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HomeMy WebLinkAbout2002-08-29 MinutesFire Pension Minutes August 29, 2002 Page 1 MINUTES OF A MEETING OF THE FIREMEN'S PENSION AND RELIEF FUND BOARD AUGUST 29, 2002 A meeting of the Fayetteville Firemen's Pension and Relief Fund Board was held on August 29, 2002 at 11:00 a.m. in Room 326 of the City Administration Building located at 113 West Mountain Street, Fayetteville, Arkansas. PRESENT: Mayor Coody, Marion Doss, Ronnie Wood, Pete Reagan, Danny Farrar, Marsha Farthing, Kit Williams and Heather Woodruff. MINUTES Mr. Reagan moved to approve the minutes with one correction. The moved to approve the minutes had Johnson first and seconded. The motion had been seconded by Reagan. Mr. Farrar seconded the motion. The motion carried unanimously. PENSION LIST Mr. Reagan moved to approve the pension list. Mr. Wood seconded. The motion carried unanimously. INVESTMENT REPORT Ms. Elaine Longer, Longer Investments, thanked the board for selecting them to manage their assets. She wanted to start with a review of their Investment Policy and some of their recommendations for changes. Then they would review the transfer of assets and the current investments. Mayor Coody asked since they were in charge of both the Fire and Police Pension Funds if they could combine them? Ms. Longer replied that was probably a legal question, but she did not think that the portfolios could be combined equally. They were really structured differently at this point in time. Mr. Williams stated he did not think that they could combine the funds. They had different boards, beneficiaries and benefits. Ms. Longer stated this was an account in transition. There was a lot more going on here than in an account that was structured the way that it needed to be structured and fully invested. Mr. Williams left the meeting. Ms. Longer presented a copy of their investment policy. The purpose of the policy is to define the guidelines which was to help them as investment manager how to invest their funds. They start everything with an investment policy and everyone of their accounts is Fire Pension Minutes August 29, 2002 Page 2 invested differently because the policy sets out the guidelines, then their job was to go out into the capital market and buy the assets that were needed to meet their fund objectives. They always start here. There were some questions that she had under investment objectives. Being a public pension fund, the most important objective is to meet the actuary return assumption. She did not find that anywhere in their policy. She did not know what their actuary return assumption is to invest the assets to achieve that return that was needed to fund their obligations. Under 1.C. long term goals that were defined in their policy is to achieve an absolute rate of return which exceeds the inflation rate by 5%. It went on to say that there was a comparative performance expectation relative to the S&P 500, relative to Corporate Bond index and relative to a combined mix of S&P 500 and the index. The problem with this section of their portfolio policy is that there is nothing that is really pertinent to what they really have to do for them, which is to meet their actuary assumption. When they combined absolute return which is 5% above inflation rate and relative return which is relative to an index, it was like coming to a Y in the road, and they can't go both ways. Typically, to define their return by an absolute return, 5% over the inflation rate, that is an arbitrary assumption and it is hard for her to figure out a way to go out there. First, she did not know what that would be. Secondly, she did not know how to do that because they would have to get into a riskier profile then what they were actually able to expend at this point in time. In her mind their policy was inconsistent with what their real goals were and with what they expect to achieve without taking on a lot of risk. This was their most important consideration in their policy. They needed to make sure that they got the goals right. It would be helpful to have an update on where the portfolio stands. In the RFP, it had mentioned that it closed the year at an unfunded liability of 4.5 million. She would like to know what the value of the portfolio was at year end. She could not compare where they were now to where it was at the time of the actuary study was done. If they could get an update somehow on where the portfolio stands now and what that would mean in terms of unfunded liability and what the actuary rate of return assumption is. They had three or four inputs into the equation. Since they did not do the administration work they did not have the tools to answer those questions. If they could have a copy of the actuary and the year end valuation of the portfolio that would help, then they could kind of tell how much the portfolio had declined in value relative to that year end valuation. But then, they also needed to know what the underlying return assumption is. She would like to get a review from Jody Carrio if at all possible on where they stand, even if it is as of