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HomeMy WebLinkAbout2017-02-14 NEERB MINUTESNONEMERGENCY EMPLOYEES RETIREMENT BOARD MEETING February 14, 2017 • Board Member Moore called the regular meeting of the Englewood NonEmergency Employees Retirement Plan Board to order at 3:00 p.m. in the Public Works Conference Room of the Civic Center, 1000 Englewood Parkway, Englewood, Colorado. • Members Present: Members Absent: Others Present: A quorum was present. David Henderson, Employee Representative John Moore, Council Appointee Mahendra Patel, Employee Representative James Phelps, Council Appointee Kathleen Rinkel , Director of Finance and Administrative Services Jim Woodward, Chairperson, Council Appointee (arrived 3:03 p.m.) Steven Yates, Council Member Carol Wescoat, Recording Secretary None Wendy Dominguez, lnnovest Portfolio Solutions Jerry Huggins, Innovest Portfolio Solutions Leslie Thompson, Gabriel Roeder Smith and Company Joan Weber, Benefits/Risk Manager Kerry Bush, Benefit/Risk Analyst * * * * * The agenda items were taken out of order. Approval of Minutes MR. PHELPS MOVED TO APPROVE THE MINUTES OF THE NOVEMBER 8, 2016 REGULAR MEETING. MR. PATEL SECONDED. Ayes: Nays: Absent: The motion carried . Phelps, Henderson, Moore, Patel, Rinkel, Yates None Woodward Gabriel Roeder Smith and Company (GRS) a. Discussion of Studies to include with the January 1, 2017 Actuarial Report Ms. Thompson reviewed some of the past studies requested by the Board. She suggested the Board may be interested in having a mortality study with the report in an effort to continue moving toward a more current table. • Chairperson Woodward arrived at 3:03 p.m. • • • Mr. Moore asked about the discount rate after the studies were done last year. The Plan 's rate is now at 6 .5%. Discussion followed regarding the newer MP2016 mortality table that is available. Ms. Thompson said that there was not a sense that the Plan was having losses on the current mortality table. GRS measures losses each year to bring to the Board for review. She suggested that at some point the Board will want to update the mortality table to the RP2014 with the projection scale through 2016. Mr . Moore said he would like to see the impact of the RP2014 mortality table and the MP2016. Ms . Thompson said that would be included with the annual cost of the actuarial valuation . Conversation follow e d about the possibility of doing an experience study after the January I , 2017 valuation. Mr. Thompson said there would be an additional fee for the experience study that might include salary scale as well as other things. The Board agreed to consider further experience studies after the valuation report is completed with the study for changing the mortality table. Election of President/Chairperson MR. PHELPS NOMINATED JIM WOODWARD AS PRESIDENT/CHAIRPERSON. MR. MOORE SECONDED. Ayes: Nays: Absent: Phelps, Henderson, Moore, Patel, Rinkel, Yates None None Abstention: Woodward The motion carried . Review of 2016 Board Attendance The Board reviewed the 2016 attendance. The Board agreed the attendance was satisfactory . Correction of Benefit for Elizabeth Vance, Beneficiary of Burton Vance Ms . Wescoat explained the Board had previously approved an incorrect amount for the surviving spouse and beneficiary of Burton Vance. The error was found during January 2017. MR. HENDERSON MOVED TO APPROVE CORRECTING THE MONTHLY BENEFIT FOR ELIZABETH VANCE FROM $430.65 TO $443.57 PER MONTH AND PROVIDING THE RETROACTIVE AMOUNT OF $103 .36 . MS . RINKEL SECONDED. Ayes: Nays: Phelps , Henderson, Moore, Patel , Rinkel, Woodward , Yates None Absent: None The motion carried. Retirement Approvals and Notifications: a . Consideration of DROP Application for Jewel Traudt b . Consideration of Retirement Benefit for Jeffrey Shultz c. Consideration of Retirement Benefit for Luanna Rowe d . Notification of Application for Early Retirement Benefit for Joe Youngren Non Emergency Empl oyees Re tireme nt Board Meetin g 2of11 e. Notification of Death of Georgine Aun er, Beneficiary of Charles Aun er f. Consideration of Refund of Accumulated Contributions for Darren Amos • g. Consideration of Refund of Accumulated Contributions for Stephen Vold • • MR. PHELPS MOVED TO APPROVE THE BENEFIT APPROVALS AND NOTIFICATIONS. MR. HENDERSON SECONDED. Ayes: Nays: Absent: Phelps, Henderson, Moore, Patel, Rinkel, Woodward, Yates None None The motion carried. Innovest Portfolio Solutions, LLC a. Discussion of Expense Reduction Analysts Report Ms. Dominguez said Innovest appreciates how the Board has responded to the ERA report and they agree that controlling the costs of the Plan is very important to achieve investment portfolio success . She continued saying that there are some areas where lnnovest disagrees with the ERA conclusions and they appreciate the opportunity to present those to the Board. She said that during their conversation, ERA demonstrated the analogy of the doctor and generic drugs and that the doctor may not