text:
S T A T E B O A R D O F A D M I N I S T R A T I O N Investment Report 2006-07 investing globally for FLORIDA'S future C O N T E N T S With a focus on global investing and strategies to reduce risk and enhance long-term growth, the State Board of Administration (SBA) is managing and investing assets on behalf of its largest client base, the 1.1 million members 5 and beneficiaries of the Florida Retirement System (FRS), as well as for 34 other mandates and trusts. L e t t e r f r o m t h e Tr u s t e e s Our goal for the FRS is to help all its members fulfill their dream of a financially secure retirement. As the investment 6 manager of the nation's top-ranked state pension fund, one of the few state pension funds with a surplus, we E x e c u t i v e D i r e c t o r 's R e p o r t are creating a world of opportunity for Florida by investing globally in stocks, bonds, private equity and real estate. 20 Ta b l e s A T h r o u g h C With record assets of $184 billion under SBA management during the fiscal year, we delivered top-quartile investment results through our diversified and balanced approach to investing in the United States and around the world. INVESTMENT REVIEW 24 Over view of SBA Investment Portfolios World Equity Markets Opportunity Set 26 Size of circle indicates relative share of worldwide market capitalization Risks, Objectives and Expectations 28 North America The 2006-07 Investment Environment Latin 31 America FRS Pension Plan Japan 40 FRS Investment Plan Europe 41 Lawton Chiles Endowment Fund Asia/Pacific Ex Japan 43 SBA Investment Pools Africa/ Mideast Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Services Utilities 45 Other Investment Portfolios 50 Based on MSCI All-Country World Index Other SBA Responsibilities Countries of Domicile for SBA Investments Argentina Chile Ghana Japan Netherlands Puerto Rico Thailand Australia China Gibraltar Jersey, C I Netherlands Antilles Romania Turkey Austria Colombia Greece Kazakhstan New Zealand Russia Ukraine Bahamas Cote d'Ivoire Guernsey, C I Kenya Nigeria Singapore United Kingdom Belgium Czech Republic Hong Kong Lebanon Norway South Africa United States Bermuda Denmark Hungary Liberia Pakistan South Korea Zimbabwe Botswana Egypt India Luxembourg Panama Spain Brazil Estonia Indonesia Malaysia Peru Sri Lanka British Virgin Islands Finland Ireland Marshall Islands Philippines Sweden Canada France Israel Mexico Poland Switzerland Cayman Islands Germany Italy Morocco Portugal Taiwan investing globally = a world of opportunity for Florida 2006-07 INVESTMENT REPORT 3 FRS Pension Plan Net Investment Returns Annualized Returns as of June 30, 2007 MISSION STATEMENT The SBA is committed to providing superior investment and trust services while adhering to the highest ethical, fiduciary and professional standards. 8.46% 1 0 Y E A R S 11.52% 5 Y E A R S 12.88% 3 Y E A R S 18.07% 1 2 M O N T H S 4 S TAT E B O A R D O F A D M I N I S T R AT I O N L E T T E R F R O M T H E T R U S T E E S ALEX SINK CHARLIE CRIST BILL MCCOLLUM November 30, 2007 $5.9 billion in pension benefits during the year. The FRS Pension Plan is fully funded with a $9.1 billion surplus, which is up from $7.6 billion in the previous TO THE HONORABLE MEMBERS OF THE year. The preliminary funded ratio estimate also shows an increase from 107.0% FLORIDA SENATE AND HOUSE OF REPRESENTATIVES: to 107.8%. A surplus of this size is a major achievement in an era when most public pension plans are underfunded. It is our privilege to submit the State Board of Administration of Florida annual Investment Report for the fiscal year ended June 30, 2007, pursuant to the The current long-term investment objective for the FRS Pension Plan is to requirements of Florida Statutes, Section 215.44(5). provide investment returns that are 5% above the annual cost of living (2.7% this fiscal year). Exceeding the investment objective this year by 10.4% has provided The SBA's statutory mandate is to invest, manage and safeguard assets of the extra assurance that the FRS will have sufficient assets to fund future pension Florida Retirement System Trust Fund and various other trust funds for our state liabilities, thereby providing a reliable source of retirement income for FRS and local governments. participants and beneficiaries. At year-end, FRS membership totaled just over one million persons. We are pleased to report that for fiscal year 2006-07, the net asset value of total funds under management grew to $184.0 billion from $151.1 billion over the The long-term investment performance of the FRS Pension Plan, the past year. As the Trustees of the SBA, we are dedicated to ensuring that the SBA fourth-largest public pension fund in the nation, is the result of our commitment invests and discharges its duties in accordance with Florida law, policies and a to being good investment fiduciaries. As such, we act solely in the best interest code of ethics that ensures high integrity, solid investment performance, low costs of the FRS members. and prudent risk management. This report provides information on the perform- ance of each of the 35 mandates and trusts managed by the SBA during the year. We encourage you to review this annual Investment Report and visit www.sbafla.com for more information. An unusually strong 18.07% net investment return for the year helped the FRS Pension Plan reach an all-time record high of $136.3 billion, after paying out Respectfully submitted, Chief Financial Officer, Governor, Attorney General, as Treasurer as Chairman as Secretary ALEX SINK CHARLIE CRIST BILL MCCOLLUM 2006-07 INVESTMENT REPORT 5 FRS Pension Plan Value Added Over Benchmark Annualized Returns as of June 30, 2007 E X E C U T I V E D I R E C T O R ' S R E P O R T 0.48% 1 0 Y E A R S 0.22% 5 Y E A R S The SBA produced excellent investment results this year. It beat the Florida Retirement System's Pension Plan policy investment objective, exceeded the total fund investment 0.56% 3 Y E A R S benchmark for all time periods and ranked in the top quartile among its peers. A very strong 18.07% net investment return, after management fees and other costs, was a major contributing factor in the growth of Pension Plan surplus this year. The Pension Plan is fully funded with a $9.1 billion surplus, which is up from $7.6 billion last year. This is good news for the members of the FRS, the State of Florida and local gov- ernments, as well as Florida taxpayers. The Trustees' solid leadership, a good economy, strong investment performance, prudent risk management, ethical investment practices and low costs of doing business all contributed to this year's success. The SBA is proud to be rec- ognized as one of the best public investment management organizations in the United States. 0.22% 1 2 M O N T H S FRS PENSION PLAN The largest fund managed by the SBA is the FRS Pension Plan. It is approximately 75% of the total value of assets under management across 35 different investment funds. The Pension Plan was fully funded for the year, unlike the vast majority of public pension funds in the United States, with net assets of $136.3 billion and a surplus of $9.1 billion after pay- ing out $5.9 billion in benefits to FRS members. 6 S TAT E B O A R D O F A D M I N I S T R AT I O N The Pension Plan's net investment return of 18.07% exceeded the investment policy bench- State Retirement Systems Funded Ratios mark by 22 basis points and the policy investment objective (cost of living plus 5%) by 10.4%. This year's above-benchmark investment performance added $291 million in value to the pension fund, over and above a total of $20.9 billion in investment returns for the year. Over the past 10 years, the SBA's investment returns have accounted for almost 72% of retirement benefits paid through the Florida Retirement System; public sector employer contributions, or tax dollars, have accounted for just 28%. In other words, the SBA's investment gains are the primary source of capital for providing FRS benefits, and thus are essential to the financial security of FRS members and important to Florida taxpayers as well. In February 2007, the Standard & Poor's Ratings Service ranked the Florida Retirement System's Pension Fund as the leading state pension fund in the nation. This ranking was based on Florida having the highest funded ratio of any U.S. public pension fund at the time: 107.3% versus an average funded ratio of 81.8% for all state pension funds. A ratio above 100% means a pension plan is fully funded, with more assets than liabilities; a ratio below 100% means there is a shortfall, with liabilities exceeding assets. Overall, 45 state pension funds had a deficit at the time of the Standard & Poor's report, while Florida was one of only five states with a surplus. The people of Florida are well-served with a fully funded FRS Pension Plan. The FRS mem- bers can trust that the SBA's team of investment fiduciaries is acting solely in their best interest. FRS INVESTMENT PLAN The SBA's leadership in managing pension assets for the benefit of Florida now includes the oversight of the FRS Investment Plan, a voluntary alternative to the FRS Pension Plan, modeled after 401(k) plans. This innovative plan gives eligible members the chance to choose from diverse investment options that are managed by the SBA. It also offers participants the advantage of portable retirement benefits. Total FRS Investment Plan assets increased to $3.7 billion from $2.3 billion a year earlier due to financial market gains, higher enrollments, payroll contributions and benefit trans- fers. Enrollment increased to more than 81,000 active members, or 12% of all FRS-covered employees, up 28% from a year earlier. Sources of Funding for FRS Pension Plan Benefit Payments 10 Years Ending June 30, 2007 The SBA's commitment to serving all members of the Florida Retirement System includes offering a groundbreaking retirement education program that provides professional, unbi- ased financial guidance to FRS Pension Plan and FRS Investment Plan members at no cost to them. The MyFRS Financial Guidance Program is helping members prepare financially 28.3% F R O M E M P L O Y E R 71.7% F R O M for their future retirement. This multimedia program includes an award-winning website – C O N T R I B U T I O N S I N V E S T M E N T www.myfrs.com – and print materials that contain a wealth of information about plan ( TA X D O L L A R S ) G A I N S choice and financial, estate and retirement planning. 2006-07 INVESTMENT REPORT 7 SBA Assets Under Management (in Billions) NON-FRS INVESTMENT FUNDS The SBA managed 33 other investment portfolios with combined assets of $44.0 billion during the fiscal year, including: $184.0 J U N E 3 0 , 2 0 0 7 • The Local Government Surplus Funds Trust Fund, the largest local government investment pool in the country, with a market value of $30.9 billion at year's end. • The Florida Hurricane Catastrophe Fund (CAT Fund), a vital source of emergency funding for residential property insurers that helps keep hurricane insurance available to Florida homeowners. The CAT Fund reimbursed insurers a total of $1.33 billion during the year and finished with a market value of $4.9 billion, inclusive of Catastrophe $116.7 Finance Corporation assets. • The Lawton Chiles Endowment Fund, whose earnings support government-sponsored health maintenance and research programs that aim to mitigate tobacco-related illness. J U N E 3 0 , 2 0 0 2 Its market value increased to $2.3 billion. • Florida debt service accounts for state bonds. $85.1 • Other smaller but important portfolios, such as the Florida Lottery Fund, the Police and Firefighters' Fund, and the Florida Prepaid College Plan, to name just a few. During the year, the SBA assumed responsibility for managing and investing the assets of J U N E 3 0 , 1 9 9 7 two state economic development funds, one supporting the Burnham Institute for Medical Research's expansion to Orlando and another involving the Torrey Pines Institute for Molecular Studies, which is constructing facilities in Port St. Lucie. The Burnham Institute Fund had a market value of $113 million as of June 30, 2007, ranking as the 12th-largest $41.3 fund managed by the SBA, and the Torrey Pines Institute Fund had a market value of $24 million, ranking 14th. I am pleased to say that the SBA managed these two new funds efficiently and professionally, without adding additional staff. J U N E 3 0 , 1 9 9 2 Separately, the SBA established two new asset classes during the year: a High Yield asset class to pursue distressed debt investment opportunities, and a Strategic Investments asset class. The latter is noteworthy because it enables the SBA to pursue innovative and specialized investment strategies. The creation of the Strategic Investments asset class, which includes $20.5 investments from our former Global Equities asset class, is part of our focus on generating attractive long-term returns by adding additional diversity to our investment portfolio. CORPORATE GOVERNANCE J U N E 3 0 , 1 9 8 7 Our fiduciary responsibility includes playing an important role in strengthening the governance of companies in which we invest. It includes active support of corporate governance reforms, prudent voting of more than 3,500 company proxies annually 8 S TAT E B O A R D O F A D M I N I S T R AT I O N and adoption of investment protection principles that have helped protect and and responsibilities, the SBA budget increased slightly to $24.45 million from grow funds under SBA management. $23.09 million. This was the first budget increase since fiscal year 2003-04. During the year, one of the SBA's major achievements in corporate governance • The SBA completed preparations to manage and invest the assets of the was an analysis of executive compensation, an issue that has generated Citizens Property Insurance Fund effective July 1, 2007. Created by the widespread concern among investors and increased scrutiny by the Securities Florida Legislature in 2002, this state-run property insurance pool is the and Exchange Commission. Our research concluded that there is a very weak insurer of last resort for Floridians without private insurance options. It will relationship between pay levels and company performance in the United States. become the third-largest fund under SBA management, ranking behind only Poorly structured executive pay packages may harm shareowner value by the FRS Pension Plan and the Local Government Surplus Funds Trust Fund. wasting money, diluting ownership and creating inappropriate incentives that may damage a company's long-run performance. The SBA also found that • Work began on Phase 2 of the SBA's Disaster Recovery Plan, which will executive compensation has become a significant portion of aggregate earnings include installing a computer system at an off-site location that will enable at public companies, resulting in a substantial diminution in company and the SBA to carry on critical cash management functions and investment portfolio values. management if a disaster impairs operations in Tallahassee. There have been numerous examples of compensation abuses, highlighting • Internally, the SBA created a Senior Operating Group and a Senior the need for additional disclosure requirements, oversight by independent Investment Group that report to the Executive Director, with the goal of compensation committees and increased shareowner monitoring to ensure enhancing communication, decision-making, efficiency and accountability. transparency and integrity. The SBA is continually examining the performance of public companies in this critical area. • The SBA received a Davis Productivity Award for exemplary sustained performance in managing Florida Retirement System assets. The SBA considers the quality of executive compensation plans at individual companies to be an excellent indicator of the quality of the board and the In closing, I want to express tremendous gratitude to the Trustees for their governance of the company. It is a direct indication of whether a board is ful- leadership and support. I also want to thank the Florida Legislature for filling its fiduciary obligation to shareowners. We are encouraging companies being fiscally responsible in funding the FRS Pension Plan in accordance in which we invest to adopt compensation practices that take into account the with actuarially sound practices. Last, but not least, I want to thank and firm's cost of capital and reward performance based on value-creating metrics acknowledge the best team of people that I've ever had the pleasure and and criteria. We believe that all executive compensation arrangements should privilege to work with during 26 years in the investment business. The entire be aligned with the best interests of the company's long-term shareowners. SBA staff is devoted to achieving the SBA mission and serving the people of Florida. During the year, the SBA participated in the International Roundtable on Executive Remuneration, served on the board of the Council of Institutional The SBA's success story is based on great leadership and a highly professional Investors and maintained membership in the Conference Board Governance and spirited team effort that is focused on doing the right thing each and Center and the International Corporate Governance Network. The SBA also every day. joined CERES, a network of investors, environmental organizations and other public interest groups working with companies to address sustainability Sincerely, challenges such as global climate change. OTHER HIGHLIGHTS • The SBA performed its mission and managed more mandates and assets with a staff that remained steady at 158 full-time equivalent employees after Coleman Stipanovich, reducing staff in the previous three years. Reflecting its expanded mission Executive Director 2006-07 INVESTMENT REPORT 9 Peace of mind for Florida retirees … Each year, thousands of hard-working Floridians retire from careers in Reflecting the success of the SBA's investment management strategies, public service. As members of the FRS Pension Plan, they receive stable the FRS Pension Plan produced an 18.07% return in the fiscal year ended retirement income and something priceless – the peace of mind that June 30, 2007 as its net asset value grew to a record $136.3 billion from comes with knowing that their pension is financially secure. $118.4 billion a year earlier. The fully-funded Plan maintained a healthy surplus of $9.1 billion after a net cash outflow of $3.2 billion for pension Here's why: Florida is one of the few states with public pension plans benefit payments to retirees and other payment obligations. that are fully funded with a surplus, making it a rare exception to the troubling national trend of underfunded state pension plans. Overall, the FRS Pension Plan is making retirement a smoother transition for thousands of Floridians because retirees know they can In fact, the FRS Pension Plan has maintained a surplus for 10 count on the Plan to deliver benefits they earned on the job. The Plan's consecutive years. This notable achievement was not an accident. financial stability helped Florida earn the highest credit rating of "AAA" To the contrary, it reflects three major factors: the SBA's historical focus from Standard & Poor's Rating Service during the fiscal year and the on maximizing long-term returns without incurring excessive risk Number One ranking as the top-performing state pension fund. or volatility; sound policy governance by the SBA's Trustees; and responsible benefit funding by the Florida Legislature. But the most important achievement is the Plan's consistent long-term performance. Investment returns can vary dramatically from year to To help reduce risk, the SBA professionally manages a highly diversified year, depending on market conditions, the economy, monetary policy global portfolio that includes a mix of U.S. and international stocks, and other factors. Therefore, financial strength is best revealed by the as well as real estate, fixed income instruments including bonds, and long-term record. Over the past 15 years, the Plan achieved an average private market investments. The FRS Pension Plan invests in nearly annual investment return of 10.32%. 12,000 different securities representing every publicly traded market on the planet. That is the kind of record that gives Florida's retirees peace of mind and greater financial security, just when they need both. 10 S TAT E B O A R D O F A D M I N I S T R AT I O N so there's more time to enjoy life. wo T plans for Florida's public sector employees … Freedom to choose from two professionally managed retirement plans The sustained success of the FRS Pension Plan over decades reflects is one of the major benefits of being a public sector employee in the more than solid investment returns – it demonstrates the SBA's finan- Florida Retirement System. cial stewardship as an ethical investment management organization that acts with integrity and in the best interest of FRS members. From teachers and state government employees to police officers and firefighters, eligible FRS members can participate in either: Managed with the same commitment to integrity and performance, the FRS Investment Plan is becoming an increasingly popular • The FRS Pension Plan, a traditional defined benefit plan that retirement planning choice, especially for potentially mobile workers provides guaranteed monthly retirement income based on a who hold a series of jobs during their career. In 2007, this Plan formula that includes service and salary; or offered 20 investment options to members, supported by an impres- sive array of retirement planning and investment education services • The FRS Investment Plan, a voluntary 401(k) style plan that through the MyFRS Financial Guidance Program. provides participants with a choice of diversified investment options, portable benefits they retain, even if they leave the FRS, The benefits paid to FRS Investment Plan members are based on and investment control over their retirement plan assets. how much money is contributed to their account and the rate of growth when that money is invested. The SBA serves as the plan The SBA professionally manages both of these plans to foster administrator and fiduciary for the Investment Plan, selecting and long-term investment growth and to reduce potential risk and monitoring the investment options, recordkeeping, custody and volatility as much as possible. education services. Its members qualify for benefits after one year of service, versus six years for members of the FRS Pension Plan. The FRS Pension Plan is one of the few fully-funded state pension plans in the U.S., with assets under SBA management that have The common bond between the FRS Pension Plan and FRS doubled to $136.3 billion from $67 billion 10 years ago. The Plan Investment Plan is that the SBA is managing a record amount of remains a national model for defined benefit pension plans, ranking assets in both plans, with diversified global investment strategies and as the top-performing state pension plan due to its financial stability. stringent policies in place to safeguard assets for future retirement. 