year end and what their actuary return assumptions are because the input into the equation. The cash flows that were going in, what the city pays on current active participants, additional tax revenues and things like that. Then there was the return assumptions and the pay out to the retirees and the expected future liabilities to the current active. All of those factors would feed into determining the real objective of the portfolio and a review of all the input to see where they stand and whether or not their obligations are secure. Her questions from a portfolio stand point, to make the fund hold in its current situation, what would be the expected rate of return. If that expected return comes out at 20% per year to make the fund hold, she would be the first one to tell them that was an unrealistic expectation without a large assumption of risk. They could not risk these assets. It was a question that needed to be answered earlier rather than later, exactly where everything stands. If their return assumptions is 7.5% as opposed to 6%, she did not feel that that Fire Pension Minutes August 29, 2002 Page 3 was completely out of line. But in a balanced portfolio fund like this, where they had interest rates that were 4.5% and expected return on stocks has moved down to a more realistic 8% or so, then they had to look at what was a reasonable expectation of return within the context of fiduciary sound portfolio. If they got back from the actuary that it needed to be 20%, then they had a problem. If the board would give them permission, they could come back next time with more information on end objectives. Mr. Reagan asked what they brought in annually from property taxes. Ms. Farthing stated it was approximately $260,000 per year. Ms. Longer stated that they would request the actuary, the year end report and they will follow up with a discussion with the Carrio firm on the return assumptions needed to make the fund hold. Under 1.C., "the short run results will be monitored and are expected to be in the top 1/3 of the valuation services" she thought as they worked into what their real investment objective is then they would get back to talking about the relative returns that they wanted to have. Some of the risk profile is inconsistent with the aggressive return assumption. Until they had a handle on what the appropriate level of risk is for the portfolio, it was kind of hard to get into that. Mayor Coody asked Ms. Longer what her assessment was of the fund up to now. Ms. Longer replied she thought the risk level was fairly high on the fixed income side. They had to sell a lot of bonds that were really a high risk profile. Some of the bonds had slipped under investment grade, which should never be held in a public pension fund. She thought that the risk profile, on the fix income side, was too high. Volatility and liquidity under II, A. risk tolerance and return expectations, seemed to be inconsistent. The volatility which is the risk in the portfolio is expected to be similar to that of the overall market and yet the return is expected to be in the top 1/3. There was some discrepancy that eventually will be worked out as they define a little what their objectives are. Under I.B., they wanted to define the expected distribution schedule a little better. That way they could maintain cash reserves sufficient to fund the distributions. Under Asset allocation and diversification, she thought that their equity allocation is 25-50% was a good allocation. That gave them plenty of flexibility to get conservative or to get more aggressive as the market improves. She thought it was a good range. Under the fixed income component, they found some discrepancy where in some places the equity and the fixed income weighting per particular issuance was defined as percent of total assets and in other places it was defined as a percent of the fixed income class or of equities. They wanted to get that consistent, so that every thing was defined as the percent of total. Under fixed income there appeared to be some words missing, "excluding directed maximum of any one issue". She thought that it should be, "excluding direct obligations of the US Government and US Government Agencies, maximum of any one corporate issue shall not exceed 15% of the fixed income portfolio Fire Pension Minutes August 29, 2002 Page 4 at cost" she would recommend 10% of the fixed income portfolio at cost. At 10% they would not have more than 5% of total portfolio in any one issue. Mr. Reagan moved to make the changes to the policy. Mr. Farrar seconded. The motion carried unanimously. Ms. Longer stated on page 3, Equities, the equity exposure is defined as, "no single issue shall exceed 5% of the cost value of the total equity portfolio," and under IV,A. , "no more than 5% of the total assets valued at cost shall be invested in the equity of any one company or affiliated group of companies." That was a discrepancy. 