CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER

INTRADEPARTMENTAL CORRESPONDENCE

Date: September 5, 2018

To: Retirement Board Members

From: Linda P. Le, Retirement Plan Manager

Subject: Board Agenda Item 15: Discussion on Rule 144A Securities Restriction in the Death and Disability Funds Managed by Wells Capital Management; and Possible Action (September 12, 2018, Regular Retirement Board Meeting)

Recommendation

That the Board of Administration (Retirement Board) of the Water. and Power Employees' Retirement Plan (Plan) rescind the side letter with Wells Capital Management (WCM) limiting the investment manager's commingled fund allocation to Rule 144A securities.

Summary

The Retirement Board hired WCM in 2004 to manage a core fixed income mandate for the Disability and Death Benefit funds. Due to the small size of the two funds, WCM proposed to manage them in its commingled fund Montgomery US Core Fixed Income Fund (Montgomery Fund) instead of establishing separate accounts. This was done in order for the two accounts to receive proper diversification, which is difficult to achieve in a separate account for smaller funds.

At the time of funding, the commingled fund's investment guidelines only permitted investing in Rule 144A securities with registration rights. This was consistent with the investment guidelines for the Retirement Plan, managed in a separate account by WCM. However, in 2006, WCM updated its commingled fund guidelines to allow for investment in Rule 144A securities without registration rights. The Retirement Board decided to continue to invest in Montgomery Fund by agreeing to adopt a side letter with WCM, limiting the Montgomery Fund's allocation to Rule 144A securities without registration rights to two percent of the fund's market value at the time of purchase (Resolution No. 06-50). Later in 2010, the Retirement Board increased the limit to 10 percent on WCM's request (Resolution No. 10-57).

Securities need to be registered with the Securities and Exchange Commission (SEC) to be traded without any restrictions. Many issuers consider the registration requirements prohibitive. Non-U.S. sovereign entities, private U.S. companies and financial entities are either unwilling or unable to conform to U.S. Generally Accepted Accounting Principles (GAAP), a requirement for SEC registration, due to the nature of their business or high cost and delays. The SEC adopted Rule 144A to address these concerns. Securities issued under Rule 144A do not require registration with the SEC but can still be traded in the secondary market amongst institutional investors which include banks, insurance companies, pension plans, broker-dealers, etc.

Over the years, issuance under Rule 144A has increased significantly. Majority of asset backed securities (ABS) and commercial mortgage backed securities (CMBS) are issued as Rule 144A

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securities. Almost all of CMBS issued during 2009 - 2011 was under Rule 144A. These vintages could provide a meaningful investment opportunity due to their short duration. Many public companies in the U.S. have become private in the last 20 years as the number of publicly listed companies dropped to 3,600 at the end of 2017, down more than half from 1997. One such company is Dell whose financial reporting burden is less stringent as a private company and has chosen to issue debt under Rule 144A. Due to preference from such companies to issue Rule 144A securities, approximately 15 percent of the Bloomberg Barclays U.S. Investment Grade Credit is comprised of Rule 144A securities.

As a result of the above mentioned reasons, WCM believes the current limitation of 1 O percent for holding Rule 144A securities is no longer in the best interest of its clients. WCM's investment guidelines permits for holding up to 15 percent in Rule 144A securities but the firm has kept exposure below ten percent due to the restriction placed in the side letter agreed between WCM and the Retirement Board. WCM has requested to increase the limit under the side letter to 15 percent, as allowed by its own investment guidelines. The firm does not intend to increase exposure to its maximum limit immediately. It only plans to increase holdings by approximately two to three percent and agrees that in the future the relative attractiveness of such securities may vary causing exposure to decline.

Staff and RVK, Inc. (RVK), the Plan's general consultant, believe increasing the limit to 15 percent is appropriate based on the growth in issuance of Rule 144A securities. The increase will provide the Disability and Death Benefit accounts with greater investment opportunities without materially impacting their risk profile. However, staff and RVK recommend the Retirement Board increase the limit by rescinding the side letter which was drafted in 2006 when market conditions were significantly different for Rule 144A securities. Staff performed a short survey to obtain Rule 144A exposure for some large core fixed income managers and discovered that majority of these core fixed income portfolios had 15 to 20 percent exposure in Rule 144A securities. Therefore, a limit of 15 percent, as permitted by Montgomery Fund's investment policy, is a reasonable restriction.

