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San Diego County Employees Retirement Association (SDCERA)
July 21, 2011
Strategy Review
1
Biographical Information
6733_cover
David J. Blair, CFAMr. Blair is a senior vice president and account manager in the Newport Beach office. He was a member of PIMCO's municipal portfolio management team from 2006-2010 and was previously a credit analyst for 10 years at Nuveen Investments, focusing on high yield California bonds, primarily in the land-secured sector, as well as utilities, multi-family housing and toll road bonds. Mr. Blair was also an auditor and certified public accountant at Arthur Andersen for three years. He has 17 years of investment experience and holds an MBA from the University of Chicago Graduate School of Business. He holds an undergraduate degree from the University of California, Santa Barbara.
Neel KashkariMr. Kashkari is a managing director and head of new investment initiatives in the Newport Beach office. Prior to joining PIMCO in 2009, Mr. Kashkari served in the U.S. Treasury Department from 2006-2009, first as senior advisor to Secretary Henry Paulson and then as Assistant Secretary of the Treasury. In the latter role, he established and led the Office of Financial Stability and oversaw the Troubled Assets Relief Program (TARP). Before joining the Treasury Department, Mr. Kashkari was a vice president at Goldman Sachs in San Francisco, advising technology companies on financings and mergers and acquisitions. Previously, he was an aerospace engineer at TRW Corporation. He holds both bachelor's and master's degrees in engineering from the University of Illinois at Urbana-Champaign and an MBA from the Wharton School at the University of Pennsylvania.
Julie A. Meggers, CFAMs. Meggers is an executive vice president and account manager in the Newport Beach office, focusing on institutional client servicing. Prior to joining PIMCO in 2003, she was a strategic management consultant with Bain & Company. Prior to that, she was a senior auditor at Arthur Andersen and also lectured at St. Augustine University in Tanzania on auditing and cost accounting. She has 12 years of investment experience and holds an MBA from Harvard Business School. She earned undergraduate degrees from Santa Clara University and is a certified public accountant.
2 6733_cover
Agenda
I. SDCERA Objectives
II. Portfolio Performance & Positioning
III. Economic Outlook & Challenges Facing Policy Makers
IV. PIMCO Update
3
SDCERA: Objectives and Requirements
Portfolio benchmarked to 3 month LIBOR and customized to meet SDCERA’s liquidity, volatility, and return objectives
Focus keenly on risk management and limiting downside risk with the primary objectives of capital preservation and liquidity
Consistently add value through a conservative investment approach focused on diversified sources of value added
Establish an ongoing partnership with PIMCO's cash management team to facilitate a portfolio structure that is dynamically adjusted to fit SDCERA’s needs
Provide superior client service, including highly accessible professionals, proactive idea generation and customized reporting, to exceed SDCERA’s expectations
6733_ST_objectives_SDCERA
The objectives above were provided by SDCERA and there is no assurance that the portfolio or strategy will achieve its investment objectives or that the stated results will be achieved.
4
Performance Review
6733_ST_perf_retu
As of June 30, 2011
Before Fees (%) 1.2 1.2 0.9 0.3
After Fees (%) 1.1 1.1 0.9 0.3
3 Month LIBORIndex (quarterly reset) (%) 0.3 0.2 0.2 0.1
9 Mos.
SinceInception09/16/10 6 Mos. 3 Mos.
SDCERA-Short TermMarket Value at Inception: 1,597,862,714$
Contributions / Withdrawals 613,747,745
Net Investment Earnings 28,755,173
Market Value as of Jun. 2011 2,240,365,632$
5
Focus on High Quality Sources of Safe Spread
6733_ST_attrib_02
SDCERA – Short Term
SOURCE: Bloomberg Financial Markets, Barclays CapitalFinancials, Industrials, and Utilities are sub-indices of the Barclays Capital Credit Index. Agency MBS is represented by the Barclays Capital U.S. MBS index; ABS and CMBS are components of the Barclays Capital U.S. Aggregate Index; Emerging Markets is represented by the Barclays Capital Global Emerging Markets Index; EM Local is represented by JPMorgan GBI-EM Global Diversified Unhedged Index; High Yield is represented by Barclays Capital High Yield Index; BABs is represented by the Build America Bond subsector within the Barclays Capital Taxable Municipals Index.
