LACERA’s investment program objective is to provide retirement benefits as required by the County Employees Retirement Law of 1937 (CERL). The Board of Investments (BOI) has exclusive control of all retirement system investments. There are a total of nine BOI members: two are elected by the active members, two are elected by 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 higher levels 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 members.
Asset Allocation
A pension fund’s strategic asset allocation policy is generally recognized to have the most impact on investment performance. The asset allocation policy determines a fund’s optimal long-term asset class mix (target allocation). This Policy is expected to achieve a specific set of investment goals such as risk and return 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 last reviewed the Fund’s Asset Allocation Policy in fiscal year 2008/2009. The following factors were considered in establishing this Policy:
- Projected actuarial assets, liabilities, benefit payments, and contributions
- Expected long-term capital market risk and return targets
- Expected future economic conditions, including inflation and interest rate levels
- LACERA’s current and projected funding status
The following graphs display LACERA’s actual and target asset allocations as of fiscal year-end June 30, 2009. As shown, the allocations are within BOI-approved Policy ranges.
*The 2009 Actual Asset Allocation is based upon the Investment Summary in this Section.
**Cash may include Corporate and Government Bonds, Certificates of Deposit, and Overnight Deposits.
The BOI implements the asset allocation plan by hiring investment managers to invest assets on LACERA’s behalf, subject to investment guidelines. 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
The credit crisis, which began with turmoil in the housing market, was considered a year old in the summer of 2008. The events that subsequently transpired, however, were unlike those witnessed by anyone in a generation. In a matter of one short month last autumn, the country’s financial markets and institutions were dramatically altered. The fallen included financial stalwarts such as: Merrill Lynch, Fannie Mae, Freddie Mac, Lehman Brothers, and insurance giant American International Group.
To avert another Great Depression, the Federal Reserve (Fed) took unprecedented action. It lowered the Federal Funds interest rate to a range of 0 to 25 basis points for the first time in history. It also instituted numerous rescue programs such as the Term Asset-Backed Securities Loan Facility (TALF) and the Commercial Paper Funding Facility to revive the seriously ailing credit markets. These programs were in addition to the legislative action initiated by the U.S. Treasury to create the Troubled Asset Relief Program (TARP).
During this historical period, credit markets seized up, curtailing new financial lending and essentially halting all commercial activity. Business investment contracted sharply and executives responded by laying off employees and subsequently cutting back production. Falling home prices, plunging stock values, and increasing unemployment resulted in plummeting consumer confidence.
When investors realized how seriously the financial crisis would impact future economic growth and corporate earnings, stock markets around the world dropped precipitously. For the fiscal year ended June 2009, the Russell 3000 Index, a broad-based measure of the U.S. stock market, returned -26.6 percent. While this return is terrible, in the broader context of volatility experienced during this period, it could have been worse. For example, the Russell 3000 Index declined almost 18 percent in October 2008 alone. Moreover, the calendar year 2008 return (-37.3 percent) was one of the worst returns in stock market history.
Although the credit crisis started in the United States, it quickly engulfed world markets. The broad-based world equity benchmark, the Morgan Stanley Capital International-All Country World Investable Market Index excluding the United States (MSCI ACWI), tumbled 30.5 percent for the fiscal year ended June 2009. Contrasted with prior crises, emerging markets fared slightly better, as the MSCI Emerging Markets Index Investable Market Index fell 26.9 percent. Prospects of stronger economic growth and limited exposure to the credit crisis were the primary reasons for this better relative performance.
Fixed income securities, which are typically considered low risk relative to equities, experienced unprecedented volatility. Investors flocked to the safe haven of Treasuries and sold bonds with any perceived credit risk. For example, during calendar year 2008, Treasuries returned 13.7 percent while high quality corporate bonds returned -4.9 percent, an astounding 18.6 percent return difference. For the fiscal year ended June 2009, the Barclays Capital Aggregate Bond Index (BC Bond Index) returned 1.90 percent. In early March 2009, as Fed actions started to take effect and investors realized the financial world was not coming to an end, investors’ aversion to risk began subsiding. Both stock and bond markets rallied strongly. From March 9, 2009, through July 31, 2009, the Russell 3000 was up almost 50 percent.
In the bond market from March 9, 2009 to July 31, 2009, the BC Bond Index returned 4.8 percent. In contrast with calendar year 2008, however, high quality corporate bonds generated a 16.3 percent return while Treasuries are down 1.2 percent. Another sign of investors’ increased appetite for risk was shown by the CCC high yield bonds which earned 71.1 percent compared with losing almost 45 percent last year.
Subtle signs of economic growth coupled with Fed Policies have begun to reestablish investors’ confidence. The challenge is determining the sustainability of any economic recovery: will it be a sharp rebound, a double dip, or tepid growth? Prior history is not the best guide; more recent recessions were not preceded by a severe credit crisis. Until clear signs of economic recovery and earnings growth appear, guarded optimism is appropriate with the expectation of volatile markets in the interim.
In the end, it was a year for the record book.