WCM agrees to continue providing monthly exposure reports for Rule 144A securities. Staff will monitor these reports for any inconsistency and will report to the Retirement Board if further action is necessary.

The following documents are attached:

• Resolution No. 19-23 • Correspondence from RVK • Copy of Resolution No. 06-50 • Copy of Resolution No. 10-57 • Side letter from WCM • Correspondence from WCM

LPL/JW/CM/FH:mea

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Memorandum To Water and Power Employees' Retirement Plan ("The Plan")

. . .

From RVK, Inc. ("RVK")

SubJ'ect Fixed Income Manager Policy - Recommendation to Increase Allocation Limit for Rule 144a Securities

Date September 12, 2018

Background

RVK

Wells Capital's Montgomery U.S. Core Fixed Income Fund ("Montgomery"), which manages the Plan's Disability and Death Benefit funds, is restricted by the Retirement Board ("Board") to invest no more than 10% in Rule 144a (" 144a") securities. Montgomery's fund guidelines permit holdings of up to 15% in such securities, but the fund has maintained a soft limit of 10%. Montgomery has requested that the Plan increase the limit to match the fund's guidelines as it believes this is in the best interest of investors. Montgomery does not plan to rncrease the fund's exposure immediately to 15%, more likely the change will result in an increase of approximately 2-3% in the fund's 144a security holdings.

The Plan's 10°/o maximum on 144a securities is enforced through a side letter between the Plan and Montgomery. The Board initially approved the side letter (with a maximum of 2% for 144a securities) through Resolution No. 06-50 on March 15, 2006. The Board later approved a modification to the side letter (that increased the maximum for 144a se?urities to 10%) through Resolution No. 10-57 on January 27, 2010.

Rec<>mmendation RVK recommends that the Plan remove the current side letter in place with Montgomery, and uti!lze the guidelines of the U.S. Core Fixed Income Fund going forward. This will effectively increase the maximum allowable investment in 144a securities from 10% to 15%. This limit is in line with other similar funds in the market, and given the continued growth of the 144a market the fund may be at a disadvantage by not increasing the limit.

144a securities provide issuers a safe harbor from the registration requirements of the Securities Act of 1933 for certain issues to qualified institutional buyers (QIBs) (generally institutions with greater than $100 milifon in assets). This allows a broader opportunity set in investment grade credit for QIBs. The market has seen an increasing reliance on the use of 144a securities, and year to date, 144as comprise over 80% of the new issuance market. Issuance is often both cost and time efficient to issuers compared to traditional listed issues. Liquidity tends to be in-line with traditional securities, with zero impact on liquidity or added risk to investors. Without greater access to the 144a market, the portfolio will likely miss out on many of the new opportunities in the credit space.

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RVK

Concluding Thot.~gMs The proposed management policy has been vetted between Staff and RVK. We look forward to discussing this recommendation with the Board.

RVK·2

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·. COP'l RESOLUTION NO. 06-50

.. . . .. :·:;SOLUTION TO ADOPT THE LETTER AGREEMENT BETWEEN THE WATER . •·: · <~D POWER EMPLOYEES' RETIREMENT PLAN (PLAN) AND WELLS CAPITAL

. :: ;1ANAGEMENT (WELLS) TO ALLOW HOLDING RULE 144A SECURITIES WITHOUT REGISTRATION RIGHTS UP TO A MAXIMUM OF 2% IN THE WELLS'

• : : . . ·· MONTGOMERY U.S. CORE FIXED INCOME FUND WHERE THE PLAN'S DEATH · . ·· ·· AND DISABILITY FUNDS ARE INVESTED

,....,;;:~~:,

;;~;~~t~ ,i . - ' - ·.~ :,

WHEREAS, Wells oversees the Plan's Death and Disability funds through a commingled core fixed income fund run by its subsidiary Montgomery Asset Management (Montgomery); and

WHEREAS, Montgomery's guidelines currently allows investment ln unregistered Rule 144A securities provided these securities have rights to SEC registration in the near future; and

