CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER

INTERDEPARTMENTAL CORRESPONDENCE

Date: July 18, 2012

To: Retirement Board Members

From~Sangeeta Bhatia, Retirement Plan Manager

Subject: Board Agenda Item 1\10. 10: Discussion of Contract Renewal for MFS Investment Management, Inc., Domestic Large-Cap Value; and Possible Action (July 25, 2012, Regular Retirement Board Meeting)

Recommendation

That the Retirement Board approve the extension of the contract for MFS Investment Management, Inc. (MFS), Domestic Equity Large-Cap Value Investment Manager, for three years beginning December 1, 2012, through November 30, 2015.

Summary

The Retirement Board hired MFS to manage a domestic large-cap value (LCV) equity mandate for the Retirement Fund (RF) in 2004 and the Retiree Health Benefits Fund (RHBF) in 2009. As of June 30,2012, the market value of the RF account was $408.7 million, and the market value of the RHBF was $68.1 million.

The contract with MFS will expire on November 30, 2012. In lieu of releasing a Request for Proposal, Staff conducted a thorough due diligence process. Staff sent MFS a comprehensive questionnaire that explored areas such as ownership, personnel, investment style and process, performance, and risk mitigation. Staff observed no significant issues in MFS' responses and noted no change in investment style. Additionally, the portfolio has been in compliance with the Plan's investment guidelines.

As seen in the following chart, MFS has generated value for the Plan when compared to its benchmark, the Russell 1000 Value Composite (R1000 Value), for the since-inception period ending June 30, 2012.

10.1 "

MF.S Large-Cap Value.vs Russell 1000 VahJe Index . ,Sincelnc~ption'endirig June 3'0,2012 •..

GroWth.oU1

. 2012'

./~.\. ,{ .\/., ., .

.\ ,../ '\ :/''I .'

I:-r·· }"",·'U

I

..,--::Russell.1000:yalue·lndex .

0.76:

1.32

0.72 0.70 L...,-,-~~"""~~~~""",~~"""""""""~~~~""",~~~"""~~~""""",,,,,,,,,,,,.-r-r~~......,....,.....,~~.,...,.,~....--.-J

SOurce:.TheBank afNewYork Mellon Cor ordon

Source: BNY Mellon

The table below shows MFS outperformed its benchmark for the five-year and since-inception periods ending June 30, 2012, by 2.74% and 2.01%, respectively, but underperformed its benchmark for the one-year and three-year periods by -0.22% and -2.69%, respectively.

. "a~@il~»

Ru.sselUOOO Value' :'i ~~.'; " ·2~_3_._0_1_0/0-+_1_5_.8_0_·0_Yo--+_-_2_.1_9_0;(_0-+__4_.0_7_°;(_0_--1 Difference ,0' •... 'l'j"<~ -0.22% .-2.69% 2.74% 2.01%

Source. BNY Mellon

On a risk-adjusted basis, MFS' since-inception return as of June 30, 2012, was 6.09% which was above its benchmark return of 4.07%. The higher return included lower risk with a standard deviation of 15.04% versus 16.40% for the Russell 1000 Value Index (see the following chart).

10.2

14.00

12.00

10.00

8.00

j 6,00

~

'.00

. 2.00

0.00

,2.00. 10.00 .12.00

Source::TheBank of Ne\ovYor1( Mellon Carpordon

Universe SOUtce: Russell Investment Glom

MFS Large-Cap Value Risk/Return us large Cap Value Equity Portfolios (USDI- MonthlY

Since Inception ending June 30, 2012

Sc:alter

'e

14.00

.'

16.00 .18.00

Ann Std Dev

20.00 22.00 24.00 . 26.00

eRPMFS Ins! Adv Lg ViII ,. 'RusseIl1000Value:lndex

Source: BNY Mellon

As noted in the next chart, MFS' performance was in the first quartile for the five-year and since­inception periods ending June 30, 2012. They were in the second quartile for the one-year period but in the fourth quartile for the three-year period ending June 30, 2012. The benchmark results were in the second quartile for the one-year and three-year periods but were in the third quartile for the five-year and since-inception periods ending June 30, 2012.

