 12.6%

2007 5.8% 5.6% 11.4%

2008 5.9% 7.7% 13.6%

2009 6.6% 7.4% 14.0%

2010 7.7% 8.8% 16.5%

2011 6.2% 6.2% 12.4%

2012 8.1% 6.2% 14.3%

2013 5.6% 6.5% 12.1%

Private Equity Quartile Returns Since Inception

13

Private Market Dry Powder and Fundamentals

Source: Aksia TorreyCove, Bloomberg, Hamilton Lane, and Pitchbook

Private Equity Dry Powder

Real Estate Cap RatesPrivate Equity Leverage and Purchase Multiples

Real Estate Dry Powder

1,047 1,042963 980

918

1,165 1,167

1,300

1,443

1,755

2,0442,156

0

500

1000

1500

2000

2500

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Dry

Pow

der

($ b

illio

ns)

Buyout Distressed PE Growth Mezzanine Other Real Estate Venture

0

50

100

150

200

250

300

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Dry

Pow

der

($b

illio

ns)

Opportunistic Value-Add Debt Core

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

2008 2012 2016 2020

0

20

40

60

80

100

120

140

160

Cap

Rate

Ag

gre

gate

Tra

nsaction

Valu

e (

$ b

illio

ns)

Volume (RHS) Apartments Office Retail Industrial

5.1x 5.3x5.7x 5.6x 5.4x

5.7x 5.8x 5.8x

5.1x

8.7x 8.8x

9.7x10.3x 10.0x

10.6x 10.6x

11.5x 11.6x

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

2012 2013 2014 2015 2016 2017 2018 2019 YTD2020

Debt Multiples Purchase Multiples

14

U.S. Treasury and Credit Market Valuations

Source: Bloomberg

Ten Year Nominal Yields and TIPS Breakeven Inflation

0.0

5.0

10.0

15.0

20.0

25.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1990 1995 2000 2005 2010 2015 2020

All

in y

ield

(%

)

All

in y

ield

(%

)

IG - A or better (LHS) Avg High Yield (RHS) Avg

0

250

500

750

1,000

1,250

1,500

1,750

2,000

0

100

200

300

400

500

600

1994 1999 2004 2009 2014 2019

Op

tion

-Ad

juste

d S

pre

ad

(in

bp

s)

Op

tion

-Ad

juste

d S

pre

ad

(in

bp

s)

Investment Grade (LHS) Avg High Yield (RHS) Avg

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1999 2003 2007 2011 2015 2019

Bre

akeve

n I

nfla

tion

Rate

(%

)

Nom

inal Y

ield

(%

)

Ten Year Nominal Treasury Yield (LHS) Ten year TIPS Breakeven Inflation (RHS)

Average Inflation

Credit Yields Are Below Historical AveragesCredit Spreads Are Above Historical Averages

Steepness of the U.S. Treasury Curve

-300

-200

-100

0

100

200

300

400

500

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

2 /

30 T

reasu

ry C

urv

e (

in b

ps)

2/30 Treasury Curve Average

15 15

Cross Sector Valuation Analysis

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

1990 1995 2000 2005 2010 2015 2020

S&

P 5

00 E

arn

ings Y

ield

less 1

0 Y

r T

reasury

Yie

ld (

%)

S&

P 5

00

Div

ide

nd

Yie

ld le

ss 1

0 Y

r T

rea

su

ry Y

ield

(%

)

Dividend Yield Premium (LHS) Avg Dividend Yield Premium

Earnings Yield Premium (RHS) Avg Earnings Yield Premium

Stocks vs. Bonds

8.7x 8.8x9.7x

10.3x 10.0x10.6x 10.6x

11.5x12.4x

15.5x16.5x

20.8x

17.2x18.1x

15.2x

16.9x

0.0x

5.0x

10.0x

15.0x

20.0x

2012 2013 2014 2015 2016 2017 2018 2019Private Equity Russell 2000

Source: Aksia TorreyCove and Bloomberg

Private Equity vs. Public Equity

16 16

Asset Allocation Recommendation

Source: Aon, Aksia TorreyCove, Cliffwater, Division of Investment, and Hamilton Lane

Portfolio Expected Return 6.52% 6.72%

Portfolio Volatility 10.79% 11.05%

Return per unit of Risk 0.605 0.608

Current Recommended Proposed Proposed Proposed

Target Asset

Allocation

Target Asset

Allocation

Ranges Benchmarks Benchmark

Weights

GLOBAL GROWTH 59.00% 59.00%

1 U.S. Equity 28.00% 27.00% 22-32% MSCI USA IMI 28.00%

2 Non-U.S. Developed Market Equity 12.50% 13.50% 11-16% MSCI EAFE + Canada (ex-prohibited) 13.50%

3 Emerging Market Equity 6.50% 5.50% 3-8% MSCI Emerging Markets (ex-prohibited) 5.50%

4 Private Equity 12.00% 13.00% 10-16% Cambridge Associates Buyouts, Growth, Distressed for Control, Subordinated Debt and Credit (one-quarter lag) 12.00%

REAL RETURN 10.00% 11.00%

5 Real Assets 2.50% 3.00% 1-5% NCREIF ODCE (one-quarter lag) 3.00%

6 Real Estate 7.50% 8.00% 5-11% Cambridge Private Equity Energy, Upstream Energy & Royalties & Infrastructure, Timber (one-quarter lag) 7.00%

INCOME 18.00% 18.00%

7 High Yield 2.00% 2.00% 1-5% Bloomberg Barclays U.S. High Yield 2% Issuer Cap Index 2.00%

8 Private Credit 6.00% 8.00% 5-11% Bloomberg Barclays U.S. Corp High Yield Index (one-month lag) + 100 bps 7.00%

9 Investment Grade Credit 10.00% 8.00% 5-11% Bloomberg Barclays U.S. Credit Index, A or better 9.00%

DEFENSIVE 13.00% 12.00%

10 Cash Equivalents 5.00% 4.00% 3-7% 91-day T-Bills 5.00%

11 U.S. Treasuries 5.00% 5.00% 3-8% Bloomberg Barclays U.S. Treasury Index 5.00%

12 Risk Mitigation Strategies 3.00% 3.00% 1-6% 91-day T-Bills +300 bps 3.00%

Alternative Investment Program 31.00% 35.00%

Return Seeking 77.00% 80.00%

Defensive 23.00% 20.00%

Total 100.00% 100.00%