12 S TAT E B O A R D O F A D M I N I S T R AT I O N so there is freedom to choose. Helping Florida rebuild after hurricanes strike … When hurricanes wreak havoc and destruction, the SBA helps cash in the wake of those hurricanes, the SBA and the Florida protect Florida homeowners and private insurers from a tide of Division of Bond Finance partnered in managing two successful bond potential insurance disasters. As manager of the Florida Hurricane issues in 2006 that raised $4.15 billion. Catastrophe Fund (CAT Fund) and its associated programs, the SBA is providing an insurance lifeline for a state that is all too often in the Through the Florida Hurricane Catastrophe Finance Corporation, the path of devastating storms. SBA reinvests bond proceeds in highly liquid, relatively short-term investments to minimize the interest cost of the bond issue. The SBA focuses on maintaining the stability and solvency of the CAT Fund, which helps keep insurance costs down by reimbursing In the fiscal year ending June 30, 2007, the CAT Fund reimbursed private insurers for a significant portion of their storm-related losses. Florida residential property insurers a total of $1.3 billion, leaving This stable and ongoing source of reimbursement for catastrophic the Fund with total assets of $4.9 billion at the end of the year. losses enables private insurers to continue offering hurricane insur- This includes funds under management in the Florida Hurricane ance to Florida homeowners. Catastrophe Finance Corporation. The Florida Hurricane Catastrophe Fund is not financed by Florida Through its focus on prudent management of risk, assets and cash taxes; it is a tax-exempt trust fund financed by reimbursement flow, the SBA is working to ensure that the Florida Hurricane premiums charged to participating insurers, emergency assessments Catastrophe Fund has sufficient liquidity and is well-positioned to on property and casualty insurers, and earnings on investments by fulfill its obligations under state law. the SBA. As Floridians know all too well from experience, hurricanes can When eight hurricanes ravaged Florida in 2004 and 2005, the destroy homes and communities and alter lives. That is why the CAT Fund was literally in the eye of the storm, paying out more SBA is dedicated to ensuring that the Florida Hurricane Catastrophe than $6.3 billion in loss reimbursements to participating insurers Fund will be there, with vital financial support, to help rebuild over two years. To ensure the solvency of the Fund and replenish communities when disaster strikes. 14 S TAT E B O A R D O F A D M I N I S T R AT I O N so families can have a garden to grow in. Investing for a healthier Florida … At universities and medical centers throughout Florida, researchers $2.02 billion a year earlier, reflecting the SBA's effective investment and health professionals are on a mission to develop potentially management strategy and performance. life-saving treatments for tobacco-related illnesses such as lung cancer and heart disease. They are also studying ways to combat the The importance of the SBA's role, however, is best measured by the powerfully addictive grip of nicotine and curb cigarette smoking by fact that the financial health of the Lawton Chiles Endowment Fund children and adults because more than 1 in 5 adults in Florida still is playing a major role in making vital biomedical research on smoke and thousands of boys and girls start lighting up each year, tobacco-related illnesses a reality in Florida. according to health officials. Consider the James and Esther King Biomedical Research Their vital mission, to help prevent thousands of smoking-related Program which supports biomedical and behavioral research in deaths each year, is getting a financial boost from the SBA, which is Florida for the prevention, diagnosis, treatment, and cure of investing for a healthier Florida. Since 1999, the SBA has been tobacco-related diseases. Funding for this program comes from responsible for managing the Lawton Chiles Endowment Fund, interest earned on a $150 million reserve within the Lawton Chiles which was created by the Florida Legislature to invest a portion of Endowment Fund. the $11 billion the state received under tobacco lawsuit settlements. With this secure source of funding, the James and Esther King The purpose of the Fund, named after the late Florida governor and Biomedical Research Program is providing grants for a wide range health-care advocate, is to provide a perpetual source of enhanced of research projects to improve the health of Floridians and expand funding for health research and programs, including those addressing biomedical knowledge. In 2006, for example, 49 Florida researchers health problems caused by tobacco. The SBA is making that possible led studies and projects sponsored by the program, some of which by protecting and enhancing the value of the Fund's assets with an hold promise for boosting the biotechnology sector of the Florida investment objective that aims to preserve the inflation-adjusted economy. value of contributed capital and provide a specified cash outflow to support vital state health programs and biomedical research on As the SBA is proving, its professional investment management of tobacco use. the Lawton Chiles Endowment Fund is a smart prescription for supporting programs that improve the health of Florida's most In the fiscal year ended June 30, 2007, the net asset value of the valuable resource – its people. Lawton Chiles Endowment Fund increased to $2.3 billion, from 16 S TAT E B O A R D O F A D M I N I S T R AT I O N so research can lead to cures. Cost-effective results for Florida taxpayers … In managing and investing the assets of the Florida Retirement Over the past 10 years, SBA investment returns have covered about System and other funds for long-term growth, the SBA also focuses 72% of retirement benefits paid through the Florida Retirement on delivering cost-effective results that benefit Florida taxpayers. System while public sector employer contributions (tax dollars) have funded the balance, just 28% of the benefit obligations. Maintaining a fully-funded FRS Pension Plan with a surplus for 10 years in a row means that Florida taxpayers are not bearing an The SBA also acts in the best interest of Florida taxpayers by undue burden in financing the state's retirement system. That is providing professional investment and trust services as efficiently as important news for taxpayers from Pensacola to Key West because possible, guided by our enduring commitment to responsible fiscal many state pension funds are underfunded and face a crisis due to and budgetary management. rising deferred pension costs. For instance, the SBA managed more mandates and more assets with As a result, some states – but not Florida – are asking taxpayers to a staff that remained steady at 158 full-time equivalent employees make up their shortfall through tax increases and other measures after streamlining staff in the previous three years. Despite an including bond issues and higher employee payroll contributions to expanding mission and responsibilities, the SBA budget increased their pension plans. It is a far different story in Florida, where the modestly to just $24.45 million from $23.09 million after holding SBA's focus on prudent risk management and maximizing long-term the line on the budget for several years. returns with a global portfolio has produced positive investment results. Florida taxpayers are also benefiting from the SBA's focus on continuous improvement at our operations in Tallahassee, including In the last fiscal year, for example, the FRS Pension Plan achieved risk management training, initiatives to improve efficiency and a funding ratio of 107.8%, meaning that assets exceeded liabilities, technology updates to enhance performance. resulting in a healthy surplus. The stellar performance earned the FRS Pension Plan a Number One ranking among U.S. state pension In short, the SBA's track record of investment success is enabling plans. Florida taxpayers to keep more money in their wallets, which helps families and the overall state economy. 18 S TAT E B O A R D O F A D M I N I S T R AT I O N so you can have more. Table A: Net Investment Returns by Fund and Asset Class For Periods Ending June 30, 2007 Multi-Asset Class Major Mandates Twelve Months Three Years Five Years Ten Years FRS Pension Plan 18.07% 12.88% 11.52% 8.46% Domestic Equities 1 19.61% 12.27% 11.34% 7.62% Foreign Equities 29.82% 24.26% 19.36% 9.24% Fixed Income 1 6.32% 4.41% 5.15% 6.29% Real Estate 16.11% 20.48% 16.04% 13.33% Private Equity 2 -- 12.39% 8.87% 8.69% Cash Equivalents 5.43% 4.01% 2.95% 4.12% Asset Allocation 18.31% 12.60% 11.48% 8.06% FRS Investment Plan 16.01% 11.50% N/A N/A Domestic Equities 18.84% 13.17% N/A N/A Foreign/Global Equities 3 26.67% 21.37% N/A N/A Fixed Income 6.41% 4.36% N/A N/A Treasury Inflation-Protected Securities 3.94% 3.78% N/A N/A Cash Equivalents 5.49% 4.10% N/A N/A Balanced Funds 16.68% 11.80% N/A N/A Lawton Chiles Endowment Fund 17.37% 12.48% 11.52% N/A Domestic Equities 19.41% 11.81% 11.16% N/A Foreign Equities 30.12% 26.01% 19.88% N/A Fixed Income 6.11% 4.11% 4.65% N/A Treasury Inflation-Protected Securities 4.08% 4.11% 6.24% N/A Real Estate 11.00% 22.14% 19.27% N/A Cash Equivalents 5.44% 4.01% 2.92% N/A Asset Allocation 17.57% 12.47% 11.54% N/A 1 The impact of certain trades that occurred during the policy transition month of June 2007 are excluded from the numbers shown above for the FRS Pension Plan Domestic Equities and Fixed Income asset classes. However, they are included in the numbers shown for the total fund (FRS Pension Plan). Had they been included for the asset classes, Domestic Equities' net return would have been 1 basis point lower over 12 months and unchanged for longer periods; that of Fixed Income would have been 7, 2, 1 and 1 basis points higher over 12 months, 3 years, 5 years and 10 years, respectively. 2 Per industry standards, Private Equity returns reflect an internal rate of return methodology. Since inception, the net return is 9.04%. 3 Consists of both domestic and foreign stocks. N/A = not applicable 20 S TAT E B O A R D O F A D M I N I S T R AT I O N Table B: Value-Added Returns By Fund and Asset Class For Periods Ending June 30, 2007 Multi-Asset Class Major Mandates Twelve Months Three Years Five Years Ten Years FRS Pension Plan 0.22% 0.56% 0.22% 0.48% Domestic Equities 1 -0.46% -0.17% -0.18% 0.07% Foreign Equities 0.20% -0.26% -0.10% 1.09% Fixed Income 1 -0.21% 0.11% 0.30% 0.13% Real Estate 9.70% 12.98% 8.37% 5.48% Private Equity 2 -- -4.61% -7.48% -2.16% Cash Equivalents 0.13% 0.01% 0.09% 0.33% Asset Allocation 0.46% 0.28% 0.18% 0.07% FRS Investment Plan -0.28% 0.12% N/A N/A Domestic Equities -0.73% 0.02% N/A N/A Foreign/Global Equities 0.51% 0.42% N/A N/A Fixed Income -0.20% 0.07% N/A N/A Treasury Inflation-Protected Securities -0.05% -0.02% N/A N/A Cash Equivalents 0.01% 0.08% N/A N/A Balanced Funds -0.16% -0.16% N/A N/A Lawton Chiles Endowment Fund 0.87% 0.72% 0.45% N/A Domestic Equities -0.51% -0.43% -0.23% N/A Foreign Equities 0.62% 1.56% 0.50% N/A Fixed Income -0.01% 0.13% 0.17% N/A Treasury Inflation-Protected Securities 0.09% 0.31% 0.20% N/A Real Estate -0.72% -0.26% -0.25% N/A Cash Equivalents 0.18% 0.03% 0.07% N/A Asset Allocation 1.07% 0.71% 0.47% N/A Value added = net return over benchmark 1 The impact of certain trades that occurred during the policy transition month of June 2007 are excluded from the numbers shown above for the FRS Pension Plan Domestic Equities and Fixed Income asset classes. However, they are included in the numbers shown for the total fund (FRS Pension Plan). Had they been included for the asset classes, Domestic Equities' value added would have been 1 basis point lower over 12 months and unchanged for longer periods; that of Fixed Income would have been 7, 2, 1 and 1 basis points higher over 12 months, 3 years, 5 years and 10 years, respectively. 2 Per industry standards, Private Equity returns reflect an internal rate of return methodology. Since inception, the value-added return is -3.88%. N/A = not applicable 2006-07 INVESTMENT REPORT 21 Table C: Asset Allocation at June 30 Fiscal Year-End Multi-Asset Class Major Mandates 2007 2004 2002 1997 This Year 3 Years Ago 5 Years Ago 10 Years Ago FRS Pension Plan 100.0% 100.0% 100.0% 100.0% Domestic Equities 42.9% 50.9% 51.5% 59.9% Global Equities 0.0% 4.1% 0.0% 0.0% Foreign Equities 16.4% 15.1% 13.0% 8.9% Fixed Income 22.9% 20.2% 26.7% 22.6% High Yield 1.3% 0.0% 0.0% 0.0% Real Estate 6.0% 5.7% 4.3% 3.2% Private Equity 3.2% 3.4% 3.4% 1.1% Strategic Investments 4.4% 0.0% 0.0% 0.0% Cash Equivalents 2.9% 0.5% 1.1% 4.3% FRS Investment Plan 100.0% 100.0% N/A N/A Domestic Equities 31.9% 32.5% N/A N/A Foreign/Global Equities 12.1% 6.5% N/A N/A Fixed Income 8.1% 7.5% N/A N/A Treasury Inflation-Protected Securities 2.1% 4.7% N/A N/A Cash Equivalents 8.8% 9.9% N/A N/A Balanced Funds 37.0% 38.9% N/A N/A Lawton Chiles Endowment Fund 100.0% 100.0% 100.0% N/A Domestic Equities 58.5% 58.7% 53.8% N/A Foreign Equities 14.9% 13.1% 12.4% N/A Fixed Income 13.6% 13.3% 16.7% N/A Treasury Inflation-Protected Securities 8.1% 9.6% 11.7% N/A Real Estate 4.1% 4.4% 4.2% N/A Cash Equivalents 0.7% 0.8% 1.0% N/A N/A = not applicable 22 S TAT E B O A R D O F A D M I N I S T R AT I O N S T A T E B O A R D O F A D M I N I S T R A T I O N Investment Review 2006-07 Overview of SBA established as a direct requirement of Florida law. Eighteen clients have at least some of their assets Investment Portfolios Trusts are investment responsibilities allowed in separately managed vehicles while another 16 under law and established pursuant to a trust are invested solely in one or more of the SBA's As of June 30, 2007, the SBA managed 22 different agreement with a client. Four of the SBA's three CAMP (Commingled Asset Management portfolios housing the assets of 35 mandates and 22 portfolios are commingled investment pools Program) pools. Nearly 1,000 clients participate in trusts. A mandate is an investment responsibility that contain the assets of a variety of clients. the SBA's Local Government Investment Pool Table 1: SBA Assets Under Management by Investment Vehicle as of June 30, 2007 (1) (2) (3) (4) (5) (6) SBA Investment Pools Separately Total Assets LGIP CAMP-MM CAMP-FI CAMP-DE Managed Assets Under Management Accounts With Separately Managed Assets 1. FRS Pension Plan $ - $ - $ - $ - $136,280,544,510 $136,280,544,510 2. Florida Hurricane Catastrophe Finance Corporation - 5 - - 3,971,634,585 3,971,634,590 3. FRS Investment Plan - - - - 3,687,530,964 3,687,530,964 4. Debt Service - - - - 2,629,390,901 2,629,390,901 5. Lawton Chiles Endowment Fund - 24,166,481 318,177,319 239,918,026 1,750,779,807 2,333,041,633 6. Department of the Lottery Fund - 1,130 - - 1,287,953,934 1,287,955,064 7. Florida Hurricane Catastrophe Fund - - - - 898,154,157 898,154,157 8. Florida Prepaid College Plan - 309,564,072 - - 194,360,978 503,925,050 9. Local Government Non-Pool Funds - - - - 457,157,338 457,157,338 10. Retiree Health Insurance Subsidy Trust Fund - 72,782,641 - - 136,226,215 209,008,856 11. Scripps Florida Funding Corporation - 37,585,287 - - 157,185,478 194,770,765 12. Burnham Institute for Medical Research Fund - 3,248,567 - - 109,672,595 112,921,162 13. Florida College Investment Plan - - - - 26,035,183 26,035,183 14. Torrey Pines Institute for Molecular Studies Fund - 750,245 - - 23,433,082 24,183,327 15. Institute of Food & Agricultural Sciences - 12,092,054 - - 5,013,167 17,105,221 16. Bond Proceeds Trust Fund 1 - - - - 5,377,339 5,377,339 17. McKnight Doctoral Fellowship Program - 1,056,993 - 1,050,910 738,483 2,846,386 18. Gas Tax Clearing Fund 1 - - - - - - Accounts Invested Solely in SBA Investment Pools 19. Local Government Investment Pool 2 30,941,610,689 - - - - 30,941,610,689 20. Police and Firefighters' Premium Tax Trust Fund - 203,568,084 - - - 203,568,084 21. FSU Research Foundation - - 37,947,950 42,728,786 - 80,676,736 22. SBA Administrative Fund 3 - 13,015,864 28,101,053 - - 41,116,917 23. PEORP Administrative Fund 3 - 27,788,883 - - - 27,788,883 24. Insurance Capital Build-up Program - 16,303,287 - - - 16,303,287 25. SRI International Fund - 13,788,647 - - - 13,788,647 26. Florida Prepaid College Foundation - 9,670,716 - - - 9,670,716 27. Pinellas Suncoast Transit Authority - - 5,924,392 - - 5,924,392 28. Florida Division of Blind Services - 41,283 898,334 1,572,268 - 2,511,885 29. Florida Endowment for Vocational Rehabilitation - 2,162,806 - - - 2,162,806 30. Arbitrage Compliance Trust Fund - 1,993,227 - - - 1,993,227 31. Bond Fee Trust Fund 3 - 1,566,247 - - - 1,566,247 32. Florida College Investment Plan Administrative Expense - 357,863 - - - 357,863 33. Florida Prepaid College Plan Administrative Expense 3 - 156,977 - - - 156,977 34. Investment Fraud Restoration Financing Corporation - 27,285 - - - 27,285 35. Inland Protection Financing Corporation - 1,420 - - - 1,420 Total Assets Under Management $30,941,610,689 $751,690,064 $391,049,048 $285,269,990 $151,621,188,716 $183,990,808,507 1 The fund balance is periodically zero due to cash flows. 2 Individual accounts are not shown. As of June 30, 2007, there were 2,331 individual accounts in the LGIP. 3 CAMP-MM balances include adjustments to the fund's cash balance for P-card expenses incurred prior to June 30, 2007, but allocated to the fund after June 30th. 24 S TAT E B O A R D O F A D M I N I S T R AT I O N Table 2: Change in Assets Under Management – Fiscal Year 2006-07 Net Asset Value as of June 30, 2006 Investment Gain (Loss) Contributions & (Distributions) Net Asset Value as of June 30, 2007 FRS Pension Plan $118,354,931,178 $21,122,621,488 $(3,197,008,156) $136,280,544,510 Local Government Investment Pool 22,134,944,704 1,467,350,106 7,339,315,879 30,941,610,689 Florida Hurricane Catastrophe Finance Corporation - 197,832,841 3,773,801,749 3,971,634,590 FRS Investment Plan 2,305,766,357 421,735,355 960,029,252 3,687,530,964 Debt Service 2,578,931,747 123,627,768 (73,168,614) 2,629,390,901 Lawton Chiles Endowment Fund 2,024,521,334 349,452,785 (40,932,486) 2,333,041,633 Department of the Lottery Fund 1,437,289,247 79,576,273 (228,910,456) 1,287,955,064 Florida Hurricane Catastrophe Fund 658,201,804 36,072,156 203,880,197 898,154,157 Florida Prepaid College Plan 73,285,481 2,387,205 428,252,364 503,925,050 Local Government Non-Pool Funds 545,802,337 32,838,993 (121,483,992) 457,157,338 Retiree Health Insurance Subsidy Trust Fund 168,435,595 10,559,323 30,013,938 209,008,856 Police and Firefighters' Premium Tax Trust Fund 158,195,193 6,130,641 39,242,250 203,568,084 Scripps Florida Funding Corporation 205,963,799 11,747,091 (22,940,125) 194,770,765 Burnham Institute for Medical Research Fund - 2,999,162 109,922,000 112,921,162 FSU Research Foundation 71,386,032 9,290,704 - 80,676,736 SBA Administrative Fund 34,543,516 2,207,842 4,365,559 41,116,917 PEORP Administrative Fund 24,636,122 1,375,029 1,777,732 27,788,883 Florida College Investment Plan - (578,913) 26,614,096 26,035,183 Torrey Pines Institute for Molecular Studies Fund - 455,327 23,728,000 24,183,327 Institute of Food & Agricultural Sciences 16,112,117 870,804 122,300 17,105,221 Insurance Capital Build-up Program 251,065,728 12,752,756 (247,515,197) 16,303,287 SRI International Fund - 388,647 13,400,000 13,788,647 Florida Prepaid College Foundation 7,502,055 518,661 1,650,000 9,670,716 Pinellas Suncoast Transit Authority - 10,128 5,914,264 5,924,392 Bond Proceeds Trust Fund 1 - 93,742 5,283,597 5,377,339 McKnight Doctoral Fellowship Program 3,130,631 215,755 (500,000) 2,846,386 Florida Division of Blind Services 2,196,927 314,958 - 2,511,885 Florida Endowment for Vocational Rehabilitation 2,273,332 93,341 (203,867) 2,162,806 Arbitrage Compliance Trust Fund 1,779,168 101,886 112,173 1,993,227 Bond Fee Trust Fund 1,450,278 93,144 22,825 1,566,247 Florida College Investment Plan Administrative Expense 522,340 33,751 (198,228) 357,863 Florida Prepaid College Plan Administrative Expense 549,946 47,693 (440,662) 156,977 Investment Fraud Restoration Financing Corporation 27,906 1,507 (2,128) 27,285 Inland Protection Financing Corporation 1,346 74 - 1,420 Gas Tax Clearing Fund 1 - 459,764 (459,764) - Total Assets Under Management $151,063,446,220 $23,893,677,788 $9,033,684,499 $183,990,808,507 1 The fund balance is periodically zero due to cash flows. through more than 2,300 individual accounts. the year, assets under SBA management increased the SBA's separately managed accounts and pooled Pooling smaller portfolios into larger investment to $184.0 billion from $151.1 billion, a gain of investment products, Table 5 indicates exposure to funds affords economies of scale and other invest- $32.9 billion. This increase represents the net each asset type. ment management advantages, enhancing returns effect of $23.9 billion in investment gains plus for participants. $9.0 billion in net contributions. Table 2 shows Performance data for the SBA's separately managed these details for each SBA portfolio. accounts and investment pools over various periods Table 1 lists the net asset value of each mandate ending June 30, 2007 are shown in Tables 3 and 4. and trust at fiscal year-end. Of the total assets The chief determinant of a portfolio's long-term Net managed returns (i.e., actual earnings) are under SBA management, $151.6 billion, or about return and risk is its asset allocation, meaning its shown in Table 3. Value-added returns, meaning 82%, was managed in separate accounts. During exposure to the various asset classes. For each of the SBA's managed return minus the portfolio's 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 25 Table 3: SBA Net Investment Returns For Periods Ending June 30, 2007 Thus, managing risk is a vital part of the invest- Portfolios With Separately Managed Assets Twelve Months Three Years Five Years Ten Years ment process. FRS Pension Plan 18.07% 12.88% 11.52% 8.46% Florida Hurricane Catastrophe Fund 5.33% 3.92% 3.04% N/A Lawton Chiles Endowment Fund 17.37% 12.48% 11.52% N/A While there are many dimensions and types of risk FRS Investment Plan 16.01% 11.50% N/A N/A that must be considered, ultimately they all bear on Retiree Health Insurance Subsidy Trust Fund 5.30% 3.87% N/A N/A Institute of Food & Agricultural Sciences 5.23% 3.86% 2.96% N/A the fundamental motivation for investing, i.e., the SBA Pooled Investment Products investment objective. A rational investor will Local Government Investment Pool 5.52% 4.03% 3.01% 4.05% CAMP - Money Market 5.44% 4.02% 2.93% N/A direct his greatest risk management effort toward CAMP - Fixed Income 6.08% 4.10% 4.65% N/A those risks that put attainment of his investment CAMP - Domestic Equities 20.01% 12.34% 11.48% N/A objective in greatest jeopardy, and vice versa. Note: The managed return for the Local Government Investment Pool has been retroactively revised since last year's report to show the Participant Effective Yield, which reflects a 365 day basis and adjustments for realized earnings by participants, expenses and other accounting items. Managed returns had been previously reported using the LGIP 30 day Rate of Return, which is based upon amortized cost and a 360 day basis pursuant to Chapter 19-7.011, Florida Administrative Code. The old With this in mind, the SBA's risk-assessment and annualized 30 day Rates of Return would be 5.44%, 3.98%, 2.97% and 4.01% for twelve months, three years, five years and ten years, respectively. risk-management efforts are framed by formal investment objectives. Table 4: SBA Value-Added Investment Returns For Periods Ending June 30, 2007 (Value Added = Net Return over Benchmark) Investment Objectives Portfolios With Separately Managed Assets Twelve Months Three Years Five Years Ten Years Investment objectives are established for each port- FRS Pension Plan 0.22% 0.56% 0.22% 0.48% Florida Hurricane Catastrophe Fund -0.15% -0.10% 0.08% N/A folio entrusted to the Board. To reduce the long-term Lawton Chiles Endowment Fund 0.87% 0.72% 0.45% N/A risk of shortfalls, the SBA prefers stocks as the FRS Investment Plan -0.28% 0.12% N/A N/A Retiree Health Insurance Subsidy Trust Fund -0.05% -0.58% N/A N/A principal return generator in its long-lived investment SBA Pooled Investment Products mandates, such as the FRS Pension Plan. Although an Local Government Investment Pool 1 0.04% 0.01% 0.05% 0.04% Local Government Investment Pool 2 0.07% 0.08% 0.11% 0.05% emphasis on stocks may create short-term volatility CAMP - Money Market 3 -0.05% 0.00% -0.03% N/A CAMP - Money Market 4 -0.01% 0.07% 0.04% N/A when equity markets are under pressure, stocks have CAMP - Fixed Income -0.04% 0.12% 0.17% N/A proven over the long run to provide the richest asset CAMP - Domestic Equities 0.10% 0.11% 0.09% N/A growth. For mandates with shorter term investment 1 Measured relative to the iMoneyNet First Tier Institutional Money Market Gross Index for all time periods. This index became the primary benchmark for the Pool effective July 1, 2006. Value-added performance against this index for earlier periods is shown as a matter of information only. horizons, the SBA typically invests in lower returning 2 Measured relative to the S&P AAA/AA Rated GIP All 30 Day Gross Index for all time periods. This index became the secondary benchmark for the Pool effective asset types which exhibit less volatility than stocks. July 1, 2006. For prior periods, it was the Pool's sole benchmark, measured net of fees. Value-added returns based on the net-of-fee version of this index would be 0.30%, 0.31%, 0.35% and 0.31% for twelve months, three years, five years and ten years, respectively. 