1. San Diego County Employees’ Retirement Association Board Retreat: Discussion on Structure of Investment Organization March 8, 2011

2. SDCERA |Board Retreat | 3/8/11 1 At a High Level, What is the Role of the Board? As it relates to investments… –Diversify investments to minimize risk of loss and maximize returns –Defray reasonable expenses of administering the investments Effectively and efficiently administer the investment program

3. SDCERA |Board Retreat | 3/8/11 2 Importance of Structure of the Investment Organization  Structure should support prudent management and oversight of the investment program –Clearly defined roles and responsibilities of various internal and external resources –Unambiguous work flow procedures –Appropriate checks and balances Today’s Goal: Discuss efficient and effective design of structure and utilization of resources

4. SDCERA |Board Retreat | 3/8/11 3 Public Funds: Structure of Investment Organization  Public funds typically have internal investment staff charged with management of the investment program  Depth of Staff resources varies: –Size of fund –Complexity of investment program –Internal management  CIO reports to the Board through the CEO / Executive Director  Typically retain one or more consultants who report to Board and augment staff resources Board CEO CIO Investment Staff Consultants Conventional Structure Report to Board Extension of Staff

5. SDCERA |Board Retreat | 3/8/11 4 Investment Functions: Staffing Selecting and Supervising External Managers Managing Investments Internally Providing Investment Administrative Services All Public Funds494 Public Funds: > $5.0 bn7147 Public Funds:$1bn - $5.0 bn212 *Greenwich Associates, 2009: Full Time Staff Resources Number of Investment Professionals:

6. SDCERA |Board Retreat | 3/8/11 5 How Have Public Funds Fared?  Over long time periods, public fund returns have trailed those of endowments and corporate defined benefit plans Risk/Return: Public Funds>$1 bn (Source: Mellon) Source: Mellon Analytical Services Average Returns by Investor Type (1990: 2010) 8.20% 8.30% 8.40% 8.50% 8.60% 8.70% 8.80% Avg. Corp. DB Plan Avg. Public Fund Avg. Endowment

7. SDCERA |Board Retreat | 3/8/11 6 Public Funds: Challenges Faced  A 2003 study conducted by EnnisKnupp indicated that public funds had registered weaker risk-adjusted returns than endowments and corporate funds*  Potential factors that could explain the weaker performance: –Asset allocation –Use of active management –Staff compensation –Governance and cultural factors (restrictions, fiduciary setting, Trustee investment experience, and culture)  Factors that did not explain weaker performance –Fund size –Operating expense *Can Public Funds Compete, Richard M. Ennis (2003)

8. SDCERA |Board Retreat | 3/8/11 7 Enhancing Public Fund Competitiveness  Continue to base asset allocation on intrinsic considerations  Play to strengths  Pay little for beta and diversification  Re-examine boundaries that exist within portfolio  De-emphasize strict organization of staff resources by asset class  Strive to bring staff compensation in line with that of the private sector  Delegate greater manager selection authority to staff

9. SDCERA |Board Retreat | 3/8/11 8 SDCERA’s Competitive Strengths  Culture of innovation  Early adopter of niche strategies that have added value  Diversified approach with an appreciation and emphasis on risk management  Access to deep bench of experts both internal and external How we do maximize effectiveness and efficiency with current resources?

10. SDCERA |Board Retreat | 3/8/11 9 SDCERA: Resource Slate CIO / Director - Private Markets & Fund Operations SDCERA Internal Investment Team (6 full time professionals) Portfolio Strategist Salient Partners Consultants: Albourne Hewitt EnnisKnupp Townsend SDCERA Investment Resources SDCERA has access to a deep bench of resources both internally and externally

