Joint Meeting of the ERS Board of Trustees and Investment ...

December 9, 2020

Joint Meeting of the ERS Board of Trustees and Investment Advisory Committee

Public Agenda #24

Call Meeting of the Board of Trustees to Order

December 9, 2020

Public Agenda #25

Call Meeting of the Investment Advisory Committee to Order

December 9, 2020

Public Agenda #26

Review and Approval of the Minutes to the August 19, 2020 Joint Meeting of the Board of Trustees and

Investment Advisory Committee – (Action)

December 9, 2020

Questions?Action Item

Public Agenda Item #27

*Discussion and Training regarding Ethics

December 9, 2020Paula A. Jones, Deputy Executive Director and General

Dr. Robert Prentice, Department Chair and Professor, University of Texas at Austin, McCombs School of Business

ERS policy requires employees to perform their duties in an ethical manner

ERS works diligently to maintain and promote an ethical work environment

All new employees receive ethics-related training during new hire orientation from the Deputy Executive Director & General Counsel (DED&GC) who serves as the ERS Ethics Officer

Ethics Training

Agenda item 27 – Joint Meeting December 9, 2020 7

Employees are encouraged to discuss issues with their supervisors, Human Resources or the DED&GC

ERS Intranet or external website available for reports of any alleged ethics violations. Reports may be anonymous

Any report goes to Directors of Human Resources, Internal Audit and to DED&GC

All reports are investigated

Ethics Training


There were no reports of ethics violations this fiscal year

ERS staff is required to complete annual ethics training All ERS staff completed ethics training in FY20

ERS Investment Policy requires that the ERS Board of Trustees, IAC members and Investment-related staff to receive ethics training annually

Agenda item 27 – Joint Meeting December 9, 2020

Ethics Training

9

Ethics training will be presented by Dr. Robert Prentice Chair of the Business, Government & Society Department The Ed & Molly Smith Professor of Business Law, and faculty director of

the Ethics Unwrapped ethics video series University of Texas at Austin, McCombs School of Business

Ethics Training


GIVING VOICE TO YOUR VALUES

DEC. 9, 2020

Robert PrenticeCenter for Leadership & EthicsMcCombs School of BusinessUniversity of Texas at Austin 11

“Please talk about tools available to those people in organizations who raise their hands to point out problems, risks, etc. in connection with ethical decision making.” (Request from IAC member following 2019 ethics training)

12

Helen Sharkey Gebhard

13

Helen Sharkey Gebhard

14

Helen: “For the first time in my life, I gave up on myself and stopped fighting for what I knew to be

right.”

How could Helen have spoken up for her values?

15

Mary Gentile, GIVING VOICE TO VALUES: HOW TO SPEAK YOUR MIND WHEN YOU KNOW WHAT’S RIGHT (2011)

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SEVEN PILLARS1. Values2. Choice3. Normalization4. Purpose5. Self-knowledge & Alignment6. Voice7. Reasons & Rationalizations

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1. VALUES

18

1. VALUES• Think carefully about what your values are, so

that:

19

1. VALUES• Think carefully about what your values are, so that:

• You can answer the question: “Is this the hill I want to die on?”

20

1. VALUES• Think carefully about what your values are, so that:

• You can answer the question: “Is this the hill I want to die on?”

• You can appeal to others who share your common values, and frame your arguments in terms of advancing those shared values.

21

2. CHOICE

22

2. CHOICE• If you look back over your business life, there are

probably times that you have chosen to stand up for your values, and times that you have chosen not to do so.

23

2. CHOICE• When you did speak up for and act for your values,

ask yourself four questions:1) What did you do and what was the impact?2) What motivated you to speak up and act?3) How satisfied are you? How would you like to have

responded?4) What would have made it easier to speak and act?

24

2. CHOICE• When you failed to speak up and act, ask four

questions:1) What happened?2) Why didn’t you speak up and act? What would have

motivated you to do so?3) How satisfied are you? How would you like to have

responded?4) What would have made it easier to speak and act?

25

2. CHOICE

• Recruit allies, because it makes it easier to:• Resist authority (Milgram)

26

2. CHOICE

• Recruit allies, because it makes it easier to:• Resist authority (Milgram)• Resist conformity (Asch)

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2. CHOICE

• Recruit allies, because it makes it easier to:• Resist authority (Milgram)• Resist conformity (Asch)• Help others (Batson)

28

2. CHOICE

• “Talk out loud about it to another person.”

• “This single act makes the decision feel more real, less hypothetical, less easily avoided. We have brought it into the light.”

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2. CHOICE

• Selection and sequencing of audiences• Who is best to approach?

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2. CHOICE

• Selection and sequencing of audiences• Who is best to approach?• Who would be the best allies to approach this person?

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2. CHOICE

• Selection and sequencing of audiences• Who is best to approach?• Who would be the best allies to approach this person?• In person or on line?

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2. CHOICE

• Selection and sequencing of audiences• Who is best to approach?• Who would be the best allies to approach this person?• In person or on line?• In public or in private?

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2. CHOICE

• Framing:• Reframe an unethical opportunity as a risk we must avoid

34

2. CHOICE

• Framing:• Reframe an unethical opportunity as a risk we must avoid• Reframe a denouncing of others’ ethics as a “learning

dialogue”

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2. CHOICE

• Framing:• Reframe an unethical opportunity as a risk we must avoid• Reframe a denouncing of others’ ethics as a “learning

dialogue”• With a little imagination, reframe win-lose scenarios as

win-win scenarios

36

3. NORMALIZATION

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3. NORMALIZATION

• Values conflicts and moral dilemmas are an inevitable aspect of today’s business world. They are normal.

• So get used to them and realize that part of your job is to work on your skills to handle them properly.

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3. NORMALIZATION

• A manager: “In retrospect, this problem really wasn’t that overwhelming once I figured out what I wanted to do. But before that, I lied – I instinctively lied – hoping that it just wouldn’t happen again. Now I realize that such choices are an inevitable part of our business journey and it doesn’t seem so huge.”

39

3. NORMALIZATION• GVV tips:

• Take the emotion out of the scenario• Realize that the people challenging your values do

not think of themselves as bad people• Consider what all parties have at stake• View the situation within a broader organizational

context to look for ways all sides can benefit without violation laws or norms

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4. PURPOSE

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4. PURPOSE

• Think carefully about why you do what you do.• Just drawing a paycheck?

42

4. PURPOSE


• And what is the company’s goal? Perhaps to be a respected corporate citizen?

• Leverage the company’s code of ethics or credo

43

4. PURPOSE


• And what is the company’s goal? Perhaps to be a respected corporate citizen?

• Leverage the company’s code of ethics or credo• Make the debate about big-picture values (individual and

organizational) rather than seamy little battles over dollars and cents.

44

4. PURPOSE

Gentile: To see ourselves as part of an endeavor to accomplish something laudable, “gives us more arguments for presenting our point of view. It also dignifies the values conflicts themselves. These are not seamy little dilemmas that we squirm over quietly and try to forget, rationalizing that they are simply the unfortunate ‘price we must pay’ to survive in a particular firm or industry. Instead, they become opportunities to take a step toward building or preserving an organization that we can be proud of. Instead of normalizing the loss of our values, we can normalize the fact that we will be called upon to preserve them in the face of predictable challenges.”

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5. SELF-KNOWLEDGE AND ALIGNMENT

“We are all the heroes of our own story.” –Mary McCarthy

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Three steps:

47


Three steps:• Create a self-narrative where you are a person who stands up

for your values.

48



for your values.• Say something out loud to someone else.

49



for your values.• Say something out loud to someone else.• Pre-script

50

• “Prescript”

• Who are the heroes?

• Psychologists interviewed them…

51

• “Prescript”

• Highlands Ranch shooting (May 2019)

Kendrick RayCastillo

Kendrick Castillo

52

• I have all my students prescript.

53

• E-mail from one student:

“Your Business law class taught me a lot about visualizing yourself with difficult situations before they are confronted, so when you face them, you already know how to act. I worked for a legal advocate for survivors of gender-based violence last year, and when I found myself in this situation, fortunately I knew what steps to take. I am grateful that BHP instilled such a strong moral compass and sense of ethics.”

54

• E-mail from another former student:

“The ethical dilemma paper that you assigned has already served me well. On my fifth day in a tax accounting internship, I was asked by a partner at my firm to hide some funds in an account where they did not belong… A pit formed in my stomach and I couldn’t help but feel that making the wrong decision could set the tone for the rest of my career.”