1 Measures a portfolio’s price sensitivity relative to the benchmark to changes in the slope of the yield curve, measured between the 2-30 year Government yields, holding the 10 year yield constant. For every 1 basis point of steepening (flattening), a portfolio with curve duration of 1 year will rise (fall) in price by 1 basis point relative to the benchmark.
12/31/10 03/31/11 06/30/11
Portfolio 0.5 0.4 0.2
Index 0.3 0.3 0.3
Total Curve Duration1 0.0 0.0 -0.1
Characteristics
Effective Duration (yrs.)
* Gov't-Related may include nominal and inflation-protected Treasuries, agency debt, interest rate sw aps, Treasury futures and options, and FDIC-guaranteed corporate securities.** Other may include convertible debt, Euro/Yankee bonds and preferred stocks.
Sector Allocations - Market Value Weighted
6 4
42
23
28
16
3 6
43
17
18
22
3 6
37
5 38
38
0 0 0 0 0 0
100
0
20
40
60
80
100
Govt Related*
Mortgage Backed
Corp Dev Non-U.S.$ Emg Mkt Other** Cash & Equiv.
Perc
ent
(%)
12/31/10 03/31/11 06/30/11 3MLR
3 2 1
Currency(MV%)
Sector Yields vs. Like-Duration Treasuries
Emerging Markets
High Yield
BABs
Treasuries
UtilitiesFinancials
IndustrialsCMBS
ABSAgency MBS
EM Local
0
1
2
3
4
5
6
7
8
9
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Duration (yrs)
Yie
ld t
o W
ors
t (%
)
6
Strong Performance While Preserving High Quality Focus
SDCERA – Short Term
+
+++
+
+
2Q ‘11
Attribution
+
+++
Yield Enhancement Strategies High average portfolio quality Held fixed income securities that offered a higher yield than Treasuries
– Mortgage-Backed Securities– Investment-Grade Credit– Emerging Markets
+Currency Exposure
Held currencies which were expected to benefit from our forecast of a secular decline in the U.S. Dollar
– EM Currencies
+
Global Interest Rate Strategies Diversified interest rate exposure in bond markets where we believed yields would fall
– Duration positioning slightly longer than benchmark for most of the quarter
– Employed strategies that would benefit from rolldown
Since Inception*
Strategy
6733_ST_attrib_01
* Inception date: 09/16/10.
7
Economic Outlook & Challenges Facing Policy Makers
Where did we come from?
– The Bubble Economy
Where are we now?
– A Bumpy Journey to a New Normal
What does the future hold?
– An opportunity to enhance U.S. competitiveness
8
Increasing debt in the U.S. economy fueled increasing equity returns and higher valuations
SOURCE: Haver AnalyticsAs of December 31, 2009
Over the Past 30 Years, We Became Used to Never-Ending P/E Expansion
0
10
20
30
40
50
60
70
52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
S&
P500 P
/E
9
Nowhere were increasing asset valuations more apparent than in the housing market
Housing Valuations Kept Climbing to Unsustainable Levels
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
70 73 76 79 82 85 88 91 94 97 00 03 06 09
U.S
. H
ouse
Pri
ces
/ In
com
e
SOURCE: Haver AnalyticsAs of December 31, 2009
10
The Bubble Economy was Fueled by Ever-Increasing Debt
0%
50%
100%
150%
200%
250%
52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09
Deb
t as
% o
f U
.S.
GD
P
Federal Households Corps State/Local
26%Households 96%
62% Federal 55%
31%
Corporate 77%9%
State/Local 17%
Total Debt has increased from 128% to 245% of GDP
SOURCE: Haver AnalyticsAs of December 31, 2009
11
Then, the Bubble Economy Popped
The necessary housing correction sparked a global financial crisis
The financial system was at risk of total collapse, which could have led to another Great Depression
Governments took extraordinary actions to take the deepest risks off the table –the risks of a catastrophic overcorrection and economic meltdown
– Massive central bank liquidity
– Bank capital
– Government guarantees
– Fiscal stimulus
The heart attack was stabilized – but the patient is still recovering
– The financial crisis triggered a terrible recession with devastating unemployment
12
3-5 Year Outlook: A Bumpy Journey to a New Normal (Driving without a Spare)
Private sector deleveraging – strained government balance sheets
Slower growth
Sustained high unemployment
Reregulation
Restrained globalization
More uncertainty: flatter distribution of possible outcomes. The impossible / improbable becomes possible
Refer to Appendix for additional outlook information.
