Retirement Board

APPROVED MINUTES OF SPECIAL RETIREMENT BOARD MEETING Monday, July 17, 2023 10:00 a.m. In-person Meeting for Trustees: City Hall, Laurel Conference Room Virtual Attendance Option for Consultants/ Staff/ Public 1. Call to Order The meeting was called to order by Chair Connie Rydberg at 10:01 AM 2. Roll Call Present: Connie Rydberg, Charles Collier, Kevin Knudsen, Matt Parker, Mathann Jackson and Nate Dupree Absent: Marshall Jarrett Staff Present: Cindy Mester and Shari Davidson Also Present: Mary Nye, AndCo Consulting 3. Virtual Trustee Approval: Connie Rydberg moved and Matt Parker seconded to allow Charlie Collier to attend the meeting virtually due to a medical condition that prevented his physical attendance. The motion passed 5-0-2 (One absent, Charlie Collier abstained). 4. Introductions and Welcome 5. Receipt of Petitions: none 6. Review of AndCo Consulting Defined Contribution Fund Option Selections: Research and Recommendations The Retirement Board reviewed the Investment Fund Option Information document prepared by AndCo to provide input. This was a deep dive of the qualitative and quantitative measures for each fund in the recommended Core/Passive and Active and Alternate fund categories. Two funds were revised from the May document due to working with MissionSquare and lower fee actions. Vanguard Real Estate Index added due to lower fee and Vanguard Equity Income added due to availability. The vote to approve the lineup of funds is planned for September. AndCo was tasked with determining a best-in-class proposed line-up of investment options based on the adopted Investment Policy Statement, while maintaining or reducing current participant fee structure with MissionSquare and not increasing costs to the City. The line-up they presented reduced fees on average from ~56 basis points to ~42 basis points while additionally covering the consulting fees for AndCo to be the Investment Consultant and a Fiduciary for the Plans. AndCo confirmed that this platform affords the Plan the lowest cost share class for all the funds. Participant statements will include fee visibility once all the changes are implemented. There will be a broad communication campaign to participants about the Plan changes. The AndCo proposed Funds are for the most part performing very well/above median or at Index. The management teams are all vetted and approved by AndCo. The proposed funds would be recommended by AndCo for any client and any type of Plan, and AndCo confirmed that it completed a thorough due diligence review on each fund. MissionSquare has agreed to allow these funds for the City of Falls Church. AndCo uses MorningStar and Invest Metrics, external firms’ third party databases for their analytics. All funds show returns net of fees. At next meeting, AndCo will provide fee information for each recommended fund and how that fee ranks in the applicable universe. Following are questions and comments about the proposed funds from the discussion and AndCo responses– including follow-up questions received after the meeting for completeness. Core/Passive Funds • All recommended funds are Fidelity, is that prudent? Fidelity has the lowest fees for the last few years. Prior to that Vanguard was lowest. Vanguard does not plan to undercut Fidelity again at this time. AndCo will advise if a lower price fund or class becomes available in the future. The mandate of their research group is to meet with the managers and learn about vehicle price changes. • Fidelity 500 (Large Cap) Index: tracking well to the index. Good choice. • Fidelity Mid Cap Index: tracking well to the index. • Fidelity Small Cap Index: closely tracks the applicable index. • Fidelity Total International Index: Morgan Stanley Capital International All Country World Index excluding the US Investable Market Index (MSCI ACWI Ex USA IMI) – may be including emerging markets. Will follow-up. Very closely tracks the benchmark but ranks in the bottom half of comparable funds. • Fidelity US Bond Index: tracks very well to the index, no concerns. Large Cap Value Vanguard Equity Income: • Returns look good except for the most recent 1 year – performance due to financial sector performance as a whole. Performed very well against the benchmark. Underweight in financials. Overweight energy and consumer staples. Could be individual stock selections like regional banks. Will provide more information. • In 3 years shown in table (page 9), defended well in down markets. • If this is a US fund, why allow maximum allocation to foreign exposure of up to 25% (p 5)? Not unusual to see broad guidelines outlined in prospectus. Can do American Depository Receipts – foreign security traded on US market (ADRs). Large names like Nestle and Healthcare companies out of Switzerland may be held in the portfolio. Large Cap Growth MFS