55

“I came up with a script as to what to say to the partner and walked to his office with my heart nearly beating out of my chest. I posed my concern and was able to follow up his answers with innocent questions until he saw my real issue. Like me, he wanted to rationalize the decision for a moment, but soon came around to seeing the right thing to do.

“I don’t think that I would have done the right thing had I not written the paper.”

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6. VOICE

57

6. VOICE• If we can learn a foreign language or learn a new software

program, we can learn to more effectively speak up for our values

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6. VOICE

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6. Voice• If we can learn a foreign language or learn a new software

program, we can learn to more effectively speak up for our values

• We just need to effectively:• Clarify the ethical issue• Bring it to the attention of the relevant people• Persuade them as to the proper path• Motivate them to take it

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6. Voice• Three tips:

• Don’t be “preachy”• Dialogue rather than sermonize

• Don’t play the Lone Ranger• Enlist allies and/or mentors

• Practice, practice, practice (and “prescript”)• It’s hard to be ethical on the fly, as Helen Sharkey

Gebhard found out

61

7. Reasons and Rationalizations

62

7. Reasons and Rationalizations• Remember that those you are trying to convince will have

their own reasons and rationalizations for their positions. These must be overcome.

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• Common rationalizations.

“Rationalizations are more important than sex.”

“The Big Chill”

“Rationalizations are more important than sex.”

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• Anand et al., categorizations:

65

Denial of Responsibility

• “I know it was wrong, but my boss ordered me.”• “I know it was wrong, but it’s what my client wanted.”

66

Denial of Responsibility:Adolf Eichmann (one of Hitler’s major organizers of the

Holocaust): “What I said to myself was this: The head of State has ordered it, and those exercising judicial authority over me are now transmitting it. I escaped into other areas and looked for a cover for myself which gave me some peace of mind at least, and so in this way I was able to shift—no, that is not the right term—to attach this whole thing one hundred percent to those in judicial authority who happened to be my superiors, to the head of State—since they gave the orders. So, deep down, I did not consider myself responsible and I felt free of guilt. I was greatly relieved that I had nothing to do with the actual physical extermination.”

Eichmann 67

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Denial of Injury“I know it was wrong, but no one was really hurt.”“I know it was wrong, but it could have been worse.”

68

Denial of InjuryMichael Lewis, LIAR’S POKER: “There was a convenient way of looking at this situation … Anyway, who was hurt besides my German? … The German’s bank had lost sixty thousand dollars. The bank’s shareholders, the Austrian Government, were therefore the losers. But compared with the assets of the nation as a whole, sixty thousand dollars was a ridiculously small sum.”

Denial of Victim

“I know it was wrong, but my client is an idiot; he deserves to be screwed.”

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Denial of Victim

--Jack Abramoff referred to his Indian clients as “monkeys” and “troglodytes.”

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Denial of Victim

--A Milgram subject after the experiment said: “He was so stupid and stubborn. He deserved to be shocked.”

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--When sex abuse survivors sued the Catholic Church, William Donohoe, president of the Catholic League, referred to them as “a pitiful bunch of malcontents.”

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Social Weighting

Condemn the condemnor• “What I did was wrong, but you have no right to criticize

me.”

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Social Weighting

Condemn the condemnor• “What I did was wrong, but you have no right to criticize

me.”Selective comparisons

• “I know I shouldn’t do this, but others are even worse.”

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Selective comparisons

• “’Don’t worry mate—there’s bigger crooks in the market than us guys!’ wrote an official of Rabobank, the large Dutch lender after he agreed to a request from one of the bank’s traders in 2007 to submit a phony rate for Libor rates in yen.”

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Appeal to Higher Loyalties

“I know this is wrong, but I have to be loyal to my firm.”“I know this is wrong, but I have a family to feed.”

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Appeal to Higher Loyalties

B.F. Goodrich made fighter plane brakes it sold to the Air Force. They kept flunking safety tests. Gretzinger went to talk to his superiors. “An hour passed and Gretzinger returned. Looking dejected, he told the engineers: ‘I’ve always believed that ethics and integrity were every bit as important as theorems and formulas, and never once has anything happened to change my beliefs. Now this….Hell, I’ve got two sons I’ve got to put through school…’”

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• Reinhard Siekaczek, an accountant who handled $50m in bribery money at Siemens:

• “We all knew that what we were doing was illegal. I didn’t really look at it from an ethical standpoint. We did it for the company. It was about keeping the business unit alive and not jeopardizing thousands of jobs overnight.”

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Metaphor of the Ledger

“I work lots of extra hours, so it’s ok if I pad my expense account.”

“I’m underpaid, so it’s ok if I take some office supplies home.”

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Jack Abramoff: “I give 80% of my income to charity, so my actions are justified”

81


A UT MBA who served in the Iraq War, and whose responsibility was to disburse large sums of cash that were always in her possession, said: “…there were days when I was so frustrated with the lack of senior leadership involvement, feeling overworked and underpaid for the amount of responsibility, and the feeling of loss from missing so much time with my family, that a sense of entitlement towards my stockpile of money would creep in, completing the perfect fraud triangle for me.”

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Two other rationalizations:

“This is the last time…”

--study of journalists

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Two other rationalizations:

“Altruistic Cheating”

-- “I’m doing this to help someone else.”

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Professors Hannah, Avolio, and May speak of moral conation: “the capacity to generate responsibility and motivation to take moral action in the face of adversity and persevere through challenges.”

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They say that moral conation takes three things:

• Moral Ownership• This is your life. These are your values. You must

take ownership and not just float along as if you are a bystander to your own career.

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They say that moral conation takes three things:• Moral Ownership• Moral Efficacy

• You’ve got to feel like you can actually make a difference. You can get there by prescripting, recruiting allies, etc. But obviously, it helps a lot if the company makes it easier, not harder, for employees to speak up for the right.

87

They say that moral conation takes three things:• Moral Ownership• Moral Efficacy• Moral Courage

• Again, speaking aloud, prescripting, recruiting allies, and saving “screw you” funds can all help

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Some good news from Mary Gentile’s experience at Columbia Business School

89

Questions?

*Public Agenda Item #28

*Review of Retirement Program Actuarial Valuations and Financial Status

December 9, 2020Ariana Whaley, Pension Policy Analyst

Ryan Falls, Senior Consultant, Gabriel Roeder & SmithJoe Newton, Pension Practice Leader, Gabriel Roeder & SmithDana Woolfrey, Senior Consultant, Gabriel Roeder & Smith

Copyright © 2020 GRS – All rights reserved.

Actuarial Valuations of the ERS Retirement Funds as of August 31, 2020

Ryan Falls, FSA, EA, MAAAJoe Newton, FSA, EA, MAAADana Woolfrey, FSA, EA, MAAA

December 9, 2020

Agenda• ERS Funding Valuation Results• LECOSRF and JRS2 Funding Valuation Results• Accounting Results at August 31, 2020

94

Purpose of Actuarial Valuation• Snapshot as of August 31, 2020 using member data,

financial data, benefit and contribution provisions, actuarial assumptions and methods as of that date

• Purposes:– Measure the actuarial liabilities and funding levels– Determine adequacy of current statutory contributions– Provide other information for reporting

GASB 67/68, Comprehensive Annual Financial Report– Explain changes in actuarial condition of the plans– Track changes over time– Analyze future outlook

95

Where are we headed now?• Outlook is similar as discussed during experience study as all

three trust funds are projected to run out of money and the funds would not be able to pay earned benefits to current members during retirement – ERS trust is projected to run out of money in ≈ 40 years– LECOSRF trust is projected to run out of money in ≈ 20 years– JRS2 trust is projected to run out of money in ≈ 40 years

• Changes are required to limit risks to benefit security• Further delays by Legislature make adjustments more costly

96

Pension Funding Equation

97

C I BContribution

IncomeInvestment

Return Benefits Paid

• Fundamental Truth: Money In = Money Out• If contributions do not increase, benefits must decrease

98

ERS Funding Valuation Results

at August 31, 2020

Updated Actuarial Assumptions• Board adopted updated actuarial assumptions in May

– Upon completion of Actuarial Experience Study• New assumptions will provide best starting point for

discussions with Legislature in upcoming session– Biggest impact was lowering investment return

assumption to 7.00%– Life expectancy consistent with prior study

99

Asset Experience• Actual rate of return on market for FY20 was ≈ 6.8%• Actuarial metrics primarily based on 5-year smoothed value of

assets (actuarial value, or AVA), not market value• 5 year smoothed return on AVA was 6.1% in FY 2020

– FY19 return on market was ≈ 3.0%

• $597 million in net deferred losses, not yet recognized– Will be recognized over next four years

100

Funded Status (ERS)($ in millions)

101

AVA MVA

Actuarial Accrued Liability $43,258 $43,258AVA / MVA 28,543 27,946Unfunded Accrued Liability $14,715 $15,312Funded Ratio 66.0% 64.6%Funding Period Never Never

AVA MVA

Actuarial Accrued Liability $39,801 $39,801AVA / MVA 28,060 27,351Unfunded Accrued Liability $11,741 $12,450Funded Ratio 70.5% 68.7%Funding Period Never Never

Actuarial Valuation as of August 31, 2019

Actuarial Valuation as of August 31, 2020

102

Funded Ratio Projections (ERS)Historical Scenario

Projections assume no changes to current assumptions and except actual asset returns, as noted, all other assumptions are met and future contributions continue at current levels.