know there are generic brands of drugs. ERA said that they do not look at the asset allocation. Innovest is the doctor, doing the asset allocation analysis, and ERA will not interfere with that, but ERA believes that the doctor may not know that there are generic drugs can be utilized in implementing treatment. She appreciates that analogy, but sometimes a generic drug is not equal to brand name drug. She is not talking about brand names here, but there are other things that go into the fund selection more than just costs. Ms. Dominguez reviewed the Innovest City of Englewood NonEmergency Employees Retirement Plan Expense Reduction Analysis. She said that ERA is recommending savings by moving to passively managed index funds across the board. They believe sometimes that is okay, but not all of the time and they will make the case as their report is reviewed. Using only passive funds is not an absolute way to think about investing. She said that the Plan has passive investments in the large cap allocation where the market is relatively efficient. They could potentially look at a passive partner with small to mid-caps but not a replacement. They believe that investments should not be all passive management or all active management. There are roles for both in the portfolio. Investment product expenses must also be considered in light of the total portfolio. Ms. Dominguez explained the differences between active and passive management styles as graphed on page four of the Innovest report. She said that in passive management, the fund just holds an index. If there is a product, for example, the S&P 500, it is an index of the largest 500 largest trading stock in the United States. If the success of Amazon or GE propels the S&P 500 index to the top due to one or two stocks, then you own more of that index fund because of it. In 1999, there were times when technology stocks were 30, 40 or 50 percent of an index because they had done so well. We all know what happened in 2000 and 2001. The S&P 500 value dropped because technology stocks were a large portion of the index at that time. A passive product simply replicates an index and is the lowest cost possible because there is no manager making the decisions. For example, regardless whether Pepsi has better earnings potential than Coke or vice versa, they are both in the index so both are held . As a result, an index fund is much cheaper to manage if one or other is not selectively omitted. On the portfolio side, there is no potential to reduce the risk exposures in bad markets. You will be fully invested and hold all of the funds of an index. NonEmergency Employees Retirement Board Meeting 3of11 • • • Active management has the ability to vary the portfolio 's weight depending on where the manager sees risk. They can raise cash in some instances to defend the portfolio and they do not have to hold all of the holdings in the index. The managers can dev iate based on where they find value. Ms . Dominguez pointed out that not all asset classes have the ability to be indexed. Some like, the floating rate for example, have un-investable portions. Real estate funds are that way too. A reason, from an investment perspective, to not just have passively managed funds is because there are cycles of performance. Ms. Dominguez referred to the chart on page five that demonstrates percentage of domestic equity active funds outperforming passive funds. There are cycles when either passively or actively managed funds outperform. Currently the market is in a cycle where passively managed funds have outperformed , but that will not always be the case . Innovest 's concern with moving to passively managed funds now is when the cycle flow changes . Perhaps five years from now when you look back, you will say you should have been in actively managed funds and at the wrong point, you moved to be 100 percent in passively managed funds. Ms . Dominguez reviewed the amount of passivel y managed products currently held in the NERP portfolio. The chart on page 6 shows the percentage of active funds that have outperformed their respective benchmarks over the past 5, 10 or 15 years as ofJune 30 , 2016. She said the lowest cost products tend to be passive funds and managing your asset managers' cost is imperative. There are managers that have outperformed benchmarks and some of the NERP managers have outperformed the benchmarks over the past ten years. Ms . Dominguez said that if they were to look at a indexing a portion of the mid to small cap managers , the weight of the index needs to be carefully evaluated. She said that exchange-traded funds (ETF) were the recommendation that ERA used in the analysis for mid to small cap managers, however ETFs trade more like a stock. ETFs do not trade like a mutual fund. ETFs trade at trade+ three and a mutual fund trades at trade+ one, so Innovest 's recommendation would be to utilize a mutual fund because there is a better settlement period. You can buy and sell the