5% of equity is different than 5% of total. Their recommendation would be to go to no more than 5% of the equity until they had percent of the total assets to be invested in any one stock. The way their policy reads, the common stocks purchased must carry an investment rating of medium grade or better by Moody or a rating of A or better by Standard and Poor. That excluded a lot of stocks out there in the universe, a number of them that they currently own and a lot of them that they buy for other accounts. What they have done in the Policemen's account is they actually do a rating of the stocks. On rated stocks they buy nothing that is rated less than B-, then they did a weighted average total on the portfolio. So that the weighted average total of the weighting on the equities are B+ or better. For non -rated stocks we assign the lowest level to it. They do buy a few stocks that are not weighted. Mostly because they were too small to be rated. They kept a whole equity portfolio in the range of B+. That seemed to give them more flexibility. If they limited it to just A rated stocks, they were excluding a lot of the universe out there. On their current holdings, on page 7 of their report, they could see they had number of B, B - stocks. There was not a lot left. A lot of times they were buying stocks that were fairly conservative on a balance sheet. They did a lot of analysis on balance sheets and earnings and making sure that the capital structure is strong, but they may carry a B or B+ rating a lot of times because of size. They have not been in the policy. The investments in their portfolio have not been adhering to the policy. She preferred to adjust the policy than to stay out of compliance with the policy. Mr. Reagan moved to amend IV.0 and IV.A to the language provided. Mr. Wood seconded. The motion carried unanimously. Ms. Longer stated under IV.B. there was another inconsistency on the debt issue. Percent of total asset. She suggested changing it under 3.b.2, she suggested amending this part of it to reflect what 3.b.2 says so that it was all consistent. Mr. Reagan moved to amend the policy. Mr. Farrar seconded. The motion carried unanimously. Ms. Longer stated under IV.c.4. f. investments in international securities shall be made only after securing approval by the majority of the board at a regularly scheduled meeting. They had a lot of individual securities, foreign stock in one of their portfolio. Their preference was to define foreign equities as a percent of total equities exposure. They then utilized mutual funds to accomplish foreign equity exposure. When they were Fire Pension Minutes August 29, 2002 Page 5 investing in a foreign market, they were really going after that currency play. They wanted the diversification relative to the US market. The US equity market and the European and Japanese markets were not perfectly correlated. The reason that they push diversification among international stock is that there is a given level of equity exposure, they had less equity risk because of the affective of the currency off setting each other. She suggested that they amend that to recommend that equity exposure in foreign, international markets be limited to a percent that they were comfortable with. They currently had a lot of international stocks that were individual stocks. She thought it was approximately 9.6% of the equity portfolio and about 4% of the total portfolio. She thought that it was better to use mutual funds because, if they were trying to buy international stocks and they bought five or six European companies, and one of them is a bad pick, they could negate the whole asset allocation by one stock out of five doing poorly. Mr. Reagan moved to amend the policy defining the foreign exposure as 10%. Mr. Farrar seconded. The motion carried unanimously. Ms. Longer stated if they ever wanted to go above that amount they could come back to the board. She thought that it was important for them to understand that by law they were a fiduciary on this account. They had to adhere to what was called the Prudent Investor Rule. That was a higher bench mark than the Prudent Man Rule. The Prudent Investor Rule requires that they adhere to a level of fiduciary responsibility that a prudent professional would use in investing public pension funds. They tended to be on the conservative side because capital was hard to replace. Losses are parts of their gains. If they were down 25%, then on their remaining principal they had to make 33% to get back to breakeven. If they went down by 50%, they had to make a 100% on what was left to breakeven. They tended to take the stance that preservation of capital is important as well as return expectation. They did incorporate small cap and mid cap stock in their selection. They did adhere to invest grade fixed income security. The credit risk that they incurred to get as little bit incremental return on a fixed income security was not worth the risk. The fixed income part of the portfolio was suppose to be the balance or the lever that did not subject the portfolio to risk, to off set the risk in the equity side. They approached the investment process, especially with this type of an account, from a risk management as well as return objective. The next thing was to look at their portfolio that