Retirement Plan for CTA Employees
and
Retiree Health Care Trust
Updated November 25, 2014

Statement of Investment Policy ("SIP")

Introduction

For the purpose of this document, any reference to the "Trustees" shall be to the Board of Trustees of the Retirement Plan for Chicago Transit Authority Employees.

The Retirement Plan for Chicago Transit Authority Employees (the "Plan" or "Plan") is a defined benefit plan, which is considered a "going concern." Trustees, who are responsible for setting investment policy, take a long-term investment perspective in planning policy, and employ independent investment consultant(s) acting in a fiduciary capacity to assist with formulating and implementing an investment policy in a systematic manner.

Implementing the investment policy is accomplished through the use of outside investment professionals; no money is managed "in house." Outside investment managers (also sometimes referred to herein as "managers") are hired to implement specific aspects of the investment policy and the managers act as fiduciaries to the Plan. Investment managers have discretion to buy and sell assets within the scope of written investment guidelines.

In accordance with the provisions of the Plan and Trust Agreement, the Trustees select the investment managers. Investment managers must have a history of proven successful performance in the management of significant sums of invested assets in the asset class and style for which it is being considered. The Trustees retain authority to select, under limited circumstances and for relatively small sums, managers who do not yet satisfy the historical standard set forth above.

This SIP has been developed after a comprehensive study and evaluation of other alternative investment approaches and reflects a consensus of input from the Plan’s office of the Executive Director the Investment Consultant, General Counsel, and the Plan’s actuary. It further reflects a commitment by the Trustees and the Investment Consultant, as fiduciaries, to act as prudent persons would be expected to act, with discretion, skill and diligence in fulfilling their responsibility to invest the Plan’s assets. The Trustees and all Plan fiduciaries operate subject to all applicable state and federal laws and the terms of the documents governing the Plan. As such, the investment policy reflects the requirements, among other things, that the fiduciaries invest Plan assets and administer the Plan solely in the interest of the participants in the Plan and for the exclusive purpose of providing benefits to participants and their beneficiaries. Therefore, this investment policy is not and cannot be guided by the interests of a third party.

The Trustees are responsible for adopting this SIP, retaining investment managers, and allocating assets among these investment managers. The investment managers are responsible, in accordance with the investment guidelines for each investment manager, for managing the assets allocated by the Trustees including the selection and disposal of individual securities, and diversifying assets within the investment manager’s portfolio.

The Trustees expect the investment return of the Plan to exceed the Plan’s assumed rate of return and, therefore, it must consider investment alternatives which are not without risk. It is also understood, however, that diversifying among various assets classes may lower risk without a commensurate lowering of returns.

The Trustees will attempt to select investment managers with the best prospects for superior risk adjusted performance as measured against the investment manager’s applicable benchmark.

The following criteria for selection of investment managers also include:

  1. Consistency of investment style and remaining "fully invested" at all times.
  2. A verifiable performance track record of superior risk adjusted results.
  3. Satisfactory outcome of a review of the ownership of the firm, the key personnel, and the firm’s investment methodology in an effort to establish a sound basis for expecting future results to be consistent with past performance.

Additional guidelines and expectations will be set forth in each investment manager’s investment management agreement.

Purpose

The purpose of this SIP is to set out the long-range goals and short term needs of the Plan, establish the overall asset allocation of the Plan, and describe the structure of and guidelines for the investment managers.

This SIP will provide a documented structure for the implementation of investment strategies which suggest the highest probability of maximizing the level of investment return within acceptable parameters for the total Plan’s volatility and risk.

Delegation of Responsibilities

The Trustees have the ability to delegate fiduciary duties to other parties relating to the prudent investment of Plan assets. The following is a description of the primary investment-related responsibilities of these parties. This summary is meant to serve as a guide and a communication aid for the parties with responsibilities related to the Plan's investment program.