mutual funds on the same day rather than sell and ETF and wait three days, before you can buy a purchase or switch out a fund . Another concern with ETFs is , liquidity studies need to be done to insure there is enough liquidity in the fund. An example was a Vanguard ETF during a recent sell-off of either energy or utilizes had a liquidity crunch and they could not implement some of the sales that were requested. Liquidity of a fund is an important factor. Mr. Huggins said that the main focus for the ERA report is to show where you can reduce costs and needs to be considered as the Board reviews this proposal from Board 's philosophical standpoint. The Board moving to a total index or a greater portion of an index portfolio is a philosophical change. Ms. Dominguez explained that lnnovest looks at each component within the portfolio when evaluating the performance relative to the index. She outlined how the portfolio has been constructed with value and growth together. As an example, the large cap was constructed with the Dodge & Cox Stock as a good compliment to the Harbor Capital Appreciation. These two funds are very different from a diversification stance. The graph on page eight demonstrates how over the past ten years the diversification has allowed the funds to say in line with the benchmark. The differences come into play during the down market when the actively managed funds capture a bit more of the up market as well as a small amount more of the down market. She reminded the Board that there currently is also index fund exposure in the large cap with one-third passive, one-third growth and one-third value funds. The mid cap actively managed portion of the portfolio exceeded the index over the past ten years while taking less risk. This is an area that lnnovest would agree that, if it is the Boards philosophy to index more , not 100 percent, but more, potentially using a passive fund to compliment the actively managed in this area is fine. The benefit would be that it would reduce costs as well as any tracking error. Tracking error is the difference above and beyond the index. You could get more index like performance, but also NonEm erge ncy Employees Retirem e nt Board Meetin g 4of 11 • • • the ability to outperform the index because you are not putting 100 percent of the investment in the index . Mid cap is an area that current the manager has done a good job of leading the index . Ms. Dominguez explained the small cap comparison on page 10 . Ms. Thompson asked ifthe fees are included on the chart. Ms. Dominguez said there are not fees in the index, however there are fees in an index fund so it might be possible that the black line performance on the chart would be lower than what is represented. The green line of the actively managed reflects performance net of the fees. Chairperson Woodward confirmed that the spread between the lines would be actually be greater if the fees were included on the index returns line . Ms. Dominguez said that was right. Mr. Moore suggested having a detailed analysis of one of the funds from the ERA report to make sure it is resonating the fees. Ms. Dominguez said that ERA did not use the benchmarks in the NERP Investment Policy Statement or that Innovest uses when categorizing the investments. The example was the Harbor Small Cap Growth. ERA used the benchmark of Vanguard Small Cap Growth ETF shares and that fund has fees in it. Mr. Moore chose another comparison from the ERA RiXtrema report on page 5of12 for discussion. The John Hancock Disciplined Value Mid Capital R6 has a 0.98 Similarity to the Vanguard Mid Capital Value ETF and he was finds the similarity comparison interesting. Ms . Dominguez tried to determine what ERA used to determine the similarity. Mr. Huggins added that the 0.98 similarity comparison is on a fund that may have 100-150 holdings is compared to an index that may have 600 holdings. Ms. Dominguez said that on page 6of12, ERA said the performance of the John Hancock is identical to the benchmark in every time period and questioned if it was a mistake . Mr. Moore commented that what is presented by ERA is just moving all of the investments to passive funds as one recommendation. What he expected to see was ifthere is another actively managed fund that would provide the same results with less expense than the current fund. Discussion followed outlining the purpose of the ERA report, the Plan's past practices of fiduciary responsibility, and how recaptured revenue sharing has been used to reduce Plan costs . The Board discussed the potential expense savings and results if all of the funds were indexed or if ETFs were used and what impact that might potentially have because of the delay of the trade due to the three day settlement restriction that mutual funds do not have. The Board reviewed the funds that would not have a comparable index fund, such as high yield, MLPs, and emerging markets are areas that do not have indexes. Ms. Dominguez said that the Board