3 Measured relative to the iMoneyNet First Tier Institutional Money Market Gross Index, CAMP-MM's primary benchmark. The SBA's primary investment objective for the 4 Measured relative to the S&P AAA/AA Rated GIP All 30 Day Gross Index, CAMP-MM's secondary benchmark. Note: Prior to May 1998, a gross version of the S&P AAA/AA Rated GIP All 30 Day Index did not exist. Its value has been approximated by adding 30 basis points to FRS Pension Plan is to provide investment returns the net-of-fees version of the index for the period from July 1997 through April 1998. that are sufficient to ensure the timely payment of promised benefits to current and future participants benchmark (typically, a broad market return), are Risks, Objectives and Expectations and to keep plan cost at a reasonable level. As shown in Table 4. additional considerations, the SBA seeks to avoid Risks Inherent in Investing excessive volatility in short-term plan cost levels Return data is not calculated individually for every Risk is an everyday fact of life for investors. and excessive risk in long-term cost trends. portfolio under management. This is either Without assuming some degree of risk, an because the portfolio is managed in one or more investor would serve no useful economic purpose To achieve these objectives, the Board has deter- commingled pools or because returns are not and hence would receive no return. How an mined that going forward a long-term real return indicative of the SBA's effectiveness in managing investor manages risk and how he chooses of 5.0% per year (compounded and net of invest- the account. Table 6 indicates the specific circum- and balances the various forms of risk are key ment expenses) should be attained, based on a stances for each affected portfolio. decisions that will influence long-term success. substantially diversified asset allocation that 26 S TAT E B O A R D O F A D M I N I S T R AT I O N Table 5: Asset Classes Represented in SBA Investment Portfolios as of June 30, 2007 Portfolios With Separately Managed Assets U.S. Equities Foreign Equities Fixed Income High Yield Treasury Inflation-Protected Securities Real Estate Private Equity Cash Equivalents FRS Pension Plan 1 x x x x x x x Local Government Investment Pool x Florida Hurricane Catastrophe Fund 2 x x FRS Investment Plan x x x x x Debt Service x x Lawton Chiles Endowment Fund x x x x x x Department of the Lottery Fund x x Local Government Non-Pool Funds x Scripps Florida Funding Corporation x x Retiree Health Insurance Subsidy Trust Fund x x Florida Prepaid College Plan x Burnham Institute for Medical Research Fund x x Florida College Investment Plan x Torrey Pines Institute for Molecular Studies Fund x x Institute of Food & Agricultural Sciences x x Bond Proceeds Trust Fund x x McKnight Doctoral Fellowship Program x x Gas Tax Clearing Fund x x SBA Pooled Investment Products Local Government Investment Pool x CAMP - Money Market x CAMP - Fixed Income x CAMP - Domestic Equities x Note: This table indicates asset types which are included as a matter of ongoing investment policy. Other asset types may also be held pursuant to a tactical investment strategy or for liquidity. 1The FRS Pension Plan also is authorized to allocate assets to a Strategic Investments asset class, which can consist of a variety of individual asset types. 2Also includes the Florida Hurricane Catastrophe Financing Corp. Table 6: Separate Account Portfolios liabilities. For this reason, we judge a real return Table 7: FRS Pension Plan Expected Risk Without Return Data by Reason target to be superior to a flat rate actuarial target. Time 10th Percentile 90th Percentile Horizon Real Return Real Return Portfolios with Dedicated Bond Strategies 12 Months -8.30% 20.28% Debt Service Department of the Lottery Fund The SBA uses sophisticated modeling techniques 5 Years -1.16% 11.59% 10 Years 0.62% 9.63% Scripps Florida Funding Corporation to ensure that its allocation of assets among the 15 Years 1.41% 8.77% Burnham Institute Torrey Pines Institute for Molecular Studies Fund various asset types provides a sufficiently high 20 Years 1.89% 8.26% 25 Years 2.21% 7.91% probability of attaining the real return objective 30 Years 2.46% 7.66% Episodically Funded Portfolios Client Directed Assets Gas Tax Clearing Fund McKnight Doctoral Fellowship Program and that it does so with a diversified portfolio that Bond Proceeds Trust Fund Local Government Non-Pool Funds presents the lowest level of expected downside risk Asset Classes Portfolios With Less Than One Year of Performance consistent with the target return. The securities in an investment portfolio are Florida Prepaid College Plan Florida College Investment Plan grouped into asset classes. Asset classes typically To achieve the absolute real target rate of return, represent groups of individual securities that have Returns for these portfolios either cannot be calculated or are not meaningful. some market risk must be borne. Table 7 illustrates common economic and legal characteristics. More minimizes expected risk. This rate presumes the the potential range of real returns that could result than 90% of the long-term cumulative growth of a Legislature makes the actuarially required annual over various investment horizons. Over a 30-year diversified investment portfolio is determined by contributions. investment horizon, there is a 10% probability that the asset class mix (i.e., by asset allocation), with the Target Portfolio will experience a compound the remainder coming from individual security Because FRS Pension Plan liabilities are driven in annual real return of 2.46% or less. Downside risk is selection within the asset classes. part by inflation, a long-term real return target considerably greater over shorter horizons, but the affords a more realistic assessment of how well our natural investment horizon for the FRS Pension Plan Within each asset class, individual portfolios have investment performance tracks overall growth in is the very long-term. disciplined investment strategies measured against 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 27 specific performance benchmarks. SBA portfolios return is uncertain. Historically, real returns have partnerships and captive (exclusive) relationships. are diversified within asset classes by maturity, been in the 2% to 4% range, but they tend to rise and Portfolio investments are predominantly equity liquidity, industry, country, company and size, fall with inflation. Bonds are generally a poor choice investments in domestic companies. Over the long- among other considerations, as appropriate. Each for long-term, unknown obligations, but they have term, the SBA expects its private equity investments portfolio is designed to contribute positively to total less short-term volatility than stocks, at roughly 8%. to surpass a risk-adjusted hurdle rate of 450 basis fund returns on a long-term basis. Generally, bonds have an expected annual real return points over the broad United States equity market of 3%, with a 35% probability of earning zero or less return. This premium reflects some important addi- Foreign and domestic stocks have higher expected in any given year. tional risks that these investments pose compared to returns and larger price volatility than other tradi- public market investments, including elevated use of tional asset classes. Stocks are shares of ownership Asset Class – High Yield leverage, substantial illiquidity and relatively limited in businesses and, as such, represent a claim on High yield bonds are fixed income securities that are opportunities to diversify. their profits. Stocks have historically yielded a rated below investment grade (below Ba/BB) by the higher return than other assets, but the uncertainty major rating agencies (Moody's, Standard & Poor's, Asset Class – Strategic Investments of return poses some risk. and Fitch). High yield bonds have higher expected This is a new asset class which received its first returns than traditional investment grade fixed funding in June of 2007. It is a marked departure Asset Class – Domestic Equities income, and lower expected returns than equity from other SBA asset classes in that it will not History demonstrates that stock ownership is an investments, with expected volatility of approx- consist of a singular asset type. Instead, its purpose effective way of participating in economic growth imately 11%. High yield bonds are more closely is to contain a diverse set of asset types and invest- over time. For more than two centuries, domestic correlated to the equity markets than investment ment strategies not encompassed by the SBA's other stocks have provided a real return approximately 3% grade fixed income. Generally, high yield bonds have asset classes. Through diversification and pursuit of over the real growth rate of the U.S. economy and 6% an expected annual real return of 4%, with a 36% idiosyncratic returns not available elsewhere, this over inflation, per year. The downside for stocks is probability of earning zero or less in any given year. asset class is expected to enhance the risk-adjusted their potential for short-term volatility. Over the past return of the total fund over multiple market cycles. 30 years, the standard deviation of stock returns was Asset Class – Real Estate about 20%. With an expected (long-term) annual Historically, institutional real estate portfolio returns Asset Class – Cash real return of 6% per year, there is a 35% chance of have been higher than bonds but lower than stocks. From the perspective of a long-term investor, the stocks returning zero or less in any given year. We expect real estate returns to exceed bond returns Cash asset class (consisting of very short-term because of the risk attributable to ownership. interest bearing securities) poses the highest level of Asset Class – Foreign Equities However, the stability of rental income dampens risk in that it is the least likely asset type to provide Foreign stocks share many of the institutional volatility of real estate returns and keeps it closer to vigorous returns. The long-term historical return on characteristics of domestic stocks. Recent academic bonds than stocks. Real estate portfolio returns cash has been lower than the other asset classes and, studies examining long-term non-U.S. stock returns appear to be correlated with inflation and tend to do in real terms, has approximated zero for long peri- have found them to deliver a slightly lower return well in periods of high inflation. However, real estate ods. Conversely, for portfolios with a dominant need than domestic stocks, while exhibiting somewhat has a notable disadvantage relative to foreign or for capital preservation (typically those facing sub- higher volatility. The pattern of returns for foreign domestic equities. Direct-owned properties, the core stantial short-term liquidity demands), cash assets equities is somewhat different from domestic stocks, of the asset, are private market investment vehicles. are the lowest risk alternative. adding a diversification effect to the total portfolio. As such, their relative illiquidity makes large expo- sures problematic in the context of the total fund. The 2006-07 Investment Environment Asset Class – Fixed Income Fixed income securities are contractual obligations Asset Class – Private Equity U.S. Economic Conditions that may be used to lock in a nominal return for an The Private Equity asset class is comprised principal- The U.S. economy grew at a modest rate for the year extended period, if held to maturity, but the real ly of private equity investments through limited as higher productivity and consumer spending were 28 S TAT E B O A R D O F A D M I N I S T R AT I O N accompanied by an ongoing correction in the growth in corporate profits, firms seemed increasingly Concerns about the upward trend subsided as core housing market. Home construction and sales reluctant to undertake capital expenditures amid inflation retreated to 1.9% in June 2007. slowed, home prices slipped and mortgage lenders heightened uncertainty over the near-term course of faced an alarming trend of mounting foreclosures. the economy and concerns about energy costs. The Domestic Equities Market Conditions upshot was that real fixed investment in equipment U.S equity markets, as measured by the broad-based The fiscal year began with real GDP (the inflation- and software, which accounts for roughly two-thirds Russell 3000 index, gained more than 20% for the adjusted value of final goods and services produced of business spending, dipped to its lowest pace in fiscal year, reflecting economic growth, solid in the U.S.) expanding at an annual rate of just 1.1% several years, dampening the rate of economic growth. corporate earnings and an uptick in merger and in the third quarter of 2006. The largest negative acquisition activity. influence on real GDP during the quarter was a Business spending on non-residential fixed invest- 20.4% fall in real residential fixed investment. This ment construction was a positive contributor to There was some investor uncertainty throughout plunge in housing-related expenditures reduced economic growth. With the housing sector in the the year, fueled by concerns about the U.S. overall growth by 1.3%. doldrums, resources became available for other types subprime mortgage market, high energy prices, of construction work and deferred business projects fear of a slowing economy and a threatened crack- For the entire fiscal year, GDP growth was 2.1%, a came on-line. The combination of a falling down on stock market speculation in China, but modest rate made possible by strong growth in the U.S. dollar and accelerating growth overseas stocks recovered to post impressive gains. final quarter, when exports surged to provide an propelled U.S. exports, which grew more rapidly economic boost. than imports for two quarters of the year, enough to Markets successfully navigated a number of provide a substantial boost to GDP growth. crosscurrents to move higher as investors rotated Overall, the economy was surprisingly resilient. their holdings into larger capitalization companies. Supported by income growth, consumer spending The Federal Reserve held the Fed funds rate steady At the same time, the markets were generally more was up 3% for the year, despite the housing trends. at 5.25% during the year after repeated interest rate volatile and riskier stocks were repriced. Consumers spent at a brisker pace after gas prices, hikes the prior year. Inflation appeared to be on which topped $3.00 per gallon in the summer of the upswing in early 2007 as year-over-year growth After earlier modest gains, stocks rallied sharply in 2006, fell throughout the fall and winter. in the price deflator for core personal consumption April and May 2007 helped by continued strong expenditures – the Federal Reserve's preferred earnings and the accelerated pace of merger and Productivity continued to expand during the year – inflation measure – rose three straight months acquisition activity. As the fiscal year wound down, albeit at a slower rate than in the last few years. before peaking at 2.5% in February 2007. investor concerns about rising interest rates and Unemployment was low at a rate of 4.5% for most of the year and the labor market was solid. Employment growth averaged 169,000 jobs per month and wages and salaries for some workers rose as labor shortages emerged. Chart 1: Major U.S. Stock Market Indices January 1, 1998 through June 30, 2007 For households with financial wealth or stock portfolios, steady gains in equity markets provided a buffer against slipping home prices. All in all, U.S. consumers provided a base of support for sustained economic growth during the year. The other main cog of aggregate spending – business investment – was problematic. In spite of sustained 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 29 inflation, and hedge fund losses, contributed to a central banks continued to raise rates; the fact that The combination of lower risk premiums, lower sell-off in June 2007. global growth remained strong as the U.S. economy growth expectations and contained inflation expecta- slowed; and finally, several central banks signaling tions induced U.S. Treasury interest rates to decline Still, led by large-capitalization value stocks, all plans to diversify their foreign exchange reserves by overall and moderately steepened the Treasury yield major segments of the Russell 3000 target – large- reducing U.S. dollar exposure. curve. The steepening of the Treasury curve was capitalization, small-capitalization, core, growth, reflected in shorter dated bond yields declining more and value – closed higher for the fiscal year. The first six months of 2007 cast a shadow over significantly than longer dated bond yields. The the prospects that the global equity rally would con- two-year Treasury yield declined 29 basis points to Foreign Equities Market Conditions tinue. A 9% drop in the Shanghai Composite Index 4.87% by the end of the fiscal year and the 10-year There was an extended surge in global equities, on February 27 triggered a global stock sell-off that Treasury yield was trimmed 9 basis points to 5.03%. interrupted only briefly at the end of February. lasted through mid-March. The problems facing the Foreign equity markets rose 29.6%, benefiting from U.S. housing and mortgage industries threatened to Given generally declining interest rates, most mea- sustained global growth, robust exports and record spill over into other markets as the U.S. economy sures of total return were positive for the year. The levels of merger and acquisition activity. Developed slowed and consumer confidence waned. Nonethe- Lehman U.S. Aggregate Index posted a total return markets led by the Pacific region (excluding Japan) less, global expansion remained resilient, with of 6.12%. The Lehman U.S. Investment Grade gained more than 27%. For the fourth consecutive healthy economies and strong corporate earnings. Credit Index produced a 12-month return of 6.72%. fiscal year, emerging markets returned more than The total return for the Lehman U.S. Treasury Yield 30%, finishing 45% higher. A surge in merger and Fixed Income Market Conditions fell 5.48%, but the Lehman U.S. Corporate High acquisition activity, low long-term interest rates, a Returns in U.S. fixed income bond markets for Yield Index returned 11.55% for the fiscal year. successful string of Chinese initial public offerings the fiscal year reflected softening U.S. economic and robust corporate earnings fueled the rally in growth, the Federal Reserve's standpat rate strategy Real Estate Market Conditions emerging markets. and declining risk premiums demanded by market Real estate assets in general experienced attractive participants. total returns. The SBA's Real Estate asset class The U.S. dollar's depreciation against most curren- produced a total return of 16.11% for the fiscal year. cies boosted returns to U.S. investors with unhedged Risk premiums embedded in bond pricing were The continuation of strong real estate fundamentals foreign stock holdings. The dollar came under pres- reduced throughout the fiscal year as investors stemming from a robust economy as well as the sure for several reasons, including: the perception remained confident that U.S. economic growth continuing availability of attractive financial terms that the U.S. Federal Reserve was at the end of its would slow only modestly, with on-track global enabled investors to enjoy another year of asset monetary tightening cycle while many foreign growth and abundant liquidity. appreciation and good income returns. For the most part, assets such as office buildings, retail properties and apartments delivered strong Chart 2: U.S. Treasury Yields returns. Most markets, especially coastal areas, January 1, 1998 through June 30, 2007 enjoyed high occupancies and positive revenue growth. While positive