Fund depleted in 2061



103

Funded Ratio Projections (ERS)Probability of Solvency

Projections assume no changes to current assumptions and except actual asset returns, as noted, all other assumptions are met and future contributions continue at current levels.

This represents the probability of the trust fund having assets at the beginning of each year

Stochastic Projections based on 7.0% median return expectation and 12% standard deviation

Funding Guidelines• Board approved the Pension Funding Priorities and Guidelines in

August 2020• Policy laid out a multi-level funding period goal to gradually achieve

funding on sound actuarial principles1. Fund normal costs,2. Avoid trust fund depletion,3. Meet current statutory standard of a 31-year funding period, and4. Match funding period to the average years of service at retirement

once a 31-year funding period is achieved, and closed.• With projected depletion date in 41 years, none of the Board’s vital

funding period goals are being met

104

Actuarially Sound Contribution (ERS)

105

106

Cost of Phasing in to Appropriate FundingIf State contributes ASC immediately and holds the rate, State will ultimately pay $29.0 billion just for interest on UAAL.

If State increases contribution by 1% per year until ASC is met (and held), State will pay $40.5 billion for interest on UAAL.

If State contributes enough to immediately start reducing UAAL, State will pay $12.1 billion for interest on UAAL.

$0

$5

$10

$15

$20

$25

$30

$35

$40

2020 2025 2030 2035 2040 2045 2050 2055 2060

UAA

L, in

bill

ions

10.00% State Contribution ASC beginning FY22Increase 1% annually up to ASC 28.42% beginning FY 2021

107

LECOSRF and JRS2 Funding Valuation Results

at August 31, 2020

LECOSRF and JRS2 Results• LECOSRF had a reduction in funded status

– Contributions are not sufficient to sustain the plan– Projected depletion date in 21 years

• JRS2 had a reduction in funded status– Contributions are not sufficient to sustain the plan– Projected depletion date in 39 years

108

Funded Status($ in millions)

109

Actuarial Valuation as of 2020 2019

Actuarial Accrued Liability $1,610 $1,483Actuarial Value of Assets 968 968Unfunded Accrued Liability $642 $515Funded Ratio 60.1% 65.3%Funding Period Never Never

Actuarial Valuation as of 2020 2019

Actuarial Accrued Liability $591 $535Actuarial Value of Assets 487 468Unfunded Accrued Liability $104 $67Funded Ratio 82.3% 87.5%Funding Period Never Never

Judicial Retirement System of Texas, Plan 2

LECO Supplemental Retirement Fund

Actuarially Sound Contribution (LECOSRF)

110

*Court fees received by LECOSRF are projected to be about $17.1 million for FY2021 and beyond, based on actual FY19 amounts. This amount is equivalent to 0.79% of pay for the next 31 years.

Actuarially Sound Contribution (JRS2)

111

112

Accounting Results as of August 31, 2020

Determining Discount Rate• Discount rate used in determining the Total Pension

Liability (TPL) is a blend of two rates– Long-term expected rate of return on pension plan

investments (7.00% based on current investment policy) Can be used to discount plan obligations as long as there are

projected assets sufficient to pay projected plan benefits– Yield or index rate for a 20-year, tax-exempt general

obligation municipal bond (2.33% as of August 31, 2020) Used to discount plan obligations after the projected assets have

been extinguished

113

Accounting Valuation Results

($ in billions)

114

August 31, 2020 CurrentIncreased Funding Difference

Single Discount Rate (SDR) 3.62% 7.00%

Total Pension Liability $65.9 $43.2 $22.7

Plan Fiduciary Net Position 27.9 27.9 0.0

Net Pension Liability (NPL) 38.0 15.3 22.7

• With stronger funding policy, unfunded liability on State’s balance sheet could immediately drop by $22.7 billion

115

Summary

Summary• Doing nothing is no longer an option• For ERS, LECOSRF, and JRS-2, current

contribution levels are not sufficient to sustain the system– Without an increase of contributions over the

current schedules the benefit security will continue to deteriorate

116

Disclaimers• This presentation is intended to be used in conjunction

with the actuarial valuation reports issued in December 2020. This presentation should not be relied on for any purpose other than the purpose described in the valuation reports.

• This presentation shall not be construed to provide tax advice, legal advice or investment advice.

117

Questions?


*Educational Presentation – Overview of Credit Rating Agency Metrics, Methodologies and Impact on State Ratings

December 9, 2020

Cathy Terrell, Deputy Executive DirectorNicholas Samuels, Sr. Vice President, Moody’s Investors Service

Tom Aaron, Vice President, Senior Credit Officer, Moody’s Investors Service

Texas and credit impact of pension funding

December 9, 2020Nick Samuels, Senior Vice PresidentTom Aaron, Vice President – Senior Credit Officer

Texas and credit impact of pension funding December 9, 2020 122

Key topics

1. State sector credit overview2. State of Texas

1 State sector credit overview


State rating distribution OUTLOOK

StableNegative

RUR Down

Positive

RUR Up

This Presentation does not announce a credit rating action. For any credit ratings referenced in this presentation, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Aaa Delaware Florida Georgia Indiana* Iowa* Maryland Missouri North Carolina South Carolina South Dakota*Tennessee Texas Utah Virginia Washington

Aa1 Alabama Arizona* Arkansas Colorado* Idaho* Massachusetts Michigan Minnesota Montana Nebraska*Nevada New Hampshire North Dakota* Ohio Oregon Vermont Wisconsin

Aa2 California Hawaii Kansas* Maine Mississippi New Mexico New York Oklahoma* Rhode Island West VirginiaAa3 Alaska Kentucky Louisiana PennsylvaniaA1 ConnecticutA2A3 New Jersey

Baa1Baa2Baa3 IllinoisBa1Ba2Ba3B1B2B3

Caa1Caa2Caa3

CaC

*Issuer rating (state either not permitted to issue GO debt or permitted to, but none is outstanding)As of 2 November 2020 Source: Moody’s Investors Service

http://www.moodys.com/


Rating Factors Measure Score

Factor 1: Economy (25%)

a) Per Capita Income Relative to US Average [1] 93.5% Aa

b) Nominal Gross Domestic Product ($ billions) [1] $1,843.8 Aaa

Factor 2: Finances (30%)

a) Structural Balance Aa Aa

b) Fixed Costs / State Own-Source Revenue [2] 11.1% Aa

c) Liquidity and Fund Balance Aa Aa

Factor 3: Governance (20%)

a) Governance / Constitutional Framework Aaa Aaa

Factor 4: Debt and Pensions (25%)

a) (Moody's ANPL + Net Tax-Supported Debt) / State GDP [2] [3] 7.7% Aaa

Factors 5 - 10: Notching Factors [4]

Adjustments Up: Growth Trend 0.5

Adjustments Down: Pension or OPEB Characteristics -0.5

Rating:

a) Scorecard-Indicated Outcome Aaa

b) Actual Rating Assigned Aaa

State methodology scorecard

Source: Moody’s Investors Service


Pensions are “must-pay” obligations for most state and local governments» Credit quality remains high for most state and local governments

– But pension affordability ratios more challenging than ever for many

» Service solvency a key credit consideration

– Bondholder risk rises as pensions + other fixed costs “crowd-out” essential services

» Bond default and/or bankruptcy usually precedes pension benefit defaults

– Detroit, MI; Harvey, IL; Puerto Rico; CA cities of San Bernardino, Stockton, Vallejo

» Pension unaffordability = debt unaffordability


State and local government pension risks are high as ever

Q2 2020 assets: $4.6 trillion (24% of US GDP)(55% corporate equities)

2007 assets: $3.3 trillion (23% of US GDP)(56% corporate equities)

Q2 2020: 22% of US GDP (Fed basis)

2007: 11% of US GDP

Contributions relative to revenues at or near historical peaks for many…

…but often do not “tread water” under reported discount rates

Larger unfunded liabilities Higher annual costs

Similar scale of asset risk

Negative non-investment cash flow (NICF) will constrain asset accumulation without higher contributions

