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SIB Investment Program
Hiring Professional Investment Managers
Establishing Investment Guidelines and Policies
Over 30 years, the ND pension funds' net performance has been above 8.0%, which is the actuarial assumed investment return rate. See the SIB performance summary page for the net of fees performance history of the various funds under the SIB for time periods ended June 30 of each year, as well as the current fiscal year-to-date. RIO, as well as the State of ND, operates on fiscal years (July 1 - June 30) rather than calendar years. When comparing investment returns, it is important to understand the time periods reported.
In general, the ND pension portfolios have performed better, relative to a broad universe of pension funds, in periods when equities did better than bonds. In the most recent period and over the long-term (30 years), the ND pension funds' performance has been similar to the average public pension fund. This exhibit shows the TFFR and PERS funds' historical returns versus a peer group of currently over 100 public funds as tracked by investment consultant Callan Associates Inc. (CAI). This exhibit uses time periods ended June 30, 2012, the most recent fiscal year-end available for this database.
It is important to note that during Fiscal Years 2008 and 2009, the stock market (both domestic and international) was down to historically low levels. The domestic stock market, as measured by the Standard and Poor's (S&P) 500 Index, was down 13.12% for the fiscal year ended 6/30/08, and down 26.21% for the fiscal year ended 6/30/09. The international stock market, as measured by the Morgan Stanley Capital International Europe, Australasia, Far East (MSCI EAFE) index, was down 10.61% for the fiscal year ended 6/30/08, and down 31.35% for the fiscal year ended 6/30/09.
The returns are all shown before the effect of investment management fees or "gross of fees" as this provides a more accurate comparison within the database of public funds.
One basis point is equal to 0.01% or one one-hundreth of a percent. As an example, if the fees on a fund are $200 and the total value of the fund is $100,000, the fees would be 200/100,000 or 0.20% which is 20 basis points.
For the fiscal year ended June 30, 2012, the SIB paid investment fees to professional investment firms for management, consulting and custodial bank services totaling 58 basis points (0.58% of total average market value). Details of these fees can be found in the 2012 Comprehensive Annual Financial Report beginning on page 164.
The breakdown of fees by trust is as follows:
Over the past 25 years, the asset allocations of the funds under the management of the SIB have become more diversified and incorporated asset classes with higher return expectations. These asset classes also have higher management fees. The expectation in selecting investment managers is that their returns will add value to the portfolio net of fees.
In mid-2010, the SIB hired Callan Associates to conduct a fee analysis for all of the fees paid to investment managers. The report can be found here. The conclusions of the study were as follows:
Studies have shown that 90-95% of the total return of a portfolio is based on asset allocation. All plans have unique asset allocations that are based on the underlying liabilities or cash flow needs of those plans. Which asset classes are performing better, what strategies are employed within each asset class, and how much is allocated to each asset class determines the total performance of the fund. It is important to note that the asset allocation is not determined by the SIB but is set by the clients, such as the PERS or TFFR boards.
Yes. Actuarial return assumptions are long-term in nature and are based, in part, on capital market projections which are obtained from multiple sources. These projections take into consideration long-term historical performance of the various asset classes as well as future long-term expectations in the markets. Currently, the majority of industry experts believe that an 8% return, over the long-term, is achievable.
All of the pension funds invested with the SIB are Defined Benefit Plans. This means that your pension benefits are determined by a formula defined as years of service × average salary × a multiplier. Fluctuations in the markets do not have a direct impact on your pension benefit; however, it may impact long-term funding available for the plans.
Asset allocation is set based on the underlying liabilities or cash flow needs of a fund. Funds that have shorter term cash flow needs (i.e. Insurance Trust clients) generally will have higher allocations to less volatile asset classes such as fixed income and cash equivalents. When a fund is more long-term in nature (i.e. Pension Trust clients), higher allocations to asset classes with more volatility are appropriate to meet long-term return objectives. Because of this, each client sets its own asset allocation.
Based on the asset allocations submitted by the individual clients, the SIB has created investment pools that clients may participate in. Each pool is made up of various investment managers hired to manage portfolios within those asset classes. RIO staff researches investment managers and brings recommendations to the full SIB for consideration. Representatives from the firm present to the full board, explaining their strategy and methods. A “Due Diligence” profile is completed for reference and fees are negotiated. All new investment management relationships are approved by the SIB.
Prior to funding a new investment manager, investment guidelines specific to the investment strategy are agreed upon and included as part of the contract documentation. Investment management firms have internal departments dedicated to ensuring that all investment guidelines are followed. If a situation arises that causes the portfolio to move outside of the investment guidelines, the investment manager will contact RIO staff and explain the situation. A decision is then made as to whether immediate action is necessary. All such instances are documented.