Investment Sub-Committee

The Trustees have established an Investment Sub-Committee with responsibilities which include, but are not limited to, the following:

  1. Developing policy and investment recommendations that are designed to achieve the policy, strategic, and tactical goals of the Plan.
  2. Reviewing policy recommendations made by the Trustees, Plan Staff and Investment Consultant.
  3. Periodically reviewing policies and making recommendations for amendments as appropriate.

Investment Consultant

The Investment Consultant has responsibilities which include, but are not limited to, the following:

  1. In conjunction with the Investment Sub-Committee, developing policies that are designed to achieve the policy, strategic, and tactical goals of the Plan.
  2. Conducting asset allocation studies and performance reviews as appropriate.
  3. In conjunction with the Investment Sub-Committee, periodically reviewing policies and making recommendations for amendment as appropriate.
  4. Designing an investment manager team and structure to achieve the performance goals of the Plan.
  5. Conducting investment manager searches, in accordance with the Plan's procurement policies, to identify the most appropriate managers to achieve the Plan's investment performance goals and making recommendations accordingly.
  6. Conducting quarterly investment performance reviews for the total Plan and for each investment manager, on a gross and net return basis.
  7. Providing educational and training materials and presentations for Trustees and Plan Staff as needed.

Investment Managers

The investment managers shall:

  1. Comply with all applicable laws, regulations, rulings, and its investment management agreement /guidelines and shall promptly inform the Trustees, Plan Staff, and the Investment Consultant regarding any instance of non-compliance.
  2. Manage the portion of the Plan's assets under its control in accordance with the policy objectives and guidelines as established.
  3. Exercise full investment discretion, within the policies and guidelines as established, to buy, hold, and sell the assets under management.
  4. On at least a quarterly basis, reconcile the account's positions with the Plan's custodian.
  5. Promptly inform the Trustees, Plan staff, and the Investment Consultant regarding significant matters pertaining to the investment of the Plan's assets, including, but not limited to changes in ownership, organizational structure, investment strategy, portfolio design, or configuration of the investment team.

Custodian

The Plan's custodian shall:

  1. Act in accordance with its custodial agreement.
  2. Hold, safeguard and accurately price the assets of the Plan.
  3. Collect the interest, dividends, distributions, redemptions, or any other amounts due.
  4. Report all necessary investment activity to the Plan's fiduciaries including Plan Staff and the investment consultant.
  5. Prepare periodic summaries of transactions, asset valuations, and other related information as deemed appropriate.
  6. All cash, interest earned, and dividend payments shall be swept on a daily basis into an investment-grade short-term money market.

Asset Allocation

The Trustees recognize that an asset allocation policy reflects a target for the allocation of assets. The Trustees recognize that since the market value of securities will fluctuate, it is not possible to meet these specific targets at all times. Plan Staff and the Investment Consultant will monitor this allocation and report to the Trustees on a quarterly basis. A formal asset allocation study and presentation will be completed every 3 to 5 years, unless extraordinary Plan or market circumstances compel an earlier analysis.

From time to time, the Trustees may reallocate assets among investment managers to better meet these targets. In the event the Trustees elect to move money from one active account to another, the Trustees may choose to utilize an appropriate passive index fund on an interim or emergency basis. The target asset allocation for the Plan is shown on the following page. The asset allocation will be maintained by periodic rebalancing when allocations approach plus or minus 5% of the target allocations.

It should be noted that the transition to the target asset allocation shown on the next page is expected to take approximately 12-18 months.

Target Asset Allocation

Asset Class
Core Fixed Income9.0%
Global Aggregate3.0%
Bank Loans2.0%
Emerging Market Debt3.0%
Total Fixed Income17.0%
  
U.S. Large-Cap18.0%
U.S. Mid-Cap5.0%
U.S. Small-Cap5.0%
Total U.S. Equity28.0%
  
Developed Large-Cap9.0%
Non-U.S. Small-Cap3.0%
Emerging Market6.0%
Emerging Market Small-Cap3.0%
Total Non-U.S. Equity21.0%
  
Hedge- Hedged Equity3.0%
Hedge FOF4.0%
Total Hedge Funds7.0%
  
Real Estate12.0%
Infrastructure5.0%
Total Real Assets17.0%
  
Private Equity - Mezzanine4.0%
Private Equity – FOF6.0%
Total Private Equity10.0%
  