WHEREAS, Wells made a decision to change Montgomery's guidelines to allow investing, not only in Rule 144A securities with registration rights, but also in those securities without registration rights, effective February 28, 2006; and

WHEREAS, the Plan consultant (PCA) and staff concluded that unregistered securities lack legal protection for investors, have limited marketability1 and are virtual private placements that should not be emphasized in the Plan's core fixed income portfolios especially for the Plan's insurance-type funds such as the Plan's Death and Disability; and

WHEREAS, PCA and staff presented the following three options to the Plan's Board each dealing with the issue of how to limit/avoid the risks of unregistered Rule 144A securities in the Plan's Death and Disability funds; namely, 1) a side letter option [Wells' side letter as amended by staff (alternate side letter)] in which Wells agrees to limit Montgomery's investment in Rule 144A securities without registration rights to 2% of the portfolio, 2) transitioning from the Montgomery fund to another Wells fund that does not invest in Rule 144A securities without registration rights, and 3) transitioning from the Montgomery fund to another investment management fund outside of Wells which does not al_so invest In Rule 144A securities without registration rights; and

WHEREAS, after careful consideration of the risk/reward characteristics and the practicality of each of the three options the Plan's Board elected to adopt the side letter option subject to approval of the terms of the side letter by staff; and

WHEREAS, a copy of the Letter Agreement agreed upon by Wells and staff is attached;

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RESOLUTION NO. 06-50

.. SOLUTION TO ADOPT THE LETTER AGREEMENT BETWEEN THE WATER ~'JD POWER EMPLOYEES' RETIREMENT PLAN (PLAN) AND WELLS CAPITAL

:.tANAGEMENT (WELLS) TO ALLOW HOLDING RULE 144A SECURITIES WITHOUT REGISTRATION RIGHTS UP TO A MAXIMUM OF 2% IN THE WELLS' MONTGOMERY U.S. CORE FIXED INCOME FUND WHERE THE PLAN'S DEATH AND DISABILITY FUNDS ARE INVESTED

WHEREAS, Wells oversees the Plan's Death and Disability funds through a commingled core fixed income fund run by its subsidiary Montgomery Asset Management (Montgomery); and

WHEREAS, Montgomery's guidelines currently allows investment in unregistered Rule 144A securities provided these securities have rights to SEC registration in the near future; and

WHEREAS, Wells made a decision to change Montgomery's guidelines to allow investing, not only in Rule 144A securities with registration rights, but also in those securities without registration rights, effective February 28, 2006; and

WHEREAS, the Plan consultant (PCA) and staff concluded that unregistered securities lack legal protection for investors, have limited marketability, and are virtual private placements that should not be emphasized in the Plan's core fixed income portfolios especially for the Plan's insurance-type funds such as the Plan's Death and Disability; and

WHEREAS, PCA and staff presented the following three options to the Plan's Board each dealing with the issue of how to limit/avoid the risks of unregistered Rule 144A securities In the Plan's Death and Disability funds; namely, 1) a side letter option [Wells' side letter as amended by staff (alternate side letter)] in which Wells agrees to limit Montgomery's investment in Rule 144A securities without registration rights to 2% of the portfolio, 2) transitioning from the Montgomery fund to another Wells fund that does not invest in Rule 144A securities without registration rights, and 3) transitioning from the · Montgomery fund to another investment management fund outside of Wells which does not al_so invest in Rule 144A securities without registration rights; and

WHEREAS, after careful consideration of the risk/reward characteristics and the . practicality of each of the three options the Plan's Board elected to adopt the side letter option subject to approval of the terms of the side letter by staff; and

WHEREAS, a copy of the Letter Agreement agreed upon by Wells and staff is attached;

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__ .,., _.

.: .. ---=~

';°l I I co ' . -- ___ E_'( RESOLUTION NO. 06-50

NOW THEREFORE, BE IT RESOLVED that the Board adopt the Letter Agreement between the Plan and Wells allowing Montgomery to invest up to 2% of its portfolio in Rule 144A securities without registration rights.

I HEREBY CERTIFY, the foregoing is a full, true, and correct copy of a Resolution adopted by the Board of Administration (Retirement Board) created by Section 1102{b) of the Charter, at its regular meeting held March 15, 2006.