market fundamentals contributed to the attractive returns, so did investor actions. Private market institutional investors targeted portfolios of real estate assets, often using high levels of leverage to acquire high quality, lower risk assets. These transactions contributed to a rise in asset values throughout the institutional grade sector of the real estate market. This run-up in 30 S TAT E B O A R D O F A D M I N I S T R AT I O N asset values resulted in higher appreciation returns $291 million in value. This contributed strongly to Chart 3: FRS Pension Plan Assets by Type in the National Council of Real Estate Investment the FRS Pension Plan remaining fully funded with a $136.3 billion as of June 30, 2007 Fiduciaries (NCREIF) Property Index, which surplus, unlike most public pension plans in the U.S. reflects institutional quality property values through the appraisal process and from data derived from It was the 14th year in the past 20 that the return actual market transactions. exceeded the SBA's long-term performance objective (currently 5.0% over the rate of inflation), which is Private Equity Market Conditions the rate of return necessary to maintain the Plan's During the year, private equity funds continued to funded status and to reasonably control plan costs, raise and invest capital at historically high rates. assuming the Legislature makes the actuarially Fundraising rose to $149 billion in 2006 from required contributions. $111 billion in 2005, and deal volume increased to $680 billion from $272 billion. Private equity Reflecting these investment results, the net asset accounted for 21% of mergers and acquisitions in value of FRS Pension Plan assets rose 15.1% to Chart 4: Cumulative Performance History 2006, five times the level in 2000. $136.3 billion from $118.4 billion at the end of the Fiscal Years 1976 through 2007 prior year, despite net cash outflow of $3.2 billion in Two major factors fueled this growth: Private equity pension benefit payments. The gross outflow for outperformed public markets, and global liquidity benefit payments was $5.9 billion for the year, which provided an abundance of cheap debt. Total debt was offset by employer contributions of $2.7 billion. levels reached 7.1 times cash flow in 2006, up from Chart 3 shows the breakdown of Pension Plan assets 4.6 times in 2001. This drove the purchase price of across the various asset classes as of June 30, 2007. companies, or total enterprise values, to 8.6 times Table 8 lists the change in net asset value over the cash flow. In contrast, large-cap public equity was year, by asset class. trading at relatively inexpensive price-to-earnings multiples when compared to the last run-up in debt Net investment returns (actual earnings) and value- levels in 2000. Accordingly, a significant number added returns (net returns relative to a market-based of public companies engaged in private equity benchmark) are shown for the total FRS portfolio as transactions in an effort to arbitrage that spread. well as other SBA investment portfolios in Tables 3 and 4, respectively. A breakdown of returns by asset Chart 4.1: Asset Class Net Investment Gains Florida Retirement System Pension Plan class is shown in Tables A and B in the front section Growth of $100 Invested During FY 2006-07 of this report. The performance of each asset class is The Florida Retirement System Trust Fund holds measured relative to a broad market index as all assets of the FRS Pension Plan, the defined specified in the FRS Pension Plan Investment Policy benefit option within the two-plan FRS system. Statement. Value-added returns reflect the SBA's The FRS Trust Fund is the single largest investment ability to outperform these market indices. mandate assigned to the SBA, accounting for 74.1% of total assets under SBA management in Chart 4.1 illustrates the relative strength of each the fiscal year ending June 30, 2007. asset class over the past year. The strongest performing asset classes were Foreign Equities, For the fiscal year, the investment return for the Global Equities and Domestic Equities, in that order. FRS Pension Plan was 18.07%, which exceeded the Due to rising interest rates, returns to Fixed Income investment benchmark by 22 basis points, adding were only slightly better than the Cash return. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 31 The investment strategy for the FRS portfolio is Chart 5 illustrates the extent to which actual to implement the policy allocation within relatively exposures deviated from target levels during narrow bands in pursuit of modest risk-controlled the year. On balance, the net effect of these over- gains, net of transaction costs. In addition, the and underweights contributed 46 basis points to strategy seeks to add value through the pursuit of the value added of the total Pension Plan portfolio active investment strategies aimed at providing for the year. Contributions over longer periods attractive long-term risk-adjusted returns. The SBA are shown in the row titled "Asset Allocation" manages this strategy through asset allocation and in Table B in the front section of this report. risk-budgeting policies. The SBA complied with its Chart 5: FRS Pension Plan Asset Allocation investment strategy for the FRS portfolio through- Managing external cash flows (i.e., providing Range of Monthly Exposures Relative to Policy Weights out the year. sufficient and timely liquidity for payment of retirement benefits) is an important part of the Significant changes were made to the FRS invest- SBA's asset management responsibilities. This ment policy during the year. Following an in-depth task has become more challenging in recent asset-liability study, the SBA concluded that total years as employer contribution levels have fund risk could be reduced without compromising fallen and new programs such as the Deferred attainment of the long-term investment objective. Retirement Option Program and the FRS This was accomplished by reductions in exposure to Investment Plan have added new and erratic Domestic Equities and to Private Equity of 12 and demands for liquidity. Nonetheless, the SBA 1 percentage points, respectively. This was offset has a robust cash management system in place somewhat by increases in exposure to foreign stocks for monitoring and meeting these needs as and fixed income instruments of 4 and 9 percentage they arise. points, respectively. Collectively, these changes are expected to modestly reduce the Fund's compound Domestic Equities Investment Performance annual return by 22 basis points while significantly The Domestic Equities asset class, comprised of lowering annual risk by 119 basis points. U.S. stocks, was valued at more than $58.5 billion Table 8: FRS Pension Plan Change in Net Asset Value Fiscal Year 2006-07 Chart 6: Annual Change in Total Fund Value by Source Net Asset Value 4 Net Contributions Investment Net Asset Value 4 6/30/06 and Transfers Gain (Loss) 6/30/07 Domestic Equities $59,657,771,773 $(12,701,110,839) $11,553,608,533 $58,510,269,467 Global Equities 5,065,077,290 (6,254,260,832) 1,189,183,542 0 Foreign Equities 1 17,936,671,894 (856,699,998) 5,206,026,848 22,285,998,744 Fixed Income 25,205,400,545 4,342,804,473 1,630,385,431 31,178,590,449 High Yield 0 1,822,105,703 (29,190,445) 1,792,915,258 Real Estate 5,850,989,421 1,339,690,589 1,025,461,088 8,216,141,098 Private Equity 2 3,643,811,949 250,000,000 496,590,114 4,390,402,063 Strategic Investments 0 6,029,110,830 (13,075,029) 6,016,035,801 Cash/Short-Term Securities 3 995,208,307 2,831,351,918 63,631,406 3,890,191,631 Total FRS Pension Plan $118,354,931,178 $(3,197,008,156) $21,122,621,488 $136,280,544,510 1 The International Equities asset class name changed to Foreign Equities, effective June 1, 2007. 2 The Alternative Investments asset class name changed to Private Equity, effective June 1, 2007. 3 The investment gain (loss) reported for the Cash/Short-Term Securities includes $18,772,890 in SBA investment service charges and $3,141,296 in bank fees paid out of the Total Central Cash/Short-Term portfolio on behalf of the entire FRS Pension Plan. Excluding these expenses, the investment gain (loss) reported would have been $85,545,592, which reflects actual investment returns. 4 Total may not foot due to rounding. 32 S TAT E B O A R D O F A D M I N I S T R AT I O N on June 30, 2007, accounting for almost 43% of the The aggregate passive portfolio surpassed the In August 2006, a second active small-cap total FRS Pension Plan portfolio. benchmark by 18 basis points for the fiscal year. manager was added to the roster of the Lawton Three factors helped to generate the strong return: Chiles Endowment Fund, bringing the total The asset class produced a solid return of 19.61% the portfolios were carefully managed to closely number of active strategies to three. The for the fiscal year but trailed the benchmark Russell reflect underlying index activity; litigation proceeds performance of the three strategies, each invested 3000 Index by 46 basis points. Returns from the were reinvested; and, most significantly, trades asso- by incumbent FRS managers, trailed their passive portion of the portfolio were strong, but ciated with index reconstitutions were successfully respective benchmarks, closely approximating results from the active portfolio were disappointing. implemented. their results for the FRS. Overall, the asset class was broadly diversified across The performance of non-FRS passive investments, Global & Foreign Equities 20 active strategies and three passive portfolios, with the commingled Russell 3000 ex-Tobacco and the Investment Performance the passive portion comprising more than 71% of the LCEF Russell 1000 ex-Tobacco Fund, closely The Global Equities and Foreign Equities asset total. The asset class reflected a target neutral mix of mirrored that of the FRS passive portfolios. classes returned 23.8% and 29.8%, respectively.2 growth, value and small- and large-capitalization Table 9: FRS Pension Plan Domestic Equities – Change in Net Asset Value by Manager strategies. Fiscal Year 2006-07 Net Asset Value Net Contributions Investment Net Asset Value During the fiscal year, three dedicated value managers Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 were added to the lineup of active small-cap man- - Alamo $322,603,845 $(25,854,064) $51,457,758 $348,207,539 - AQR Capital Management 198,819,663 0 29,382,638 228,202,301 agers. The addition completed the SBA's initiative to - Aronson & Partners 2,639,645,628 (1,175,681,883) 399,061,652 1,863,025,397 diversify the roster of active small-cap managers to - Avatar R1000 Index Fund 16,448,634,933 (4,431,796,886) 3,452,339,552 15,469,177,599 - Barclays Global Inv. Russell 2000 Alpha Tilts 2 0 (2,648) 2,648 0 enhance our ability to pursue potential investment - Barclays Global Inv. R1000 Alpha Tilts 1,060,693,104 540,491,960 263,586,560 1,864,771,624 opportunities in this area of the U.S. equity market. - Batterymarch Financial Management 297,271,296 (141,632,531) 39,499,759 195,138,524 - Cortina Asset Management 144,936,509 0 24,238,641 169,175,150 - Delaware Investments 1,086,475,872 0 106,611,941 1,193,087,813 - Delta 1 0 50,000,003 643,654 50,643,657 Within the small-cap core segment of the active - Domestic Equity Policy Transition 1 0 (40,655,340) 40,697,796 42,456 portfolio, the SBA completed research and funded - Domestic Equity Restructuring Account 78,585 57,677,986 (57,511,640) 244,931 - Earnest Partners 279,989,984 (81,253,197) 37,564,487 236,301,274 an internally managed quantitative strategy to pro- - Enhanced Investment Technologies, Inc. 2,129,215,235 0 397,693,982 2,526,909,217 vide a platform for staff development and a clearer - Fisher Investments 1 0 131,896,199 36,757,114 168,653,313 - Goldman, Sachs & Company 2 0 (21,054) 21,054 0 perspective on externally managed active strategies. - Jacobs Levy Equity Management 1,209,743,463 0 221,787,909 1,431,531,372 - Loomis Sayles & Company LLP 1,562,147,825 0 237,317,199 1,799,465,024 - PanAgora Asset Management 352,251,574 (60,933,070) 48,746,234 340,064,738 In the large-cap value portfolio, a manager was - Phoenix Portfolio 26,538,464,116 (5,938,932,210) 5,327,470,887 25,927,002,793 terminated for process and performance reasons - Private Capital Management 1,227,680,483 (335,718,206) 179,685,956 1,071,648,233 - Quantitative Management Associates 1,405,411,993 0 315,419,744 1,720,831,737 while two others were retained. - Renaissance Investment Management 196,207,713 0 12,985,284 209,192,997 - Riversource 2, 3 136,022,847 (128,320,579) (7,702,268) 0 - Smith Asset Management Group 874,351,539 0 136,079,476 1,010,431,015 Most of the shortfall in active investments - Turner Investment Partners 452,284,946 (259,993,640) 48,177,668 240,468,974 occurred in the third quarter of 2006, when active - Tygh Capital Management 178,735,735 0 33,150,378 211,886,113 - Vaughan Nelson Investment Management 191,054,579 0 36,878,393 227,932,972 strategies across the spectrums of large/small and - Wellington Management Company 725,050,306 (860,381,679) 141,564,077 6,232,704 growth/value performed poorly. Both fundamental Total Domestic Equities $59,657,771,773 $(12,701,110,839) $11,553,608,533 $58,510,269,467 and quantitative managers cited a market that failed 1 Account opened during the fiscal year. to reward stocks with attractive valuations and solid 2 Account closed during the fiscal year. 3 Name changed from Transition Account to Riversource. fundamentals. For the balance of the fiscal year, the performance of active investments was more in line with the benchmark. 2 Global equity performance is for the 12 months ending May 31, 2007, the date the Global Equities asset class was terminated. (A global equity strategy is now a component of the Strategic Investments asset class.) 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 33 Table 10: FRS Pension Plan Foreign Equities4 – Change in Net Asset Value by Manager Despite strong absolute returns, Global Equities Fiscal Year 2006-07 struggled to keep pace with its benchmark while Net Asset Value Net Contributions Investment Net Asset Value Foreign Equities modestly outperformed its Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 benchmark. Developed Markets: - Aberdeen Asset Management $109,643,765 $41,000,000 $60,044,659 $210,688,424 - Artisan Partners 1,218,140,886 (57,100,000) 310,710,593 1,471,751,479 Global equity managers found the investment - Barclays Global Inv. Index Plus 851,863,997 0 238,578,930 1,090,442,927 - Barclays Global Inv. World Ex-US 4,549,628,045 (355,000,000) 1,207,356,102 5,401,984,147 environment challenging, but two of the SBA's - Barclays Global Inv. World Ex-US Alpha Tilts 2,346,025,754 0 665,790,411 3,011,816,165 global equity managers, Templeton and Acadian, - Capital Guardian Trust Company 1,130,551,779 (251,300,000) 251,133,341 1,130,385,120 - Foreign Equity Internal Active 4 107,031,683 (20,000,000) 26,810,916 113,842,599 bucked the trend. Templeton, the best-performing - Foreign Equity Market Exposure 4 9,238,364 (1,965,268) 2,090,092 9,363,188 manager, benefited from superior stock selection in - Morgan Stanley Investment Management 3 1,124,526,258 (85,600,000) 273,701,531 1,312,627,789 - New Star Institutional Asset Management 927,319,025 (50,800,000) 247,387,913 1,123,906,938 almost every sector and a heavy overweight to - Putnam Investments 2 11,909 (24,063) 12,154 0 telecommunications, one of the top-performing - Pyramis Global Advisors 3 950,021,877 (86,200,000) 222,630,332 1,086,452,209 - Sprucegrove Investment Management 1,092,441,846 0 323,275,903 1,415,717,749 sectors. Acadian, a quantitatively-driven manager, - Templeton Investment Counsel 1,279,779,653 (91,100,000) 425,759,034 1,614,438,687 benefited from stock selection in the U.S. and a Emerging Markets: -Acadian Asset Mgt Inc. 473,605,580 0 193,053,153 666,658,733 combination of market positioning and stock - EM Market Exposure 117,355 58,740,982 19,340,682 78,199,019 selection in Germany, Japan and Turkey. Overall, - Genesis Emerging Markets 474,756,969 113,000,000 208,130,046 795,887,015 - JP Morgan Asset Management 411,869,894 (490,635,710) 78,837,593 71,777 being underweight the United States and Japan, - Mondrian Investment Partners Ltd. 395,317,121 0 172,004,595 567,321,716 coupled with good stock selection, added value. - SSGA Daily Active Emerging Markets 484,591,856 0 221,803,915 706,395,771 - Trilogy 1 0 420,294,728 57,393,896 477,688,624 Other Foreign Equities: Unfortunately, two other global equity managers - Foreign Equity Cash 4 94,255 29,425 216,911 340,591 - Foreign Equity Asset Allocation Portfolio 4 94,023 (40,092) (35,854) 18,077 underperformed. Walter Scott lagged the benchmark Total Foreign Equities $17,936,671,894 $(856,699,998) $5,206,026,848 $22,285,998,744 due to a large overweight to Japan and stock selec- 1 Account opened during the fiscal year. tion. UBS had an underweight position in material 2 Account closed during the fiscal year. stocks, one of the better performing sectors, and its 3 The name Morgan Stanley Asset Management was changed to Morgan Stanley Investment Management. Also, Fidelity Investments changed their name to Pyramis Global Advisors. stock selections in consumer staples, financials, 4 The asset class name changed from International Equities to Foreign Equities effective June 1, 2007. Relevant internally managed portfolio names were also industrials and telecommunications lowered value. updated to reflect this change. Within Foreign Equities, the developed active Table 11: FRS Pension Plan Global Equities – Change in Net Asset Value by Manager component added value, driving the aggregate's Fiscal Year 2006-07 modest outperformance. Representing about Net Asset Value Net Contributions Investment Net Asset Value 60% of public market foreign equity investments, Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 developed active managers surpassed the bench- - Acadian Asset Management 2 $486,225,523 $(621,729,696) $135,504,173 $0 - Bank of Ireland Asset Management 2 3,893,309 (3,905,043) 11,734 0 mark by 89 basis points. - Fisher Investments, Inc. 2 514,638,786 (630,629,413) 115,990,627 0 - FTI Institutional 2 839,590,268 (1,103,062,187) 263,471,919 0 - Global Equity Cash Account 2 21,154 (45,446) 24,292 0 The best relative performance came from investment - McLean Budden 2 1,078,127,892 (1,316,533,524) 238,405,632 0 - Putnam Advisory Company, LLC 1 356 (358) 2 0 managers Templeton and Sprucegrove. Consistent - Trilogy Global Advisors 2 468,832,603 (578,590,692) 109,758,089 0 with its performance in the global equity aggregate, - UBS Global Asset Management 2 1,080,896,332 (1,318,348,489) 237,452,157 0 - Walter Scott & Partners, Ltd. 2 592,851,067 (681,415,984) 88,564,917 0 Templeton demonstrated superior stock selection to add considerable value. Its stock selection in indus- Total Global Equities $5,065,077,290 $(6,254,260,832) $1,189,183,542 $0 trials, telecommunications, consumer discretionary, 1 Account closed during the fiscal year. 2 Account was managed under the Global Equities asset class through May 31, 2007. On June 1, 2007, it was transferred to the Strategic Investments asset class. and energy, coupled with an underweight position in energy, benefited the portfolio. Geographically, 34 S TAT E B O A R D O F A D M I N I S T R AT I O N a large underweight to Japan, the worst-performing own asset class and, subsequently, the benchmark returned 10.31% for the year as corporations developed market country, helped performance. for Fixed Income was changed to the Lehman reported strong earnings and corporate default rates Sprucegrove benefited from an overweight to Aggregate Bond Index. were low. The Lehman Mortgage-Backed Securities emerging markets and from an underweight to (MBS) Index had a 6.39% total return, and the Japan. Its stock selection in telecommunications, The three major sectors of the fixed income Lehman Aggregate less Mortgages (ex-MBS) Index financials and materials added value. benchmark produced varying returns during the had the weakest performance, with a return of fiscal year. The leading sector was high yield, which 5.97% for the year. The emerging market component of Foreign Equities produced a strong absolute return of 42.4% but Table 12: FRS Pension Plan Fixed Income – Change in Net Asset Value by Manager lagged the benchmark by 263 basis points. One Fiscal Year 2006-07 bright spot among the SBA's emerging market Net Asset Value Net Contributions Investment Net Asset Value Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 managers was Aberdeen, which was hired just over Aggregate: a year ago. Aberdeen benefited from large - BlackRock $3,619,430,846 $0 $210,991,444 $3,830,422,290 - Fixed Income Transition Account 1 0 7,058,310,176 53,782,561 7,112,092,737 overweights to India and Latin America, markets Government/Corporate: that were up over 60%, and a large underweight to - Active Core Portfolio 9,201,282,278 (424,000,000) 532,818,826 9,310,101,104 - Fixed Income Gov't./Corp. Passive Account 3,458,715,501 (717,700,000) 202,864,882 2,943,880,383 Russia, which trailed most other emerging markets. - Taplin, Canida & Habacht 253,342,659 (10,000,000) 16,300,806 259,643,465 High Yield: - High Yield Asset Allocation 2,4 1,410,666 (1,953,397) 542,731 0 Fixed Income Investment Performance - High Yield Active Synthetic 3,4 421,119,869 (457,248,955) 36,129,086 0 Returns in the Fixed Income asset class increased - Lehman Brothers High Yield 4 275,053,460 (310,680,629) 35,627,169 0 - MacKay Shields, LLC 4 284,054,893 (317,937,465) 33,882,572 0 sharply from the prior year, reflecting the end of - Post Advisory Group 4 280,497,801 (314,163,829) 33,666,028 0 Fed rate increases and the impact of modestly - Shenkman Capital Management LLC 4 458,418,797 (505,121,428) 46,702,631 0 Mortgage: lower interest rates which improved bond prices. - MBS Active Synthetic 105,854,710 389,000,000 2,663,534 497,518,244 - MBS Enhanced Synthetic 685,228,128 (138,400,000) 39,123,858 585,951,986 - Fixed Income Mortgage Passive (Lehman) 1,760,697,716 49,700,000 108,621,836 1,919,019,552 As of June 30, 2007, the asset class was valued at - Lehman Brothers Asset Mgt. LLC 121,653,842 113,000,000 6,829,175 241,483,017 - Smith Breeden Associates 1,436,924,822 230,000,000 90,271,660 1,757,196,482 approximately $31.2 billion, accounting for 22.9% - Trust Company of the West 1,741,193,962 (400,000,000) 107,303,410 1,448,497,372 of the total FRS Pension Plan portfolio. Overall, the - Utendahl Capital Management 662,500,885 0 44,605,626 707,106,511 - Wellington Management Company 438,019,710 100,000,000 27,657,596 565,677,306 Fixed Income asset class produced a 6.32% total return for the year, up from 0.02% a year earlier. Total Fixed Income $25,205,400,545 $4,342,804,473 $1,630,385,431 $31,178,590,449 1 Account opened during the fiscal year. However, Fixed Income's return underperformed the 2 Name changed from High Yield Active Synthetic to High Yield Asset Allocation. benchmark by 21 basis points. Actively managed 3 Name changed from High Yield Passive Synthetic to High Yield Active Synthetic. 