Additionally, RIO staff monitors the portfolios using both sophisticated software products and various reconciliation procedures. Portfolio performance data is collected monthly from the investment managers. The investment consultant, Callan Associates, Inc., also recalculates the performance of each portfolio based on the custodian bank data. RIO staff then compares the returns provided by the investment managers to Callan’s calculations to ensure that all data is reasonable. Investment returns are then compared to benchmarks chosen by the SIB and staff to ensure that the portfolios are performing as expected. Large deviations from benchmarks can indicate that the portfolio is not being managed within original parameters. Investment managers are brought in at least annually to provide an update on their firms, discuss performance and provide overall economic analysis. If the SIB believes an investment manager is not meeting its stated objectives, they may put them on a “watch list,” giving that portfolio added scrutiny for a period of time, until they feel the situation has improved or, when necessary, they terminate the relationship.
As of June 30, 2012, the SIB utilized 39 professional investment firms that manage 60 separate investment strategies. A listing of these firms and investment strategies can be found in the 2012 Comprehensive Annual Financial Report beginning on page 68.
This can be explained in one word…diversification. No more than 7% of the total pension portfolio is invested in any one investment strategy. Therefore, if an investment manager underperforms, or an investment strategy does not perform as expected, it should not have a significant negative effect on the total portfolio.
Investing is an enterprise where the investor puts capital at risk with the general objective of increasing the value of that wealth within the confines of the investor's risk tolerance. There are essentially two ways that capital can be invested. First, the investor can take an ownership position in the enterprise. This is called equity investing. As an owner, the equity investor has a claim on both the earnings of the enterprise and to the value of the enterprise. The size of those claims is in direct proportion to the investor's share of ownership. Equity investors are typically focused on capital gains rather than income.
The second approach to investing is where the investor lends money to the enterprise. This is called debt investing. Unlike an equity investor who has an ownership interest in the enterprise, the debt investor only has the right to collect a stated rate of interest on the money that was lent to the enterprise. Further, the debt investor is entitled to a return of the amount lent (called principal). The debt investor typically has no claim on the earnings of the enterprise, or on the value of the enterprise. Debt investors are typically focused on income rather than on capital gains.
There are, of course, exceptions to these rules, but all investments are based on the principles outlined above: you either buy (a percentage) of the investment and become an owner, or you lend it money and become a creditor.Finally, something that is also taken into consideration is correlation coefficients. Correlation coefficient is just a fancy way of saying how close two different types of investments will perform compared to each other in a given economic environment. If two types of investments perform similarly in up and down markets, they are said to be “positively correlated.” Investments that are very highly correlated may be considered part of the same asset class. For example, if a potential investment that may be classified as an alternative investment has a similar correlation coefficient to a fixed income benchmark; consideration will be given to placing the potential investment in the fixed income asset class.
The SIB as well as the individual pension fund boards employ professional investment and actuary firms to assist them in ensuring the retirement funds are managed appropriately. Asset/liability studies are performed, at a minimum, every 5 years by a 3rd party firm. These studies take into account the underlying liabilities of the pension fund as well as the total assets. These studies result in a range of options considered to be the optimum asset allocation for the fund based on risk and return assumptions.
The SIB also uses a custodian bank, The Northern Trust Company, whose job includes settlement of trades directed by the investment managers, record keeping of all investment transactions and safe-keeping of the assets. The custodian bank is audited annually, including a review of their internal controls and processes.
Audits are also performed annually on all of the investment management firms and any underlying funds or partnerships. The reports on these audits are made available to the RIO office and are reviewed for any issues that may be included in the reports.
An annual financial audit of the RIO office is also conducted (see question 20). RIO’s auditors review the audits of the investment firms and custodian bank as well.
An investment consultant is also utilized for 3rd party performance measurement of the investment manager accounts, to assist with investment manager searches and to provide education and other special projects for the board.
Under NDCC 54-10-01, the State Auditor must perform or provide for the financial audits of state agencies at least once every two years. To comply with that requirement, the State Auditor contracts with a public accounting firm to complete a financial audit of RIO each year. Contracts generally cover three fiscal years. RIO just finished the first year of the current three year contract with CliftonLarsonAllen LLP. The purpose of the financial audit is to determine whether RIO’s financial statements present fairly, in all material respects, the financial position of the fiduciary funds under its responsibility as of and for the year ended June 30 of each fiscal year. The most recent financial audit report of RIO can be found here.
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