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5~·~ Sangeeta Bhatia

Secretary

RESOLUTION NO. 10 .. 57

RESOLUTION TO ADJUST THE INVESTMENT POLICY RELATING TO 144A SECURITIES IN THE DEATH AND DISABILITY INVESTMENT PORTFOLIOS

WHEREAS, Wells Capital Management (WGM) manages a core fixed income mandate for the Water and Power Employees• Retirement Plan's {WPERP) Death and Disability Plans through a commingled fund vehicle called the Montgomery U.S. Core Fixed Income Fund (Montgomery Fund); and

WHEREAS, prior to Februa1y 28, 2006, the Montgomery Fund's investment guidelines only allowed investments in Rule 144A securities with registration rights; and

WHEREASJ WCM decided to change the Montgomery Fund's investment guidelines to atlow investing, not only in Rule 144A securities with registration rights, but also in those securities without registration rights, effective February 28, .2006; and

WHEREAS, the WPERP Board of Administration (Board) adopted a side letter with WCM to limit the amount of Rule 144A securities without registration rights to two percent (2%) of the market value of the portfolio at the time of purchase; and

WHEREAS, representatives from WCM notified Staff in November, 2009, of their intent to change the investment guidelines of the Montgomery Fund to allow up to 10% of the portfolio in Rule 144A securities regardless of registration rights; and

WHEREAS, representatives from Pension Consulting Alliance (PCA) believe the change to the Montgomery Fund will provide additional flexibility for WCM and will not materially impact the portfolio's return, liquidity, or risk: profile for the Death and Disability accounts; and

WHEREAS, PCA recommends, and Staff concurs, to allow the Montgomery Fund to invest up to 10% in Rule 144A securities regardless of registration rights.

NOW, THEREFORE, BE IT RESOLVED, the Retirement Plan Manager is hereby authorized to allow the Montgomery Fund to invest up to i 0% in Rule 144A securities regardless of registration rights and to inform the investment manager accordingly.

I HEREBY CERTIFY, the foregoing Is a full, true, and correct copy of a Resolution adopted by the Retirement Board of AdmJnistration, [created by Section 1102 (b) of the Los Angeles City Charter], at its regular meeting held on January 27, 2010.

y ~:S:~~- ~·1?~ ---- -Sangeeta Bhatia Retirement Plan Manager

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1 vVELJ._,s CAPIT/\L .MANA(~ErvIENT ! ,~ -~--·· .. --------·--------·-· ·-

March 8, 2006

Water and Power Employees' Retirement, Disability and Death Benefit Plan Attn: Ms. Sangeeta Bhatia Retirement Plan Manager (Interim) l 11 North Hope Street, Room 357 Los Angeles, CA 90012

Dear Sangeeta:

The Disability and Death Benefit funds of the Water and Power Employees' Retirement Disability and Death Benefit Plans ("WPERP") are invested in the Montgomery U.S. Core Fixed Income Fund (the "Ftmd") managed by Investment Manager, Wells Capital Management. Wells Capital Management is providing certain additional representations to WPERP and entering into certain additional agreements, as set forth in this letter. Upon execution by' all parties hereto, this Letter Agreement shal1 be a binding agreement between the parties hereto ~nd may not be amended without your written consent.

Reference is made to the Montgomery U.S. Core Fixed Income Fund Wells Pargo Trust for Institutional Investments (Confidential Memorandum) that governs the Fund and is dated December 31, 2005.

Representations:

(1) The Fund shall not invest in Rule 144A securities without registration rights in excess of 2% of the Fund's market value at the time of purchase. The Rule l 44A securities in which the Fund invests will have the same investment criteria as the other securities selected for the portfolio. Such se.curities must provide good financial disclosure, be liquid and actively traded by at least several broker dealers, and be priced where possible by a third party pricing service.

(2) Wells Capital Management agrees, as part of its ongoing reporting process, to include info:i.nation to VlPERP regarding the Fund's holdings of l 44A securities with or without registration rigb'.s.