Total100%

Total Plan Performance

The Trustees set the goals and objectives of the investment portfolio solely in the interest of the Plan, its participants and their beneficiaries. The performance objectives of the Plan are to:

  1. Meet or exceed the Plan's actuarial return assumption of 8.25% on a net-of-fees basis over time with a level of risk deemed appropriate by the Trustees while maintaining liquidity sufficient to cover benefit payments and other obligations.
  2. Outperform the risk-adjusted return, net-of-fees, of the policy benchmark corresponding to the target allocations outlined above. This objective should be met over a market cycle typically defined as a period of three to five years.

Investment manager goals and objectives are outlined below:

  1. Each investment manager is expected to outperform the agreed-upon benchmark on a risk-adjusted basis over a market cycle typically defined as a period of three to five years.
  2. The total net-of-fees return of each investment manager should rank at or above the median within the respective peer universe.
  3. The investment manager shall attempt to achieve its return objectives while maintaining an appropriate level of risk as determined by the Trustees and as specified in the investment guidelines.

Active Investment Manager Guidelines

The Trustees will select a combination of active and passive investment strategies to implement the above asset allocation. General investment guidelines for active investment managers are listed below. Specific investment guidelines for each investment manager are contained in Exhibit F of the respective Investment Management Agreements. Active investment strategies were selected based on their performance and fit; therefore, the investment guidelines that generated those results must also be accepted. It is understood that the tools that are available for measuring investment performance are limited and need to be understood in the context of the active strategy. The Trustees understand that a strategy that too closely emulates a benchmark index is not active.

Assault Weapon Divestiture Resolution

The Board of Trustees recognizes that, as a fiduciary, it must act solely in the interest of the participants and beneficiaries of the Plan. The Board has an obligation to protect Plan assets and minimize the risk of investment losses. Consistent with the Board's fiduciary duties, and subject to an investment manager's exercise of fiscal and fiduciary duty, an investment manager should refrain from purchasing or holding securities of an assault weapons manufacturer if the investment manager determines that the same investment goals concerning risk, return and diversification can be achieved through the purchase or holding of another security. For purposes of this policy, "assault weapon" shall mean a weapon identified as an assault weapon the civilian possession of which is prohibited by the Municipal Code of Chicago or the laws of the State of Illinois and "assault weapons manufacturer" shall mean any entity that derives revenue from the sale of such prohibited assault weapons for civilian use.

Equity Managers

Equity investment managers serve in a specialist role managing equity securities. Unless otherwise authorized in writing by the Trustees, the following guidelines apply to each equity investment manager, as defined by their role with the Plan's asset allocation. Equity managers must stay "fully invested", with the exception of the equity income manager who may from time to time have a fixed income allocation usually to meet overall portfolio yield requirements.

Commingled funds and collective trust funds may be utilized with the approval of the Trustees as long as the investment parameters of the trust funds are in substantial agreement with the remainder of the Plan's investment policy.

U.S. Large Company Equity Managers

Large company equity managers may invest in the common stocks and convertible bonds of U.S. companies, ADR's with respect to companies organized under the laws of countries other than the U.S., and equity securities of foreign companies trading in the U.S. markets and capable of settlement in the U.S. They may also invest in the short term investment funds of the Plan's custodian and individual securities that qualify for investment as detailed below.

Investment managers are selected based on their style of management such as Value, Growth, or Core. It is expected that the selected large cap investment managers will outperform the median return of a representative database of investment managers with a similar style, on average, over multiple rolling periods of one, three, and five years. Over the same periods of time, it is expected that these managers will exceed the return of the S&P 500 or similar benchmark index. Passive or index fund managers are expected to approximate the returns of the benchmark index.