13
What Does the New Normal Mean for Investors?
Developing economies lead global growth; developed markets grow more slowly
– Look globally for the best risk-adjusted return opportunities, rather than domestically
Increased inflationary uncertainty
– Potential short-run deflation; longer-term inflation possible
Investment returns across asset classes likely to be tempered and more volatile
Substantial differentiation between regions, countries and companies
– Invest up the quality curve
Be prepared for a wide range of economic and investment outcomes
Heightened volatility can provide buying opportunities, but with it comes risk –requires better tail hedging
Refer to Appendix for additional investment strategy, outlook, and risk information.
14SOURCE: International Monetary Fund (IMF), World Economic Outlook April 2010Refer to Appendix for forecast information.
global_advantage_review_42
Average Projected Real GDP Growth During 2010-2011 (Percent)
Emerging Market Dynamism Outpacing Industrial Countries
Below 0
Between 0 and 3
Between 3 and 6
Above 6
15 global_advantage_review_39
SOURCE: International Monetary Fund (IMF), World Economic Outlook April 2010
Traditional Patterns of Indebtedness Are Being Reversed
0
25
50
75
100
125
150
Perc
ent
(%)
G20 Industrialized Countries G20 Emerging Markets
Gross Government Debt-to-GDP Ratios
20072010F2015F
Gross Government Debt-to-GDP Ratios
16
Consumers Have Begun Paying Down Debt
SOURCE: Federal Reserve Bank of New York Consumer Credit PanelAs of September 30, 2010
Consumer debt grew 172% in under 10 years. It has since fallen 7% and will take time to reach a sustainable equilibrium
$0
$2
$4
$6
$8
$10
$12
$14
99:Q
199
:Q3
00:Q
100
:Q3
01:Q
101
:Q3
02:Q
102
:Q3
03:Q
103
:Q3
04:Q
104
:Q3
05:Q
105
:Q3
06:Q
106
:Q3
07:Q
107
:Q3
08:Q
108
:Q3
09:Q
109
:Q3
10:Q
110
:Q3
Tota
l C
onsu
mer
Debt
Outs
tandin
g (
$ T
rillio
n).
Other
Student Loan
Credit Card
Auto Loan
HE Revolving
Mortgage
$4.6
$12.5
$11.6
17
What Should Policymakers Do?
Attempts to re-inflate the bubble economy will fail – the dollars eventually must be turned off:
– Ongoing stimulus to maintain consumer spending
– Tax credits to boost housing
– Temporary jobs such as the census
The bubble economy must adjust to a new fundamental equilibrium, which may include:
– Lower consumer price increases
– Lower nominal GDP growth
– Lower asset returns
Monetary policy has limitations
18
If Prices Fall, is the U.S. Headed for a Deflationary Spiral?
Not necessarily
Deflation is scary for a number of reasons:
– Traditional policy tools are of limited usefulness
– Relatively little experience for policymakers to rely upon
But there is a reason deflation is rare – demographics are a powerful force:
– A growing population is a natural countervailing force to runaway deflation
– Runaway inflation is far more common than a deflationary spiral
The demographics of Japan and the U.S. have similarities, but also important differences
19
U.S. Working-Age Population is Forecast to Continue to Grow
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
Fore
cast
ed A
nnual
Gro
wth
Rat
e of
Wor
king-
Age
Popula
tion
(15-6
4)
Japan USA China Western Europe
Japan’s working-age population has been shrinking for more than a decade. The U.S. working-age population is expected to continue growing.