Growth • Does the “Maximum Foreign Exposure = None” indicate that there is no upper limit to foreign exposure, or that no foreign exposure is allowed (p 26)? Will confirm. • What is Maximum Position Size? A single security can either be held at 5% or 1.5x the index. • MFS vs Russell 1000 Growth Index is discouraging (p 29). US Large Cap Growth space has been difficult with 90% of managers underperforming the benchmark. Index results are usually median but currently in top decile. Apple, Microsoft and a few other stocks are dominating and managers do not want to hold overweight positions – too much in  one stock. This situation is an anomaly over the last few years. AndCo looks at the handful of managers that have done well historically. • Is this the best choice versus the universe of funds (not above median until 5-year compound return)? MFS is not as aggressive as others. Will do better when the returns are from a more diversified group of stocks. Recommended due to long term track record and more conservative volatility. • What drove lower returns in 2022 (-31% vs -29% benchmark)? Did not defend in down market. Will provide more information. • Standard deviation is lower than benchmark (more conservative) but Sharpe ratio (higher is better) and Alpha (return above the index) are below benchmark. They are underweight Information Technology stocks. AndCo still recommends this as a very good fund because peers are in the same position. If they looked good over the last few years they are likely too aggressive for the long term (holding too much of very few stocks). Russell Index may have done better in 2022 due to reconstitution of what is considered growth vs value. US Mid Cap Value Victory Sycamore Established Value • Excellent metrics. • Only taking money from current clients (soft closed). Currently at capacity. Is this an issue for City of Falls Church participants? Does happen quite often because with mid and small cap because funds can only buy a small amount. Capacity comes into play. They incorporate capacity for current clients. Manager has assured AndCo that their clients can go into this fund. AndCo would be concerned if they didn’t look at capacity. • Price/Earnings Ratio (PE Ratio) (page 40) is at 17.27 vs 14.72 for the Benchmark vs (page 50) 17.14 for the Overall Index. Value PE Ratio is typically lower, surprised to see PE Ratio higher than combined Value and Growth Benchmark. Looks like a Mid-Cap Core. This is a point in time. Will provide more information. • Returns look amazing. Defending well in down markets Just want to make sure they are really value. There are different flavors of value. Style map shows them in value to core space and majority overlap of Index. Not too far to the left or aggressive. Mid Cap Growth Touchstone Mid Cap Growth - Looks good. Solid returns. Defending well in down markets. (page 63- 64). US Small Cap Value Allspring Special Small Cap Value • Points to consider (page 83) – Ownership change. Wells Fargo ownership change impact on special management team autonomy will be monitored. New entity in place for a while and teams have been maintained. • Historically very good returns but most recent 3 years isn’t great (up and down markets). Not too concerned because long term performance has been competitive. Small Cap Growth Hood River Small Cap Growth • Market Capitalization – 22% in Mid Cap vs 7% for Index (page 95). Less overlap with Index. Staying mostly true to style, but “growthier” than the Index. Still in small cap quadrant.  • Have done very well in rankings (often above the 95 percentile) Active International Equity American Funds Europacific Growth • Ranking beat the Benchmark in 9 of 10 multi-year periods analyzed (page 111), but usually near 40-50th percentile in the universe of funds. • Is there a better option for active international? Not as aggressive as benchmark – Core growth. Also includes some emerging market exposure with low fees. Long term performance is competitive. • Add to communication that this fund is International/Emerging Markets Active Fixed Income: Dodge and Cox: • Returns are strong (generally ranked in top 5 for all compounded returns – (p 133) and above median returns for all calendar years shown except 2014 – 2015 • Defended well in down markets (2013 and 2022) • Only calendar year below benchmark is 2015, and that was less than 1 percentage point below benchmark • Is there any way to assess this fund’s “style” – similar to what was done for stocks (e.g. p 120). Style shown below: • If this is a US fund, why allow allocation to foreign of up to 25% (p 130). The mutual fund prospectus has wide guidelines. – 80.7% currently in North America. Provided historical country exposure showing over 80% in US Bond. Western Core Plus • 99th in last year, at benchmark year before, often ranked number 1 in outer years. • Commentary (p 152) notes that the CIO is nearing retirement age and has had prior medical issues, but has not indicated interest in retiring. AndCo believes co-CIO will be able to effectively manage when he does retire.  • What is the difference between the investment style or approach of Dodge and Cox vs Western Core? They both list the same benchmark, peer group and investment style. Are the two similar enough that we only need only one of the two and not both? The system does not have a good benchmark/universe for core plus fixed income products so the same benchmark/universe are used. In the future, a secondary benchmark for the core plus fund will be added so there is another comparison point. Western Core Plus fund will hold more sectors e.g. bank loans, non-agency RMBS, and CMOs (thus the ‘plus’). See below for “style”. Both options are recommended. • What led to such poor returns (in comparison to peers) in 2022 (99th percentile) and 2018 (98th percentile). In 2022. overweight duration had a significant negative impact as well as high yield and bank loan exposure. In 2018, sector allocation and issue selection detracted. Additional details provided. Alternatives / Other Vanguard REIT index • Based upon the name, would assume this is a passive fund. Is it? Yes, passive fund. • In 2016 and prior, the fund tracked the stated index very closely. Since then, it has not. Has the fund switched to a different index? Yes, the benchmark has changed: MSCI US REIT Index adjusted to include a 2% cash position (Lipper Money Market Average) through April 30, 2009; MSCI US REIT Index through February 1, 2018; MSCI US Investable Market Real Estate 25/50 Transition Index through July 24, 2018; MSCI US Investable Market Real Estate 25/50 Index thereafter. Note Vanguard has historically changed benchmarks in many of their products, so this is not unusual. MissionSquare Funds: Less data is available for these funds. MissionSquare does not report their information to 3rd party databases. Need some independent analysis. MissionSquare PLUS Fund • Typical money market fund with fees about the same. • Kept it in lineup with lower share class. • What are the restrictions on a participant (if any) on withdrawing money from this fund? What are the restrictions (if any) if the Plan wanted to close entry to this fund? What happens if the plan chose to eliminate this fund?  Participate restrictions: Participants are generally restricted from directly transferring funds into competing funds like money market funds, cash management funds, other stable value products, etc. This is a moot point for the current fund lineup that are proposed as there are no competing funds. Plan Actions regarding the Fund: Generally, when a plan effectively freezes a fund (i.e. no longer allows new contributions to a fund), it is accompanied by a new alternative being added to a plan. Such a situation may impact the pricing of the plan administration (i.e. recordkeeping services) as the current pricing reflects the inclusion the MissionSquare PLUS Fund as the sole stable value investment option. Similarly, if the plan chose to eliminate the fund, this would also impact the pricing of the plan administration services being charged. Additionally, in order to receive the book value of the assets, MissionSquare would need to receive written notification of the employer’s intent to initiate the withdrawal of all or part of the plan’s assets from the PLUS fund at least 12 months in advance. • While the investment objective is to preserve capital, this is not guaranteed, correct? Correct. • This type of fund seems like it is relatively common and therefore it should be relatively straightforward to independently compare this fund to others in the peer group? Yes. MissionSquare IncomeAdvantage Fund – different kind of fund with recurring payments to help participants with distributions and making the money last throughout remaining lifetime. Higher fee product due to insurance companies managing money and lifetime income guarantee provided. • How does this fund work? When you invest you are essentially buying an annuity? If so, how does MissionSquare ensure that the annuities are competitive in the market – for example, do they run a competitive bidding process every year? Something else? Provided brochure describing the features of the product. MissionSquare can answer any follow-up questions. This product is a group annuity. The evaluation includes both an evaluation of the investments, the insurance portion, and the structure. Many annuity products are structured in such a way that costs are varied based on specific actions taken by participants. These costs could cumulate to in excess of 5%, depending on the action because they also tend to include penalties and charges for liquidating the annuity, etc. In evaluating and creating a product in this area, we prioritized the following: 1. Pricing that was clear, simple and did not vary dependent on the actions taken by the participant. 