came in and how it was structured on their July 31 valuation. Look at the sales that were conducted, then they would look at where the portfolio currently stands. On page 9, they had the portfolio summary based on Merrill Lynch valuations. They say based on Merrill Lynch valuation because the valuations Merrill Lynch was showing on some of their less than investment grade bonds were not an accurate valuation given the market. When they went in and bid those bonds the prices that came back were not anywhere close to what they were showing on the valuation. Some of the credit ratings from Merrill Lynch was showing was not correct. For instance, Xerox bonds were showing an A rating, they have not been A rated for over a year. They were actually junk debt. The valuations that they saw on July 31 are not exactly what they would consider accurate, but it was right at 10 million given the Fire Pension Minutes August 29, 2002 Page 6 distribution that went out on August 7 to cover August and September distribution needs. Page 10, showed the sales that they bid before the transfer took place. Again, what they were facing was that the transfer of assets could take anywhere from three to five weeks. When they were in transfer, they could not touch them, given the large number of holdings that they had. They went through and sold most of the individual stocks that were international, non -rated, less than A rated. If they looked at the sales of their stocks, then to hold the equity value, at 40% of total portfolio during transfer, they bought the S&P Index, called Spiders and the NASDQ equitant which is called the 222. They were under weighted in tech stock. By buying one-fourth of the total amount in the NASDQ 100 they were able to bring them up to a neutral position with the S&P 500 on technology stocks, but also taking it into the S&P hold their equity weighting while they go through transfer. Getting them ready for transfer they had utilized tools like the S&P and the NADQ index to hold their position. They still had all of the stocks on page 7 and 8 left in their portfolio. Page 11 showed the bond sales that took place. They were not finished with what they wanted to sell out of the portfolio, but they had the majority of the credit risk that was of immediate concern out of the portfolio. Their investment policy calls for nothing less than investment grade to be held in the fixed income part of the portfolio. She thought that was a good policy guideline. These bonds were either on the lowest rung of the ladder as far as investment grade was concerned or they were subject to review and further down grade. In the case of the Motorola and Disney those two were going to possibly be down graded Xerox had been rated A on the Merrill Lynch report and the ITT Bonds had a BBB-, both would have been investment grade, had that been true, but Xerox actual credit rating was B+ and ITT was BB+ so those were junk bonds. Southern Cal Edison was junk. Sola International and Enron, they had carried them forward and transferred them because they could not even get a good bid on them. On Enron the bid had been between $2 and $.50. she did not want to call that shot. She wanted them to tell her what to do with the Enron Bonds. There was not enough assets to satisfy all the obligations against Enron. They were in bankruptcy right now. She did not think that the bid would ever get any better. They did not have a good enough market to get a good enough bid on it. That was the best that they could do. There was not even anyone who wanted to bid on it. They were a bond holder which meant that they had a higher claim on assets than shareholders. There were so many liabilities against those assets that she did not think that there would be anything left for the bond holders. They did not have any reason not to have an Enron bond other than it violated their policy. They put it under a restricted asset so it did not show on their fixed income bond portfolio, because they were in violation of their policy. There would be class action lawsuits. They would be part of the class action lawsuit because of the time it was purchased. If they wanted to keep it in the portfolio as a restricted asset category was to authorize them to keep it. They had $50,000. It was worth $1,000 right now. Their down side risk was $1,000. It should have been sold when it was not an investment grade bond and it was not. It was now worthless. She did not know if they wanted to keep it. It had dropped below investment grade on November 28, 2001. Mr. Farrar moved to sell Enron Bonds. Mr. Reagan seconded. The motion carried unanimously. Fire Pension Minutes August 29, 2002 Page 7 Mr. Reagan stated he understood that there was a lawsuit on Merrill Lynch in New York. Did she think that they would have a part in that because Merrill had been there investment advisor on this? Ms. Longer stated that they should receive class action lawsuit information when there is a class action lawsuit. They were part of a class if they purchased a stock or bond during a given time period. She would think that they would be part of that