CAFR 2008 - Investment Officer's Report

LACERA's investment program objective is to provide Association participants with retirement benefits as required by the County Employees Retirement Law of 1937. The Board of Investments (BOI) has exclusive control of all retirement system investments. There are a total of nine Board members: four are elected by the active and retired members, four are appointed by the Los Angeles County Board of Supervisors. The County Treasurer-Tax Collector serves as an ex-officio member.

The BOI has adopted an Investment Policy Statement, which provides a framework for the management of LACERA's investments. This Statement establishes LACERA's investment policies and objective, and defines the principal duties of the BOI, investment staff, investment managers, master custodian, and consultants.

The assets are managed on a total return basis with a long-term objective of achieving and maintaining a fully funded status for the pension fund. LACERA employs Modern Portfolio Theory principles that recognize varying degrees of investment risk are expected to be rewarded with higher returns in the long run. Consequently, prudent risk-taking is warranted within the context of overall portfolio diversification to meet this objective. These activities are executed in a manner that serves the best interests of LACERA's members.

Asset Allocation
A pension fund's strategic asset allocation policy is generally recognized to have the most impact on a fund's investment performance. The asset allocation policy determines a fund's optimal long-term asset class mix (target allocation), which is expected to achieve a specific set of investment objectives. The Policy also establishes ranges around the optimal target asset class mix, which act as a trigger for reallocating assets to ensure adherence to target weights.

The BOI considered the following factors to determine LACERA's current asset allocation which was last reviewed in fiscal year 2004/2005:

Projected actuarial assets, liabilities, benefit payments, and contributions
Expected long-term capital market risk and return behavior
Expected future economic conditions, including inflation and interest rate levels
LACERA's current and projected funding status

These charts display LACERA's fiscal year end, June 30, 2008, target and actual asset allocations. As shown, the allocations are close to the BOI-approved asset allocation policy.

The BOI implements the asset allocation plan by hiring passive (index fund) and active investment managers to invest assets on LACERA's behalf, subject to investment guidelines incorporated into each firm's investment management contract. LACERA's investment staff closely monitors manager activities and assists the BOI with the implementation of investment policies and long-term investment strategies.

Economic and Market Review
Given the noteworthy events occurring in the stock and bond markets during this fiscal year, the U.S. economy continued to grow at an annual pace of 2.8 percent for fiscal year ended June 2008. The strong economic growth was supported by export growth and the federal tax rebate program. The housing market slowdown, which turned into a steep decline, is expected to lead to slower economic growth later in 2008-2009.

The fiscal year started with the failure of two hedge funds investing in mortgage-backed securities. This was the first event that led investors to realize the potential magnitude of the sub-prime mortgage meltdown on the credit markets. As the sub-prime mortgage markets continued to unravel, the Federal Reserve lowered the Federal Fund's interest rate seven times to help maintain market liquidity and economic growth.

In March 2008, the Federal Reserve took the unprecedented action of guaranteeing a $29 billion loan for the purchase of failed investment bank, Bear Stearns. At the time, The Federal Reserve believed a Bear Stearns' bankruptcy would wreak havoc on the credit markets. Clearly, events subsequent to this action were the warm up act for the Treasury's and Federal Reserve's later actions. As of this writing, the Treasury Secretary requested a $700 billion rescue package to buy bad mortgages from financial institutions.

Not surprisingly, stock market volatility increased tremendously while bond investors were primarily interested in the safety of U.S. Treasury bonds. The U.S. equity market, as measured by the Russell 3000 (a broad-based benchmark), was down 12.7 percent during the fiscal year. Smaller stocks returned a -16.2 percent, as measured by the Russell 2000 benchmark.

In the bond market, the Lehman U.S. Aggregate, a broad measure of government, mortgage-backed, and high-quality corporate bonds, returned 7.1 percent during this fiscal year. Investors became very risk averse during the fiscal year as the magnitude of the credit market catastrophe became more apparent. As a result, the Lehman U.S. Corporate High Yield benchmark returned a -2.3 percent for the one-year period ended June 2008. This contrasts sharply with the safe haven Long-Term Treasury index, as measured by Lehman, which returned 12.7 percent during this period.

International equity markets provided little solace for investors, returning -6.6 percent in U.S. dollars, as measured by the Morgan Stanley Capital International All Country World ex U.S. index (ACWI ex U.S.). The continued decline of the dollar against most major currencies (the Euro, the Yen, and the Pound) improved U.S. investor returns as the local currency return for the ACWI ex U.S. was down 15.0 percent. Emerging Markets were the only component of the ACWI ex U.S. index to generate positive returns for the one-year period ending June 30, 2008, returning 4.9 percent.