Weaker cash flow

Less pension “smoothing” capacity

2 State of Texas


Credit strengths» Strong long-term demographic and employment trends that drive tax revenue

» Economic diversification that helps buttress the state from energy market volatility

» Conservative revenue forecasting and a rainy day fund that provides an ample budgetary cushion

» Bonded debt ratios on both a per capita and personal income basis that are well below Moody's 50-state medians

Credit challenges» Weak pension funding practices

» Budget balancing pressure amid growing state spending for K-12 education and demand for transportation funding in a political environment that is generally adverse to tax increases

» Social pressures like the nation's highest healthcare uninsured rate and above-average poverty that drive safety net spending

» Above-average economic exposure to climate risks, especially water stress and hurricanes that require policy and capital investment to mitigate

Texas credit profile


Pensions & OPEB drive Texas liabilities

0%

2%

4%

6%

8%

10%

12%

14%

2015 2016 2017 2018 2019

NTSD ANPL ANOL Total leverage (50-state median)

Source: Moody’s Investors Service

Debt, pensions & OPEB as a percentage of state GDP (adjusted net OPEB liabilities unavailable before 2017)


Pensions a challenge in Texas’ credit profile

ANPL % own-source revenue

ANPL per capita

ANPL % personal income ANPL % GDP

NTSD+ANPL+ANOL % GDP

Tread water shortfall % own-source revenue

Texas 161% $4,550 8.6% 7.0% 11.2% 2.7%

50-state median 80% $2,258 5.2% 4.8% 7.9% -0.1%

Rank 10 19 18 20 21 3

Texas and 50-state median pension metrics

Sources: Moody’s Investors Service, state and pension plan financial statements, US Bureau of Economic Analysis

Texas’ FY 2019 ANPL (based on 2018 pension measurements): $131.4 billion» TRS: 75%

» ERS: 24%

» Misc. others (e.g., Judicial and Emergency Services systems): 1%


Moody’s adjusted liabilities reflect market-based discount rate as of measurement dateGASB “depletion” signals cash flow challenge, but no liability impact

August 31, 2019: 3.00%

August 31 2020: …

0%

1%

2%

3%

4%

5%

6%

7%

Source: Society of Actuaries

Measurement date 8/31/2019$ blns Actuarial valuation GASB Moody'sDiscount rate 7.50% 4.42% 3.00%

Total liabilities $39.8 $57.3 $70.1

Assets $27.4 $27.4 $27.4

Unfunded liability $12.5 $30.0 $42.8

Sources: Moody’s Investors Service, Texas ERS financial statements and actuarial valuation

Texas ERS Funding


Asset volatility and reduced “smoothing” capacity will remain the key pension risk drivers for governments

Texas ERS’ probability of depletion, with current contribution rates

Source: Moody’s Investors Service, using Texas ERS actuarial valuations

Texas ERS’ probability of depletion, with 12% return volatility

0%

5%

10%

15%

20%

25%

30%

35%

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

12% volatility 15% volatility

0%

5%

10%

15%

20%

25%

30%

35%

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

10% of payroll contribution rate(current)

Source: Moody’s Investors Service, using Texas ERS actuarial valuations

moodys.com

Nick Samuels

Senior Vice President

[email protected]

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Vice President – Senior Credit Officer

[email protected]

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mailto:[email protected]

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Questions?

Public Agenda Item #30Review, Discussion and Consideration of the Texa$aver Program Updates:

Texa$aver Product Review Committee Recommendations -(Action – BOT)

December 9, 2020

Diana Kongevick, Director of Group BenefitsGeorgina Bouton, CTCM, Assistant Director of Group Benefits

Thomas Nun, CFA®, GWI Portfolio Strategista

• Defined contribution plan established in 1985• Available to employees of state agencies• Procure plan administrator and investment advisory service

providers through competitive bid process• Feature automatic enrollment for new hires since 1/1/2008 • Offer traditional and Roth contributions

• Defined contribution plan established in 1974• Available to employees of eligible higher education and state

agencies• Procure plan administrator and investment advisory service

providers through competitive bid process• Offer traditional and Roth contributions

Texa$averSM 401(k) / 457 ProgramProgram Overview

Agenda item 30 - Joint Meeting December 9, 2020 138

Texa$aver programExecutive Summary 401(k) Plan, 3Q20 457 Plan, 3Q20

Assets under Management (AUM) $2,802 million Assets under Management (AUM) $1,029 million

Traditional balances $2,740 million Traditional balances $978 million

Roth balances $61 million Roth balances $51 million

No. of Participant Accounts 218,749 No. of Participant Accounts 26,263

Contributing 105,470 Contributing 16,037

Non-contributing 113,279 Non-contributing 10,226

Contributions, deposits, loan repayments $53 million Contributions, deposits, loan repayments $20 million

Change in value & Interest/Dividends $172 million Change in value & Interest/Dividends, annual $58 million

Plan withdrawals ($51) million Plan withdrawals ($16) million


• Texa$aver 401(k)/457 Program Investment Policy• Diversified assortment of mutual funds and collective trust funds, self-

directed brokerage account, and a target date fund series • Institutionally priced offerings between the plans are the same

• All fee reimbursements are paid to participants• Through 3Q20, approximately $1.4 million in 12b-1 fee reimbursements

were paid to participants

Texa$aver program Investment funds


Texa$aver Investment OfferingsSeptember 30, 2020

BlackRock Mid Cap Equity Index

Wellington CIF II Mid Cap Opportunities S

Large Cap Blend

141

• Porter Wilson – ERS Executive Director• Catherine Terrell – ERS Deputy Executive Director• Diana Kongevick – ERS Director of Group Benefits• Tom Tull – ERS Chief Investment Officer• Leighton Shantz – ERS Director of Fixed Income• Carlos Chujoy – ERS Investment Risk Officer• Gene L. Needles, Jr. – Chairman and CEO Resolute Investment Managers

and Vice-chair of ERS’ Investment Advisory Committee (IAC)• Laurie L. Dotter, CPA – IAC member• Laura T. Starks, Ph.D. – Charles E. and Sarah M. Seay Regents Chair in Finance and

Co-Executive Director, Social Innovation Initiative, McCombs School of Business, University of Texas at Austin

Agenda item 30 - Joint Meeting December 9, 2020

Product Review Committee (PRC)Members

PRC

142

• PRC may appoint a sub-committee for a specific purpose (e.g., due diligence, fund evaluation, research, etc.), assisting the PRC in fulfilling its duties.

• PRC sub-committee members include:• Carlos Chujoy – PRC Member• Leighton Shantz – PRC Member• Dr. Laura T. Starks – PRC Member• Lauren Honza – ERS Portfolio Manager• Brannon Andrews – ERS Assistant General Counsel• Gene Needles – PRC Member to serve as an alternate, if necessary


PRC Sub-committee

143


PRC

• The PRC meets at least semi-annually to conduct investment reviews and undertake any other action required for the administration of the Program

• July 28, 2020 meeting PRC addressed • Concerns and next steps regarding Davis New York Venture A

(NYVTX) – program’s large cap blend fund • Opportunities to enhance the program’s fund line-up

PRC Semi-annual MeetingJuly 28, 2020

144

Fund Line-up Opportunities

GWI Portfolio Strategist led the PRC through a strategic review of the funds offered within the program

PRC determined the following Adequate coverage of major equity and fixed income categories Opportunity to explore a passive international equity Opportunity to explore a high yield bond

Sub-committee appointed to determine options for a passive international equity and high yield bond fund within the program

Texa$aver Investment OfferingsEnhancement opportunities


Passive International Fund Due diligence for a passive international offering is underway The prospective fund would be in addition to the existing international

fund, Fidelity Diversified International There would not be a fund transfer to this new (prospective) core fund

offering Target recommendation is 1st calendar quarter 2021

Texa$aver Investment OfferingsEnhancement opportunities update


High yield bond fund and large cap value fund Due diligence on both of these funds would be conducted following the

passive international fund search There would not be fund transfers to the new (prospective) core fund

offerings Target recommendation would be on or before 3rd calendar quarter 2021

Texa$aver Investment OfferingsEnhancement opportunities update


Davis New York Venture A

PRC has been closely monitoring Davis New York Venture A fund Performance issues

- Underperformed 90% of peers over 10 years - Underperformed its benchmark (S&P 500 Index) 2 of the last 3 calendar

quarters- Carries a 1-star rating from Morningstar

47 stock holdings comprise the entire portfolio- Non-US holdings - Heavy bias in financial services sector (>35%)