U.S. Mid Size Company Equity Managers

Mid size company equity managers may invest in the common stocks and convertible bonds of U.S. companies, ADR's with respect to companies organized under the laws of countries other than the U.S., and equity securities of foreign companies trading in the U.S. markets and capable of settlement in the U.S. They may also invest in the short term investment funds of the Plan's custodian and individual securities that qualify for investment as detailed below

Investment managers are selected based on their style of management such as Value, Growth, or Core. It is expected that mid-cap investment managers will outperform the median return of a representative database of investment managers with a similar style, on average, over multiple rolling periods of one, three, and five years. Over the same periods of time, it is expected that these investment managers will exceed the return of the Russell Mid-Cap Index or similar benchmark index.

Small Company Equity Managers

Small company equity managers may invest in the common stocks and convertible bonds of U.S. companies, ADR's with respect to companies organized under the laws of countries other than the U.S., and equity securities of foreign companies trading in the U.S. markets and capable of settlement in the U.S. They may also invest in the short term investment funds of the Plan's custodian and individual securities that qualify for investment as detailed below.

Investment managers are selected based on their style of management such as Value, Growth, or Core. It is expected that small cap investment managers will outperform the median return of a representative database of investment managers with a similar style, on average, over multiple rolling periods of one, three, and five years. Over the same periods of time, it is expected that these investment managers will exceed the return of the Russell 2000 Index or similar benchmark index.

Non U.S. Equity Managers

Non-U.S. equity managers may invest in non-U.S. dollar denominated securities and ADRs. They may also invest in the short-term investment fund of the Plan's custodian and individual securities that qualify for investment as detailed below.

These investment managers may hedge the currency risk of their portfolio by utilizing currency derivatives. At no time may a manager use currency derivatives to leverage the portfolio or for speculative purposes.

It is expected that the Non-U.S. Equity managers will exceed the return of the MSCI EAFE Index or similar benchmark index, on average, over multiple rolling periods of one, three, and five years.

General Guidelines for Equity Managers

Equity managers are prohibited from investing in venture capital, private equity, options, futures (except for the non U.S.-equity managers), and other derivative investments.

The equity managers are expected to diversify their portfolios to avoid large losses.

Fixed Income Managers

Fixed income managers serve in specialist roles managing debt securities. Unless otherwise authorized in writing by the Trustees, the following guidelines apply to each fixed income manager. Bank commingled funds and collective trust funds may be utilized with the approval of the Trustees as long as the investment parameters of the trust are materially consistent with the remainder of the Plan's investment policy.

U.S. Fixed Income Managers

Domestic fixed income managers' investments may include (i) U.S. dollar denominated obligations of the United States Government and its Agencies and instrumentalities, and U.S. corporations, (ii) mortgage-backed securities including Collateralized Mortgage Obligations ("CMO's"), (iii) Asset Backed Securities ("ABS's"), (iv) municipal bonds, (v) short term securities, (vi) securities of foreign companies denominated in U.S. dollars, trading in the U.S. markets and capable of settlement in U.S. markets ("Yankee Bonds"), and (vii) dollar denominated obligations of U.S. companies or foreign companies trading outside the U.S. ("Eurobonds"). Fixed income securities must be rated at least Baa3/BBB- or higher by Moody's or Standard & Poor's, respectively at the time of purchase. Short-term instruments may include the short term investment fund of the Plan's custodian or its affiliate and individual securities that qualify for investment as detailed below. In addition up to 15% of the value of the fixed income portion of the portfolio may be invested in securities rated below Baa3/BBB- and private placements (limited to 144A securities). In the event of a split rating, the higher rating will prevail.

If a security held in the portfolio is downgraded below the above stated limitations, the portfolio manager will immediately notify the Trustees in writing of the event and describe the portfolio manager's plans for dealing with the security. Should the portfolio manager decide to continue to hold the downgraded issue, the portfolio manager will report to the Trustees quarterly in writing as to the status of the security.

The domestic fixed income investment manager is expected to outperform the appropriate fixed income benchmark index over a market cycle or three years, whichever is shorter.

No purchase shall be made which would cause the holding of any one issuer, excluding the U.S. Government and agencies of, or securities guaranteed by the U.S. Government, to exceed 10% of the investment manager's portfolio valued at market.