had originally evaluated Harding and DF A at the same time and determined that the two funds were different enough to have both and split the allocation. It would mean revisiting that philosophy to go with just DF A because it is cheaper. The Board had discussed all of the pros and cons, and decided, purposefully, to split the allocation to the two funds. It was not just a cost decision, there were reasons behind it. She said it cannot just be costs; costs should be kept down, but there are certain asset classes that they don't think can be indexed. In the funds that can be indexed, the active managers have done a relatively good job against the index. If the Board wants to consider a couple of options in the mid cap value and small cap growth areas where lnnovest would agree to index a portion of the assets, however, not 100 percent of the allocation would go to a passive index. Innovest would not choose the ETF index fund. It would be a mutual fund rather than an ETF. Mr. Huggins added that Innovest goes through the process of evaluating all the benefits of using a fund rather than just the cost savings. Mr. Moore is frustrated that the ERA analysis is biased based upon just shifting to passive funds. He said what Innovest is presenting solidifies his opinion that the comparison is not apples to apples. He said ERA is making the argument that switching to passive makes a valid question, why spend the money, which the Board has discussed. He said the ERA presentation is not about a fund by fund selection, it is active versus passive . NonEmergency Employees Retirement Board Meeting 5of11 • Mr. Huggins said that the Board discusses fees , cost savings and investment managers when a fund is being evaluated during the search process. Conversation followed what ERA might have also presented as saving comparables . Ms . Dominguez presented the Innovest Share Class Review that was included in their handouts. She reminded the Board that this was also done during the custodial search when Schwab was selected because of the variety of funds available through Schwab. The mutual funds frequently change some of the share classes for their funds . As she reviewed the sheet, she said potentially there are five funds that could provide a savings of about $7,500 by changing the share class of an existing fund. The review shows share classes within the current funds that could save fees by switching classes and because of the revenue sharing. The Board questioned if this should have been looked at before . She explained the Board has looked at these types of classes before and that there are frequent renegotiations to create new share class funds . This process is part of the regular service Innovest provides and it just happens to coincide with the ERA report. Mr. Huggins said that during the custodial change to Schwab, the shares were tran sferred in kind because the revenue sharing is being retained by the Plan and is being used to cover the cost of the custodial fees. Ms. Dominguez said with passive investments , there is no revenue sharing, so the custodial fees would be more and Plan would need to provide the payment of the services. It is up to the Board determine how to pay for the fees or other costs . The Board discussed the complexities of making sure all of the costs are included when doing the evaluation and to think about potential fund changes beyond just the cost, the investment performance in down markets, the way the portfolio is constructed and from a Board 's standpoint, philosophically saying, do they believe 100 percent passively managed funds is what they choose to implement for the Plan. • Ms . Dominguez agreed that it would be simpler to take everything to passive index funds. Innovest does not think it would be the best choice for the Plan . She said there are some index funds, like large cap , which is already held in the portfolio. Mid and small cap could be evaluated. The evaluation is not based on only investment performance necessarily, but also to reduce tracking errors and potentially reduce costs. Innovest agrees , first and foremost that cost savings are important. lnnovest 's opinion is that you can index portions of the portfolio, but not 100 percent. • Ms . Rinkel asked what portion of the portfolio would be indexed in the three areas. Ms . Dominguez said , Large Cap Index is one-third of that allocation and they do not recommend more than that be indexed. The Mid and Small Cap allocations are each $1.6 million and Innovest said $800 ,000 of each could be put into the appropriate passive index funds. lnnovest will provide the complete analysis of the funds to the Board for evaluation . The Board discussed the ERA recommendation of using ETFs . It is not preferred by Innovest because of the three day settlements for a transactions versus a one day settlement with mutual funds . Ms. Dominguez outlined the process lag of trading ETFs when rebalancing the portfolio and the potential issues that could be