11. SDCERA |Board Retreat | 3/8/11 10 Innovative Investment Structure: Requires Different Set of Resources Growth Oriented Assets40% Developed equities20% Emerging equities5% Private equity10% High Yield bonds5% Inflation Sensitive Assets25% Core real estate10% Natural resources10% TIPS5% Stable Value Assets70% U.S. Treasuries40% Relative value strategies10% Asset allocation strategies10% Emerging market debt10% Source: Greenwich Associates, 2009; All Public Funds – Dollar Weighted Asset Mix Public Fund: Average Asset Mix Dom. Equities 31% Intl. Equities 19% Dom. Fixed Income 29% Private Equity 8% Hedge Funds 2% Other 3% Intl. Fixed Income 1% Real Estate 7% SDCERA: Target Asset Allocation Growth Oriented Assets, 40% Stable Value Assets, 70% Inflation Sensitive Assets, 25%

12. SDCERA |Board Retreat | 3/8/11 11 Proposed Structure: Macro View Board Counsel: Fiduciary Counsel Investment Counsel CEO General Consultant CIO / Director of Pvt Markets and Fund Operations Portfolio Strategist CFO / Back Office and Operations

13. SDCERA |Board Retreat | 3/8/11 12 CFO / Back Office and Operations CFO Back Office/ Opps BNY Mellon Compliance and Derivatives Administration Investment Accounting 3 Positions Burgiss Group Pvt Market Administration and Accounting Investment Operations 1 Position

14. SDCERA |Board Retreat | 3/8/11 13 Portfolio Strategist Portfolio Strategist Futures Trading Russell Risk Analytics (Consultant) Tactical Analysis: Roubini Global Economics Portfolio Manager Salient Implementation Agent SSgA External Manager Research Operational Due Diligence Reporting and Analytics Internal Management MLP Implementation US Treasury and Large Cap Stocks Research: Hedge Fund Consultant

15. SDCERA |Board Retreat | 3/8/11 14 CIO / Director of Private Markets and Fund Operations* CIO/ DPM Performance and Derivatives Trading Private Equity Real Assets And Natural Resources Real Estate Research: Private Equity Consultant Research: Real Asset Consultant Research: Real Estate Consultant *This chart does not show two administrative positions within the Investment Department, which are necessary positions

16. SDCERA |Board Retreat | 3/8/11 15 Structural Considerations: Roles and Responsibilities  SDCERA has access to a deep bench of internal and external resources  Roles and responsibilities of different parties needs to be defined clearly –Eliminates ambiguity –Ensures accountability –Promotes effective utilization of all resources to full potential

17. SDCERA |Board Retreat | 3/8/11 16 Roles and Responsibilities: Policy Formulation and Oversight Creates / Primary Responsibility Approves / ReviewsImplements Asset/Liability StudyGeneral Consultant working with the Portfolio Strategist and DPM BoardForms the basis for asset allocation Asset AllocationPortfolio Strategist drives process with input from DPM and General Consultant BoardPortfolio Strategist directs DPM on implementation Creation and Maintenance of Written Policy and Guidelines DPM working with the General Consultant Board-- Periodic Review of Compliance with Stated Policy General ConsultantBoard--

18. SDCERA |Board Retreat | 3/8/11 17 Roles and Responsibilities: Tactical Asset Allocation and Risk Budget Creates / Primary Responsibility Approves / ReviewsImplements Development of Risk Budget Portfolio Strategist with input from DPM and General Consultant Board-- Monitoring Compliance with Risk Budget General Consultant and the DPM Board-- Development of Tactical Allocation Framework Portfolio StrategistBoardPortfolio Strategist directs DPM on implementation Monitoring Efficacy of Tactical Allocation Decisions General ConsultantBoard--

19. SDCERA |Board Retreat | 3/8/11 18 Roles and Responsibilities: Manager Selection and Due Diligence – Public Markets Creates / Primary Responsibility Approves / ReviewsImplements Manager Selection: Public Markets Portfolio StrategistBoard (managers may be pre-approved for use) General Consultant reviews to support Board’s decision Portfolio Strategist directs DPM on implementation Operational Due Diligence: Public Markets Portfolio StrategistBoard General Consultant reviews to support Board’s diligence -- Ongoing Diligence: Public Markets Portfolio StrategistBoard General Consultant reviews to support Board’s diligence --