Davis New York Venture Due Diligence


Davis New York Venture A (NYVTX)Large Cap Blend

PERFORMANCE, 9/30/2020 1Y 3Y 5Y 7Y 10Y

Fund 2.15 4.56 9.26 8.57 9.86

Benchmark: S&P Index 15.15 12.28 14.15 12.68 13.74

Peer Group Median 11.92 10.44 12.43 11.07 12.52

PORTFOLIO COMPOSITION Assets

Investment type Mutual fund

Investment strategy Active

Fund expense ratio 0.89%

Fund reimbursement 0.55%

Net Texa$aver expense 0.34%

FUND OVERVIEWBenchmark

Overall Morningstar Rating™


Program Assets: $141 million No. of Texa$aver accounts: 32,128

Cash 0.92% US Stocks 75.70% US Bonds 0.00% Non-US Stocks 20.05% Preferred Stocks 0.00% Convertible Bonds 0.00% Other 3.33% Non-US Bonds 0.00% 3 Year Rolling Performance (Oct 15-Sep 20)

-4

3

8

13

18

1/2016 3/2016 1/2017 3/2017 1/2018 3/2018 1/2019 3/2019 1/2020 3/2020

5th to 25th Percentile25th to MedianMedian to 75th Percentile75th to 95th Percentile

Davis NY Venture AS&P 500 Index

April 23, 2020 meeting with GWI Portfolio Strategist July 20, 2020 meeting with members of PRC, Texa$averSM and GWI

Portfolio Strategist Fund’s overall poor performance Lack of appropriate risk controls Large sector deviation to financials Exposure to international private equities

Davis New York VentureDue Diligence


At the July 28, 2020 PRC meeting, GWI Portfolio Strategist presented a performance overview for Davis NY Venture noting: Year-to-date performance is at -9.8% versus its benchmark One year performance is reported at -10.6% Underperformed to its benchmark for 2 of the last 3 calendar quarters

Findings on inappropriate risk controls, large sector deviations, exposure to non-US holdings were discussed

PRC appointed a sub-committee to determine fund for potential asset mapping

Davis New York VentureDue Diligence


Recommend mapping assets to the Vanguard Institutional Index (VIIIX), a large cap blend fund (same category as Davis NY Venture) Employs an indexing investment approach designed to track the

performance of the S&P 500 Index Replicates the target index, holding each stock in approximately the same

proportion as its weighting in the index Diversifies risk and accurately represents the composition of the US large

cap market Holds a 5-star Morningstar rating, as well as a Gold rating by Morningstar

Fund MappingVanguard Institutional Index (VIIIX)


TPA and ERS staff will coordinate the operational process for fund transitions Timing considerations Funds transfers Communication strategy for participants

Next Steps


The Texa$aver Product Review Committee and staff recommend Board of Trustees of the Employees Retirement System remove the Davis New York Venture A (NYVTX) fund from the Texa$aver program with the program assets being moved to the Vanguard Institutional Index (VIIIX) fund.

Texa$aver program Staff recommendation


Questions?Action Item –BOT


*Educational Presentation – Environment, Social and Governance

December 9, 2020Tom Tull, CFA, Chief Investment Officer

Benjamin Schuman, CFA, Global Equity Portfolio Manager

Introduction to ESG

Tom Tull, CFA, Chief Investment Officer

Benjamin Schuman, CFA, Global Equity Portfolio Manager

What is ESG? Why is ESG potentially important to ERS? Steps taken by ERS and plan moving forward


Agenda

160

What is ESG? Environmental, Social, Governance

Environmental Social Governance

Carbon/Greenhouse Gas Emissions Diversity Transparency

Ecosystem Change Consumer Protection Reporting and Disclosure

Fossil Fuel Dependence Fair Trade Executive Compensation

Climate Change Animal Testing Shareholder Rights

Water Issues Human Rights Board Accountability and Makeup

Clean Tech Health Care Director Independence

Toxic Chemical Usage Working Conditions Accounting Practices and Policies

Renewable Energy Child Labor Voting Practices


What is ESG? Application of ESG factors to investing varies widely

Exclusion-based ESG

Comply with ESG mandate by avoiding certain investments

Exclude sectors

Exclude regions

Impact/Sociallyresponsible

Investing (SRI)Seek to promote ESG agenda with targeted

deployment of capital

Example: Renewable energy investments

Popularized in Europe

Integrated ESG

Combine ESG data with traditional fundamental

analysis to improve returns and/or reduce

risk

Focus on financial materiality

Aligned with fiduciary responsibility


What is ESG? Integration within asset classes

Source: NEPC

Strategy Type Level of ESG Integration Notes

Public Equity High Highest level of adoption; European market generally ahead of US

Fixed Income ModerateESG ratings more applicable for corporate debt; sovereign debt

and structured credit generally less compatible; growing adoption

Private Equity Moderate

Funds are often smaller in size, have shorter track records and are newer entities; ESG issues can present an opportunity to

unlock value

Real Estate ModerateValue-add and opportunistic strategies are often more focused on

ESG given their emphasis on property repositioning

Real Assets ModerateSustainable real assets present a wide range of options from

renewables to agriculture

Hedge Funds LowLimited but growing adoption of ESG amongst hedge funds; will

be strategy dependent


Why is ESG Potentially Important to ERS? Fund flows demonstrate mainstream adoption in U.S.

ESG flows up 4x in 2019, on track to double in 2020*

40% of U.S. asset managers have adopted some form of ESG integration

Policy, demographics, corporate behavior, technology, social trends & data availability are driving adoption

Many ERS external managers integrate ESG already

*Based on universe of 303 funds with ESG central to strategies and 564 funds that consider ESG factors


Academic research suggests firms with higher ESG scores: Attract more or higher paying customers Have increased productivity due to higher employee morale Attract lower-cost capital Have managers who avoid short-term decision making Decreased firm risk

Investment performance inconclusive ESG funds have outperformed recently Longer-term studies show neutral to slight-positive impact Nascent nature of ESG data makes integrated approach hard to study

Why is ESG Potentially Important to ERS? Impact on investment performance


Department of Labor (DOL) recently implemented restrictive guidelines* Requires ERISA plans to select investments solely on financial considerations Could prevent ESG-centric strategies from inclusion in plan assets No jurisdiction over state plan, but could guide oversight decisions Reinforces need for fiduciary alignment with ESG strategy

*Although the DOL has no jurisdiction over governmental plans because they are exempt from ERISA, ERS complies with many of those requirements in the course of

meeting its fiduciary duties to administer the Trust and manage the assets of the Trust.

Why is ESG Potentially Important to ERS? Pension considerations


Adoption within broad investment landscape appears at a tipping point based on adoption rates, asset flows, & corporate behavior

Reporting standards and best practices evolving quickly External managers already integrating ESG

Why is ESG Potentially Important to ERS? Timing considerations


Current approach Administering scrutinized investment decisions in compliance with Texas state law such as prohibitions on investments in

Sudan, Iran, companies boycotting Israel, and terrorist organizations, all consistent with our fiduciary responsibility ERS does not change its due diligence or prudent processes for the sole purpose of ESG investments Active voting of proxies via Institutional Shareholders Services our proxy advisor with a strong emphasis on corporate

governance Plan moving forward Continue to actively evolve our research and monitoring processes with annual updates to the Board and IAC Define ESG @ ERS on our terms that can be beneficial to competitive risk adjusted rates of return Build key relationships and knowledge, including possible participation in working groups and standards bodies Engage with external managers on ESG integration process for educational purposes Evaluate use of growing pool of ESG information in conjunction with ERS investment processes to help maximize long-term

risk adjusted returns

Steps Taken by ERS and Plan Moving Forward


Questions?


*Review of Investment Performance for 3rd Quarter of 2020, Risk Update, and Liquidity

December 9, 2020


Carlos Chujoy, CFA, Director of Risk Management and Applied Research

Sam Austin and Michael Malchenko, NEPC

TABLE OF CONTENTS

Tab

Executive Summary 1

Total Fund Performance Summary 2

Appendix and Disclosures 3

172

NEPC, LLC

EXECUTIVE SUMMARY

ERS TRUST DASHBOARDProfile

Market Value at 9/30/2020:$28.62 BillionActuarial Accrued Liability 8/31/19:$39.8 BillionActuarial Assumed Rate of Return:7.0%Retirees and Beneficiaries 8/31/2019:115,155Retirement Payments Year Ended 8/31/2019:$2.62 BillionERS Trust Funding Ratio 8/31/201970.5%

3rd Quarter 2020

CYTD FY 2020Fund Performance 0.8% 6.8%Policy Benchmark 1.4% 8.2%Excess Return -0.6% -1.4%

3 Yr Tracking Error 2.20%

5 Yr Sharpe Ratio 0.945 Yr Sortino Ratio 1.00

Largest Contributors (Quarter)

Private Equity contributed +1.6% versus the policy benchmarkLargest Detractors (Quarter)Cash contributed -0.1% versus the policy benchmark

48%

52%

Management

Internal

External 82%

18%

Allocation

RiskReducing

ReturnSeeking

65%

35%

Liquidity

Illiquid

Liquid

174

TOTAL FUND PERFORMANCE DETAIL (NET OF FEES)

• One-year ended September 30, 2020, the Fund underperformed the policy benchmark by 1.1%.