encountered. The discussed followed that rebalancing happens not only when the Board meets and makes changes , as well as , monthly with the distribution of funds to pay the NERP benefits or expenses . She also explained when they are evaluating an investment you need to know what benchmark is used, how much of a tracking error they have for that benchmark, what the fees are, how liquid the fund is , how many investors are in the fund , and more. Ms. Rinkel said you need to evaluate all of the transactions to see if it had been done with ETFs. Ms. Dominguez agreed , but mutual funds alleviates the risk having the three day lag loss so that you are buying and selling on the same day and are never really out of the market and sitting in cash . The amount could be evaluated ifthe ETF provided savings and it meant that there would be a three day settlement as opposed to one day. Non Eme rgency Empl oyees Re tire ment Board Mee tin g 6of 11 • • • Mr. Huggins also said that the possibility of collective investment trust could also be evaluated . Those choices are from the Board direction to lnnovest and provide some modeling that demonstrate the benefits of changing the approach from what has been directed by the Board in the past. Ms. Dominguez said that it ultimately comes back to passive versus active and is the price of active investing worth value received , perceived value or potential valu e going forward. Innovest can implement the philosophy the Board selects . Mr. Moore reviewed the conversation for his understanding in how Innovest would , as an example, take half of the funds in John Hancock and purchase an index fund, Vanguard Mid-Cap Value, probably not an ETF , but perhaps the mutual fund version and also consider another mid cap value passive fund that might be a better fit. Mr. Huggins also said considering how it is currently structured, the Board may consider a mid to small cap index fund which is a combination fund as well. Ms. Rinkel asked if passive a good place to be , wh y half and not all of the fund allocation. Ms. Dominguez said that it is because of the cycles . There is no way of knowing when active will outperform passive funds or vice versa . She also said that is why in the large cap allocation there is both active and passive now . Innovest thinks that active managed small cap has been a good decision for the portfolio from a performance stand point. Mr. Huggins said that if you compare the John Hancock fund, which has been owned since July 2013, to the index, Hancock has outperformed the index by 200 basis points since that time on an average annualized rate of return . He continued reviewing other funds ' performance. He said that all of the data ERA presented went ten years out and that period of time indicates eight years of a bull market for passive indexes that outperform active and the market reasoning for that situation. Ms. Dominguez said reviewing the Hancock outperforming the index by 200 basis points is an example of why the NERP may want to have both active and passive funds since it there is no way of predicting when passive or active funds may outperform. Ms. Rinkel ask why 50/50 , why wouldn 't you hold passive? Ms. Dominguez said that assuming equal investment performance it would be the case, but that has not been the case so you are getting smoother investment performance by holding both. Mr. Huggins also that some of the indexes are cap weighted so the larger companies are getting the most representation in the index and in active management that is not the case. In a declining market active managers tend to protect against the down side and if you are all passively invested , you will get all of the down side versus only a portion of that market down side. It is just as important to limit your losses as it is to capture all of your gains. Ms. Dominguez used the example that the Board may remember periods of time that the Dodge and Cox fund has underperformed, however the current report reflects it is up 11 percent for the quarter when the index is up seven percent. She said that is one quarter that the fund outperformed the index by four percent. If you would have been in the index, you have just experienced the index. This fund , since inception, is in the top percentile averaging 10.3 percent where the index average 7.8 percent. lnnovest's goal, as a firm , is find all of the Dodge and Cox funds they can . Sometimes they are successful and sometimes they are not, it is not a perfect science . Ms . Dominguez commented that if the Board elected only index funds there would never be the potential outperform or under the index . At the end of the day, it is a philosophical decision . Ms. Rinkel provided the Board an article by W. Scott Simon , dated February 3, 2005 , regarding active and passive management of funds. Mr. Moore suggested that the Board 's decisions may be 1) what percentage by fund class might be in the index funds; 2) what amount the Board determines is passively