class. As far as recourse against Merrill Lynch, they wanted to talk about the loses taken on less than investment grade bonds because they had taken about a $61,000 loss on less than investment grade bonds which Merrill Lynch held in violation of their policy. That did not include the $50,000 loss on Enron and the Sola Bonds. The Sola Bonds they could not even get them to give them a bid on. It was a junk bond. Merrill Lynch was pricing it at $.89 on the dollar. When they put it out for bid the best bid that they received was for $.49 on the dollar. That was another one that they did not sell. They went out for five bids on every bond that they sold. They could only get one bid for it. Without having a competitive bid they did not want to sell it. They will continue to get more bids after the transfer. The next page showed them the bidding that took place on the bonds. A number of firms had passed on a number of bonds. The only firm that would bid on Sola was Merrill Lynch. Their bid had been $.49, yet they had priced it at $.89. Her recommendation would be to try and get rid of it. It was in violation of their policy. It was a junk bond. The next page showed them the corporate bonds that had been sold and the loss that had been taken on it. $91,000 loss; $60,000 were from bonds that were rated less than investment grade. That did not include the approximate $75,000 in unrealized loss that they had on Enron and Sola. There was still a question in her mind if they had recourse there. They did have the investment policy and those securities were not in compliance with their policy. She did not know would answer that question. The Merrill Lynch products they had to sell because none of it would transfer. The losses were really the strategic return notes and strides which were tied to an EMC price. They were aggressive investments. The mutual funds that they sold, the largest lost was on the Conseco Fixed income fund. That fund had a weighted average credit rating that was 50% less than A rated. 10% of it was junk bonds. They sold that, Conseco was in bankruptcy anyway. They did not want to have a half million dollars in a mutual fund run by a defunct company. The preferred debt securities that they sold, they did have some preferred debt that was in that that was less than investment grade as well. They kept a few of them that were investment grade. They added a couple that they had in their portfolio that was triple A rated. Most of the large loses there were on junk. The Molorola and Dillards was junk rated. The Tribune Company they were convertible into AOL stock. They did not carry a very high income yield, so that it was really a play on American Online Stock without much income. That was the reason for the decline in the value there. Xerox went to less than investment grade on October 23, 2001. The Conseco fixed income, the Morning Star Report showed the ratings on it were 50% of less than A rated and about 10% was junk. The 30 day SEC yield was 5%. They were not being paid to take that kind of risk. They were not getting enough income yield to off set the kind of default risk that these funds were experiencing. The three year returns have only been about 6% on that fund. Most bonds funds were about 8.5% year to date that are investment grade or treasuries and agencies. Fire Pension Minutes August 29, 2002 Page 8 They held their position and gotten rid of the things that needed to be gotten rid of. The only problem was that on the fixed income side, now they had cash reserves on the bond side. They wanted to get that money back into treasuries and agencies because as a percentage of total portfolio their government securities are under 5%. She would rather see that 35% or 40%. They wanted to pick their timing to go in. Interest rates were at a forty year low. The ones that they were buying they were trying to monitor and to not go out there for ten years. Bonds did have price risk. If they bought a ten year treasury and interest rates went up, they were still going to earn their income return, but the price of that bond was going to stay down. They did not want to go out there and put a bunch of money into a ten year treasury. They might sprinkle some of that in there, but with the cash they had raised from bonds they were trying to take their time and see if they go a little bit of an increase in the economy going into the fourth quarter and they would have a better buying opportunity on the fixed income side. This was their report on their portfolio appraisal, it was every thing that was in the process of transferring. Their equities was at 41% of total. There was still some bonds that she did not want to keep, for instance the Ford Motor. They had sold all of theirs out of their accounts because they were down to a minimum investment grade. They were not in violation of their policy. They were not junk debt, but one more down grade and they would have to be sold. They have been out of auto bonds for about a year. As they find other opportunities in the fixed income market, they would probably sale the auto bonds. Restricted fixed income, those were