20. SDCERA |Board Retreat | 3/8/11 19 Roles and Responsibilities: Manager Selection and Due Diligence – Private Markets Creates / Primary Responsibility Approves / ReviewsImplements Manager Selection: Private Markets DPM; Collaborate with Portfolio Strategist to ensure fit with stated objectives Board (managers may be pre-approved for use) General Consultant reviews to support Board’s decision DPM responsible for implementation Operational Due Diligence: Private Markets DPM; Collaborate with Portfolio Strategist Board General Consultant reviews to support Board’s diligence -- Ongoing Diligence: Private Markets DPM; Collaborate with Portfolio Strategist Board General Consultant reviews to support Board’s diligence --

21. SDCERA |Board Retreat | 3/8/11 20 Roles and Responsibilities: Reporting Creates / Primary Responsibility Approves / Reviews Oversight and Management of Custodial and Related Vendors Relationships Primary responsibility of DPM with support from the General Consultant Board approves retention of custodian Performance Reporting and Review General ConsultantBoard Risk ReportingPortfolio StrategistBoard Market OutlookPortfolio StrategistBoard

22. SDCERA |Board Retreat | 3/8/11 21 Case Study: Manager Recommendation – Private Markets Lead responsibility  DPM with support from specialist consultants  DPM collaborates with Portfolio Strategist to ensure strategy fit with stated goals, objectives and risk tolerance Operational and Ongoing Due Diligence  DPM Legal Review  Investment Counsel Document Retention  SDCERA Recommendation to Board  DPM with support from Portfolio Strategist and specialist consultants, as needed

23. SDCERA |Board Retreat | 3/8/11 22 Case Study: Manager Recommendation – Public Markets (non-Salient mandates) Lead responsibility  Portfolio Strategist with input from specialist consultant Operational and Ongoing Due Diligence  Portfolio Strategist Legal Review  Investment Counsel Document Retention  SDCERA Recommendation to Board  Portfolio Strategist with support from specialist consultant, as needed

24. SDCERA |Board Retreat | 3/8/11 23 Case Study: Manager Recommendation – Public Markets (Salient mandates) Lead responsibility  General Consultant Operational and Ongoing Due Diligence  General Consultant Legal Review  Investment Counsel  Fiduciary Counsel Document Retention  SDCERA Recommendation to Board  General Counsel

25. SDCERA |Board Retreat | 3/8/11 24 Due Diligence Review of Salient  HEK conducted onsite meeting on 2/22 and met senior leadership team  Significant changes afoot; led by CIO, focussing on developing a more institutional framework –Re-alignment of responsibilities of professionals –Development of manager research-related infrastructure –Enhancement of operational due diligence team and capabilities –Addition of MLP capabilities –Enhancement of compliance function  Reviewed capabilities for Salient to manage passive assets for SDCERS, specifically MLPs –Base infrastructure and capabilities in place –Further development and documentation of capabilities needed before Salient is delegated mandate of managing assets passively

26. SDCERA |Board Retreat | 3/8/11 25 Salient: Passive Management Roadmap  Develop fund factsheet / documentation –Management approach (replication or optimization) Approach to construction (less liquid names, liquidity management) Policies relating to rebalancing, index reconstitution, etc. Tracking error target –Trading policies Trading approach, broker review policies, etc. Use of soft dollars, policy on crediting client for soft dollar credits – Compliance procedures Proxy voting, corporate actions Pricing policies –Reporting policies and procedures

27. SDCERA |Board Retreat | 3/8/11 26 Next Steps  Based on Board feedback and guidance, solidify roles and responsibilities  Develop timeline for implementation of passive mandate with Salient