4 Account was managed under the Fixed Income asset class through May 31, 2007. On June 1, 2007, it was transferred to the High Yield asset class. portfolios returned 6.34% for the year, underper- forming their performance benchmark by 25 basis points. Passively managed portfolios returned Table 13: FRS Pension Plan High Yield – Change in Net Asset Value by Manager 6.21%, surpassing their benchmark return of 6.12%. Fiscal Year 2006-07 Net Asset Value Net Contributions Investment Net Asset Value Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 For all but the last month of the fiscal year, the - High Yield Asset Allocation 1 $0 $953,397 $206,785 $1,160,182 asset class was benchmarked to the Fixed Income - High Yield Active Synthetic 1 0 397,248,955 (6,268,479) 390,980,476 - Lehman Brothers High Yield 1 0 342,680,629 (6,809,098) 335,871,531 Management Aggregate target, a market-weighted - MacKay Shields, LLC 1 0 328,937,465 (3,892,168) 325,045,297 blend of the Lehman Aggregate Bond Index and - Post Advisory Group 1 0 347,163,829 (5,252,525) 341,911,304 - Shenkman Capital Management LLC 1 0 405,121,428 (7,174,960) 397,946,468 the Merrill Lynch High Yield, B/BB Cash Pay Total High Yield $0 $1,822,105,703 $(29,190,445) $1,792,915,258 Rated Index. As of June 1, 2007, High Yield was 1 Account was managed under the Fixed Income asset class through May 31, 2007. On June 1, 2007, it was transferred to the High Yield asset class. removed from Fixed Income and placed into its 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 35 As of June 30, 2007, the High Yield managers The asset class is made up of directly owned assets of its apartment property investments, returning underperformed their benchmark by 63 basis (including office buildings, apartment communities, $135.0 million. Although primarily in an acquisi- points.3 Their performance reflected a more shopping centers and warehouse/distribution tion mode for the year, one direct-owned property defensive position relative to the index, facilities), commingled funds, and publicly traded was sold: a 302-unit rental apartment community in underweighting high yield bonds in general securities (mostly Real Estate Investment Trusts). Atlanta, for $25.0 million. Also during the year, and longer maturity bonds specifically. $150 million of our public real estate investments The direct-owned portfolio's total return was 17.16% (i.e., REITs) was reallocated to a new internally As of June 30, 2007, the portfolios actively managed for the year. Commingled fund investments pro- managed account. against the Lehman Aggregate ex-MBS Index duced a total return of 15.24% and public securities underperformed the index by 21 basis points. The returned a total of 11.82% for the year. Real estate Overall, significant progress was made in diversifying primary reason for the underperformance was an assets generally rose in value aided by strong market the portfolio as the SBA continued to implement a underweight to corporate bonds overall, with an fundamentals, resulting in high occupancies and three-pronged strategy for real estate, supplementing underweight to lower rated bonds within the corpo- rent growth. our core stable value portfolio with value-added rate universe. The strategy reflected the view that assets and high return assets. investors were not being duly compensated for During the year, the SBA acquired five apartment owning corporate bonds relative to the risk inherent communities. They consist of 2,329 rental apart- Private Equity Investment Performance in such investments. The active mortgage managers ment units located in five states. The SBA's equity The Private Equity asset class had a market value underperformed their benchmark by 13 basis points investment was $135.4 million. The SBA also of $4.4 billion at the end of the fiscal year, due to the sensitivity of these instruments to changes acquired 21 retail shopping centers containing a representing 3.2% of total FRS assets. The asset in interest rates. The only portfolio benchmarked total of 3,577,000 square feet located in nine states class had holdings in 65 investment vehicles man- against the Lehman Aggregate Bond Index returned at an equity cost of $322.8 million. This reporting aged by 39 different external managers. During the 5.83% for the year but fell short of the index return period, the SBA joint ventured with a nationally year, this asset class committed $1.1 billion to of 6.12%. respected congregate care investor and, through an 10 new partnerships and added $242 million to equity investment of $78.3 million, acquired a existing investments. Real Estate Investment Performance majority interest in 15 congregate care facilities The SBA's Real Estate asset class generated a strong containing a total of 1,904 beds. For the year, Private Equity generated a time- total return of 16.11% for the fiscal year as the mar- weighted return of 12.9% versus the benchmark ket value of its investments rose to $8.22 billion Three land parcels located in Atlanta were acquired of 24.6%. Ample market liquidity continued, from $5.85 billion a year earlier. $1.03 billion of the for $22.4 million in a joint venture. Two of the driven by leveraged buyout partnerships, especially rise was due to investment gains, and the balance of parcels are currently being developed for rental large ones that benefited from cheaper debt; less $1.34 billion represents increased exposure. apartments. The Board obtained financing on three competition; and the increased issuance of dividends to existing shareholders after adding more Table 14: FRS Pension Plan Real Estate – Change in Net Asset Value by Investment Type Fiscal Year 2006-07 debt to the balance sheet. The asset class had a net cash outflow of $54.2 million to general partners for Net Asset Value1 Net Contributions Investment Net Asset Value1 Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 the year. The largest capital call was for Freescale - Commingled Funds $1,349,570,438 $927,341,316 $271,446,272 $2,548,358,026 Semiconductor, Inc. Four general partners plus our - Direct-Owned Investments 3,928,737,034 278,974,505 704,372,730 4,912,084,269 - Real Estate Cash 19,522,229 (16,025,143) 1,180,316 4,677,402 Co-Investment Program called an aggregate of - Real Estate Investment Trusts (REITs) 552,659,701 150,000,000 48,311,686 750,971,387 $65 million from the SBA to acquire the former - Real Estate Stock 500,019 (600,089) 150,084 50,014 Total Real Estate $5,850,989,421 $1,339,690,589 $1,025,461,088 $8,216,141,098 semiconductor unit of Motorola. Significant distri- 1 Real estate net asset values are an estimate of value which may or may not represent the value which would be reflected by an actual arm's-length sales transaction. butions included $60 million from Apollo and the Co-Investment Program following the sale of GNC, a nutritional products retailer, and $48 million 3 This reflects 11 months of performance as a component of the Fixed Income asset class plus one month performance as a new High Yield asset class. 36 S TAT E B O A R D O F A D M I N I S T R AT I O N Table 15: FRS Pension Plan Private Equity2 – Change in Net Asset Value by Manager3 Fiscal Year 2006-07 Net Asset Value Net Contributions Investment Net Asset Value Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 - 3i Eurofund V, L.P. 1 $0 $8,653,581 $(954,042) $7,699,539 - Apollo Investment Fund IV, L.P. 164,697,778 (62,990,722) (6,462,156) 95,244,900 - Apollo Investment Fund V, L.P. 120,160,811 (68,886,688) 61,197,807 112,471,930 - Apollo Investment Fund VI, L.P. 554,506 70,675,892 5,270,098 76,500,496 - Blackstone Capital Partners V, L.P. 9,917,529 27,093,066 (464,946) 36,545,649 - Carlyle Partners Europe III, L.P. 1 0 1,002 1 1,003 - Carlyle Partners II 26,847,276 (5,266,561) 6,072,356 27,653,071 - Carlyle Partners III , L.P. 259,508,636 (167,769,943) 5,454,959 97,193,652 - Carlyle Partners IV, L.P. 30,821,186 18,381,622 9,276,482 58,479,290 - Centre Capital Investments II 55,719,128 (15,617,375) 9,747,419 49,849,172 - Chartwell Capital Investors II, L.P. 61,732,054 (35,034,526) (664,280) 26,033,248 - Cypress Equity Fund 9,265,007 (1,726,760) 925,569 8,463,816 - Fairview Ventures Fund II, L.P. 10,262,386 9,403,325 438,276 20,103,987 - Fairview Ventures Fund III, L.P. 487,536 1,666,133 (864,713) 1,288,956 - First Reserve Fund XI, L.P. 1 0 8,385,348 (568,914) 7,816,434 - Freeman Spogli (FS) Partners V, L.P. 14,295,104 9,026,380 9,491,832 32,813,316 - Goldman Sachs Distressed Opportunities, L.P. 97,322,805 20,846,271 9,048,994 127,218,070 - Gores Capital Partners, L.P. 32,849,436 (4,586,741) 9,598,904 37,861,599 - Green Equity Investors III, L.P. 34,275,815 (26,481,807) 7,389,044 15,183,052 - Green Equity Investors IV, L.P. 51,847,081 35,592,733 2,844,248 90,284,062 - Green Equity Investors V, L.P. 1 0 14,009 0 14,009 - Grove Street Partners LLC 23,913,357 27,700,460 (1,367,401) 50,246,416 - Grove Street Partners Buyouts LLC 1 0 15,300,545 (1,904,653) 13,395,892 - Hellman & Friedman Capital Partners V, L.P. 43,906,870 12,860,993 33,023,852 89,791,715 - Hellman & Friedman Capital Partners VI, L.P. 1 0 17,390,350 (1,282,843) 16,107,507 - Hicks, Muse, Tate & Furst III, L.P. 32,936,958 (361,388) 14,563,848 47,139,418 - Hicks, Muse, Tate & Furst Fund IV, L.P. 49,028,585 (26,881,988) 3,565,699 25,712,296 - Hicks, Muse, Tate & Furst Fund V, L.P. 19,695,496 (13,091,186) 4,863,536 11,467,846 - Kelso Investment Associates VII, L.P. 21,864,641 7,045,355 24,759,661 53,669,657 - Kohlberg Investors V, L.P. 15,539,644 18,164,001 (48,218) 33,655,427 - Lexington Capital Partners IV, L.P. 111,886,896 (65,588,804) 35,937,023 82,235,115 - Lexington Capital Partners V, L.P. 70,144,297 (22,636,890) 11,075,782 58,583,189 - Lexington Capital Partners VI-B, L.P. 2,767,508 17,836,827 2,344,136 22,948,471 - Lexington Co-Investment Partners (Pools I & II), L.P. 58,396,126 (35,766,436) 26,355,638 48,985,328 - Lexington Co-Investment Partners II (Pools III & IV), L.P. 458,952,757 (240,999,354) 218,262,746 436,216,149 - Lexington Co-Investment Partners 2005, L.P. 40,736,420 148,664,427 3,979,980 193,380,827 - Liberty Partners I 2,579,716 0 0 2,579,716 - Liberty Partners II 50,421,331 (26,052,601) 5,136,461 29,505,191 - Liberty Partners III 242,946,052 3,729,062 (41,546,306) 205,128,808 - Liberty Partners IV 1,935,388 (1,277,904) 209,051 866,535 - Liberty Partners V 144,717,199 803,754 (8,413,107) 137,107,846 - Liberty Partners VI 533,375,262 33,655,228 (47,351,896) 519,678,594 - Liberty Partners VII 50,963,920 140,505,899 (2,809,300) 188,660,519 - Lindsay Goldberg & Bessemer II, L.P. 1 0 25,653,659 (1,076,369) 24,577,290 - New Mountain Partners II, L.P. 10,692,304 18,462,053 8,413,984 37,568,341 - Pantheon Venture Partners II, L.P. 10,619,183 12,500,000 18,413 23,137,596 - Paul Capital Top Tier Investments II, L.P. 54,712,525 13,720,712 2,206,058 70,639,295 - Paul Capital Top Tier Investments III, L.P. 3,147,134 15,459,863 (158,410) 18,448,587 - PCG Special Situation Partners, L.P. 135,730,014 (5,261,709) 17,903,763 148,372,068 - Permira IV, L.P. 1 0 17,232,185 (342,795) 16,889,390 - Platinum Equity Capital Partners, L.P. 20,869,182 (16,017,136) 25,171,398 30,023,444 - Pomona Capital VI, L.P. 10,045,038 12,987,705 605,621 23,638,364 - Private Equity Cash 66,247,027 192,031,985 5,237,290 263,516,302 - Providence Equity Partners VI, L.P. 1 0 6,794,045 (289,455) 6,504,590 - RCP Advisors Fund IV, L.P. 1 0 7,540,540 (945,417) 6,595,123 - Ripplewood Partners I, L.P. 52,764,619 (42,368,134) 13,540,009 23,936,494 - Ripplewood Partners II, L.P. 30,796,374 30,036,937 (1,188,539) 59,644,772 (continued on pg. 38) 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 37 (continued from pg. 37) Table 15: FRS Pension Plan Private Equity2 – Change in Net Asset Value by Manager3 Fiscal Year 2006-07 Net Asset Value Net Contributions Investment Net Asset Value Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 - Special Situation Partners II, L.P. 1 0 46,693,264 0 46,693,264 - Thoma Cressey Fund VIII L.P. 2,828,917 17,250,000 (683,836) 19,395,081 - Thomas H. Lee Equity Fund IV, L.P. 22,845,752 (6,553,595) (1,455,464) 14,836,693 - Thomas H. Lee Equity Fund V, L.P. 52,755,028 (12,385,030) (858,206) 39,511,792 - Thomas H. Lee Equity Fund VI, L.P. 1 0 22,085,511 (3,070,169) 19,015,342 - TowerBrook Capital Partners, L.P. 7,799,441 27,719,267 (827,585) 34,691,123 - TPG Partners IV, L.P. 37,464,780 2,848,192 13,050,550 53,363,522 - TPG Partners V, L.P. 788,928 27,068,641 238,861 28,096,430 - TSG Capital Fund III, L.P. 6,671,775 0 (1,895,162) 4,776,613 - Warburg Pincus Private Equity IX, L.P. 21,737,884 25,034,906 3,540,631 50,313,421 - Wellspring Capital Partners III, L.P. 35,583,211 (12,142,914) 12,968,200 36,408,497 - Wellspring Capital Partners IV, L.P. 5,328,268 10,837,500 (1,834,217) 14,331,551 - Willis, Stein & Partners II, L.P. 10,155,933 (5,529,490) 721,022 5,347,465 - Willis, Stein & Partners III, L.P. 86,956,135 (14,077,546) 1,469,311 74,347,900 Total Private Equity $3,643,811,949 $250,000,000 $496,590,114 $4,390,402,063 1 Account opened during the fiscal year. 2 The asset class name changed from Alternative Investments to Private Equity effective June 1, 2007. 3 Private Equity net asset values are an estimate of value which may or may not represent the values which would be reflected by an actual arm's-length sales transaction. The net asset values are self-reported by the external managers of these accounts and incorporate their estimate of the value of illiquid publicly traded securities and private market holdings. from our Co-Investment Program following the Table 16: FRS Pension Plan Strategic Investments – Change in Net Asset Value by Manager Fiscal Year 2006-07 sale of Ameripath, a leading provider of anatomic Net Asset Value Net Contributions Investment Net Asset Value pathology and molecular diagnostics. Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 - Acadian Asset Management 2 $0 $621,729,696 $(1,695,143) $620,034,553 - Bank of Ireland Asset Management 2 0 10,291 563 10,854 Since the SBA's first private equity investment was - Blackstone 1 0 4,650,000 (259,500) 4,390,500 made in 1989, the overall dollar-weighted return has - Fisher Investments, Inc. 2 0 616,429,413 2,503,664 618,933,077 - FTI Institutional 2 0 1,046,562,186 (3,832,014) 1,042,730,172 been 9%. This lags the asset class's benchmark by - McLean Budden 2 0 1,276,213,465 (4,768,186) 1,271,445,279 388 basis points. Private equity investments were - Strategic Investments Cash Account 2,3 0 260,614 935 261,549 - Trilogy Global Advisors 2 0 578,590,692 (2,908,501) 575,682,191 made within the Domestic Equities asset class prior - UBS Global Asset Management 2 0 1,238,248,489 (9,561,811) 1,228,686,678 to November 1999. Subsequently, a stand-alone - Walter Scott & Partners, Ltd. 2 0 646,415,984 7,444,964 653,860,948 Total Strategic Investments $0 $6,029,110,830 $(13,075,029) $6,016,035,801 SBA contracts with private equity partnerships require the following 1 Account opened during the fiscal year. disclosure: 2 Account was managed under the Global Equities asset class through May 31, 2007. On June 1, 2007, it was transferred to the Strategic Investments asset class. 3 Name was changed from Global Equities Cash Account to Strategic Investments Cash Account. • Because of the long-term nature of investing in private equity, funds can produce low or negative returns in the early years of the partnership. In the first few years of the partnership, management fees are drawn from partners' capital, and portfolio companies are Table 17: FRS Pension Plan Miscellaneous Portfolio Assets – Change in Net Asset Value held at cost, leading to a potential understatement of ultimate value. Fiscal Year 2006-07 Net Asset Value Net Contributions Investment Net Asset Value • Due to numerous factors, including the lack of standardized valua- Account Name 6/30/06 and Transfers Gain (Loss) 6/30/07 tion and reporting standards, the return information for Private Total Central Cash/Short-Term 1 $995,208,307 $2,831,351,918 $63,631,406 $3,890,191,631 Equity in this report may not reflect the expected returns of the part- nerships. The returns contained in this report are calculated by the 1 The investment gain (loss) reported for the Total Central Cash/Short-Term portfolio includes $18,772,890 in SBA investment service charges and $3,141,296 in SBA and have not been reviewed by the general partners. bank fees that were paid out of this portfolio on behalf of the entire Florida Retirement System Trust Fund. Excluding these expenses, the investment gain (loss) reported would have been $85,545,592, which reflects actual investment returns. • Interim returns may not be meaningful or indicative of ultimate performance during the early stages of the investment life cycle. 38 S TAT E B O A R D O F A D M I N I S T R AT I O N Private Equity asset class was created and provided generated from these programs for the fiscal year Table 19: FRS Pension Plan with a dedicated staff. Investments committed to was $54 million. External Investment Management Fees since that time have had a dollar-weighted return Fiscal Year 2006-07 of 22.2% and have surpassed the benchmark by Net income from all FRS Pension Plan securities Asset Class Dollar Amount 2 Return Basis1,2 598 basis points. lending programs for the previous seven years, Domestic Equities $48,702,082 0.29% including fiscal year 2006-07, is shown in Strategic Investments 3 16,148,758 0.29% Foreign Equities 4 47,108,334 0.24% Strategic Investments Investment Performance Table 18. Fixed Income 6,436,837 0.06% The Strategic Investments asset class was authorized High Yield 5 5,284,164 0.39% for funding effective June 1, 2007. On that date, the Table 18: FRS Pension Plan Real Estate 31,273,443 0.46% Private Equity 6 51,102,163 1.36% SBA's set of global equity portfolios was transferred Net Security Lending Revenue by Fiscal Year Total $206,055,781 0.32% to this asset class. The portfolio composition of 2000-01 $45,645,138 1 Return basis expresses external management fees as a percent of the Strategic Investments as of June 30, 2007 is shown 2001-02 $49,744,143 average of the beginning and ending net asset value of assets in the last column of Table 16. As the asset class externally managed in each asset class. This measure is comparable to 2002-03 $34,568,715 matures, it is anticipated that it will contain a diver- 2003-04 $34,558,808 an annual expense ratio. 2 In order to calculate an annualized return basis for each asset class, sified set of investment types and strategies. 2004-05 $38,447,917 portfolio manager fees for the entire fiscal year are reported within the 2005-06 $50,490,779 appropriate year-end asset class. Cash/Short-Term Investment Performance 2006-07 $54,097,509 3 The Global Equities asset class was eliminated and all portfolios were The performance measurement of Cash pertains moved to the new Strategic Investments asset class effective June 1, 2007. only to the Cash and Central Custody Account, FRS Pension Plan Investment Management Fees 4 The International Equities asset class name was changed to Foreign which was valued at $3.89 billion on June 30, Investment management fees on externally Equities effective June 1, 2007. 5 The High Yield asset class was created June 1, 2007. High Yield 2007. Cash and Central Custody produced a 5.43% managed FRS Pension Plan portfolios are deducted portfolios were previously included in the Fixed Income asset class. total return for the fiscal year, beating its bench- from the portfolios and are not included in 6 The Alternative Investments asset class name was changed to Private mark by 13 basis points. Cash is also held in other budgetary allocations. Table 19 shows investment Equity effective June 1, 2007. asset class portfolios and is reported in the market management fees by asset class for fiscal year values and returns for those portfolios. 2006-07. The SBA's existing infrastructure enables us to Brokerage commissions are paid for executions of Table 20: FRS Pension Plan provide cash management services for FRS Pension securities orders and on trades of exchange-listed Net Brokerage Commissions Plan portfolios at a lower cost than those supplied by equity investments. Net brokerage commissions Asset Class 1 Dollar Amount 1 external service providers, without sacrificing return. for the fiscal year are shown in Table 20 by Domestic Equities $19,606,668 Strategic Investments 2 4,920,482 asset class. Foreign Equities 3 16,056,817 FRS Pension Plan Supplemental Income Program Fixed Income 402,994 Securities lending is an incremental income program Commissions recaptured are credited to the High Yield 4 1,081 implemented through multiple providers. During the Real Estate 501,704 accounts that generated the dollars. Therefore, periods securities are on loan, collateral equal to or the amounts in Table 20 are net of commission Total $41,489,746 greater than 100% of the market value plus accrued recapture rebates. The SBA has one outstanding 1 Brokerage commission amounts for the entire fiscal year are presented interest is received in the form of United States in the appropriate year-end asset class. third-party vendor relationship that provides 2 The Global Equities asset class was eliminated and all portfolios government and agency securities or cash. Cash is commission dollars to fund performance evalua- moved to the Strategic Investments asset class effective June 1, 2007. reinvested in securities authorized by the SBA. tion and research. The SBA follows Employee 3 The International Equities asset class name was changed to Foreign Equities effective June 1, 2007. Retirement Income Security Act (ERISA) standards 4 The High Yield asset class was created June 1, 2007. High Yield During the fiscal year, the SBA utilized six that specifically address commission dollars and portfolios were previously included in the Fixed Income asset class. securities lending agents for FRS assets. Income deem them to be plan assets. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 39 Florida Retirement System Investment Plan reflected an increase in enrollments, particularly among eligible new hires, and an increasing number Created by the Legislature as a voluntary alternative of members using their one-time second election to to the FRS Pension Plan, the FRS Investment Plan, a move from the FRS Pension Plan to the FRS defined contribution plan, continued its growth Investment Plan. The total includes terminated Chart 7: FRS Investment Plan trend, with total assets increasing to $3.69 billion by members who left their balance in the Plan. Asset Allocation by Product Type the end of the fiscal year, reflecting higher enroll- Overall, approximately 12% of all active FRS- $3.69 billion as of June 30, 2007 ment and investment performance. Assets rose by covered members were enrolled in the Investment $1.38 billion from the prior year. Plan at fiscal year-end, up 2.2% from a year earlier. First offered in fiscal year 2002-03, the FRS During the year, the FRS Investment Plan received Investment Plan is modeled after private sector $1.48 billion from employer payroll contributions 401(k) plans. Eligible public sector employees may and benefit transfers from the FRS Pension Plan. enroll in the traditional FRS Pension Plan, which Incoming benefit transfers were almost entirely offers stable, formula-based retirement benefits, or attributable to members using their one-time second the alternative FRS Investment Plan. Unlike the election. The balance of the change in Plan assets FRS Pension Plan, member benefits received from resulted from financial market gains and losses, and the FRS Investment Plan vary, depending on the distributions of $492 million in benefits paid to individual member's Investment Plan account per- terminated members. Effective July 1, 2005, current formance which is based on the investment options and former DROP (Deferred Retirement Option selected by the member. The FRS Investment Plan Program) participants of the FRS Pension Plan enables members to play an active role in selecting became eligible to roll over their DROP accumula- from a diverse set of 20 investment options, tions into the FRS Investment Plan. For the fiscal including three balanced funds. Vesting in the year, 390 participants did so, transferring more than Investment Plan is one year compared to the $46.0 million into the Plan. Since 2005, the Plan Pension Plan's six-year vesting schedule. has gained 630 DROP member accounts totaling Distribution options include rollovers, lump sums, $69.6 million. Chart 8: FRS Investment Plan Net Asset Value periodic distributions and a variety of low-cost fixed, variable and deferred annuities. The composite total return for all FRS Investment Plan assets was 16.01%, net of investment manage- Employer contribution rates are set by law and go ment fees, for the fiscal year. The Plan underper- directly into members' accounts, with rates ranging formed its performance benchmark by 28 basis from 9% to 20% of salary, depending on member- points. While some individual funds outperformed ship class. The FRS Investment Plan is an their individual benchmarks, only the Foreign/ employer-only funded plan. Active members Global Equities asset class as a whole outperformed enrolled in the Plan cannot make personal its aggregate benchmark. These aggregate results contributions. Investment Plan members only pay reflect the asset allocation and investment fund investment management fees. selections of individual participants. In the fiscal year ended June 30, 2007, the FRS FRS Investment Plan Asset Allocation Investment Plan had 98,070 member accounts, a The FRS Investment Plan includes three balanced 30% increase from the previous year. This growth funds that provide members with low-cost 40 S TAT E B O A R D O F A D M I N I S T R AT I O N investment options that optimally balance risk, Investment Policy Statement and any proposed return and cost. At fiscal year-end, more than changes prior to its presentation to the Trustees. 77% of the members allocated at least some of their assets to one or more of the three available balanced The SBA selects and monitors available investment funds. More than 37% of total plan assets were in funds, subject to the ERISA fiduciary standards of the balanced funds, up from 34% the previous year. care and the Investment Policy Statement. Chart 9: Lawton Chiles Endowment Assets by Type $2.33 billion as of June 30, 2007 Members generally favored asset allocations to U.S. For the 2006-07 fiscal year, there were 20 diversi- and international stocks, and fixed income funds. fied investment funds offered in the Investment They also clearly favored low-cost funds, resulting Plan, including eleven stock funds (eight domestic in a weighted investment management fee of and three foreign), four bond funds, a money mar- roughly .29% for the FRS Investment Plan. ket fund, a U.S. Treasury Inflation-Protected Securities Fund, and three balanced funds. FRS Investment Plan Oversight and Management Through the Investment Policy Statement, the Board Lawton Chiles Endowment Fund of Trustees delegates responsibility for the day-to- day management of the FRS Investment Plan, In the fiscal year ending June 30, 2007, the including recordkeeping, asset custody and invest- market value of the Lawton Chiles Endowment ments, to the SBA's Executive Director. Fund (LCEF) increased to $2.33 billion from $2.02 billion, reflecting a net investment gain of The Investment Policy Statement identifies long- $349.5 million and withdrawals of $40.9 million. term objectives for the FRS Investment Plan. It With a total return of 17.37%, the LCEF outper- stipulates that the Plan should offer members formed its target by 87 basis points for the fiscal meaningful, independent control over the assets in year, an exceptionally strong result. Created by the their account, and the following: Florida Legislature in 1999, the purpose of the Fund is to invest a portion of the state's tobacco ■ A diversified mix of low-cost investment options settlement monies to provide a perpetual source of that span the risk-return spectrum and give par- enhanced funding for health maintenance and Chart 10: LCEF Capital Preservation Objective ticipants the opportunity to accumulate retire- research programs related to tobacco use. Value of Post-Payout Fund Assets ment benefits; as a % of Inflation-Adjusted Contributions The SBA has the statutory authority and responsi- ■ Investment options that avoid excessive risk and bility for the investment of LCEF assets, subject to have a prudent degree of diversification relative to certain investment limitations and consistent with broad market indices; and an Investment Policy Statement approved by the SBA Trustees. ■ Investment options providing a long-term rate of return – net of all expenses and fees – that Florida law specifies that the Lawton Chiles achieve or exceed the returns on comparable Endowment Fund shall be managed as an annuity, benchmark market indices. with an investment objective of long-term preserva- tion of the real value of the principal. The law fur- Similar to its role for the FRS Pension Plan, the ther requires a specified regular annual cash out- SBA's Investment Advisory Council reviews the flow for appropriation, as nonrecurring revenue. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 41 Shortly after the LCEF was initially funded, the increase the probability of preserving the inflation- stock market experienced a severe downturn that adjusted value of contributed capital over a 30-year Chart 11: Lawton Chiles Endowment Asset Allocation eroded the balance of the Endowment and placed horizon. This past year saw a continuation of an Range of Monthly Exposures Relative to Policy Weights attainment of the statutory objective at risk. In important reversal that occurred the prior year. February 2003, the Trustees approved changes to LCEF asset growth, net of cash outflows, was the Investment Policy Statement with the goal of sufficient to maintain the Fund's net asset value improving the prospects for long-term solvency of above the value of contributed capital in both the Fund and increasing future payouts, given the nominal and real (inflation-adjusted) terms. fact that additional contributions from tobacco settlement monies are not expected. Fund Performance The short-term performance of the LCEF is The changes, effective July 1, 2003, replaced the measured against a relative target, and each asset previous fixed annuity payout structure with a class is measured relative to a broad market index. participating annuity structure. Under the new The Fund's relative target return is an average of structure, 75% of the regular annual cash outflow is those indices' returns, weighted according to the based on the prior year inflation-adjusted payout; target allocations. Net investment returns and the remaining 25% is based on a factor designed to value-added returns for the Endowment as a whole are shown in Tables 3 and 4, respectively. A breakdown of performance by asset class is shown Table 21: Lawton Chiles Endowment Fund Assets Under Management Market Value Change by Manager in Tables A and B in the front portion of this Net Asset Value Net Contributions Investment Net Asset Value Investment Report. Account Name 6-30-06 and Transfers Gain (Loss) 6-30-07 Domestic Equities Managers - Internal Chiles Domestic Equities Portfolio $210,777,344 $(12,215,812) $41,356,494 $239,918,026 Chart 11 shows the target asset allocation for the Chiles Domestic Equities Trading 1 0 (25,886) 25,886 0 Endowment and the range of actual month-end Chiles Large Cap Index Fund 619,775,634 (9,023,971) 125,062,229 735,813,892 Enhanced Investment Technologies, LLC 257,268,987 (7,003,316) 46,882,964 297,148,635 allocations during the fiscal year. Exposures Earnest Partners Inc. 81,079,763 (38,696,389) 2,722,174 45,105,548 remained relatively close to the target allocations PanAngora Asset Management Inc. 1 0 38,860,229 8,605,421 47,465,650 Foreign Equities Managers - External 3 throughout the year. Net asset values by portfolio Barclays Global Investors-MSCI ACWI 2 29,904 (30,346) 442 0 are shown in Table 21, together with details on Capital Guardian 10,655 (10,048) 2,780 3,387 Chiles International Equities Portfolio (Acadian) 307,173,523 (45,959,606) 87,402,574 348,616,491 asset growth over the year. Fixed Income Managers - Internal Chiles Government/Corporate Portfolio 2 0 132 (132) 0 Chiles Lehman Aggregate 246,304,799 56,610,938 15,272,444 318,188,181 Fixed Income Managers - External Table 22: Lawton Chiles Endowment Fund Chiles Lehman Brothers Asset Mgt LLC 2 1,282 (597) (685) 0 External Investment Management Fees Inflation-Indexed Bonds - Internal Fiscal Year 2006-07 Inflation Linked Treasury 181,717,313 0 7,379,301 189,096,614 Real Estate Managers - External Asset Class Dollar Amount Return Basis1 Chiles Endowment Real Estate 247 (481) 234 0 Domestic Equities $872,697 0.24% AEW Capital Management 52,490,955 (11,749,832) 6,759,521 47,500,644 Foreign Equities 2 742,297 0.23% Invesco Institutional 52,686,992 (11,749,687) 7,116,098 48,053,403 Fixed Income 23,259 0.02% Cash/Short-Term Managers - Internal Real Estate 453,045 0.40% CAMP Money Market Fund 15,203,936 62,186 865,040 16,131,162 Total $2,091,298 0.23% Total Lawton Chiles Endowment $2,024,521,334 $(40,932,486) $349,452,785 $2,333,041,633 1 Return basis expresses external management fees as a percent of the average of the beginning and ending net asset value of assets 1 Account opened during the fiscal year. externally managed in each asset class. This measure is comparable to 2 Account closed during the fiscal year. an annual expense ratio. 3 International Equities asset class name changed to Foreign Equities. 2 International Equities asset class name changed to Foreign Equities. 42 S TAT E B O A R D O F A D M I N I S T R AT I O N As of June 30, 2007, the inflation-adjusted value of ■ Provide a short-term, very liquid, high-quality total contributions to the LCEF was approximately investment vehicle to participating local $1.653 billion (in 1999 dollars). The comparable governments; net asset value was $1.862 billion, or $208 million ■ Purchase securities consistent with above total contributions. In nominal terms, the Section 215.47, Florida Statutes; Fund's net asset value of $2.333 billion exceeded ■ Operate the pool as a "2a-7 like" fund using cumulative gross contributions into the Fund by the Securities and Exchange Commission $632 million. investment requirements for 2a-7 Money Market Funds as guidance; Chart 12: Local Government Investment Pool SBA Investment Pools ■ Provide liquidity to the participants on a daily Client Composition by Share of Assets basis; and The SBA currently operates four open-pool ■ Add incremental income by participating in the investment funds, including the Local Government securities lending program. Investment Pool (LGIP), the largest local govern- ment investment pool in the nation. The other The SBA manages the LGIP to be competitive with three funds constitute the CAMP, or Commingled the iMoneyNet First Tier Institutional Money Asset Management Program, and are open to Market Index and the S&P Rated LGIP 30-Day non-pension assets of all Florida governmental Yield Index. The SBA's actual net returns in excess entities. All four funds operate in essentially the of this index are termed "value-added" returns. same fashion as mutual funds. Net investment returns and value-added returns are shown in Tables 3 and 4, respectively. Short-Term Option 1: Local Government Investment Pool (LGIP) As a money market fund, the LGIP invests in The Local Government Investment Pool is open short-term, high-quality money market to all units of local government in Florida. It was instruments issued by financial institutions, established to help local governments maximize non-financial corporations, the U.S. government earnings on invested surplus funds, thereby reduc- and federal agencies. Money market instruments ing the need to impose additional taxes. The SBA must be of the highest applicable rating, while has operated the LGIP since January 1982. other eligible securities must be rated investment grade. All nongovernmental securities must As of June 30, 2007, the SBA managed approxi- have a maturity of less than 13 months. The mately $30.9 billion in the Pool, up 39.8% from maturity of obligations of the U.S. Treasury and $22.1 billion a year earlier. This change consisted U.S. agencies may not exceed two years. The clerks of the Circuit Court, sheriffs, property of $7.34 billion in net contributions and $1.47 bil- weighted average maturity of the portfolio may appraisers, tax collectors, supervisors of elections, lion in investment gains. The latter includes not exceed 90 days. Compliance with these and authorities, boards, public corporations or any other $2.9 million in securities lending income. At other investment guidelines are observed and veri- political subdivision of the state. year-end, the Pool served a larger number of local fied on a daily and monthly basis. During the government participants: 993 versus 930 a year year, the LGIP met all compliance requirements. Likely investors are those with a short-term invest- earlier. The number of accounts also increased by ment horizon where liquidity and the preservation 321 to a total of 2,336 at year-end. The LGIP is open to units of local government of capital are of primary importance. Contribution that are not state governmental entities, including and redemption transactions can be executed on a The objectives of the LGIP are as follows: counties, cities, school districts, special districts, daily basis. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 43 Table 23: Local Government Surplus Funds Trust Fund This includes state agencies and other governmen- Assets by Type as of June 30, 2007 tal entities, trusts or endowments on whose behalf Net Asset Value1 % of the SBA can make investments as provided by law 6/30/07 Total 2 or by the Florida Constitution, provided that the Pooled Accounts (LGIP) Cash $4,111,278 0.0% funds are not pension plan assets. Certificates of Deposit 2,925,520,419 9.3% Commercial Paper 9,485,738,121 30.2% Extendable Notes 6,035,884,916 19.2% Likely investors are those with a short-term Federal Agency Obligations 100,263,333 0.3% investment horizon where liquidity and the Floating/Adjustable Rate Notes 571,062,533 1.8% Liquidity Notes 11,819,030,089 37.6% preservation of capital are of primary importance. Subtotal Local Government Investment Pool $30,941,610,688 98.5% Contribution and redemption transactions can be Non-Pooled Accounts Cash $3,409 0.0% executed on a daily basis. Commercial Paper 19,933,694 0.1% Liquidity Notes 37,026,247 0.1% Repurchase Agreements 400,193,988 1.3% In addition to commingling the assets of clients Subtotal Non-Pooled Investments $457,157,338 1.5% with purely short-term investment objectives, Total Local Government Surplus Funds $31,398,768,026 100.0% the CAMP-MM Pool also invests the cash alloca- 1 Net Asset Value includes accrued interest. In addition, the Pooled Investment Account includes the Local Government Pool Securities Lending Account. tion component or residual cash for longer term, 2 Totals may not foot due to rounding. multi-asset class portfolios. The Lawton Chiles Endowment Fund, the McKnight Doctoral Assets by client type are shown in Chart 12. The objectives of the CAMP-MM are as follows: Fellowship Program, and the Division of Table 23 presents the composition of the Pool, as Blind Services are examples of multi-asset class well as other accounts within the Local Government ■ Provide a short-term, very liquid, high-quality portfolios with a cash allocation component Surplus Funds Trust Fund, by type of security. investment vehicle for non-pension assets of invested in the CAMP-MM Fund. tax-exempt Florida governmental entities, trusts Short-Term Option 2: and endowments; Intermediate-Term Option: Commingled Asset Management ■ Securities purchased are consistent with Commingled Asset Management Program – Money Market (CAMP-MM) Section 215.47, Florida Statutes; Program – Fixed Income (CAMP-FI) To better serve a variety of governmental clients, ■ Operate the CAMP-MM as a "2a-7 like" fund This commingled portfolio was established miscellaneous trust accounts and endowment using the SEC investment requirements for a in 2000 to offer clients exposure to the long-term funds with non-pension assets to invest, the SBA 2a-7 Money Market Fund as guidance; and fixed income market for non-pension funds. created a series of investment products under the ■ Provide liquidity to the participants on a Like CAMP-MM, the Money Market Pool, Commingled Asset Management Program. Each daily basis. each client participating in the Pool holds units operates in a fashion similar to mutual funds, of CAMP-FI, similar to investing in a mutual where participants hold units whose value is based CAMP-MM is managed to be competitive with the fund. on the underlying securities in the overall portfolio. iMoneyNet First Tier Institutional Money Market Index. Authorized investments may include As an intermediate-term bond fund, CAMP-FI The first of these products, created in July 1999, is obligations of the United States government and invests in a broad array of investment grade fixed CAMP-MM, a money market product for clients related agencies, repurchase agreements and income securities, including government, corporate, seeking liquidity with a focus on preservation of high-quality money market instruments. mortgage and asset-backed securities. All are capital. As of June 30, 2007, CAMP-MM consisted instruments with maturities greater than one year. of 24 client accounts with total assets valued at CAMP-MM exists to serve entities that are not CAMP-FI is a passively managed portfolio, $751.7 million, up from $683.3 million a year eligible to participate in the local government pool, currently designed to track the performance of earlier. yet seek the same type of investment opportunity. the Lehman Aggregate. 44 S TAT E B O A R D O F A D M I N I S T R AT I O N Likely investors are those seeking a high and to facilitate investment of cash flows and equitize CAMP products.4 Fees are applied on a pro-rata relatively stable level of income, but willing to cash and/or dividends receivable. basis. Note that in the future the fee structure tolerate moderate return fluctuations over time. could change. Changes in interest rates will cause volatility in the Likely investors are those seeking relatively high net asset value of the portfolio. As with any bond returns over a long investment horizon, who are Other Investment Portfolios fund, the net asset value of the Fund will decline willing to tolerate significant return fluctuations if interest rates rise. Consequently, the Fund may over time and whose return objectives strongly In addition to the large investment mandates be an inappropriate investment for investors favor capital gains over income. Stocks generally discussed earlier, the SBA's investment responsibility required to meet short-term cash needs; however, expose investors to a greater probability of extends to a wide range of smaller trust and it may be appropriate for investors that have a short-term losses than bonds or money market mandate portfolios. Assets are invested to support somewhat longer time horizon. Contribution and instruments. As a result, this fund is not suitable programs that provide supplemental retirement redemption transactions are allowed on a monthly for investors required to meet short-term cash benefits, foster economic development, make basis. needs, but it may be appropriate for investors who lottery payouts and for a variety of other special have a longer term time horizon. Contribution purposes. The portfolio structures vary in each The following were participants in the Fixed and redemption transactions are allowed on a fund, depending on the investment objectives, Income Pool during the fiscal year, with their net monthly basis. time horizon and size. asset values as of June 30, 2007: the Lawton Chiles Endowment Fund ($318.2 million); the Florida The following were participants in the Domestic PORTFOLIOS WITH SEPARATELY State University Research Foundation ($37.9 mil- Equity Pool during the fiscal year, with their net MANAGED ASSETS lion); the SBA Administrative Expense Fund asset values as of June 30, 2007: the Lawton Chiles ($28.1 million); the Pinellas Suncoast Transit Endowment Fund ($239.9 million); the Florida Bond Proceeds Trust Fund Authority ($5.9 million); and the Division of Blind State University Research Foundation ($42.7 mil- The Bond Proceeds Trust Fund is a fiduciary fund Services ($0.9 million). lion); the Division of Blind Services ($1.6 million); established to temporarily hold good faith deposits and the McKnight Doctoral Fellowship Program from brokers and underwriters of Florida Long-Term Option: ($1.1 million). government bonds received by the Division of Commingled Asset Management Program – Bond Finance. Monies are invested in U.S. Domestic Equities (CAMP-DE) SBA's Investment Management Fees Treasury securities or repurchase agreements The objective of the Domestic Equity Pool is to Table 24 shows a brief history of the SBA's invest- backed by U.S. Treasuries until the bonds are provide investment returns and risk exposures ment management fees on assets in the LGIP and issued. The proceeds are then transferred to the matching that of the Tobacco Free Russell 3000 indebted unit of government. Because the monies Table 24: SBA Commingled Investment Pool Fees Index, for non-pension client funds. It is currently reside with the SBA only briefly, the objective of Fiscal Year SBA Annual Fee managed as a purely passive portfolio with no the Fund is safety and liquidity. Due to these Pre-1998-99 2.00 basis points (0.0200%) intentional active risk relative to the benchmark. 