MFS Value Peer Group Comparison 'us large Cap V.alue Equity Portfolios (USDI: MonthlY­

As of June 30, 2012 Quartile

30.00 r---------------------------------,

20.00 D10.00 D n[J " n l'=l0.00

[Je----------fD~' ' I. -10.00

.20.00 L- .-- .-- .,-- -,-_~...~ln!M""IX~

1 yellr J )'ear 5 year Since InceptIOn. Universe Source: RU5selllnvestment Group; Unlve~e status: CalClJ1Sl!d

.' "RPMFSlnslAdv Lg VIII • Russell 1000VlIluo IndcltPerf Only

Source: BNY Mellon

10.3

The following chart illustrates MFS' excess return over its benchmark on a monthly basis since March 2004. Over this time period, MFS generated positive returns relative to its benchmark 58 out of the previous 100 months, or approximately 58% of the time.

MFS Large-Cap Value 'Since Inceptloriendlrig June 30, 2012

Value Added 30,00 r'---'---------'-------------------'-----------,

25.00

20.00 '

15.00

10.00

6,00

0.00, ,

2004 2005

Markel: Proxy: Russell1000Value Index Source:,The Bank ofNeY/York M'ellon Co oranon

..

... -"'..·.I·II_-••i;..jli.(·II···-··il:'·.·"...,i.---";_;;'·lj·~

2012

......;..:... Cumulative Value Added • V.lue'Added

Source: BNY Mellon

MFS has outperformed its benchmark in the five-year and since-inception periods ending June 30, 2012, by 2.74% and 2.01%, respectively, while assuming less risk than its benchmark. The Retirement Board hired MFS for a domestic LCV mandate, and the firm has not deviated from this investment philosophy.

MFS has effectively managed a portfolio that complements the Plan's other domestic LCV portfolio manager; therefore, Pension Consulting Alliance (PCA) recommends, and Staff concurs, that the Retirement Board extend MFS' contract for three years beginning December 1, 2012, through November 30,2015.

MFS' new contract will include the standard clause (Section A.2 - "Term, Termination and Resignation") that allows the Retirement Board to terminate the contract, with or without cause, at any time within thirty (30) calendar days after written notice to the firm.

The following documents are attached:

• Resolution No. 13-11 • Correspondence from PCA

Jer Ch'

,j-------'"

SB:JW:SV:CM

'0.4

RESOLUTION NO. 13-11

RESOLUTION TO EXTEND THE CONTRACT WITH MFS INVESTMENT MANAGEMENT, INC., FOR THE PLAN~S LARGE CAP VALUE MANDATE

WHEREAS, the Retirement Board hired MFS Investment Management (MFS) to manage a domestic large-cap value (LCV) equity mandate for the Retirement Fund (RF) in 2004 and the Retiree Health Benefits Fund (RHBF) in 2009; and

WHEREAS, as of June 30, 2012, the market value of the RF account was $408.7 million, and the market value of the RHBF was $68.1 million; and

WHEREAS, the contract with IVIFS will expire on November 30, 2012; and

WHEREAS, Staff conducted a thorough due diligence process in lieu of releasing a Request for Proposal and sent MFS a comprehensive questionnaire that explored areas such as ownership, personnel, investment style and process, performance, and risk mitigation; and

WHEREAS, Staff observed no significant issues in MFS' responses and noted no change in investment style; and

WHEREAS, the portfolio has been in compliance with the Plan's investment guidelines per the Plan's Investment Policy; and

WHEREAS, IVIFS outperformed its benchmark, the Russell 1000 Value (R1000 Value), for the five-year and since-inception periods ending June 30, 2012, by 2.74% and 2.01 %, respectively, but underperformed its benchmark for the one-year and three-year periods by -0.22% and -2.69%, respectively; and

WHEREAS, the higher inception-to-date return included lower risk with a standard deviation of 15.04% versus 16.40% for the benchmark; and

WHEREAS, MFS' performance was in the first quartile for the five-year and since­inception periods ending June 30, 2012, in the second quartile for the one-year period, but in the fourth quartile for the three-year period ending June 30, 2012; and

WHEREAS, the R1000 Value Composite was in the second quartile for the one-year and three-year periods but was in the third quartile for the five-year and since-inception periods ending June 30, 2012; and

WHEREAS, MFS' new contract will include the standard clause (Section A.2 - "Term, Termination and Resignation") that allows the Retirement Board to terminate the contract with or without cause, at any time within thirty (30) calendar days after written notice to the firm; and

WHEREAS, Pension Consulting Alliance recommends, and Staff concurs, that the Retirement Board extend MFS' contract for three years beginning December 1, 2012, through November 30, 2015.