Stable Value Asset Manager

Up to 100% of the Plan's stable value asset allocation may be invested in commingled funds composed of guaranteed investment contracts (GIC's), bank investment contracts (BIC's), other stable value instruments, or cash and cash equivalents. Alternatively, an investment manager may be retained to actively manage a separately held stable asset portfolio. In either case, the manager will be responsible for evaluating the financial health of each issuer. However, in no circumstances may contracts be purchased from insurance companies with a rating of less than "A" by a major recognized rating agency. Bank issuers must have a debt rating no lower than "A" by the major rating agencies. The commingled fund portfolio is to be diversified so that no more than 15% of the portfolio is invested in the contracts of any single issuer.

The duration of the commingled fund portfolio shall not exceed 3 years.

Cash Manager

The Trustees may utilize a cash manager to manage un-invested cash held in investment manager accounts. In the event a cash manager is utilized, the cash manager is responsible for the investment of cash not invested by the investment managers and cash held for Plan benefit or expense payments. The custodian is responsible for sweeping all investment manager accounts daily so that no cash is left un-invested each night.

The cash manager may include (i) U.S. dollar denominated obligations of the United States Government and its Agencies and instrumentalities, and U.S. corporations, (ii) Mortgage-backed securities including Collateralized Mortgage CMO's, (iii) ABS's, (iv) municipal bonds, (v) short term securities, (vi) Yankee Bonds, and (vii) Eurobonds. Fixed income securities must be rated at least Baa3/BBB- or higher by Moody's or Standard & Poor's, respectively at the time of purchase.

Short-term investments may include certificates of deposit, bankers acceptances and commercial paper of banks subject to regulation by the U.S. Government and having total assets of $1 billion or more, commercial paper rated A1/P1, repurchase agreements backed by U.S. Government and U.S. Federal Agency collateral, and U.S. Treasury Bills. Commingled short term investment funds may be used whose investment guidelines, as identified in the fund prospectus, are materially consistent with these guidelines. The cash manager must maintain sufficient liquidity to meet the needs of the investment managers and the Plan's expenditures.

The average option adjusted duration of the portfolio may not exceed 3 years.

It is expected that the annual return of this portfolio will exceed the Salomon Brothers 1 Year Treasury Index.

Short Term Investments

A short term investment fund, offered by the Plan's custodian or its affiliate, will be used to invest cash not invested by the investment managers, and cash held for Plan benefit or expense payments. The Plan's custodian is responsible for sweeping all manager accounts daily so that no cash is left un-invested each night.

Short term investments may include certificates of deposit, bankers acceptances and commercial paper of banks subject to regulation by the U.S. Government and having total assets of $1 billion or more, commercial paper rated A1/P1, repurchase agreements backed by U.S. Government and U.S. Federal Agency collateral, and U.S. Treasury Bills. Commingled short term investment funds may be used whose investment guidelines, as identified in the fund prospectus, are materially consistent with these guidelines.

It is expected that the annual return of cash portfolio will exceed the Donoghue's Money Market Fund Average.

General Guidelines for Fixed Income Managers

Fixed income managers are prohibited from investing in venture capital, private equity, options, futures (except the non-U.S. fixed income managers) and other derivative investments (except Collateralized Mortgage Obligations or CMO's).

CMO's are limited to Planned Amortization Class (PAC's) and Sequential issues so long as their inclusion is consistent with the letter and spirit of the above stated guidelines. Specifically prohibited are companion tranches or support bonds, floaters, inverse floaters, income only, and principal only CMO's and structured notes, unless specifically allowed in writing. At no time may derivatives be utilized to leverage the account fund or for speculation.

The fixed income managers are expected to diversify their portfolios to avoid large losses.

The fixed income managers are responsible for notifying the Committee if in the manager's judgment it is imprudent to manage these assets within any of these guidelines.

Passive Investment Manager Guidelines

Passive equity and fixed income managers are responsible for matching the financial and risk characteristics of the specific benchmark assigned them, such as the S&P 500 or Barclays Aggregate Index. They may only invest in the securities that comprise the assigned index. S&P 500 Index managers may use Index futures to expedite cash investments.