1998-99 through 2002-03 1.75 basis points (0.0175%) restrictions, the Bond Proceeds Trust Fund is Like CAMP-MM, the Money Market Pool, each 2003-04 1.65 basis points (0.0165%) considered a nondiscretionary account. 2004-05 1.50 basis points (0.0150%) fund that participates in this pool holds units of Compliance with these terms is determined at 2005-06 1.50 basis points (0.0150%) CAMP-DE, similar to investing in a mutual fund. 2006-07 1.50 basis points (0.0150%) the time of purchase. As of June 30, 2007, the Note: No fee for 4th quarter of FY 2000-01; no fee for 2 months of market value of the Fund was $5.4 million, The Pool's portfolio is constructed to closely 4th quarter of FY 2001-02; no fee for July & August 2005; no fee for compared with no proceeds in the Fund that day May & June 2007. represent the benchmark index. Dividends and one year earlier. other internal cash flows are retained and reinvest- ed within the Fund. Index futures contract positions or Exchange Traded Funds may be used 4 Certain clients pay additional or minimum fees pursuant to a contract with the SBA based on special circumstances or for special services rendered. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 45 Burnham Institute for Medical Research Fund Periodically, the SBA acts as a trustee and escrow Government guaranteed debt. U.S. Government In 2006, the Florida Legislature approved a agent for the purpose of defeasing previously issued zero-coupon bonds (STRIPS) are currently the only $155.3 million incentive package for the Burnham debt. The proceeds of any new debt will be placed securities held in the Lottery Fund. Due to these Institute for Medical Research to establish and in an irrevocable trust fund to provide for all future restrictions, the Lottery Funds are considered operate a state-of-the-art biomedical research debt service payments of the old bonds. Due to nondiscretionary accounts. Compliance with these institution and campus in Florida and to recruit these restrictions, Debt Service Funds are consid- terms is determined at the time of purchase. world-class scientists, as well as launch an addition- ered nondiscretionary accounts. Compliance with al research program in the area of diabetes and these terms is determined at the time of purchase. As of June 30, 2007, the market value of the Fund obesity. In the fiscal year ended June 30, 2007, the was $1.29 billion. A securities lending program is SBA began administering the short-term invest- During the fiscal year, seven existing bond issues in place for Lottery Fund investments and utilized ments for Burnham. The primary investment were either partially or completely defeased as market conditions warrant. For fiscal year objective is to provide liquidity and meet the through the issuance of new debt, and two of the 2006-07, net Lottery Fund lending income totaled scheduled Burnham disbursement plan through seven were called for redemption. In addition, the $3,166,336. 2015. Authorized investments include U.S. University of South Florida deposited with the SBA, government and agency securities, investment as the escrow agent, sufficient funds to provide for Florida Hurricane Catastrophe Fund grade corporate debt and high-quality money the defeasance of the State of Florida, University of The Florida Hurricane Catastrophe Fund (CAT market instruments. The majority of the Fund is South Florida Housing Facility Revenue Bonds, Fund) provides a stable, ongoing and timely source invested in U.S. agencies with the remainder in the Series 1996A. The New College of Florida also of reimbursement to insurers for a portion of their CAMP-MM Fund. Due to these restrictions, the deposited with the SBA, as escrow agent, sufficient catastrophic hurricane losses. The CAT Fund was Burnham account is considered nondiscretionary. funds to provide for the defeasance of the New created in 1993 in response to Florida's property Compliance with these terms is determined at the College Housing Facility Revenue Bonds, Series insurance crisis resulting from Hurricane Andrew. time of purchase. As of June 30, 2007, the market 1996B and Series 1998. As of June 30, 2007, the value of the Fund was $112.9 million. market value of the Fund was $2.63 billion. In keeping with our commitment to enhancing and protecting Florida's future, the SBA recognizes the A securities lending program is in place for Department of the Lottery Fund Fund as critical to promoting the confidence of Burnham investments and utilized as market The SBA provides investment services for various residential property insurers in the Florida market. conditions warrant. For fiscal year 2006-07, net Florida Department of Lottery games. Upon writ- Our objective is to create and maintain additional Burnham lending income totaled $77,618. ten instructions, the SBA will invest prize winnings insurance capacity for residential property in equal face amounts of U.S Government or U.S. insurance in Florida. Debt Service The SBA administers Debt Service Funds for bonds Table 25: CAT Fund Net Asset Value by Fiscal Year1 issued by the Division of Bond Finance on behalf ($ Thousands) 2002-03 2003-04 2004-05 2005-06 2006-07 2 Beginning Net Asset Value $4,363,178 $4,943,166 $5,475,890 $3,314,731 $658,202 of any state agency. All monies are invested in Premium Revenue 498,151 488,459 617,043 734,720 1,202,707 a manner consistent with the provisions of the Investment Gain/(Loss) 104,906 58,102 108,658 103,325 233,905 Operating Expenses (4,066) (3,837) (3,960) (4,813) (4,935) authorizing bond resolutions and official state- Hurricane Loss 72 0 (2,821,625) (3,486,390) (1,330,397) ments. Permissible investments are limited to U.S. Emergency Assessment Revenue 0 0 0 0 94,574 Bond Proceeds 0 0 0 0 4,195,199 Treasury securities, repurchase agreements backed Bond Interest Paid 0 0 0 0 (169,461) by U.S. Treasuries and any other investments speci- Bond Trustee Fees 0 0 0 0 (5) Transfer from/(to) other funds (19,075) (10,000) (61,275) (3,371) (10,000) fied in bond indentures and approved by the Ending Net Asset Value $4,943,166 $5,475,890 $3,314,731 $658,202 $4,869,789 Division of Bond Finance. Investment maturities are dictated by the schedule of principal and 1 These amounts are reported on a cash basis. Beginning and ending asset values include cash, net market value of securities and accrued income. 2 Beginning in FY 2006-07, this schedule includes the Florida Hurricane Catastrophe Fund and the Florida Hurricane Catastrophe Fund Finance Corporation. interest payments on the various bond issues. 46 S TAT E B O A R D O F A D M I N I S T R AT I O N The Florida Hurricane Catastrophe Fund is financed tax-exempt bonds are invested in U.S. Treasury in anticipation of scheduled debt repayment are by three sources: State and Local Government Series (SLGS) invested in U.S. Treasury securities or short-term securities in order to satisfy compliance with yield repurchase agreements collateralized by U.S. ■ Reimbursement premiums charged to participat- restriction or arbitrage rebate provisions of the Treasuries. Investment maturities are dictated by ing insurers; Internal Revenue Code. The Demand Deposit the schedule of principal and interest payments on ■ Investment earnings; and SLGS are redeemed upon notification of claims the various debt issues. Due to these restrictions, ■ Emergency assessments on property and casualty from the Florida Hurricane Catastrophe Fund. the Gas Tax Clearing Fund is considered a nondis- insurers. The funds from the taxable notes are managed in a cretionary account. Compliance with these terms separate account, and the investment earnings will is determined at the time of purchase. The Gas Tax Since claims may be filed at any time following a be used to offset all, or a portion of, the interest Clearing Fund held no assets on June 30, 2007. covered event and the magnitude of the claims is cost on the taxable notes. All securities purchased Since the Gas Tax Fund operates simply as a dependent upon hurricane frequency and intensity, will be consistent with the requirements of conduit fund to distribute local gas tax collections, investment strategy for the CAT Fund emphasizes Section 215.47, Florida Statutes. The SBA manages after debt service requirements are met, the Fund highly liquid, relatively short-term investment the funds to track the 1-month London Interbank rarely holds assets at month-end. strategies. Money market instruments must be of Offered Rate (LIBOR). the highest applicable rating, while other eligible Institute of Food and Agricultural Sciences (IFAS) securities must be investment grade. Most securi- Florida Prepaid College Plan et al. Supplemental Retirement Fund ties will have a maturity of less than three years, The Florida Prepaid College Plan enables parents The SBA invests assets of the Institute of Food and although 2% may mature within three to five years. and others to fix the future cost of Florida public Agricultural Sciences (IFAS) Supplemental The weighted average maturity of the portfolio colleges at current tuition rates. The Florida Retirement Fund. The Florida Legislature created shall not exceed 365 days. Compliance with these College Investment Plan provides a tax-free way to the Fund in 1984 to supplement the retirement and other investment guidelines are observed and save for college through a variety of investment benefits of certain IFAS employees. The intent was verified on a monthly basis. As of June 30, 2007, options. Four separate funds have been estab- to provide them with a retirement benefit equal to the Florida Hurricane Catastrophe Fund invest- lished to meet the immediate obligations and what they would have received under the Florida ment portfolio met all compliance requirements. administrative expenses of these plans. Two are for Retirement System, plus Social Security (for which operations, and two are for administrative expense. Federal employees are not eligible). On June 30, 2007, the net asset value of the These are listed as items 8, 13, 32 and 33 in Table 1. Florida Hurricane Catastrophe Fund was At year-end, total assets were $530.5 million. The The Department of Management Services adminis- $4.87 billion, up from $658 million a year earlier. administrative expense account assets are invested ters the IFAS supplemental retirement benefits plan Details are shown in Table 25. in CAMP-MM, while the operating funds include for certain IFAS employees. The primary invest- separately managed assets. Due to liquidity ment objective is to provide liquidity for the Fund. A securities lending program is in place for demands, Florida Prepaid College Plan funds Authorized investments include U.S. Government CAT Fund investments and utilized as market are considered nondiscretionary accounts. and agency securities, and high-quality money mar- conditions warrant. For fiscal year 2006-07, Compliance with applicable provisions of the ket instruments. A large portion of the assets are net CAT Fund lending income totaled $32,262. mandate is determined at the time of purchase. invested in the CAMP-MM Fund. Due to liquidity demands, the IFAS Fund is considered a nondiscre- Florida Hurricane Catastrophe Gas Tax Clearing Fund tionary account. Compliance with these terms is Finance Corporation The Gas Tax Clearing Fund is a conduit for the determined at the time of purchase. In 2006, the Florida Hurricane Catastrophe distribution of debt service payments generated Finance Corporation issued tax-exempt bonds to from County Gas Tax collections and remitted to As of June 30, 2007, the market value of the IFAS fund past claims and taxable notes to pre-fund the Department of Revenue and to the Department Supplemental Retirement Fund was $17.1 million, claims for future storms. The funds from the of Highway Safety and Motor Vehicles. Funds held compared with $16.1 million a year earlier. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 47 Effective July 1, 2007, the IFAS Plan was merged invested in money market instruments of the high- Torrey Pines Institute for Molecular Studies Fund into the FRS and its assets were transferred into est applicable rating. Other eligible securities must In 2006, the Florida Legislature approved a the FRS Trust Fund. be rated investment grade. Most securities will $32 million incentive package for the Torrey Pines have a maturity of less than three years, although Institute to establish a state-of-the-art biomedical Local Government Non-Pool Funds 2% may mature within three to five years. The research institution in Florida. In the fiscal year The SBA invests funds on an individual basis for weighted average maturity of the portfolio cannot ended June 30, 2007, the SBA began administering local governments with specific needs that cannot exceed 1.5 years. The Retiree Health Insurance the short-term investments for Torrey Pines. The be met by the Local Government Pool or the Subsidy Trust Fund is also a participant in the SBA's primary investment objective is to provide liquidity CAMP products. Investment maturities and types CAMP-MM Fund. Compliance with these and and meet the scheduled Torrey Pines disbursement are dictated by the local government and executed other investment guidelines are observed and plan through 2015. Authorized investments by the SBA. Due to the restrictions, these are con- verified on a monthly basis. During the year, the include U.S. government and agency securities, sidered nondiscretionary accounts. Compliance Fund met all compliance requirements. investment grade corporate debt and high-quality with these terms is determined at the time of money market instruments. The majority of the purchase. As of June 30, 2007, the net asset value As of June 30, 2007, the market value of the Fund Fund is invested in U.S. agencies with the remain- of the Fund was $457.2 million. was $209.0 million, compared with $168.4 million der in the CAMP-MM Fund. Due to these restric- a year earlier. tions, the Torrey Pines Fund is considered a McKnight Doctoral Fellowship Program nondiscretionary account. Compliance with these The SBA manages endowment monies for the Scripps Florida Funding Corporation terms is determined at the time of purchase. As of McKnight Doctoral Fellowship Program under a In 2003, the Florida Legislature approved a June 30, 2007, the market value of the Fund was trust agreement with the Florida Education Fund, $310 million incentive package for the Scripps $24.2 million. Inc., a not-for-profit statutory corporation. The Research Institute to build a biotechnology center in program assists candidates with educational Palm Beach County. The SBA administers the A securities lending program is in place for endeavors and enhances opportunities for program short-term investments for the Scripps Florida Torrey Pines investments and utilized as market graduates to be hired for faculty positions in Funding Corporation. The primary investment conditions warrant. For fiscal year 2006-07, net Florida. The initial transfer of $9 million in objective is to provide liquidity and meet the Torrey Pines lending income totaled $12,876. securities is, at the present time, client-directed, scheduled Scripps disbursement plan through 2013. meaning that the SBA is responsible for custody of Authorized investments include U.S. government CLIENTS INVESTED SOLELY IN CAMP the securities, but not for managing them. Income and agency securities, investment grade corporate POOLED FUNDS from these assets that is not withdrawn by the debt and high-quality money market instruments. client is invested in the CAMP-MM Fund, whose The majority of the Fund is invested in U.S. agen- The SBA's investment pools include assets of investments the SBA does manage. On June 30, cies with the remainder in the CAMP-MM Fund. discretionary clients as well as those of mandated 2007, the market value of the Fellowship Program Due to these restrictions, the Scripps Florida investment funds. The following portfolios are Fund totaled $2.8 million, compared with Funding Corporation account is considered non- invested wholly within the SBA's pooled $3.1 million a year earlier. discretionary. Compliance with these terms is deter- Commingled Asset Management Program. The mined at the time of purchase. As of June 30, 2007, SBA monitors and enforces compliance with all Retiree Health Insurance Subsidy (HIS) Trust Fund the market value of the Fund was $194.8 million, investment guidelines for the CAMP pools on The Retiree Health Insurance Subsidy Trust Fund compared with $206 million a year earlier. a monthly basis. There were no compliance supports the monthly health insurance subsidy exceptions during the fiscal year. payments to retired members of state-administered A securities lending program is in place for retirement systems. Cash flow projections by the Scripps investments and utilized as market Arbitrage Compliance Trust Fund Division of Retirement guide the level of liquidity conditions warrant. For fiscal year 2006-07, One of the responsibilities of the Division of required to meet monthly obligations. Monies are net Scripps lending income totaled $173,938. Bond Finance is to ensure compliance with the 48 S TAT E B O A R D O F A D M I N I S T R AT I O N provisions of federal arbitrage laws. The objective are invested in all three CAMP pools. As of Inland Protection Financing Corporation of the Arbitrage Compliance Trust Fund is to June 30, 2007, the total value of the account was The Inland Protection Financing Corporation was maintain liquidity to fund these activities. $2.5 million. created by Florida Statute for the purpose of Investments are limited to the CAMP-MM Fund. financing the rehabilitation of petroleum contami- As of June 30, 2007, the value of the account was Florida Endowment for Vocational Rehabilitation nation sites. The Corporation, which is adminis- $2.0 million. The Florida Endowment for Vocational tratively housed within and staffed by the SBA, Rehabilitation was enacted to enhance the can issue bonds to pay claimants and is authorized Bond Fee Trust Fund opportunities for disabled citizens of Florida to to use funds from the Inland Protection Trust The Bond Fee Trust Fund financially supports the become self-supporting, productive members of Fund to pay debt service. administrative functions of the Division of Bond society. Assets are invested in the CAMP-MM Finance related to bond issuance, the Private Fund. Florida law specifies that the principal In 1998, the Corporation issued $253.3 million in Activity Bond Allocation Program and the (contributed capital) of this fund shall be bonds. Once all bonds are repaid, the Local Government Bond Disclosure Information $1,000,000 in fiscal year 2000-01, and increased Corporation's statutory responsibilities will cease Program. Investments are limited to the 5% each year thereafter. Funds in excess of the and the SBA will have no further responsibility to CAMP-MM Fund. As of June 30, 2007, the principal requirement are available to the Florida the program. Under state law, the Corporation value of the account was $1.6 million. Endowment for Vocational Rehabilitation for will terminate on July 1, 2011. expenditure. As of June 30, 2007, the value of Florida Division of Blind Services the account was $2.2 million. The funds are held and invested pursuant to a The Florida Division of Blind Services was trust agreement between the Inland Protection originally created by an act of the Florida Florida Prepaid College Foundation Financing Corporation and the SBA. Liquidity Legislature in 1941 to serve as a state board to The Florida Prepaid College Foundation was and preservation of capital are important provide services for blind persons in the state. established to accumulate tax-deductible contribu- considerations of the Fund. Currently, all assets Currently, Blind Services is under the Department tions from businesses, community groups and of the corporation are invested in CAMP-MM. of Education. Its mission is to ensure that blind individuals to fund Florida Prepaid College As of June 30, 2007, the portfolio's net asset value and visually impaired persons living in Florida scholarships. The SBA administers the short-term was $1,420. have the tools, support, and opportunity to investments for the Foundation. Assets are achieve success. Blind Services provides services invested in the CAMP-MM. As of June 30, 2007, Insurance Capital Build-Up Incentive Program to persons who are blind or have severe visual the value of the account was $9.7 million. The Insurance Capital Build-up Incentive Program impairments, and to persons who have disabling (Program) was created in 2006 and amended conditions that make it difficult to read regular Florida State University Research Foundation during the 2007 Legislative Session. The print. Services are provided through 12 district The Florida State University Research Foundation Legislature appropriated $250 million from State offices, the Division's Orientation and Adjustment (FSURF) is a not-for-profit corporation and a General Revenues. The Florida Hurricane Center for the Blind, local community rehabilita- direct-support organization of Florida State Catastrophe Fund, within the SBA, has day-to-day tion programs serving the blind, or through a local University as provided for in Section 1004.28, responsibility for the administration of the Program Center for Independent Living. In addition, the Florida Statutes. FSURF is the assignee of the which provides funding in the form of "surplus Florida Rehabilitation Council for the Blind assists University's Intellectual Property (IP) and, there- notes" to new or existing residential insurers. Blind Services in the planning and development of fore, is the fiscal agent for all activities with By law, the amount of the surplus note is not to statewide rehabilitation programs and services, respect to the commercialization of the IP. The exceed $25 million, except that the note for an and consists of 19 members appointed by the , SBA invests certain assets of FSURF under a trust insurer writing only manufactured housing policies Governor. The Council also recommends agreement, in CAMP-FI and CAMP-DE. As of may not exceed $7 million. The qualifying insurer improvements to programs and services on behalf June 30, 2007, the value of the account was must contribute new capital to support writing of Floridians with visual impairments. Assets $80.7 million. Florida residential insurance. The CAT Fund 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 49 successfully "loaned" all of the funds available to Police and