10.5

NOW, THEREFORE, BE IT RESOLVED, the Retirement Plan Manager is hereby authorized to extend the contract with MFS for three years beginning December 1,

·2012, through November 30,2015, 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 Administration, [created by Section 1102 (b) of the Los Angeles City Charter],.at its regular meeting held on July 25,2012.

Sangeeta Bhatia Retirement Plan Manager

10.6

Date: July 13, 2012

To: Water &Power Employees' Retirement Plan (WPERP)

From: Pension Consulting Alliance, Inc. (PCA) ~ cc: Neil Rue, CFA - PCA David Sancewich - PCA Kay Ceserani - PCA Colin Bebee - PCA

RE: MFS Large Cap Value Equity ­ Contract Renewal

Recommendation

PCA recommends that WPERP renew its contract with MFS for its Large Cap Value Equity strategy before the current contract expiration date of November 30, 2012. WPERP contracts reserve the right for the Board to terminate the agreement with or without cause at any time upon thirty days notice.

Summary

In making this recommendation, PCA considered recent and extended time period investment performance and the stability of the organization and investment personnel for the MFS Large Cap Value Equity strategy.

PCA's analysis finds that the MFS Large Cap Value Equity portfolio has produced mixed performance results; underperforming in recent periods while outperforming over longer periods. Despite lagging the benchmark in recent periods, the MFS portfolio has produced strong performance results versus their peers; placing above median over the most recent quarter and 1-year period and in the top-quartile over the 5-year and since inception periods. MFS continues to apply the same investment process and philosophy and the Large Cap Value Equity team responsible for the WPERP portfolio has been stable.

Discussion

WPERP approved hiring MFS to manage a Large Cap Value Equity account in December 2003; the Retirement account funded in February 2004 and the Health Plan funded in August 2009. WPERP's total exposure to the MFS large cap value equity account was approximately $477 million ($409 million Retirement and $68 million Health Plan) as of June 30, 2012. The MFS account is currently, exceeding all of WPERP's manager watch criteria thresholds. However, the portfolio was on watch status from August 2010 to June 2011 for performance concerns1.

1 Falling below WPERP's short-term relative perfonnance criteria: Trailing 1-year underperformance greater than (3.0%) for two consecutive calendar quarter end dates, gross of fees.

10.7

--

.1---,--------­Investment Performance

PCA's analysis finds that the MFS Large Cap Value Equity portfolio has produced mixed performance results; underperforming in recent periods while outperforming over longer periods. Despite lagging the benchmark in recent periods, the MFS portfolio has produced above median results over the most recent quarter and 1 year period and top-quartile results over the 5-year and since inception periods. (Please note, since June 30, 2012 universe data is currently preliminary as only 57 of the 465 large cap value equity managers within'the universe have submitted their second quarter 2012 performance results.)

Over the recent quarter, 1-, and 3-year periods MFS underperforrned the Russell 1000 Value Index. Over the latest 5-year periods and since inception, the portfolio has outperformed its benchmark by 2.8% and 2.0% per annum, respectively, gross of fees. On a calendar year basis MFS outperformed the benchmark in four of the last five year periods.

Performance Results, Gross of Fees

" ~~-__ ~~ _J. ~ _~ ~~ A-n~u~li~;d~'Endi~g 6/~1-2--=~] Calendar Years, Ending 12/31 -, -- r- --- ,.- - --1[' -- -'--1--,~--- --~r'---;-

Ii II I I, Inception Performance _ il Quarte~_t 1 Yr 11.3 Yr I' 5 Yr (2/28/04) 2007 2008 2009 2010 2011I

MFS LeV

Russell 1000 Value Difference

Peer Rankin A

Source: BNY Mellon, MPI 68 48

APeer rankings are based on gross of fee perfonnance, Rankings: 1 =best and 100 =worst, data preliminary

The following exhibit shows the growth of $100 for the MFS portfolio, gross of fees, and the Russell 1000 Value Index since inception through June 30, 2012. Over this 100 month period, MFS has exceeded the Russell 1000 Value Index by 2.0% per year, gross of fees.

