Rhode Island SIC Inflation Protection Class Policy & Structure - PowerPoint PPT Presentation

Rhode Island SIC Inflation Protection Class Policy & Structure Discussion John Burns, CFA August 23, 2017

Today’s Discussion I nfla tio n Pro te c tio n Cla ss Po rtfo lio : • Ba c kg ro und • Ob je c tive s • Pro po se d Po lic y E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 2

Inflation Protection Class Portfolio: • E RSRI , like a ll lo ng -te rm inve sto rs is vulne ra b le to spike s in infla tio n tha t re duc e the inve sto r’ s purc ha sing po we r a s no mina l a sse t re turns a re e ro de d b y infla tio n • 2016 a sse t / lia b ility re vie w: a llo c a tio n to infla tio n pro te c tio n c la ss 10% • Re c e ntly re duc e d to 8% po lic y we ig ht (b a nk lo a ns / sho rt-dura tio n hig h yie ld mo ve d to I nc o me Cla ss) • T he re a re two prima ry fo rms o f infla tio n 1. Una ntic ipa te d / sha rp rise 2. Antic ipa te d / me a sure d rise • I ndividua l a sse ts b e ha ve diffe re ntly in diffe re nt infla tio na ry re g ime s • T I PS / na tura l re so urc e s / e ne rg y re so urc e s in g e ne ra l fa re we ll in una ntic ipa te d infla tio n re g ime s • Co re Re a l E sta te / I nfra struc ture (a sse ts tha t ha ve pe rio dic re se ts o f re nts / c o ntra c tua l inc o me – tie d to infla tio n) in g e ne ra l fa re we ll in a ntic ipa te d infla tio na ry re g ime s E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 3

Inflation Protection Class Portfolio: Basic Construct a func tio nal c lass de sig ne d to pe rform we ll in infla tiona ry ma rke t e nvironme nts I nve stme nt Ob je c tive s: • L o ng -te rm re a l re turn (CPI + ~3%) I nve stme nt Cha ra c te ristic s: • Gro wth dive rsific a tio n • Vo la tility lo we r tha n pub lic e q uity / hig he r tha n Co re fixe d inc o me Risks: • Re a l I nte re st Ra te Risk • Ac tive Ma na g e me nt Risk • E c o no mic Gro wth Risk • L iq uidity Risk • Unde rwriting a func tio na l c la ss to pro vide infla tio n pro te c tio n is c ha lle ng ing • T he re is no pe rfe c t he dg e fo r infla tio n • Asse ts tha t ha ve se nsitivity to infla tio n a lso ha ve se nsitivitie s to o the r fa c to rs tha t c a n o ve rwhe lm the infla tio n impa c t in the ne a r to mid te rm E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 4

Inflation Protection Portfolio: Investable Universe Inve sta ble Unive rse 1. L iq uid F ixe d I nc o me I nfla tio n-linke d b o nds (T I PS o r GI L Bs) o 2. L iq uid Na tura l Re so urc e s Co mmo ditie s (o il future s, a g ric ulture future s) o 3. Priva te Asse ts Co re Re a l E sta te (fo c us o n inc o me / lo w le ve ra g e ) o I nfra struc ture o Ag ric ulture / F a rmla nd o T imb e r o E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 5

Inflation Protection Portfolio: Policy E RSRI Polic y Customiza tion Decrease inflation protection class allocation to 8% (≈ $640mn) • (fo rme rly 10%) Ra tio na le : inc re a se d I nc o me Cla ss (b a nk lo a ns / sho rt-dura tio n HY mo ve d to I nc o me Cla ss) o • Struc tura l a llo c a tio n po lic y: inc lude re la tive ly wide a llo c a tio n b a nds fo r ma na g e me nt fle xib ility Pro vide fle xib ility to de via te fro m po lic y we ig hts a s ma rke t c o nditio ns e vo lve o Co nside r timb e r / a g ric ulture if ma rke t c o nditio ns wa rra nt o Allo c a tio n to priva te a sse ts re q uire s so me po lic y we ig ht fle xib ility o • Ma ximum: 80% priva te a sse ts • Pe rfo rma nc e fo r the infla tio n pro te c tio n c la ss e va lua te d o n ro lling 5 ye a r pe rio ds E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 6

Inflation Protection Portfolio: Modeling Process Stra te g ic Alloc a tion Mode ling Proc e ss / Polic y De ve lopme nt 1. I de ntify inve sta b le unive rse E xa mine c urre nt funda me nta ls a nd histo ric a l tra its/ b e ha vio r o 2. De ve lo p a ssumptio ns (vo la tility / to ta l re turn / c o rre la tio ns) 3. Run o ptimiza tio n (with minima l c o nstra ints) a ) Me a n-va ria nc e o ptimiza tio n e sse ntia lly o ptimize d e a c h po rtfo lio o n a risk/ re turn b a sis a nd ke pt the po rtfo lio CPI b e ta a t the 0.50 flo o r 4. Na rro w inve sta b le unive rse 6. Se le c t po te ntia l po lic y a llo c a tio ns a nd te st fo r re a so na b le ne ss T e st fo r fide lity to a sse t / lia b ility mo de ling a ssumptio ns a nd o b je c tive s o NOT E : Mo de ling input / c o nstra ints in a ppe ndix E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 7