their Sola and Enron. They would sell the Enron and try and get a bid on Sola when it comes in. Their treasuries were only 1.6% of total portfolio and their government agency represent about 4.5%. They still had CDs, about 2% and 1.2 monthly payment CD, about 3.2% were in CDs. One of which is callable this month and will probably be called. For the total market value as of Friday, their were at 9.93 million. That compared to about 10 million on July 30. That did not include the right down on the bonds that they had sold verses the prices that Merrill had. There was about a $200,000 difference. $150,000 difference on the fixed income prices. Net net, their portfolio thorough all of this has held. The equities have come up this month, enough to offset the decline in the pricing in the bonds where they had to sell at current market prices. Their current stock holding, this was another way to look at them. The first report just showed them the alphabetical list. This report showed them how they looked at the portfolio. It breaks out their equity holdings as a percent, but also breaks it down by economic sector. They could look at the different stocks that they have within the industry and equity category. Then it gives them a percent of what they own and the sum within the industry. They could see how they stacked up to the percent that was represented in the S&P 500. It was a good way to look at their portfolio in a little more detail than just looking at the names. They really had a good structure right now. There was still some tighten up that needed to be done. Their capital goods was at 9.8% verses 7.5% in the S&P 500. Under their consumer, Noncyclical, page 25, they had a good weighting in food beverage and tobacco, house hold product and retail. Their consumer rating is at 22% compared to 20% in the S&P 500. Transportation and cyclical industries are about 4.75% which is approximately equal to the S&P 500. they were a little bit under weighted in energy. They would beef that up with some of cash that is in the portfolio. She would probably add to the Royal Dutch and the Chervon Texaco. Even though there had been a lot of upheaval and chaos, they were left with a good core. Fire Pension Minutes August 29, 2002 Page 9 Financial, their total financial weighting, which include banks, financial services and insurance companies, was at 12.4%. That was a little light relative to the S&P500 at 20%. They had good medical supply companies in their medical stocks. Their total health care weightings was 14.75% verses 13.5% on the S&P 500. They had a good health care weighting. They were a little light on technology stocks, but the ones that they had, they had sold Electronic Arts, and lighted up on Microsoft because the weighting was too high. With three equity managers managing money for them, what they had discovered was all three of them had stock in the same companies. Tech was still in a big correctional. A lot of their costs were much higher than where the technology stocks are currently trading. Their current list of fixed income holdings. They could see the weightings by S&P on what they had left. Anything less than BBB - was junk bonds. Everything at they had left was investment grade. They had a lot of good bonds in there. She would like to see more government and government agency bonds in there. They were going to take their time. Mr. Reagan asked because they had junk bonds and because Merrill or Yada did not comply to their investment policy, did they have any recourse. Ms. Longer replied that would be something that they would have to ask the attorney. Was Merrill provided with the investment policy? Mr. Reagan stated Merrill had assisted them in developing the policy. Ms. Longer stated they had been lacks in keeping them in line with their policy. Ms. Longer stated their total losses, in their realized loses on the bonds that were junk, plus the unrealized loss on Enron and Sola that comes to about $150,000. She would also say that the losses that occurred on the preferred debt that was less than investment grade would add to that and the loss on the Conseco Mutual fund was also out of their policy limit. That would also be something that would be included. They were talking about $200,000 to $250,000. If they wanted to get into stocks rated less than A, then they had a whole different ballgame. Looking at the realized losses year to date before they came in were close to $500,000, year to date. She would think that there had been some stuff in there that they had to get out of. If they got into that, the attorney would be looking back and finding everything that had been in violation of their investment policy. She suggested that they ask Catherine Hinshaw if anything like this has happened before. Everyone had taken losses in this market, but when it was clearly in contradiction with their investment policy then it was a different ball game. Mr. Reagan moved to pursue researching the legal aspects of recovering some of the losses that were outside of our policy. Mr. Farrar seconded. The motion carried unanimously. Meeting adjourned at 12:30 p.m.