Cumulative Performance Since Inception: 2128/04 - 6/30/12

7

1

(}j----------------------------~

1ot-----.f"L-=------------fu,.-f-----:rl--'o-N-------­

c MFS

aa Russell 1000 Value Index

7O+-----r-----.----r-----r------,~--...,-------r----___, Feb-04 Dec-04 Dec·OS Dec-OS Dec-07 Dec-Ill Dec-09 Dec-lO J..,.12

10.8

PCA also considered MFS' performance relative to its peers across trailing periods ending March 31,2012 and the last five calendar years. (Please note, universe data is shown below represents periods ending March 31, 2012 to provide a more accurate representation, since June 30, 2012 universe data is currently preliminary as only 57 of the 465 large cap value equity managers within the universe have submitted their second quarter 2012 performance results.) In the following charts, MFS' long-term and short-term performance has predominantly been either at or above the median manager, with a top-quartile result over the since inception period.

Peer Group Performance Comparison, Gross of Fees (Trailing Periods, Ending 3/31/2012)

o 5th to 25th Percentile

I!! 25th to Median

o Median to 75th Percentile

o 75th to 95th Percentile

c ,

· 0:

"· N

·, c c

'" · o ....

1

1

... l!l

I

'"

. I . I

(l) MFS

<> Russell 1000 Value Index

<>

QTR 1Yr 3Yr 5Yr

On a calendar year basis (see below), MFS' peer rankings were top-quartile in calendar years 2007 and 2008, above median in 2011, and third quartile in 2009 and 2010.

Peer Group Performance Comparison, Gross of Fees (Calendar Years, Ending 12/31)

"

o 5th to 25th Percentile

(;) 25th to Median

o Median to 75th Percentile

o 75th to 95th Percentile

(l) MFS .lo-H (l) <> Russell 1000 Value Index

I I ~ l ...

·1

I I...

0ec-07 0ec-08 0ec-09 0ec-10

10.9

The following chart shows the top quartile managers' risk adjusted returns in comparison to MFS and the Russell 1000 Value Index over the since inception period as of March 31, 2012. The chart highlights that MFS has been a top quartile manager since inception of the WPERP account. The top quartile managers shown represent the eVestment Alliance U.S. Large Cap Value equity products with equal-to-or-greater than $1 billion in AUM and a track record since February 28, 1999, (5-years prior to the funding of the MFS WPERP mandate). This produces a list of 75 managers from the Large Cap Value Universe. Of these institutional quality products, the MFS Large Cap Value product placed in the top quartile of returns since inception of the mandate while producing volatility that was in the lowest decile. For this trailing period, MFS produced an annualized return of 6.8% and annualized standard deviation of 15.1 %.

Since Inception Risk/Return (ending March 31,2012)

12

10 • 8

g •E" 6::I

'OJ

•."'" ~ "iii 4 ::I I:

••I: «

2 • 0

-2

0 5 10 15 20 25

Annualized StDev, (%)

• large Cap Value Universe 0 Russell 1000 value Index • MFS

Among the top quartile managers, MFS compared favorably on a risk-adjusted return basis, which is further illustrated in the table below. Over the since inception period, MFS has produced a Sharpe Ratio of 0.4, trailing the leading manager in the quartile by only (0.1).