• The Fund's assets decreased to $28.62 billion from $28.64 billion in the last calendar year which includes an investment gain of $1.283 billion for the year.

Note: Long Term Public Index is comprised of 79% MSCI ACW IMI and 21% Barclays Intermediate Treasury Index. Index Definitions can be found in the appendix.

3rd Quarter 2020

Market Value($) Fiscal YTD 3 Mo(%) YTD(%) 1 Yr(%) 3 Yrs(%) 5 Yrs(%) 10 Yrs(%)

Total Fund 28,618,113,390 -1.2 5.5 0.8 4.7 5.6 7.5 7.4

Total Fund Policy Index -1.3 3.1 1.4 5.8 5.5 7.6 7.3

Long Term Public Index -2.4 6.5 2.8 9.9 6.6 8.9 7.6

TOTAL FUND PERFORMANCE DETAIL (NET OF FEES)

• Three–year period ended September 30, 2020, the return of 5.55% outperformed the benchmark by 0.07%. On a risk-adjusted basis, the Sharpe Ratio and Sortino Ratio outperformed the benchmark.

• Five-year period ended September 30, 2020, the Fund returned 7.47% and underperformed the policy benchmark by 0.16%. On a risk-adjusted basis, the Fund’s Sharpe Ratio and Sortino Ratios outperformed the benchmark and suggests that active management benefitted the Plan.

Note: Long Term Public Index is comprised of 79% MSCI ACW IMI and 21% Barclays Intermediate Treasury Index. Index Definitions can be found in the appendix.

3rd Quarter 2020

3 Years Ending September 30, 2020Anlzd Return Anlzd Standard Deviation Sharpe Ratio Sortino Ratio RF

Total Fund 5.55% 7.69% 0.52 0.56

Total Fund Policy Index 5.48% 8.57% 0.46 0.54

5 Years Ending September 30, 2020Anlzd Return Anlzd Standard Deviation Sharpe Ratio Sortino Ratio RF

Total Fund 7.47% 6.72% 0.94 1.00

Total Fund Policy Index 7.63% 7.69% 0.84 0.99

Employees Retirement System of Texas

TOTAL FUND ASSET GROWTH SUMMARY

3rd Quarter 2020

Summary of Cash FlowsFiscal Year-To-Date Last Three Months Year-To-Date One Year Three Years Five Years

Beginning Market Value $29,076,050,354 $27,435,810,375 $29,406,588,242 $28,644,607,856 $27,797,322,053 $24,533,633,307Contributions $1,036,537,402 $3,432,416,123 $9,263,436,354 $13,934,817,042 $38,019,878,634 $52,834,873,185Withdrawals -$1,148,161,496 -$3,747,279,725 -$10,224,000,047 -$15,244,508,725 -$41,789,373,374 -$58,489,355,177Net Cash Flow -$111,624,093 -$314,863,602 -$960,563,693 -$1,309,691,683 -$3,757,375,192 -$5,642,362,444Net Investment Change -$346,312,871 $1,497,166,617 $172,088,841 $1,283,197,217 $4,578,166,529 $9,726,842,528Ending Market Value $28,618,113,390 $28,618,113,390 $28,618,113,390 $28,618,113,390 $28,618,113,390 $28,618,113,390

177


FUND ASSET ALLOCATION VS. POLICY TARGETS

3rd Quarter 2020

Current Allocation Current Target

Current CurrentLong-Term

TargetLong-Term Target

Range

Public Equity $11,033,796,775 38.6% 37.0% 27.0% - 47.0%

Total Rates $3,175,910,934 11.1% 11.0%

Global Credit $3,605,082,990 12.6% 11.0% 1.0% - 21.0%

Opportunistic Credit - - 3.0% 0.0% - 8.0%

Private Equity $4,516,571,861 15.8% 13.0% 8.0% - 18.0%

Absolute Return $1,285,919,071 4.5% 5.0% 0.0% - 10.0%

Real Estate - Private $2,357,343,706 8.2% 9.0% 4.0% -14.0%

Real Estate - Public $802,886,954 2.8% 3.0% 0.0% - 13.0%

Infrastructure $1,117,452,575 3.9% 7.0% 2.0% - 12.0%

Cash $593,224,497 2.1% 1.0% 0.0% - 1.0%

ERS Launchpad $129,924,026 0.5% 0.0% - 5.0%

Total $28,618,113,390 100.0% 100.0%

38.6% 37.0%

11.1% 11.0%

12.6%11.0%

3.0%

15.8% 13.0%

4.5%5.0%

8.2% 9.0%

2.8% 3.0%3.9% 7.0%2.1% 1.0%0.5%

178


TOTAL FUND RISK/ RETURN

Note: Long Term Public Index is comprised of 79% MSCI ACW IMI and 21% Barclays Intermediate Treasury Index. Index Definitions can be found in the appendix. 3rd Quarter 2020


TOTAL FUND ATTRIBUTION ANALYSIS

*Total Fund Attribution Analysis uses policy weights.

180


TOTAL FUND ATTRIBUTION ANALYSIS

* Total Fund Attribution Analysis uses policy weights.

181


LONG TERM INVESTMENT RESULTS

Note: Long Term Public Index is comprised of 79% MSCI ACW IMI and 21% Barclays Intermediate Treasury Index. Index Definitions can be found in the appendix. 3rd Quarter 2020 182


ROLLING INFORMATION RATIO AND TRACKING ERROR

3rd Quarter 2020 183

• Over the past 10 years, Total Fund returns outperformed the policy benchmark by 0.1% and outperformed the Plan’s actuarial rate of return.

• In the one-year ended September 30,2020 the Fund underperformed the policy benchmark by 1.1%. – Global Credit detracted -0.6% and Public Equity detracted -0.6% from Fund returns vs. the policy

benchmark – Rates contributed positively to returns (+0.4%) vs. the policy benchmark

• In the past one-year, portfolio positioning at the asset class level detracted -0.2% from Total Fund returns vs. policy benchmark. – An over-weight position to Private Equity contributed negatively (-0.2%) to total fund returns vs. the policy

benchmark. – An overweight position to Global Public Equity (-0.1%) and Cash contributed (-0.1%) negatively to total

fund returns vs. the policy benchmark.– An underweight position to Absolute Return contributed negatively (-0.1%) to total fund returns vs. the

policy benchmark.– An over-weight position to Rates contributed positively (+0.4%) to Fund returns versus the policy

benchmark.

SUMMARY PERFORMANCE COMMENTARY

3rd Quarter 2020 184

Risk Management & Applied ResearchRisk Update

Carlos Chujoy, CFA, Director of Risk Management & Applied Research

Risk Update3Q2020 Update


• Headwinds and Tailwinds• Performance Review of Selected Markets• Market Stress• Concentration and Tail Risk• ERS Market Exposure and Sensitivity Analysis• ERS Liquidity • Risk Concerns• Conclusions

186

Risk Update3Q2020 Update


Headwinds• Resurgence of COVID-19• Market Concentration Risk• Market Valuation• Delayed Fiscal Stimulus• Uncertainty regarding upcoming US

election• Brexit• Economy still in state of flux

Tailwinds• Major progress in vaccine research• Easy monetary policy (low interest

rates)• Economic indicators improving• Strong housing market• Unemployment rate on right path• Weakening of the dollar• ERS portfolio resiliency

187

Market PerformanceYTD and 3Q20 Returns

Agenda Item 32 – Joint Meeting December 9, 2020

Technology and Discretionary markets benefitted the most from current economic policy Risk-on environment in 3Q20 led by equities, gold and oil.