2. Provides liquidity to participants to access funds within the annuity without paying surrender charges or penalties should they need these funds. 3. Provides the ability to port the lifetime income guarantee should they change employers. In numerous discussions with other consultants, the consistent feedback is that these combination of features are relatively unique compared to what is seen in the marketplace. • Based upon the Transfer and Restrictions Section on the MissionSquare page provided, it appears a participant can pull their money out (with certain restrictions then for re-investing the money). Is that correct? Correct. Assets invested in the MissionSquare Retirement IncomeAdvantage Fund can be withdrawn at any point without any penalty or surrender charges. • The net expenses listed of 1.67% seems high. What does this cover? This covers the investment management fees along with the 1% annual guarantee fee charged by the insurer (Prudential Insurance and Annuity Company).  • Is there any return of premium feature – e.g. If a participant is concerned the could die shortly after purchasing the annuity, is there an option to select an annuity that guarantees total payments equal amount invested in an annuity? Can participants elect joint and survivor annuities, or is a single life annuity the only option? There is no return of the premium. If the participant dies shortly after purchasing the investment, the market value of the fund would pass to beneficiaries, just as it would if it were any other fund. For example, let’s say there was $500,000 in the MissionSquare Retirement IncomeAdvantage Fund when it was locked-in and the participant takes the annual income distributions that was guaranteed for life. If the participant had taken $50,000 worth of distributions, and the market hadn’t moved, then the market value of the fund remained at $450,000. In that scenario, the market value of the fund would simply be passed along to beneficiaries just like any other fund. The fund does not offer just a plain annuity where you pay $500,000 today and you get 25,000 annually in equal payments over the next 25 years. One of the benefits of this product is that even while you’re taking income distributions, if the market value of the underlying investment increases, your guaranteed annual income also increases. This remains true whether you’re in the accumulation phases or in the withdrawal phase. Recommend the committee takes the time to walk through the structure of this product. If participants are interested in a plain vanilla annuity product, shopping between the insurance companies would probably be a better alternative. When the participant decides to lock-in, they elect to have it based solely on their life or to include the spousal benefit. To elect the spousal benefit, both the participant and the spouse must be at least 55 years or older at the time of lock-in. • If we discontinued this option, are there any penalties or other hurdles? There are no penalties or hurdles to freeze or remove this investment option from the lineup. However, it should be noted that doing so essentially removes the lifetime guaranteed income for those participants that have elected this option. In other words, those participants are paying the guaranty fee currently could end up in a situation in which they paid for nothing if access to this investment option is no longer provided. Balanced Funds – Target Based Funds For the Target Date Funds, the Retirement Board asked AndCo to provide a slate of possible candidates for the Board’s consideration. As background, the Target Date funds are a series of funds that target a specific retirement date (e.g. 2030, 2035, 2040 etc.) with an asset allocation that adjusts over time. They are similar to a balanced fund but the asset allocation adjusts based on the number of years until (or since) the expected retirement date. They are a good choice for participants who don’t know how or don’t want to select different funds and asset classes to create a diversified portfolio. When an employee joins the 457 and 401a Plans, their contributions default into the QDIA, which is currently the MissionSquare Target Date Funds. They can immediately access their account and change their elections. Many employees continue to invest in the QDIA (expertly managed, already mixed asset classes). While the Plan defaults participants to the year they are expected to turn 65, employees always have the option to choose a fund based upon their actual expected retirement year (e.g. age 55). Before the Target Date Funds were added to the Plan, the default was the