Firefighters' Premium Tax Trust Fund which is simultaneously dependent upon client insurers by June 30, 2007, which was the statuto- The SBA invests assets of the Police and resource availability for investment and market rily determined deadline for expending these Firefighters' Premium Tax Trust Fund into the conditions. funds. The proceeds were entirely invested in CAMP-MM Fund. The Division of Retirement CAMP-MM. As of June 30, 2007, the value of the issues annual distributions to eligible municipali- Administrative fund balances are invested in two account was $16.3 million. ties. As of June 30, 2007, the value of the account of the SBA's commingled funds, the CAMP-MM was $203.6 million. and CAMP-FI products. As of June 30, 2007, Investment Fraud approximately one-third of the Fund was Restoration Financing Corporation Public Employee Optional Retirement Program invested in the former. The ending balance was Created by state law in 1998, this non-profit (PEORP) Administrative Fund $41.1 million. public benefits corporation financed the compen- The SBA administers the short-term investments sation of approximately 1,200 Florida citizens who for the Public Employee Optional Retirement SRI International Fund suffered security losses as a result of actions by Program (PEORP) Administrative Fund. The In 2006, the Florida Legislature approved a Guaranteed Investment Contract Government PEORP Administrative Fund was established to $20 million incentive package for SRI Securities, Inc. The market value of this fund on support the administrative (i.e., non-investment International to establish a state-of-the-art June 30, 2007 was $27,285, all of which was management) costs of the FRS Investment Plan research institution and campus in Florida invested in the CAMP-MM Fund. and the MyFRS Financial Guidance Program. focusing primarily on marine science and related Assets are invested in the CAMP-MM. As of fields. The SBA administers the short-term Pinellas Suncoast Transit Authority June 30, 2007, the value of the account was investments for SRI International. The primary The Pinellas Suncoast Transit Authority, formerly $27.8 million. investment objective is to provide liquidity and known as Central Pinellas Transit Authority meet the scheduled SRI disbursement plan (CPTA), was created by state legislation in 1970 SBA Administrative Fund through 2011. Investments are limited to the and service began in 1973 with 21 buses and The SBA's operating budget is funded through CAMP-MM Fund. As of June 30, 2007, the 9 bus routes in northern and central Pinellas investment and administrative service fees market value of the account was $13.8 million. County. In 1982, the Central Pinellas Transit charged to client trust funds under management. Authority was renamed Pinellas Suncoast Transit Additional revenues are derived from administer- Other SBA Responsibilities Authority (PSTA) to more clearly describe the ing escrowed bonds, earnings on balances in area served. Following the passage of two the Administrative Trust Fund, and other In addition to its core mission as the state's referendums, in 1984 PSTA expanded the service miscellaneous sources. For fiscal year 2007-08, long-term investment board, the SBA is area by merging with the St. Petersburg Municipal the 1.5 basis point investment management fee responsible for additional investment-related Transit System. Today, PSTA serves most of the will be continued and the service charge for functions that do not directly involve asset unincorporated area and 21 of the county's principal debt under administration will also management. 24 municipalities, which account for most of the remain unchanged at 1.0 basis point. county's population and its land area. PSTA is MYFRS FINANCIAL GUIDANCE PROGRAM governed by a 15-member Board of Directors The SBA maintains a minimum amount in appointed by local governments. The management the Administrative Trust Fund sufficient to fund The MyFRS Financial Guidance Program is a staff consists of an Executive Director and seven approximately one year of operating costs. landmark program that gives FRS members free Department Directors. In addition to passenger This budget reserve ensures business continuity and convenient access to personalized multimedia fares, funding for PSTA is obtained through ad while allowing the SBA time to adjust to adverse retirement planning services. Its goal is to provide valorem taxes, as well as state and federal grants. cash flows, such as bear markets. Revenue cash objective information to help members make Assets are invested in CAMP-FI. As of June 30, flows to the SBA are dependent upon the market informed retirement planning choices that meet 2007, the value of the account was $5.9 million. value and amount of assets under management, their individual preferences and needs. 50 S TAT E B O A R D O F A D M I N I S T R AT I O N Members receive support through four channels: Table 26 illustrates the growing demand for services of the unbiased financial planners and to log on to offered by the MyFRS Financial Guidance Program. the program website MyFRS.com to run additional ■ Print and Video – Employees have access to benefit projections using the online Choice Service. personalized statements, a 10-minute New Hire During the fiscal year, over 89,000 newly-hired video and customized, award-winning, material employees had the opportunity to choose from the The Florida Retirement System offers employees on FRS plan choice, retirement planning and two FRS retirement plans: the FRS Pension Plan, a an opportunity to choose a retirement plan that is investing for retirement. traditional defined benefit plan with six-year vest- compatible with their preferences and financial ing; or the FRS Investment Plan, a self-directed planning goals. The FRS Investment Plan was ■ Toll-free MyFRS Financial Guidance Line – defined contribution plan with one-year vesting. designed to provide a portable retirement benefit Employees can confidentially discuss their FRS Each newly-hired employee received an FRS New to help attract and retain today's mobile workforce options and retirement planning issues with Employee Enrollment Kit that consisted of a Benefit because about one-half of new FRS hires will leave experienced and objective financial planners Comparison Statement projecting benefits under their jobs before meeting the six-year requirement from Ernst & Young and counselors from the both plans, plan information on both retirement to qualify for FRS Pension Plan benefits. The FRS Florida Division of Retirement. plans, a 10-minute new hire video CD on the Pension Plan offers employees formula-based benefits offered in both plans, an investment fund pension benefits that are guaranteed for life, ■ MyFRS.com – This award-winning web portal is summary showing the available investment funds based on salary and years of service. the official FRS education website. It provides in the Investment Plan and their fees and projected FRS plan choice information and personalized returns, and an EZ Enrollment Form. New Table 27 illustrates that active enrollments in the retirement planning applications, including employees were encouraged to call the toll-free FRS Investment Plan have continued to rise during Financial Engines' Choice Services and their MyFRS Financial Guidance Line to speak with one the past three fiscal years. Enrollments in the Personal Online Advisor Service. Members can enroll and manage their FRS Pension Plan or FRS Investment Plan benefits within the portal's Table 26: MyFRS Financial Guidance Program Employee Usage FY Change From secure single-sign-on architecture. 2006-07 Prior Year Toll-Free MyFRS Guidance Line Counseling Calls 182,789 31% MyFRS.com Sessions 1,724,006 20% ■ Workshops – Ernst & Young conducts Retirement Income Forecasts 677,853 30% 90-minute FRS retirement plan choice, New Hire Choice Service 18,286 7% 2nd Election Choice Service 106,473 16% retirement planning, financial planning and Personal Online Advisor Service 132,743 15% estate planning workshops throughout Florida. Workshop Attendance 10,478 23% Personalized Printed Statements During 2006-07, four new 60-minute workshops New Hire Benefit Comparison Statements 89,238 .05% on debt management, education funding, estate Personal Retirement Forecast Statements 605,002 12% planning, and insurance planning were added. Figures include data from the MyFRS supporting organizations of Ernst & Young, Financial Engines and Enterpulse, but not from the Division of Retirement. Fiscal year 2006-07 was the third year that Personal Retirement Forecast Statements were Table 27: FRS Enrollments by Newly-Hired Employees prepared for each active member of the FRS. Defaults into Active Enrollments Active Enrollments Total Pension Plan into Pension Plan into Investment Plan* Enrollments These statements provide a retirement income Sept. 2002 – June 2003 87% 5% 8% 100% projection that includes Social Security and FRS FY 2003-04 73% 11% 16% 100% FY 2004-05 62% 17% 21% 100% benefits. They also indicate how much retirement FY 2005-06 59% 19% 22% 100% income could be needed from personal savings and FY 2006-07 59% 18% 23% 100% how much could be saved in tax-deferred accounts Rounding may prevent rows from totaling to 100%. * Includes active enrollments into the Hybrid Option. to attain reasonable income replacement goals. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 51 Pension Plan decreased slightly during the last year. The CEO directs and supervises the administrative facilities management, human resource manage- Active enrollments reflect the impact of the affairs and the operations of the two corporations. ment, purchasing, receiving, courier, mailroom, redesigned and enhanced new hire education and These two public purpose corporations work with copy center and technology infrastructure support enrollment process. the Department of Environmental Protection to services. The SBA works very closely with each finance underground petroleum tank cleanup program, interacting on a daily basis to ensure Employees who do not make an active plan projects and water pollution control project timely, accurate performance. The SBA analyzes choice are automatically enrolled in the FRS construction loans to local governments in all services and costs on a biannual basis to Pension Plan (default), but they are given one Florida, through the issuance of bonds. determine their cost effectiveness and modifies the more opportunity during their active FRS career Employees of the SBA also serve as corporate fees charged as appropriate. In both daily to switch plans. The number of members who officers and provide administrative support for the interactions and biannual reviews, the Division defaulted to the FRS Pension Plan has dropped day-to-day operation of the corporations. of Bond Finance and Florida Prepaid College 28% in the past three fiscal years. Survey data Programs have expressed high levels of indicates that as many as 41% of defaulting The SBA also serves as agent and trustee for the satisfaction with support services received. members used the default option as their active Division of Bond Finance for the administration of retirement plan choice, believing that if they all debt service funds for bonds issued by the CORPORATE GOVERNANCE knowingly defaulted there could be no mistakes Division of Bond Finance. The SBA invests the made in their plan choice. reserve funds for bonds issued by the Division of The SBA's fiduciary responsibility extends beyond Bond Finance and serves as trustee for any sinking direct investment decisions to corporate NON-FRS PLAN ASSISTANCE funds or any other funds of the bond issue, governance. Corporate governance shapes the provided no bank or trust company is designated interactions between a company's shareowners, The SBA provides prudent and cost-effective to serve in that capacity in the proceedings which board of directors, and management in an environ- investment consulting to assist the Plan authorized the issuance of the bonds. For the ment defined by the corporation's charter, bylaws, Administrators of the State of Florida Deferred issuance of refunding bonds, the SBA serves as formal policy, and rule of law. Corporate gover- Compensation Program (FDCP), the State escrow agent for the proceeds of the refunding nance focuses on the procedures and structures University System Optional Retirement Program bonds which are used to defease the refunded that investors, the suppliers of capital, rely on to (SUSORP) and the Senior Management Service bonds and, at the direction of the Division of Bond assure a reasonable return on their investment. Optional Annuity Program (SMSOAP) in fulfilling Finance, the SBA will redeem bonds prior to their Through active support of corporate governance their fiduciary responsibilities to select investment maturity date. In case of the default of any bond reforms and prudent voting of company proxies, products. During fiscal year 2006-07, the SBA issued on behalf of a state agency, the SBA the SBA works to enhance shareowner value and reviewed 14 separate proposals from Investment succeeds to the power of the state agency and support its long-term investment objectives. Providers to FDCP and SUSORP requesting new shall act on its behalf to collect the funds pledged manager hiring or termination of existing for the payment of the debt service on the bonds, The SBA strongly believes in accurate and honest managers. The SBA also participated in the including the levying and collection of taxes financial reporting practices by public companies semi-annual Investment Provider reviews pledged to the payment of the bonds. and supports the adoption of internationally conducted by FDCP. recognized governance practices for well-managed ADMINISTRATIVE SERVICES public companies including independent boards, CORPORATE OFFICER/TRUSTEE SERVICES transparent board procedures, performance-based For an annual fee, the SBA provides administrative executive compensation, accurate accounting and By statute, the Executive Director of the SBA support to the Division of Bond Finance and the audit practices, and policies covering issues such serves as the Chief Executive Officer of the Inland Florida Prepaid College Board Programs, including as succession planning and meaningful share- Protection Financing Corporation and the Florida accounting, financial reporting, accounts receiv- owner participation. The SBA also expects Water Pollution Control Financing Corporation. able, accounts payable, cash management, companies to adopt rigorous stock ownership and 52 S TAT E B O A R D O F A D M I N I S T R AT I O N retention guidelines, and annually seek on executive compensation. The 2006-07 environmental organizations and other public shareowner ratification of the external auditors. fiscal year period marks the highest level of SBA interest groups working with companies to opposition to broadly structured compensation address sustainability challenges such as global Proxy Voting plans within the last 10 years. After a thorough climate change. CERES promotes meaningful The proxy vote is a fundamental right tied to evaluation of company proposals and analysis of standards for corporate environmental reporting owning stock. The SBA has a fiduciary responsi- pay-for-performance practices, only 29.3% of all and created the Global Reporting Initiative (GRI), bility to ensure proxies are voted in the best omnibus stock plans (consisting of stock options an international standard used by companies to interest of fund participants and beneficiaries. and/or restricted stock grants) were supported disclose environmental, social and economic The SBA routinely votes proxies on all publicly across all portfolio holdings. performance. As well, the SBA joined the Investor traded equity securities held within domestic and Network on Climate Risk (INCR), coordinated internally managed international stock portfolios, Shareowner Activism by CERES, whose purpose is to promote better managed within either the defined benefit or The SBA actively monitors the governance understanding of the financial risks and invest- defined contribution plans of the Florida structures of individual companies, and we may ment opportunities posed by climate change. Retirement System. For omnibus accounts take specific action intended to prompt changes at The INCR has worked with numerous companies including open-end mutual funds utilized within those companies. For example, the SBA frequently to improve their climate policies, practices and the FRS Investment Plan, the SBA votes proxies discusses proxy voting issues and general corporate disclosure, including many of the leading oil, auto on all shares for funds that conduct annual share- governance topics directly with public companies and insurance companies. owner meetings. in which we hold shares. The SBA routinely interacts with other shareowners and groups of Transparency & Reporting To ensure that proxies are voted consistently and institutional investors to discuss significant In the interest of ensuring full transparency, the reliably, the SBA has developed a comprehensive governance topics, helping us stay abreast of issues SBA publicly discloses its proxy votes subsequent set of proxy-voting guidelines and procedures. involving specific companies and important legal to shareowner meetings and also publishes a com- These policies are updated each fiscal year as and regulatory changes. prehensive corporate governance report each year. needed and cover a wide range of financial issues, The SBA's annual governance report describes the such as director and auditor independence, board As new governance-related rules and regulatory year's corporate governance activities, including and capital structures, and the types and level of proposals are released publicly, the SBA periodically highlighted votes and significant capital-market executive compensation. submits formal comment to regulatory oversight events. The most recent annual report highlights bodies such as the Securities and Exchange SBA voting on mutual fund investments within the During the 2006-07 fiscal year, the SBA voted Commission, the New York Stock Exchange, the FRS Investment Plan, new forms of shareowner on 3,563 public company proxies covering Financial Accounting Standards Board and the activism taken by hedge funds, the impact of approximately 27,160 individual voting items. Public Company Accounting Oversight Board. securities lending on the effectiveness of share- On all proxy issues, the SBA voted for, against, During fiscal year 2006-07, the SBA submitted nine owner voting, as well as ongoing reforms to the or abstain on 76.4%, 21.9% and 1.72% of all items, formal regulatory comments on proposed reforms, director election process in U.S. capital markets. respectively. Of all votes cast, 25.2% were against including efforts to eliminate uninstructed broker the management recommended vote, reflecting an votes, enhance disclosure related to the backdating Executive Compensation increase of 2.3 percentage points above the prior of stock options, improve mutual fund governance As a major institutional investor with a long-term year. structures, and improve record date and ballot item investment horizon, the SBA has a vested interest disclosures designed for more efficient proxy voting. in improving executive compensation practices Support levels across voting topics were largely and seeks to improve the overall quality of com- stable year over year. Notably, far fewer stock Environmental Issues pensation disclosures and positively impact the option and restricted stock compensation plans In June 2007, the SBA became the newest practice of executive compensation in U.S. public were supported by the SBA due to rigorous policies member of CERES, a network of investors, companies. 2006-07 INVESTMENT REPORT INVESTMENT REVIEW 53 As a companion document to the SBA's Corporate data and evaluated 16 distinct "Compensation Governance Annual Report, in January 2007, the Efficiency Ratios" for over 2,100 U.S. companies. SBA also published a separate report focused Based on the data analysis, we concluded that exclusively on executive compensation. there is very little, if any, overall relationship between executive pay and company performance. "Perspectives on Executive Compensation" Total executive compensation does not appear to provides detailed coverage of our policies related be appropriately linked to total stock returns or to compensation disclosure, pay-for-performance return on total capital. However, total compen- analysis and other compensation policies and sation was found to be significantly related to a metrics. Our report concluded that far too many company size and industry classification. U.S. companies lack a pay-for-performance Information gleaned from this study is used to compensation framework, with large sums paid to make proxy voting decisions as well as for attract and then terminate individual CEOs, which individual company engagement. distorts any notion of pay-for-performance. To learn more about the SBA's proxy voting and As part of this report, the SBA analyzed five corporate governance activities, please visit years' worth of compensation and performance www.sbafla.com. Chart 13: Assets Under SBA Management 54 S TAT E B O A R D O F A D M I N I S T R AT I O N A B O U T T H E S B A The SBA manages, invests and safeguards assets of the Florida Retirement System Trust Fund and other funds for the State of Florida and local governments. The SBA is a non-political organization with a professional investment management staff and a strong record of delivering positive long-term returns on investment. Founded in 1943, the SBA is required to invest assets and discharge its duties in accordance with Florida law and in compliance with fiduciary standards of care. Under state law, the SBA and its staff are obliged to: • Make sound investment management decisions that are solely in the interest of Pension Plan participants and their beneficiaries; and • Make investment decisions from the perspective of subject-matter experts acting under the highest standards of professionalism and care, not merely as well-intentioned persons acting in good faith. To ensure accountability, the SBA is subject to oversight by the Board of Trustees and a variety of bodies and organizations, and follows an array of formal policies and guidelines. To learn more about the SBA, visit our website at www.sbafla.com. This year's annual report is printed on recycled paper. Front Section: 10% post-consumer fiber. Investment Review: 30% post-consumer fiber. S TAT E B O A R D O F A D M I N I S T R AT I O N 1801 Hermitage Boulevard, Suite 100 ■ Ta l l a h a s s e e , F l o r i d a 3 2 3 0 8 ■ 850-488-4406 ■ w w w. s b a f l a . c o m
Pages to are hidden for
"FLORIDA'S"Please download to view full document