188

Presenter

Presentation Notes

Market StressGlobal Stress Financial Indicator and Cross Asset Class Implied Risk


• GSFI levels points to continued concerns • 3Q20 saw fund outflows in risk-on assets such as equities and pricing of increasing levels of risk in Technology

189

Concentration Risk and Tail RiskWhat drove the markets during the 3rd Quarter


Drivers• FED’s September FOMC meeting• Market Valuation and Concentration Risk in Technology stocks. • Resurgence of second wave of COVID-19 in Europe• US Presidential Elections• Brexit negotiations• Delayed Fiscal Policy Response• Escalated tension between US and China• No recovery in sight for industries involving travelling and gathering• Low mortgage rates leading to a strong housing market

190



• Order flow dominated by retail investors• Single stock option notional ballooned almost 7-fold from prior year

191



• Outperformance of Growth relative to the market accelerated in 2020 during the pandemic • Growth has outperformed Value for 10+ years

192



Source: ERS, Bloomberg

• Market outperformance dominated by the largest companies by market cap, irrespective of size, style or geography • Outperformance by mega cap companies: a reflection of “new economy” vs “old economy” given the pandemic

193



Europe second waveCOVID-19

• Acceleration of COVID-19 cases around the world threatens economic recovery • Near-dated contracts pricing of US election risk, lower pricing on longer tenors suggest market expect low risk of a contested

election 194


ERS Market ExposureSector Allocation (through 09/30)

Public Equities ExposureTrust Level Exposure

Source: ERS Only 11% of Trust Healthy 20% of Equities but diversified

195

ERS Plan Exposure and SensitivityContribution to Risk Analysis

Agenda Item 32 – Joint Meeting, December 9, 2020

• ERS portfolio exhibits same level of exposure to Growth and Momentum factors. Concentration risk same as policy benchmark • Volatility explains the largest contribution to total risk. While Growth and Volatility contribute the most to active risk

196

Presenter

Presentation Notes

In order to understand how much the plan is exposed to the risks that we just reviewed (that is concentration risk by way of Growth, the building up concentration risk to Size and others, the risk team performed an analysis utilizing industry standard factor drivers.) The factor analysis yielded the following results: 1. Relative to ERS’ policy benchmark, the ERS portfolio’s exposure to the growth and momentum factors is close to zero. In other words, no additional concentration risk borne from an allocation to Technology over and above those present in the ERS policy benchmark. 2. The largest contributor to ERS’ total risk comes from the volatility factor. 3. The largest contributors to ERS’ active risk comes from the growth and volatility factors.

ERS Plan ExposureLiquidity Risk


• Projected Total Unfunded Commitments as end of 2020 is at $5.8b

• Net Operating Cash Outflow* of $1.4B • Total liquidity level (Rates portfolio and Cash) as

of October is at $4.25b• Other liquid assets** stand at $ 14.7b• Therefore, total current liquidity level is sufficient

to meet the ongoing net pension payment plus majority of the unfunded commitments of illiquid investments.

Source: ERS. Projection assumes ERS Trust grows at an annual return of 7%.

$- $2,000 $4,000 $6,000 $8,000

$10,000 $12,000 $14,000 $16,000 $18,000 $20,000

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2020 2021 2022 2023 2024

$MM

ERS ILLIQUID INVESTMENT PROJECTIONS

Unfunded Commitments NAV Liquidity Level

Note * Net Operating Cash equals net monthly contributions of $112mm minus monthly Pay Outs of $228mm or approx. -$1.4b per year

* *Assets include Global Public Equities, Global Credit and Public Real Estate

197


ERS Risk SurveyCollective views

1. Coronavirus – 2nd Wave

2. US Elections

3. Delayed Fiscal Stimulus

4. Credit Event

5. UK-EU Brexit

1. Bull market

2. Early cycle

3. Economy, Company Profits and Margins to Improve

4. High Quality, High Momentum , Low Vol

Downside Risk Upside Risk

Source: ERS Risk Survey

198


Concentration and Left Tail Risk in the markets dominated end of 3Q performance In particular, Large Cap Stocks with a Growth orientation Long derivative position in Technology stocks, in June-Aug ‘20, 5x the average volume traded in 2019

Resurgence of COVID-19, US-China trade conflict, the US presidential elections and delayed Fiscal stimulus at the forefront of investor’s minds. By all counts, implied levels of risk higher than average. Risk-on assets experienced market correction towards the end of the quarter

From a plan level risk standpoint, higher volatility and higher growth momentum contribute the most to active portfolio risk. Rotation risk stands at its highest stemming from concentration risk in style, sector positioning and size exposure

ERS liquidity profile suggests the ERS portfolio is properly positioned to absorb cash needs and market volatility

ERS collective risk concerns revolve around 3 main issues: COVID-19, uncertainty about the US Elections and delayed Fiscal stimulus

ERS ConclusionsKey Takeaways

199

Questions?


*Global Public Equity Market Update and Program Overview

December 9, 2020

John Streun, CFA, Director of Global Public EquitiesMichael Clements, CMT, Chief Trader

Michael McCrary, External Management Investment Analyst

Investment Objective and Recent Performance Global Public Equity Team Update Portfolio Structure and Positioning Internal Program Update External Advisor Program Update Trading Update COVID-19 Impact Global Public Equity Initiatives for 2021

Global Public Equity ProgramAgenda


Investment Objective – Outperform the Global Public Equity benchmark over rolling five-year periods, while maintaining compliance with the active risk budget.

Investment Strategy – Combine lower risk internal strategies with higher risk external strategies to produce a stable excess return with a target tracking error of 150 basis points and an excess return ratio of 25 basis points or better.

Global Public Equity ProgramInvestment Objective & Strategy


Positive return of 8.50% Relative under performance of -141 basis points 4 out of 4 fundamental internal portfolios outperformed their benchmarks 6 out of 11 external portfolios outperformed their benchmarks Stock selection from both internal and external portfolios was a positive contributor Significant drawdown from an external manager that focused on equity options (Allianz Global

Advisors) hurt performance An under weight to U.S. large cap stocks detracted from performance Internal special situations portfolios (Capitol Hill and Spinoff) detracted from performance The small allocation to cash in a rising market environment also detracted from performance

Asset Class Performance HighlightsSeptember 30, 2019 to September 30, 2020


(years of industry experience)

Public Equity TeamLeadership: John Streun, Andrew Hodson, Tim Reynolds, Michael Clements, Lauren Honza

Domestic Portfolio Managers:Large Cap

Kelley Hewell, MBA, CFA (28)Small and Mid Cap

Andrew Hodson, MBA, CFA (19)

International Portfolio Managers:International DevelopedKeith Lyons, MBA (17)

Nancy McCarthy, MBA, CFA (13)

Emerging MarketsTim Reynolds, MS, CFA, CAIA (29)

Canada & International ValueCarlos Chujoy, MBA, CFA (28)

John McCaffrey, MBA (6)

QuantitativeCarlos Chujoy, MBA, CFA (28)

John McCaffrey, MBA (6)

TradingMichael Clements, CMT (22)

Rob Newhall, CMT (20)Kyle Fenton, MBA (13)

External Advisor TeamJohn Streun, MS, CFA, CPA (28)Lauren Honza, MBA, CFA (27)

Michael McCrary, MBA (20)Mark Long, MBA, CFA (24)

Kelley Hewell, MBA, CFA (28)Agenda item 33 – Joint Meeting December 9, 2020

Global Public Equity ProgramPublic Equity Team

205

Global Public Equity ProgramPublic Equity Team

Public Equity StructureInternational Domestic

Emerging MarketsTim Reynolds, MS, CFA, CAIA (29)

John Taylor, MBA, CFA (14)June Kim (14)

Ian Smith, MBA, CFA (12)Jim Gassman, MBA (20)

Large CapKelley Hewell, MBA, CFA (28)

Bob Wood, MBA, CFA (31)Micheal Yuan, CFA (23)Paul Knight, CFA (19)

Derek Sadowsky, CFA (22)

International DevelopedKeith Lyons, MBA (17)

Nancy McCarthy, MBA, CFA (13)Teofilo Bacungan, MBA, CFA (20)

T.J. Qatato, MPA, CFA (25)Scott Schrier, CFA (10)

Small and Mid CapAndrew Hodson, MBA, CFA (19)

Ben Schuman, CFA (15)Jake Tisinger, CFA (12)

Mark Long, MBA, CFA (24)Aris Oglesby, MBA (2)


Global Public Equity ProgramGlobal Portfolio Structure – Dollar Allocation (9/30/2020)

207

Global Public Equity ProgramTracking Error as of 10/1/2020

208

Global Public Equity ProgramPortfolio Structure and Positioning – Sector Exposures

209

Global Public Equity ProgramPortfolio Structure and Positioning – Regional Exposures

210

Global Public Equity ProgramFactor Exposures (Portfolio Characteristics)