Balanced Funds, which is why both choices are still available in the Plans. The Board is now moving to best practice guidelines for selection and review of Target Date Funds. Documentation of the process and communication to participants are key actions. To begin the discussion, AndCo reviewed the features of Target Date funds that require Retirement Board input for determining the best fit for inclusion in the Plan as the Qualified Default Investment Alternative. The Retirement Board discussed the 4 Target Date Fund candidates presented by AndCo. (American Century, American Funds, T. Rowe Price and Vanguard) • Glide path (shift in asset allocation – becoming more conservation as time passes): Retirement Board consensus is that higher exposure to equity should go “through” the expected lifetime of the participant, not just “to” retirement date because life expectancy during retirement can be 20 years or more (page 1). In addition, in a “through” approach, the asset allocations continue to adjust after the expected retirement age (in a “to” approach the asset allocation does not change after the expected retirement date). Vanguard, American Funds and T. Rowe Price have ‘through strategies” and American Century has a “to” strategy. • Average Expense Ratio – The Retirement Board reviewed the fees of each of the 4 candidates. Vanguard uses passive funds in their TDFs, resulting in lower expenses (8 bp). In AndCo’s database, the Industry 50th percentile ranking of providers’ average expense ratio is 42 bp. American Funds is below the median at 34 bp, whereas T. Rowe and American Century are near or above the median at 41 and 47 bp respectively. Nevertheless, the 3 active TDFs have expense ratios that are relatively similar. • Actives vs Passive (index) funds - Retirement Board consensus was that active management strategies are preferable to passive (index based) due to improved flexibility during difficult times (can protect on the downside). Additionally, the non-TDF recommended Plan line-up already includes a wide range of passive index funds if participants want a mix of passive assets. All the TDF candidates are active except Vanguard. • Investment Mix: the amount of equity, fixed income and exposure to cash over time. T Rowe Price holds more equity throughout the fund lifecycle. American Century holds less equity in the middle years, but levels out to be similar to American Funds and T. Rowe in the later years. Vanguard ultimate equity allocation is lower than the other candidates (27% versus 37 – 42%). American Funds has traditionally held more cash to allow for flexibility in down markets and to accommodate required minimum distributions. • Up Capture/Down Capture (returns in excess of the index results) – AndCo provided three- year and five-year graphs that plotted up capture on the y-axis (i.e. vertical axis) and down capture on the x-axis. The ideal result is in the left quadrant of the graph – i.e. more than 100% on the up capture and less than 100% on the down capture. None of the four candidates are in the top left quadrant in both the 3-year and 5-year graphs, although American Funds has a 2 funds in the upper left quadrant in the 5-year graph. AndCo also provided the data used in the upside / downside graphs. The data table showed the average of the monthly upside or downside capture across five target dates (2010, 2020, 2030, 2040 and 2050) for both graphs. As further analysis, for the five-year graph, the Board averaged the upside and downside capture across the five target dates, and reviewed the net outcome. A higher net outcome indicates more upside capture than downside. In this analysis, American Funds has the best result. Fund Upside Downside Net American Century 101.2% 100.7% +0.5% American Funds 100.6% 96.2% +4.4%  T. Rowe 109.0% 109.2% -0.2% Vanguard 98.4% 99.6% - 1.2% • Total Return relative to standard deviation (Sharpe Ratio). AndCo provided the Sharpe Ratio for 4 target dates (2020, 2030, 2040 and 2050) across the three-year and five-year period. A higher Sharpe ratio is better (more return for level of risk taken). For the three-year table, T. Rowe had the best results for all 4 target dates. For the five-year table, American Funds had the best results for all 4 target dates. • Past performance vs AndCo median and S&P Target Date Index (no normalization for asset allocation) – AndCo provided the ranked return for each of the four candidates for 2010, 2015, 2020, 2025, … 2060 target dates, and for the 1, 3, 5, 7 and 10-year time periods. When looking at the longest time period available for each target date (10 years for all but the 2060 target date fund), American Funds was the best performer of the four candidates (often ranked 1st across all TDFs) for all target dates except the 2020 target date where it was ranked 7th and T. Rowe was