managed and what is the right fund ; 3) how does that translate to how ERA is paid. Ms. Thompson commented that risk in pension plans is asymmetrical. If you earn more than the assumption, you are not in much trouble. If you earn less than the assumption, you get in a lot of trouble. She thinks that downside risk management is a higher priority in pension funds because of that. No n Emergenc y E mpl oyees Re tir ement Board Meet in g 7 of 11 • • • Ms. Rinkel commented that she thinks ERA 's point is that if you can do the same thing passively as you can actively, then why pay more; that is their promise . M s. Dominguez said that the point ERA is missing is that the investment performance is the delta that they cannot predict. Discussion followed regarding the process use by actively managed funds . She agreed to managing cost, but also to investing with proven investment managers as well. Mr. Moore asked how the Board is to move forward. He is not prepared to make a decision. Some background reading on the active/pass ive fund comparisons . Ms. Rinkel suggested some apples to apples comparisons, perhaps, past performance for a period . Ms. Dominguez ask if the review would be for the areas that Innovest believes the NERP could use passive management or all areas . Discussion followed regarding the scope of that type of review and the information available globally regarding the active/passive comparison . Ms. Thompson asked how the savings could be measured because there is not an explicit expense assumption for this, instead of inve stment return . If there are savings to a retirement plan , are you paying them more than you are actually saving the plan? She reminded the Board there are other factors such as smoothing, so the investment return would not be just current year returns. Mr . Moore said that ERA wants the Board to agree to a baseline , such as , this was your old fund and this is the new fund and what are the expense ratios between those two funds. The focus is how much is spent in expenses on the ERA anal y sis. Mr. Moore said that ERA looks at the balance in the new fund and what are the expenses in that new fund. He said it is executable and it flawed in the sen se that there is no knowledge that the Board may have made other changes along way on their own. It is difficult to say that the Board change is 100 percent due to this analysis . Mr. Huggins clarified that what ERA monitors as the savings will not include what the net performance might have been if those new funds underperform the prior fund. Discussion followed outlining the process used by ERA for future funds and if other entities have used ERA 's services and what their outcomes have been . Ms. Thompson recalled one entity approached by ERA and their legal counsel provided a wall that would not let ERA consider the retirement plan because of the fiduciary issue. Mr. Moore reviewed the three steps he suggested earlier. He sees the first two steps are made as a fiduciary but where does that leave the third step of what it means to the ERA contract? He sees the third step as falling out if the Board cannot take the first two steps as a fiduciary . Mr. Huggins suggested looking at an apples to apples comparison of what ERA says are like funds currently and come up with whatever that savings will be over the however many years that would be based upon the dollar amount that would be invested in that fund. That would be it and then whatever the Board takes, philosophically, from that stand point is not based upon anything that ERA has done because they are not an investment advisor and the Board is not taking ERA recommendations as to how to run the portfolio in the future. Chairperson Woodward said there are funds where it does not make sense to use passive funds and he does not see the need to illustrate those fund comparisons. Mr. Phelps ask if the Board was obligated to enter into a contract with ERA. Ms . Rinkel said the funds are managed by the City and the Board is an advisory board . It was further clarified that the Board are Trustees and control the Plan. The Plan document is in Englewood Municipal Code, but the Board of Trustees controls the Plan . Ms . Rinkel said that the Board needs to be sure that they have the welfare of the Plan in mind and part of that is the fees paid and make sure there is the right structure . Ms. Dominguez asked if the City or the Plan pays ERA the cost savings. Ms. Rinkel said the Plan pays because the Plan would have paid the expenses and now it is sharing the savings for two years and after that the Plan keeps it all. NonEme r gency Empl oyee s Ret irem ent Board Mee tin g 8of 11 • • • Mr. Huggins said, that is not necessarily so . Should the funds selected by ERA underperform , then the funding level would be less than it was so the Plan is losing money because the funding is not as good and the Plan is sharing expense savings with ERA. Ms. Rinkel said it could go the other way as easily, as that is