211

Global Public Equity ProgramActive Risk/Tracking Error

212

Global Public Equity ProgramPortfolio Position Values

213

Global Public Equity ProgramPortfolio Structure Changes – Internal Actively Managed Portfolios

Dom

estic

Por

tfolio

s Large Cap Active Core

Mid Cap Active Core

Small Cap Active Core

Inte

rnat

iona

lPo

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ios

Europe International Equities

Asia International Equities

Emerging Markets Core


Dom

estic

Po

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ios

Large Cap Active Core

Small/Mid (SMID) Cap

Active Core

Inte

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iona

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s

Europe/Asia (EAFE) International Equities

Emerging Markets Core

214

Global Public Equity ProgramInternal Emerging Market Process

Quantitative• Search for

companies with improving fundamentals, strong growth, reasonable valuation

• Assess and manage risk

• Analyze factor, sector and regional exposures

Fundamental • Focus on bottom up

research• Provide context,

perspective, and analysis on company metrics

• Conduct research by region

• Perform on the ground research when possible


External Advisor Program

Michael McCrary, MBA, Investment Analyst

External Advisor Program UpdateFunded External Advisors

217

External Advisor ProgramFunded External Advisors


Firm Strategy Selection Date Portfolio Inception

Acadian Asset Management Emerging Markets 12/2/2011 11/1/2017

Axiom International Investors International Small Cap Equity 12/20/2018 3/1/2019Barrow, Hanley, Mewhinney & Strauss Large Cap Value 12/2/2010 4/1/2011

BlackRock International 12/2/2011 3/1/2015

Brandywine GIM Large Cap Value 12/2/2010 4/1/2017

EAM Investors International Small Cap 12/20/2018 3/1/2019

Global Alpha Capital Management International Small Cap 12/20/2018 3/1/2019

Kayne Anderson Rudnick International Small Cap 12/20/2018 3/1/2019

Lazard Asset Management International 8/23/2011 12/1/2011

Quantitative Management Associates Emerging Markets Small Cap 12/20/2018 3/1/2019

Templeton International 11/19/2002 4/1/2003

Legato Capital Management International Small Cap 5/25/2010 2/1/2017

Legato Capital Management Emerging Markets 9/25/2019 11/1/2019

218

External Advisor ProgramSelect Pool


Firm Strategy Selection Date Portfolio Inception

Algert Global International Small Cap 12/20/2018 TBD

Ativo Capital Management International Small Cap 12/20/2018 TBD

Copper Rock Capital Partners Emerging Markets Small Cap 12/20/2018 TBD

Fisher Investments International 1/24/2006 TBD

Strategic Global Advisors International Small Cap Equity 12/20/2018 TBD

TimesSquare Capital Management International Small Cap 12/20/2018 TBD

219

Published January 24, 2020 Benchmarks: MSCI ACWI ex-US and MSCI EAFE Process Phase I: Minimum Requirements and Short Form Review Phase II: Investment DDQ Review and Operational DDQ Review Phase III: Onsite Meetings and Reference Checks Phase IV: Committee Approval Phase V: Contract/Fund

External Advisor Program UpdateRFP Update: International Advisory Services


Expected to be Published March 2021 Benchmarks: MSCI Large Cap, Large Cap Value, Large Cap Growth Process Phase I: Minimum Requirements and Short Form Review Phase II: Investment DDQ Review and Operational DDQ Review Phase III: Onsite Meetings and Reference Checks Phase IV: Committee Approval Phase V: Contract/Fund

External Advisor Program UpdateNew RFP: Domestic Large Cap


Trading Update

Michael Clements, CMT, Chief Trader

Global Public Equity ProgramTotal Commissions

223

Global Public Equity ProgramThe average “All-In” blended commission rates

224

Global Public Equity ProgramInternational Commission Rates

225

Global Public Equity ProgramCommission by Portfolio

226

ERS Global Public EquityCovid-19 Impact

John Streun, MS, CFA, CPA, Director of Global Public Equity


Sharp increase in Market Volatility

Global Public Equity ProgramCOVID -19 Impact

228


Global Public Equity ProgramCOVID 19 Impact

229


Global Public Equity ProgramCOVID-19 Impact

230

Goals and Objectives for 2021

John Streun, MS, CFA, CPA, Director of Global Public Equity

Global Public Equity ProgramInitiatives for 2021

Select Pool buildout Increase active share of internal portfolios Enhance portfolio construction process


Questions?


*Emerging Manager Market Update and Program Overview

December 9, 2020Lauren Honza, CFA, Emerging Manager Portfolio Manager

Background Overview Team Approach Current Allocation Performance

Calendar Year 2020 Highlights Calendar Year 2021 Initiatives

Emerging Manager ProgramAgenda


Texas Government Code § 815.301 (g), (h) and (i) requires the Employees Retirement System of Texas to make a good faith effort to acquire financial services from emerging managers. Emerging managers are defined in the statute as private professional investment managers with less than $2 billion in assets who provide pension fund management, consulting, investment advising, brokerage services, hedge fund management, private equity management, and real estate investment.


Emerging Manager ProgramDefined

236


Emerging Manager ProgramTeam

237

Emerging Manager Program*

Public Equity Lauren Honza, CFA

Private Equity Adriana Ballard

Private Real EstateAmy Cureton

Hedge FundsPanayiotis

Lambropoulos, CFA, FRM, CAIA

Fixed IncomeRichard Inzunza, CFA

*Emerging Manager Program efforts are coordinated by Lauren Honza in conjunction with the CIO

ERS External Advisor Website Managers of Emerging Managers Consultants Outreach

Emerging Manager Program Approach


Emerging Manager ProgramInvestments and Commitments as of August 31, 2020


Emerging Manager ProgramPerformance


As of 08/31/20 Public Equity Annualized Since Inception Legato International Small Cap Portfolio (Inception: February 1, 2017) 7.99% MSCI EAFE Small Cap Index 6.95% Legato Emerging Markets Portfolio (Inception: November 1, 2019) 7.27% MSCI Emerging Markets Index 7.80%

Private Equity Net IRR Total Emerging Manager Portfolio (Inception: November 2010) 12.38% Total Private Equity Portfolio 10.28%

Private Real Estate Net IRR Total Emerging Manager Portfolio (Inception: December 2010) 15.17% Total Private Real Estate Portfolio 11.13% Sources: The Burgiss Group, LLC and BNY Mellon

240

TRS/ERS Emerging Manager Conference Real Estate Emerging Manager (REEM) Summit Asset Class Updates Public Equity Private Equity Private Real Estate Hedge Funds

Emerging Manager Program Calendar Year 2020 Highlights


Maintain the target of 10% of externally managed assets with emerging managers Focus on relevant direct relationships with emerging managers in ERS Portfolio Promote emerging manager program best practices by working with other investors Continue to work on ERS PAAMCO Launchpad 2020 ERS & TRS Emerging Manager Conference – January 26, 2021

Emerging Manager Program Calendar Year 2021 Initiatives


Questions?


Chief Investment Officer’s Report

December 9, 2020


Appreciation and commendation of IAC for increased time commitments and involvement to include: New Asset Class Investment Committee meeting participation as voting

members (at least 30 held during this calendar year) Texa$aver Product Review Committee

Appreciation of the Office of General Counsel and the Investment Compliance Officer for effectively meeting the demands of current and new deal flow

Chief Investment Officer’s ReportInvestment Division Appreciation


COVID-19 containment Accommodating monetary and fiscal policy Political risk due to agenda of the majority party New normal Geopolitical and trade risks

Chief Investment Officer’s ReportInvestment Challenges for Fiscal Year 2021


Chief Investment Officer’s ReportInvestment Opportunities for Fiscal Year 2021


Opportunistic Credit Portfolio Development Focus on Infrastructure Portfolio Development Ramping up the seeding platform for Hedge Funds Enhancement of risk management and risk reporting to Board

247

Chief Investment Officer’s ReportMajor Initiatives for Fiscal Year 2021


Support legislative initiatives for addressing unfunded pension liabilities Expand existing core competencies for innovative investment management by exploring

new investment opportunities Refresh select pool of external advisors/managers and initiate searches to refine mix of

internal and external management

248

Chief Investment Officer’s ReportMajor Initiatives for Fiscal Year 2021


Diligent negotiation of best economic deal terms Continue development of ERS emerging manager program Leverage external relationships for strategic resources and opportunities Enhance Investment Division career path development, communication, succession

planning and team development

249

Questions?


Adjournment of the Joint Meeting of the Board of Trustees and Investment Advisory Committee

December 9, 2020

Joint Meeting of the ERS Board of Trustees and Investment ...

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