Top Quartile Managers Ranked by Sharpe Ratio (Risk-A~justedReturn) (Rank, Manager, Sharpe Ratio)

1. Wells Capital 0.5 7. Wellington 0.4 13. Westwood 0.42. GCIC Ltd. 0.5 8. ICAP 0.4 14.

3. Columbia Management 0.5 9. Nuveen 0.4 15. FIL Limited 0.4 4. Eagle Capital 0.5 10. Edge Asset Mgmt 0.4 16. WEDGE Capital 0.4 5. Levin Capital 0.5 11. Putnam 0.4 17. Harris Associates 0.4 6. Wasatch Advisors 0.5 12. Robeco 0.4

10.10

Other Considerations

Ownership MFS is a majority owned subsidiary of Sun Life of Canada (U.S.) Financial Services Holdings, Inc., which in turn is an indirect majority owned subsidiary of Sun Life Financial, Inc. (a diversified financial services organization). The firm has been a subsidiary of Sun Life since 1982. While the firm operates with considerable autonomy, this partnership offers MFS additional resources as they continue to expand their global research presence. Currently Sun Life Financial, Inc. has a 78% ownership stake in MFS, while the remaining 22% is employee owned.

Investment Team and Decision Making Practices The Large Cap Value Equity team includes, Steven Gorham, Nevin Chitkara and Katrina Mead. Portfolio Managers Steven Gorham and Nevin Chitkara maintain overall responsibility for the portfolio construction, final buy and sell decisions, and risk management for the institutional Large Cap Value portfolios as well as participate in the research process. While Katrina Mead, Institutional Portfolio Manager, participates in the research process, strategy and portfolio construction discussions, assesses portfolio risk, customizes portfolios to client objectives and guidelines, manages daily cash flows, and communicates investment policy, strategy, and tactics. The team is supported by MFS' fundamental research analysts, quantitative analysts and other portfolio managers across the firm. The Large Cap Value team has significant experience and has been with MFS on average 17 years.

Investment Philosophy and Process MFS's investment process is derived from their belief that over time valuation is one of the most important drivers of stock price performance. This underlying belief is fundamental to their disciplined valuation approach when evaluating all potential investment opportunities for the MFS large cap value portfolio.

MFS utilizes a fundamental bottom-up global research platform to identify high-quality companies which have sustainable, durable franchises, generate significant free cash flow, have strong balance sheets, and management teams who are good stewards of capital. MFS looks to buy these companies at attractive valuations based on assessment of their future cash flows, returns and outlook over a 3-5 year time horizon.

10.11

~~~~------ -----

- - -

- -----

.~------Fee Structure WPERP is currently invested in MFS's Large Cap Value Portfolio through a separate account, which has the following fee schedule. (Please note that the market values for both plans are aggregated for billing purposes.)

MFS Annual Fee Schedule First $100 million 0.40% Next $100 million 0.30% Above $200 million 0.28%

The annual eA Large Cap Value Equity Universe of management fees on a $477 million mandate range from 0.16,% - 1.50% with a median fee of 0.42%. MFS's estimated fee (based on the portfolio's June 30, 2012 market value) of 31 basis points placed in the top quartile, exhibiting favorable fees versus its peers.

Universe Name: eA Large Cap Value Equity Mandate Size: $477 million

r---- - - - ­ .·l ---Ann~:; - -r -~epa~~;~~co~~~~ Separate Account I Basis Points

JI _ Fe~s~ ____ J _ _ _ (bllS) _ Low

~

$756 000 1600 5th Percentile $1,234,895 26.00

25th Percentile $1,723,625 36.00... ":w,,, " 75th Percentile $2,420,625 51.00

95th Percentile $3,750,425 75.00 High

# of Observations $7,155,000

348 150.00

348

Assets Under Management As of March 31,2012, MFS managed approximately $283 billion in assets, including $38 billion in the Large Cap Value Equity strategy. During the tenure of the WPERP relationship, the Large Cap Value Equity product has been stable with regard to asset/account gains/losses.

MFS Assets / Accounts

2011·12

I --­ - -

1____ ­

2012-03

II

$251,424

Assets (millions) $283,139

510 $34,120

Fi~r~.~id~e ~-~~g~_~~ \Lal-u~ Str;tegy Assets

Accounts (millions) Accounts 520 $38,448 44

42

-1

2010·12 $219,656 489 $34,442 41 2009·12 $183,448 443 $26,595 39 2008·12 $127580 422 $17,743 34 2007·12 $197,726 392 $24,909 33 2006·12 $187,372 388 $22,313 35

Source: eVestment Alliance

,10.12