Real Estate Manager Guidelines

Mortgage Managers

Mortgage managers serve in a specialist role managing real estate debt. Unless otherwise authorized in writing by the Trustees, the following guidelines apply to each mortgage manager.

Mortgages may be created directly or purchased through commingled funds. Selection, evaluation, and servicing of loans shall be assumed by each mortgage manager utilizing prudent underwriting criteria including, but not limited to, debt service and loan to value ratios and risk adjusted spreads over comparable maturity U.S. Treasury securities. It is expected that these managers will exceed the return of the 10 year U.S. Treasury by 2% per year, on average, over multiple rolling periods of one, three, and five years. Mortgage funds which are made up exclusively of government guaranteed issues are expected to exceed the return of the 10 year Treasury by 1% per year, on average, over multiple rolling periods of one, three, and five years.

Real Estate Equity Managers

The Real Estate investment policy adopted on May 23, 2000, shall be adopted and incorporated by reference.

Alternative Investment Manager

Private Equity Limited Partnerships

The Plan's investment in Private Markets (also known as Private Equity) shall be implemented through investing with one or more Private Market Managers via a direct investment or through an allocation to a fund of funds. The Plan may also choose to select separate manager(s) for investments in venture capital, buyouts, and other categories of the Private Markets, including international. The Plan shall seek a diversified portfolio of private market investments, including early-stage and later-stage venture capital funds, buyout funds, and mezzanine capital funds. It is expected that the cash-on-cash return on these investments, after all fees and expenses, will exceed the return of the S&P 500 Index plus 3%, on average, over multiple rolling periods of one, three, and five years.

Committed Capital Relative to Meeting Target Private Market Allocation

The Plan has a target allocation of 6% of total assets to private markets. Achieving the 6% target allocation objective is complicated by several factors. First, there is a time lag between commitment of capital and when it is drawn down.

This time lag is primarily related to market conditions and the ability of the Private Market Managers to find attractive investments and invest in the same. Second, the timing and magnitude of distributions (return of invested capital) from Private Market Managers is uncertain and dependent on overall conditions in the equity market.

In recognition of the issues associated with achieving the target allocation for private market investments, the Plan has adopted a "multiple commitment strategy". The Plan will maintain commitments of 1.25 times the target 6% allocation to Private Market Managers. New commitments will be based on the current allocations (called and committed) to sub-strategies and investment opportunities. This approach will enable the Plan to maintain an invested portfolio in Private Market Managers that approximately equals the target allocation.

The selection of a Private Market Manager will include the following factors:

  • Depth and breadth of research and portfolio management experience in the major asset sub-classes in private markets. This is to be measured by the number of investment professionals and their years of experience in the industry and working together with the firm.
  • The firm's access to deal flow
  • Ability to Identify Successful Areas of Investment and Add Value to the Program in the future
  • Assets Under Management
  • Quality of Investor Base
  • Track Record of Previous Private Equity Investments
  • Structured Process in Researching Individual Partnerships
  • Investments in Private Market Funds of Funds by Principals of the Firm
  • Investment Management Fees
  • Lack of Conflicts of Interest
  • Alignment of Financial Interests between the Private Market Manager and Clients
  • Reputation Among Other Plans Sponsors and Pension Consultants

Private Market Portfolio Objective

The portfolio represents diversified investment interests in equity or equity like securities principally through intermediary manager entities. The portfolio objective is to achieve equity like returns, including an appropriate risk premium, on portfolio securities, although the actual investment securities may be equity, debt, or equity like (hybrid securities). While the predominant focus is on private securities in middle market companies through specially structured investment vehicles, the portfolio should reflect a balanced exposure to the full range of private equity strategies, ranging from venture capital to late stage large buyouts. Acceptable secondary strategies include:1) co investments with private equity investment funds, 2) secondary interests in funds (i.e. repurchases of others' portfolios), and 3) investments in specialty private equity investment opportunities. Secondary strategies will be evaluated, approved, and undertaken on a case by case basis under a specifically proposed transaction or program. Investment interests may reflect control or minority positions, provided sufficient control elements exist to ensure protection of the Plan's investment interest. Investment interest may be in funds (e.g., limited partnerships) or fund of fund structures. The objective is to opportunistically allocate the portfolio over time, emphasizing seasoned management teams and attempting to capitalize on attractive market opportunities.