yet to be determined. Mr. Moore said the Board has to approve the expenditure of the fees and it has be reasonable. The Board should agree on what is being done is reasonable . He said that ifthe Board took what ERA proposed as a blanket, he is not sure he would agree the fees are reasonable . Mr. Moore reviewed a scenario where the Board made no change from the proposed , how long is the Board locked in to not making a change to the funds. When does the two year begin? Ms . Rinkel said that if the Board does not choose the ERA proposal, there is no obligation to ERA. Mr. Moore suggested proceeding with the process and when they are at number three, they will try to be fair to the ERA effort and fair to what the Board 's fiduciary duties are as Trustees. Mr. Moore emphasized again , that he made sure it was clear at last week's meeting, that he did not like the statements made that the Board may have been failing in their fiduciary duties. Every decision the Board has made thus far, they have gone through a process and even if things are left alone today, he does not feel like he has been negligent because ERA provided their report . Ms . Dominguez agreed. He continued saying the Board is being prudent in reviewing the report and giving it fair analysis, which if the Board is not prepared to act today and he does not believe anyone is , he feels very comfortable from the fiduciary standpoint of taking the report under advisement. Mr. Moore would like to leave time on the next agenda for this topic of discussion. He encourages the Board to do a more research and reading on active versus passive investments . Ms. Dominguez reviewed page five of the Quarterly Plan Review. She pointed out the benchmark has no fees. The Plan has fees. Historically the Plan has outperformed the benchmark by 27 basis points in the last year and since inception by 67 basis points . The Plan has outperformed and there are not fees in the benchmark . The Board has done an exceptional job from a fiduciary stand point. She said performance is not the judge of fiduciary responsibility, it is always the process. She said if the performance were poor, a bigger argument could be made that change is warranted based on performance and there would need to be a new philosophy from the Board. Ms. Rinkel commented that it is not that the Board has not done a good job. Ms. Dominguez agreed adding that cost savings is that area you must constantly look for. Ms . Dominguez expressed concern of the timing of the change. If the Board were sitting in a situation with eight years of active management having outperformed , Jnnovest might more comfortable with the move to passive management. Because passive management has been outperforming and they could continue to outperform , they do not know what the future cycles hold . Ms. Rinkel said the Board needs to look at how much the funds have outperformed , by how much , and are the fees worth it? Chairperson Woodward asked if the Board had provided direction to lnnovest. Ms. Dominguez said they could look at small and mid cap index areas , and could look at more areas if the Board provided direction. Based on what the Innovest beliefs when constructing a portfolio, they agree that looking at small and mid cap closely makes sense. Philosophically they do not believe the other areas should be evaluated , however, if the Board believes that more areas should be considered , Innovest will come back with more information . Mr. Huggins added the difference between efficient and inefficient markets is that in the inefficient markets there tends to be more opportunities for active managers . Innovest and the Board reviewed chart on page 6 of the NERP Expense Reduction Analysis indicating when active funds perform best compared to their benchmarks. The chart shows a study that was a net of fees comparison. NonEme rgen cy E mpl oyees Retirement Board Meetin g 9of 11 • • • Mr. Moore asked for further explanation of pages 9 and I 0 of the Analysis that compares the current fund to the benchmark. The clarification indicated that the current funds ' performance are net of fees , but the benchmark does not have fees because it a benchmark and not a fund. Chairperson Woodward said that an index fund would have a smaller fee and Ms. Dominguez added that if it were an index fund of the benchmark, it would make the black line on the chart a bit lower. Mr. Moore commented that looking back, it was a good decision, but the reality is you are guaranteed to pay the fee; you are not guaranteed to outperform the index so it really is a risk issue . The Board di scussed the fee as it relates to the charts . Mr. Moore suggested advancing the conversation at the next Board meeting by doing a bit more reading on the active versus passive and getting by more information from lnnovest in the small or mid cap areas for Board review at next meeting. The Board can make decisions on a change at the next Board meeting . The Board continued discussing the