SOURCE: United Nations World Population Database
20
U.S. Demographic Trends Lead to Funding Challenges Even More Than to Deflation
SOURCE: United Nations World Population Database
50%
55%
60%
65%
70%
75%
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
Perc
enta
ge
of P
opula
tion
Bet
wee
n
15 a
nd 6
4 Y
ears
Old
Japan USA China Western Europe
Japan: (13%)
Western Europe:(11%)
USA:(5%)
China:(10%)
% Reductionin forecast period
A declining percentage of the population that is working-age will strain fiscal balance sheets via entitlement programs that rely on current funding.
21
Policymakers Should Focus on Enhancing U.S. Economic Competitiveness
1. Policymakers should allow the necessary adjustment to take place, while helping families navigate through the transition:
– Unemployment benefits
– Worker retraining
2. Improve the productive capacity of the U.S. economy by investing in:
– Education
– Basic research
– Infrastructure
– And encouraging high-skilled immigration
3. Give the private sector confidence to invest and create jobs:
– Fundamental pro-growth tax reform
– Minimize regulatory uncertainty
– Control long-term deficits
It is difficult to design government policies that will quickly create sustainable jobs – the private sector needs to create them
22
Unchecked, Entitlement Spending Will Crowd Out Investment and Harm Competitiveness
SOURCE: Congressional Budget Office – Long-term Budget Outlook (June 2010)
-50
0
50
100
150
200
250
300
350
400
1800 1850 1900 1950 2000 2050
Feder
al D
ebt
Hel
d b
y th
e Pu
blic
as
% o
f G
DP
World War I
"ExtendedBaseline"
current lawno AMT
patch, or other routineadjustment
GreatDepression
"Alternative Fiscal
Scenario" continuation
ofcurrent
underlying fiscal policy
World War II
The CBO forecasts either crippling tax increases or unsustainable deficits if entitlement programs are not restructured
23
Entitlement Spending is Forecast to Grow Unsustainably
SOURCE: Congressional Budget Office – Long-term Budget Outlook (June 2010)
0
2
4
6
8
10
12
14
16
18
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
Proj
ecte
d S
pen
din
g o
n E
nti
tlem
ents
(%
of
GD
P)
Alternative Fiscal Scenario Social Security Outlays
FederalHealth Care
Spending10.9%
3.4%
Social SecuritySpending
6.2%
4.1%
Due to demographic trends and risings costs, social security and health care are expected to grow unsustainably
24
Our Political System is Capable of Making Hard Choices (Though not Often)
Although rare, the U.S. political system is capable of making unpopular decisions
– 2008 TARP was passed by Democrat and Republican leaders
– Deeply unpopular but necessary to prevent economic devastation
Fiscal crisis is more challenging than the financial crisis:
– Must make cuts before the crisis is upon us
– Bailing out the financial system violated beliefs in fairness
Three steps are necessary to tackle entitlements
– Economy needs to grow so people feel secure
– Emotional bruising from financial crisis needs to heal
– Leaders need to risk their own political fortunes to make the case for entitlement reform
Refer to Appendix for additional outlook information.
25
What are the Policy Options to Deal With Entitlements?
Means testing
Increasing the retirement age
Changing the indexation of benefits to slow their growth
Raising revenue (potentially as part of comprehensive pro-growth tax reform)
The good news is, unlike most crises, we actually see this crisis coming and the policy solutions are easy to list
The challenge is finding the will to make hard choices before we have an acute fiscal crisis
26
An Acute Fiscal Crisis Could Severely Affect U.S. Economic Competitiveness
U.S. could lose its reserve currency status and could face substantial inflation
Treasury borrowing costs could increase meaningfully
Crowding out could leave less money for other national priorities, such as infrastructure, basic research, defense, education
CBO estimates a 4% increase in Treasury rates is almost $500bn additional debt service costs by 2015
– 10X Homeland Security spending
– 5X Education spending
Once confidence in Treasuries is lost, it could take years, or longer, to return
Rapid fiscal adjustment forced by an acute crisis will be far more painful for American families than making difficult choices in advance
Refer to Appendix for additional outlook information.