Private Market Portfolio Construction (Overall)

The portfolio will be allocated overtime with a blend of several sub-strategies with certain structural characterizations (e.g., core, specialty, custom, or direct). Although these groups are somewhat subjectively defined when applied to individual transaction proposals, the overall objective is to diversify the portfolio among the below listed groups overtime. The target allocation represents the longer-term target allocation; the actual allocation may significantly deviate from the target allocation based on Private Market Managers' capital calls and distributions and market opportunities.

Private Market StrategyTarget Allocation
(within Private Markets)
Core Strategies – Fund of Funds 75%
Specialty/Custom Strategies – Single Funds/Direct 25%
Total 100%
  
Buyout Capital50%
Venture Capital25%
Other25%
Total100%
Other includes Expansion Capital, Mezzanine Debt Capital, Distressed Debt Capital, and Non-U.S. Buyout Capital  

Manager Allocation / Participation ConstraintsCommitted Capital within Private Markets
Fund of Funds Allocation 25% Maximum
Single Manager Allocation 10% Maximum
Single Fund Participation 20% Maximum
Total 100%

Hedge Fund Investment Strategies

A diversified core and satellite hedge fund portfolio offers a low risk alternative to bonds in an institutional portfolio. Indeed, the risk characteristics of such a portfolio are significantly lower than that for stocks, and much closer to that for bonds. Hedge fund returns are also relatively uncorrelated with the returns on other asset classes. Thus, they are expected to offer a superior lower risk alternative to stocks, and a return enhancement to bonds with no significant increase in overall portfolio risk.

The Trustees realize that there are no shortcuts in hedge fund and fund of fund selection. For risk-averse investors, diversification is often said to be the only true free lunch in finance. Thus, institutional investors willing to include hedge Plans in their portfolios must realize that to deliver their favorable return/risk characteristics, hedge funds must carry additional risks, which are not common to traditional stock and bond investments. These risks are inherent to the strategies pursued; the instruments and markets used, the amount of leverage employed, and the specific skills of the selected hedge fund managers. Consequently, risk-conscious investors are coming back to the central tenet of modern portfolio theory, namely, diversification.

By combining several hedge fund vehicles with differing return distributions and risk profiles in a portfolio, we are able to diversify specific risk away and ensure a more disciplined exposure to the overall hedge fund asset class. This is likely to result in better long-term risk-adjusted returns.

Portfolio Construction

Hedge funds – even more than for traditional long-only managers – must be subject to rigorous analytic and fundamental analysis to qualify for inclusion in a portfolio. This is not simply a matter of predicting which fund managers will outperform their strategy averages, but it also requires a clear assessment of the risk profile and the systems employed by a manager. This due diligence process is ongoing and a pivotal part of constructing the portfolio.

A core and satellite portfolio consists of a "core" of fund of funds and a ring of "satellite" direct funds. We expect fund of funds to outperform the S&P 500 in bear markets, slightly underperform in bull markets, and produce competitive returns in trendless markets.

There is an art and science to investing in hedge funds. The allocation of capital among the hedge fund managers in the portfolio is a subjective process. A capital allocation for a particular manager is based more on the conviction and confidence the Trustees have in the manager rather than a complex optimization model. The resulting portfolio is a culmination of successful and complementary hedge fund managers that take a similar approach to investing in securities as the Trustees do in hedge fund managers.

Specific Guidelines for Commingled Funds, Mutual Funds, and Limited Partnerships (Index, Equity, Fixed Income, Real Estate, Hedge and Private Equity Fund managers)

Commingled funds, mutual funds and limited partnerships may be used from time to time. The funds and limited partnerships used by the Plan must adhere to the written objectives and guidelines as established in the contract, prospectus, or Private Placement Memorandum. If at any time the fund or limited partnership deviates from these guidelines or investment objectives, liquidity permitting, a new, limited partnership or separate account manager will be substituted for the current option.