ranked 1st. Other features considered: • Fund of Funds – each Fund Family has mutual funds in each major asset class and they create the Target Date Funds using their products vs. purchasing individual securities and funds. All 4 Fund Family’s under consideration are Funds of Funds. • Number of holdings • Average manager tenure • Average assets under management American Funds stands out as consistently being a top performer, and meets the Retirement Board’s key decision making criteria. American Funds is a “through” asset allocation, uses actively-managed funds, has a 5-year manager tenure, has the lowest expense ratio, and superior return, upside/downside capture, and risk/return (i.e. Sharpe Ratio) results. American Funds has strong results for each decision point. The committee agreed with AndCo’s recommendation to select the American Funds Target Date Retirement R6 as the Plans’ Target Date Funds offering. The committee also agreed that the American TDFs should serve as the Plans’ QDIA. (Please see the May 2023 meeting minutes for the rationale for selecting the TDFs as the QDIA). Comparison to Investment Policy Statement: AndCo is working to respond to the following from Chair, requested after the meeting: Has AndCo reviewed each of the recommended Options against ALL of the criteria shown in our approved Investment Policy Statement, Section 6? • Example –Is “significant cash flow” reviewed by the AndCo analysts? • Note our policy says that we will review all funds for fees (lines 279- 283) which further reinforces that the committee needs to review each fund’s fees before we adopt the funds, and that info needs to be in our analysis book and final documentation. • Has AndCo reviewed each recommended fund against the criteria listed at the top of page 7, including quarterly performance. If any of the options do not meet these criteria, and we still believe they are the best option for the plan, then we need to review the discrepancy and document why we will still move forward. In other words, we shouldn’t select new options that are expected to immediately fall below our criteria for ongoing performance analysis.  o Example: Just taking a quick look at a few sample recommendations: Western Core Plus 3 and 5 year compounded returns are below 50th percentile against its peer group, which doesn’t meet our policy. Allspring small cap 3-year compound return is below 50th percentile against its peers. What documentation are we including for why we are including options that don’t meet our criteria? Should our criteria be different – e.g. a 5-year and 7-year assessment rather than 3 and 5? • Are there any instances where the recommended fund does NOT meet any of the other criteria (i.e. the criteria other than the investment return)? o Example: Vanguard Equity Income’s 2 decision makers are listed as starting to manage the fund in 2021 – 2 years ago. How do we reconcile that with our statement (around line 260 in the IPS) that any new option must generally have a manager with a 3-year track record? If they don’t meet the 3-year guideline, where are we document this difference and why we are okay with a new option not meeting one of our guidelines? • In lines 313-321 of the IPS we list specific funds that can’t be reviewed with the “standard” process, but we don’t list the Income Advantage type option in this section. Note we do NOT use the language “such as” when listing the options needing alternative analysis, so my reading is that we can only use an alternative analysis for the actual fund types listed. Shouldn’t we include this type of fund in this section of our IPS? 8. Other business not on the agenda: Transition from Securian to USBank for payments is done. Retirees getting payments can register at USBank. Active employees should request an estimate through HR. USBank does not have a portal for active employees. Segal created new benefit spreadsheets with streamlined total average compensation calculation. Segal will generate annual statements for active participants beginning in 2024. Government staff are collaborating with School Benefits Staff on administration process (for School employees that participate in the Basic Plan). Have completed 3 months of payments through US Bank. Working with Purchasing Manager to finalize Securian termination when all data is received. Will then negotiate Memo of Agreement for going forward, pay final Securian bill and receive the residual assets currently remaining at Securian (mostly Police Plan). 9. Adjournment: Matt Parker moved and Kevin Knudsen seconded to adjourn the meeting at 12:14 PM. The motion passed 6-0-1 (One absent). THE CITY OF FALLS CHURCH IS COMMITTED TO THE LETTER AND SPIRIT OF THE AMERICANS WITH DISABILITIES ACT. TO REQUEST A REASONABLE ACCOMMODATION FOR ANY TYPE OF DISABILITY, CALL 703-248-5129, TTY711.