Inflation Protection Portfolio: Modeling Output E ffic ie nt F r ontie r | Ge ome tr ic Re tur n & Risk 6.00% #10 5.75% #9 #8 5.50% Ge ome tric Re turn Sta ff/ PCA #7 5.25% Cho ic e #6 A/ L 5.00% #5 Mo de l 4.75% #4 4.50% #3 #2 4.25% #1 4.00% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 10.5% 11.0% Vola tility Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio A/ L Sta ff/ PCA # 1 # 2 # 3 # 4 # 5 # 6 # 7 # 8 # 9 # 10 Mo de l Cho ic e Ge o . Re turn 4.1% 4.3% 4.5% 4.8% 5.0% 5.2% 5.4% 5.6% 5.8% 5.9% 5.0% 5.3% Vo la tility 6.6% 6.7% 6.8% 7.0% 7.2% 7.5% 7.8% 8.2% 8.6% 10.0% 8.6% 8.5% Sha rpe Ra tio 0.31 0.34 0.37 0.39 0.41 0.42 0.43 0.44 0.45 0.41 0.36 0.40 CPI Be ta 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.43 0.61 CPI b e ta : “CPI Surprise Be ta s” a re b e ta s to une xpe c te d infla tio n (F ull de sc riptio n in a ppe ndix) E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 8

Inflation Protection Portfolio: Allocation Selection • I nfra struc ture + inc lude s infra struc ture / timb e r / a g ric ulture • T I PS / Na tura l Re so urc e s a re liq uid inve stme nt s Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio A/ L Sta ff/ PCA # 1 # 2 # 3 # 4 # 5 # 6 # 7 # 8 # 9 # 10 Mo de l Cho ic e Ge o . Re turn 4.1% 4.3% 4.5% 4.8% 5.0% 5.2% 5.4% 5.6% 5.8% 5.9% 5.0% 5.3% Vo la tility 6.6% 6.7% 6.8% 7.0% 7.2% 7.5% 7.8% 8.2% 8.6% 10.0% 8.6% 8.5% Sha rpe Ra tio 0.31 0.34 0.37 0.39 0.41 0.42 0.43 0.44 0.45 0.41 0.36 0.40 CPI Be ta 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.43 0.61 Staff Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio Po rtfo lio A/ L / PCA # 1 # 2 # 3 # 4 # 5 # 6 # 7 # 8 # 9 # 10 Mo de l Cho ic e T IPs 54% 47% 40% 34% 27% 20% 13% 6% 0% 0% 30% 13% Natural Re so urc e s 11% 11% 11% 11% 12% 12% 12% 12% 11% 0% 0% 12% Co re RE 18% 21% 23% 25% 27% 28% 30% 32% 38% 67% 47% 45% Infrastruc ture + 16% 21% 25% 30% 35% 40% 45% 50% 52% 33% 23% 30% E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 9

Inflation Protection Portfolio: Allocation Selection & Policy • PCA a nd Sta ff re c o mme nd po lic y b e lo w • Ro unde d/ na ïve a llo c a tio ns a re inc o rpo ra te d to re fle c t humility • T his struc ture is lo g ic a l, imple me nta b le , a nd b a la nc e s the risk/ re turn tra de o ff • I lliq uid infla tio n pro te c tio n a sse t mo ve to lo ng -te rm po lic y we ig ht a t a me a sure d pa c e Po lic y Guide line s L ong - te r m L ong - te r m Infla tion Pr ote c tion Cla ss Polic y Compone nts T a r g e t R a ng e s Po lic y g uid e line s a llo w ma na g e me nt fle xib ility a s ma rke t c o nd itio ns e vo lve 13% 0-25% T IPs Na tur a l R e sour c e s 12% 0-25% Cor e R e a l E sta te 45% 30-60% 15-45% 30% Infr a str uc tur e + 100% --- E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 10

Inflation Protection Portfolio: Benchmarks & Diversification Po lic y Be nc hma rk: • Ble nd o f individua l a sse t c la ss indic e s I ndividua l a sse ts’ b e nc hma rks: • Co re Re a l E sta te NF I -ODCE I nde x • I nfra struc ture CPI +4% • T I PS Blo o mb e rg Ba rc la ys 1-10 Ye a r T I Ps I nde x • Na tura l Re so urc e s Blo o mb e rg Co mmo dity I nde x (T o ta l Re turn) Dive rsific a tio n • T he infla tio n pro te c tio n c la ss is e xpe c te d to pro vide dive rsific a tio n o f e q uity (g ro wth risk). • T he po rtfo lio will b e dive rsifie d a c ro ss nume ro us so urc e s o f re a l re turn E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 11

Appendix

Inflation Protection Class Portfolio: Modeling Inputs Re turn/ Risk Assumptio ns Str ate gy Ar ithme tic Re tur n Ge ome tr ic Re tur n Volatility CPI Be ta T IPs 3.00% 2.80% 7.00% 0.25 Na tura l Re so urc e s 4.25% 2.25% 22.00% 2.00 Co re Re a l E sta te 6.30% 5.55% 13.33% 0.75 Infra struc ture 6.30% 5.55% 13.33% 0.00 T imb e r 6.30% 5.55% 13.33% 0.00 Ag ric ulture 6.30% 5.55% 13.33% 0.00 Co rre la tio n Ma trix T I Ps Co mmo ditie s Co re I nfra struc ture T imb e r Ag ric ulture T I Ps 1.00 Co mmo ditie s 0.30 1.00 Co re 0.15 0.30 1.00 I nfra struc ture 0.25 0.15 0.35 1.00 T imb e r 0.10 0.00 0.05 0.15 1.00 Ag ric ulture 0.05 0.00 0.15 0.15 0.35 1.00 E RSRI • Infla tio n Pro te c tio n Cla ss Disc ussio n 13