Critical Investment Manager Performance Review

The Investment Consultant and Investment Sub-Committee will recommend terminating a manager when confidence is lost in the firm or the management of a strategy; when the characteristics of the portfolio no longer satisfy the desired or expected elements of the mandate, or the current style is no longer deemed appropriate.

Listed below are scenarios that would lead to a loss of confidence in an investment manager:

  • Performance: Continued performance shortfalls versus a peer group of managers with a similar style and market index. An investment manager that lags the benchmark indexes over an average of rolling three year periods for three consecutive quarters will be considered for critical review.
  • Changes in strategy: If the investment manager departs from the strategy and/or style it was originally hired to implement, such as a switch from a quantitative process to a fundamental one, or the strategy deviates from the peer universe and benchmark indexes dramatically and in a manner that would not have been expected given the tracking error and correlation expectations of the particular strategy.
  • Change in organizational structure or personnel: A significant change in culture through a merger or acquisition that is likely to distort incentives and promote turnover, or if significant members of the investment team leave the firm.
  • Compliance: Any negligence, willful misconduct, violation of investment guidelines or this policy, or breach of federal and state securities laws; and
  • Other: Any other reason the Trustees deem necessary for a heightened review of the investment manager.

The Investment Sub-Committee, with assistance from the Investment Consultant, will conduct a critical review of investment managers as necessary and provide recommendations to retain, modify, or terminate relationships. These recommendations will be brought to the Trustees for a final decision.

The following terminology has been developed to facilitate communication among the investment manager(s), Investment Consultant, the Investment Sub-Committee and the Trustees. Each term signifies a particular status with the Plan and any conditions that may require improvement. In each case, a change in investment manager status is made only after consultation with the Investment Sub-Committee, Plan Staff and the Trustees:

"In-Compliance" – The investment manager is in accordance with its Investment Policy Guidelines.

"Alert" – The investment manager is notified of a problem in performance (usually related to a benchmark or volatility measure), a change in investment characteristics, an alteration in management style or key investment professionals, and/or any other irregularities.

"On Notice" – The investment manager is notified of continued concern with one or more "Alert" issues. Failure to improve upon stated issues within a specific time frame justifies termination.

"Termination" – The Trustees have voted to terminate the investment manager. The investment manager is notified and transition plans are put into place.

Liquidity

Contributions are not expected to cover the benefits and expenses of the Plan. Consequently it will be necessary to withdraw cash from the Plan's investment managers to cover these liabilities.

The Plan staff will estimate annually the amount of cash needed to meet the Plan's expenditures. Cash will be drawn from each investment manager in a manner to improve compliance with the Plan's target asset allocation described above.

Proxy Voting

Each investment manager shall have full discretionary authority and responsibility to exercise the proxy voting rights related to securities held on behalf of the Plan. As fiduciaries, investment managers shall exercise voting rights in a manner consistent with the economic best interests of the Plan, its participants, and their beneficiaries. Each investment manager shall avoid conflicts-of-interest in exercising voting rights.

Each investment manager shall provide the Trustees with a copy of its proxy voting policy and on or before January 31st of each year provide a report detailing each proxy vote made during the prior calendar year.

Securities Lending

The Plan will participate in the securities lending program of the Plan's custodian. The specific terms of the program are described in the executed securities lending agreement.

Investment objectives and guidelines for investing cash collateral funds shall be adopted from the Securities Lending Policy of the Securities Lending Agent.

Investment guidelines for eligible securities and credit quality shall be adopted from the Securities Lending Policy of the Securities Lending Agent.

The securities lending manager is expected to diversify their portfolio to avoid large losses. The average option adjusted duration of the portfolio may not exceed 2 years.

This Statement of Investment Policy was adopted December 22, 2009, and amended November 25, 2014.

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