27
Conclusion – A Challenge and an Opportunity to Invest in Our Future
Decades of debt accumulation went on about as long as it could
It created the conditions that triggered the terrible financial crisis of 2008
Government policies were effective in preventing another Great Depression, but there are limits to what governments can quickly do to sustainably boost economic growth and create jobs
In the Bumpy Journey to a New Normal, we will see continued deleveraging and modest economic growth and asset appreciation. There are no quick, easy solutions
Rather, policymakers should focus on taking structural actions to enhance U.S. economic competitiveness
– Investing in people, research and infrastructure
– Controlling runaway deficits
– Implementing pro-growth tax reform
We have an opportunity. Do we have the political will to take advantage of it?
Refer to Appendix for additional outlook information.
28 1cs_pimco_update_04
PIMCO Snapshot
Global Presence
People
HistoryFounded in 1971
Specialty fixed income manager
Assets under management:
employees: investment professionalstechnical and support
Highly experienced Experience at PIMCO– All investment professionals
– Senior professionals
1,748
13 7
19 7
Average Years
As of March 31, 2011
Newport BeachIP’s: 261
New YorkIP’s: 62
TorontoIP’s: 6
LondonIP’s: 71 Munich
IP’s: 50
SingaporeIP’s: 7
Hong KongIP’s: 6 Tokyo
IP’s: 20
SydneyIP’s: 8
ZurichIP’s: 4
AmsterdamIP’s: 1
$ 1,282.2 B
1,252496
29
PIMCO Continues to Enhance Services and Resources to Meet Client Needs
1cs_pimco_update_01
As of March 31, 2011
Newport Beach Seminars– 2-day Fundamentals
– 5-day Investment Seminars
– Both sessions available in June and September
Regional Offerings
Topical Conference Calls
PIMCO Institute Educational Programs Robust Recruitment of Top Talent
Global EquityAnne Gudefin
20 years experienceCharles Lahr
16 years experience
Emerging Markets Equity
Masha Gordon 13 years experience
Client Analytics– Simple and accessible reporting
– Breakdown of allocation and assumptions
– Summary of factors and volatility
Product Solutions– Existing and customized
– Evaluation of impact on allocation
Solutions by Client-type, and Allocation Goals
– Liability Driven Investing
– Retirement, including Target Date
– Inflation and Rising Rates
– Portfolio and Tail Risk Hedging
Risk Factor Analysis– Customized analysis of target asset
allocation
– Decompose and identify sources of portfolio risk
– Focused portfolio analysis
PIMCO Solutions
30 6733_pimco_orga_assets_01
Assets Under Management by Strategy
PIMCO’s expertise spans asset classes to provide effective solutions that meet investor needs
Potential differences in asset totals are due to rounding. * Stable Value assets have not been netted from U.S. Total Return, US Moderate Duration and U.S. Low Duration assets. Total Stable Value assets equal $28.8 B
As of March 31, 2011
Alternative Absolute Return Strategies Long/short or unconstrained bond strategies, benchmarked to LIBOR indices $34.63Investments: Commodities Commodity-linked exposures enhanced with active bond portfolios 30.88
Real Estate Real Estate-linked exposure backed by inflation index bonds 0.22CBO / CLO Collateralized bonds / loan obligations 5.93
Asset Allocation: Asset Allocation Strategies Global Multi Asset, All Asset, All Asset All Authority 41.17
Equities: StocksPLUS® Combines derivatives-based equity exposure with active bond management 17.28Pathfinder Global and Europe - only deep value equity strategy 1.33
Fixed Intermediate* Total Return, Moderate Duration 510.5Income: Cash Management* Money Market, Short-Term, Low Duration 107.79
Long Duration Focus on long-term bonds; asset liability management 85.85Real Return TIPS and other inflation-hedging strategies 68.54Credit Investment Grade Corporates, High Yield 125.92Mortgages Emphasis on management of mortgage pass-throughs 42.88Global Non-U.S. and global multiple currency formats 104.53Emerging Markets Emerging market debt, EM local currency, active EM currency 48.63Diversified Income Global credit combining corporate and emerging markets debt 21.30Municipals Tax-efficient total return management 12.55Other 22.27
Total Assets Under Management: $ 1,282.29 B