(3) This Letter Agreement supplements the governing documents of the Fund with respect to WPERJ>. To the extent the1·e is any conflict between the Confidential Memorandum, the Investment Management Contract with Wells Capital Management, and this Letter Agreement, t11e tenns hereof shall control with respect to the Plans.

Agreed and Acknowledged by:

:«~'nagem:nt fo

Name: Robert W. Bissell, CFA Title: President

rporated Board of Administration of the Wate!' and Power Employees' Retirement, Disability and Death

Benefit Pl)~f} By:~ Name: I :::la uje.r \?oM.Uo Title: Boa.rd Pccs'16e.""J-

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333 fiCHITh Grnnd AYm1L1e. S11He 2200

lo!; Ann!:les, C~1Jfom1(j !">OUY 1

2l 3.2f,3.3H~:i fq~ 2~ 3.C 23 LH1~5

August 28, 2018

Mr. Fahad Haider, CFA Investment Officer Los Angeles Water and Power Employees' Retirement Plan 111 North Hope Street, Room 357 Los Angeles, CA 90012

Dear Fahad:

Wells Capital Management 333 s. Grand Avenue Suite 820 Los Angeles, CA 90071

J am writing to inform you that Wells Capital Management plans to modify the U.S. Core Fixed Income Fund's (the Fund) investment strategy in a manner that will impact the Water and Power Employees' Retirement Disability and Death Benefit Plans. Specifically, our Montgomery Fixed Income team plans to increase its internal limit for investment in Rule 144A securities, without registration rights from 10% to potentially 15% as allowed by the Fund's Private Placement Memorandum and Investment Guidelines (enclosed). Total exposure to Rule 144A securities, with or without registration rights, will be limited to 15%.

Further to the side letter agreed between Wells Capital Management and the Water and Power Employees Retirement Plan Board of Administration dated March 8, 2006 and subsequently revised on January 27, 2010, the Fund's exposure to Rule 144A securities has been limited to 10%. Given the continued growth in issuance of Rule 144A securities, the M<:mtgomery Fixed Income Team believes that it is no longer in the best interests of the Water and Power Employees Retirement Plan and other Fund investors to limit the Fund's exposure to 10%.

The Montgomery Fixed Income team believes that its ability to opportunistically hold Rule 144a designated securities in client portfolios is accretive to performance, without a commensurate increase in risk. The relative attractiveness of holding Rule 144a designated securities will vary over time, however by allowing these securities to be held, the universe of investable securities increases dramatically, creating additional opportunities for the team to generate returns in excess of the benchmark.

In support of this modification, we confirm that the Rule 144A securities in which the Fund invests will continue to have the same investment criteria as the other securities selected for the portfolio. All investments in these securities will require a review of financial disclosures and a determination that the securities are liquid, actively traded, and priced, where possible, by a third party pricing service. As part of our ongoing reporting process, we will continue to provide information to the Water and Power Employees' Retirement Plan (WPERP) regarding the Fund's holdings of 144A securities, with or without registration rights.

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I Nor 1'01(:··1N"suRm NO sMiK Gut1.r<ii°NrEF--iuw wsE i/Al.u~ l... ...•....•...•....•....•..........•....•.•.•.••...... ...•.....•.......•....•.........•.•...•....•.•..........•.•.•.•.•..............................................•........................................•

Wells Capital Management 333 s. Grand Avenue Suite 820 Los Angeles, CA 90071

While we note that this change is consistent with the investment guidelines outlined in the U.S. Core Fixed Income Fund PPM, we acknowledge that the modification requires that WPERP consent consistent with the Agreement dated March 8, 2006. Therefore, we ask that you review this change to insure that it meets your investment objectives. We intend to implement this change the earlier of October 31, 2018 or upon receipt of notification that WPERP is in agreement with the new guidelines. If you choose to remain in the Fund, you will be deemed to have consented to this change and to the corresponding modification to the side letter.

We greatly value our relationship with the Los Angeles Department of Water and Power and understand that this change may result in your determining that the U.S. Core Fixed Income Fund no longer meets your investment objectives and / or risk tolerances. However, we sincerely hope that you elect to remain invested in the Fund as we do believe that the relaxation of the 144a holding restriction will be beneficial to the Fund and your participants.

Sincerely,

Daniel E. Anderson Director, Client Relations

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