possible use of Vanguard index funds where the funds might be best used by professional managers or individual investors. Mr. Huggins pointed out the ERA did not recommend passive managers in all cases. The Vanguard International Growth Fund is an actively managed fund. It is easy to look back and find a fund that has outperformed. The Board discussed the processes used by lnnovest when researching the current fund a s a candidate and the fund choices from ERA. Mr. Moore demonstrated a fund that is being considered today would have possibly different historical information than it would have years ago when a current fund was selected. The review today may provide positive indicators that were not there when the consideration was done previously. Mr. Huggins and Ms . Dominguez confirmed Mr. Moore's demonstration with the review of information from other current funds . lnnovest will schedule time to review their report with ERA. Mr. Moore does not have objection to the meeting, but he questions lnnovest's responsibility to spend any more time and does not mean to direct a further meeting. Ms . Rinkel said it would be just to sync up the data presented by both ERA and lnnovest to compare apples to apples. Mr. Moore asked ifthere was something that ERA did not feel was being presented fairly by lnnovest to the Board that it be brought back to the Board. Ms. Dominguez agreed. b. Asset Allocation Study Ms. Dominguez said that the asset allocation mix recently changed when the Board added a Reinsurance product. The Board agreed to review the performance evaluation next. c . Performance Evaluation Ms . Dominguez continued reviewing the lnnovest's Long-Term Outlook for the Economy and Capital Markets handout. She reviewed the 2016 market conditions highlighting the incidents that had an impact during the year. Mr. Moore asked ifthe reinsurance investment process has started. Ms. Dominguez said there was a two percent allocation that was funded towards the end of December working towards five percent. Mr. Huggins reviewed the performance of the funds for the quarter and year as compared to the fund's benchmark beginning on page 14 of the portfolio review the Manager Score Card page to address the rating changes for each of the funds and those changes that may be of concern . He noted that there are two changes since the last report. lnnovest added minor concerns to the PIMCO Unconstrained Bond Fund and the JP Morgan Strategic Opportunity Fund for asset based concerns. He explained that when NonE me rge ncy E mployees Ret irement Board Meeting 10of11 • Innovest sees flows in or out of the fund, depending on the asset class , they will flag the fund for a concern. Innovest saw money flowing out of these funds where investors were either taking money out of the fixed income investments or moving funds back to equity investments and it was at a rate that Innovest has flagged the funds. It is a concern because the manager may need to keep cash on hand against future redemptions and have it invested. If it is not invested, then it is not earning. The Board may see that flag come on and off depending on what happens during the quarter. Mr. Huggins said that Thornburg International Value Fund is still a minor concern for organization as well as the only fund flagged for performance which is the Harbor High Yield fund. Mr. Huggins said the Board needs to understand that when Innovest monitors a fund that underperforms it peers or benchmark, for the three and five year cumulative periods, they put a watch on the fund. They only have it as minor concern because Innovest knows that Harbor High Yield is a quality focused manager. They will not choose non-rated or CC rated credits, so with no lower quality credits the fund will underperform the benchmark. Innovest wants good performance with the high yield that is better than the rest of the fixed income market. Mr. Huggins also outlined the Thornburg fund change and how is has changed. Mr. Huggins continued reviewing each fund's performance for the past quarter and the major impact to each fund that may cause a fund fluctuation. For the Board 's information , he said that the Stone Ridge Reinsurance Premium fund shows an increase of 0.71 for the quarter. Although the fund was not purchased until the end of the fourth quarter, the date of inception is listed as October 1, 2016 . Mr. Huggins said that the total portfolio slightly outperformed the custom benchmark for the last quarter of 2016 . He reviewed the over and underperformance for each of the periods reported . He said the Plan has outperformed the actuarial assumptions overall. • Member Choice • No further items were discussed. The next Board meeting will be May 9 , 2017. The start time will be 3:00 p.m. since there will be presentations of the asset allocation study and the 2017 actuarial report. The Board adjourned at 4:53 p.m. tn~ tY~~ Caro 1 Wescoat Recording Secretary NonEme rge ncy E mpl oyees Retirement Board Meetin g II o f II