Inflation Portfolio Review...2021/02/24 · Role in the Portfolio 2 • Provide some degree of...

Inflation Portfolio ReviewFebruary 24, 2021

Investment Management Division

Role in the Portfolio

2

• Provide some degree of protection against the risks associated with inflation

Inflation Protection

• Provide an attractive return over the long-term by making investments that provide a nominal total return that rises with inflation

Attractive Absolute Returns

• Achieve or exceed the return on the performance benchmark over a long period of time, within reasonable risk parameters

Competitive Relative Returns

• Enhance the diversification of the Fund’s total investment portfolio relative to public equity and nominal fixed income

Diversification

• Provide a source of liquidity to the Fund when other Portfolios are experiencing lower returns due to unanticipated inflation

Liquidity

Source: Investment Policy Statement for North Carolina Retirement Systems, November 1, 2020


3

• Inflation Sensitive Portfolio diversification has expanded substantially• 24 managers and 47 funds / co-investments

Historical Allocation by Sub-Strategy

Note: Information is based on market value

Portfolio HistoryAs of December 31, 2020

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

$ M

illio

ns

Inflation-Linked Bonds Publicly Traded Natural Resources Energy

Private Natural Resources Lending Timber Infrastructure

Liquid Diversifiers Real Assets Real Asset Lending

Inflation Sensitive as % of Total Plan


4

Historical New Commitments by Component and Total Unfunded

Portfolio HistoryAs of December 31, 2020

Note: Unfunded values are as of each respective calendar year end

300

988

1690

1,015

1,733

541

1,610

2,244

973

600

0

950

500

0 $-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

$ M

illio

ns

Inflation-Linked Bonds Publicly Traded Natural Resources Private Natural Resources

Other Real Assets and Diversifiers Total New Commitments Ending Total Unfunded


Current Portfolio AllocationAs of December 31, 2020

5

24%

4%

8%

16%18%

12%

0%

17%2%

24%

4%

41%

31%

Inflation-Linked Bonds

Publicly Traded Natural Resources

Energy

Private Natural Resources Lending

Timber

Infrastructure

Liquid Diversifiers

Real Assets

Real Asset Lending

Note: Information is based on market value

Components (Outer): Sub-Strategies (Inner):

Allocation by Component and Sub-Strategy


Portfolio PerformanceAs of December 31, 2020

6

Notes: Periods greater than one year are annualizedSee slide 28 for details on the composition of the Inflation Sensitive Benchmark

Calendar Year Performance

Annualized Performance

-3.5%

1.7%

4.0%

1.3%0.3%

-1.2%

0.7%1.6%

2.8%

0.4%

-0.6% -0.4%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

1 Year 3 Year 5 Year 7 Year 10 Year Since June 2009

Inflation Sensitive Inflation Sensitive Benchmark

7.2% 7.5% 6.9%

2.1%

-3.5%

5.1% 4.2%2.2% 2.1%

0.7%

-6%-4%-2%0%2%4%6%8%

10%

Inflation Sensitive Inflation Sensitive Benchmark


-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

1 Year 3 Year 5 Year 7 Year 10 Year Since June 2009

Inflation-Linked Bonds Publicly Traded Nat. Res. Private Natural Resources Other RA & Diversifiers

ICE BofAML 1-3 Year U.S. TIPS Bloomberg Commodities Private Natural Resources Bench. Other RA & Diversifiers Bench.


7

Performance by Component

Notes: Periods greater than one year are annualizedSee slide 28 for details on the composition of the Inflation Sensitive Benchmark


Public Market Performance ComparisonsAs of December 31, 2020

8

Calendar Year 2020 Q1 Q2 Q3 Q4

S&P 500 18.39 -19.60 20.54 8.93 12.14

S&P 500 Energy -33.68 -50.45 30.51 -19.72 27.76

Bloomberg Commodities Index -3.50 -23.53 5.04 9.04 10.17

Bloomberg Barclays High Yield Energy -0.34 -38.94 40.01 2.88 13.30

Bloomberg Barclays High Yield 7.11 -12.68 10.18 4.60 6.45

Bloomberg Barclays 1-3 Year TIPS 3.81 -1.34 2.51 1.43 1.89

Bloomberg Barclays 5-10 Year TIPS 11.48 1.41 4.69 3.21 1.74

Bloomberg Barclays 5-10 Year Treasuries 9.09 8.66 0.86 0.35 -0.81


Inflation Sensitive Benchmark CompositionAs of December 31, 2020

9

Long-Term Target Benchmark Benchmark Composition by Current Market Weight

Note: See slide 28 for details on the composition of the Inflation Sensitive Benchmark

ICE BofAML 1-3 Year U.S. TIPS

33%

Bloomberg Commodity

Index 17%

Dynamic Blended Sub-Benchmark

50%

ICE BofAML 1-3 Year U.S. TIPS

24%

Bloomberg Commodity

Index 4%

ICE BofAML 5-10 Year U.S.

TIPS29%

NCREIF Timberland

Index18%

Private iQ Infrastructure

Index13%

Private iQ Energy Index

10%

NCREIF HFRI ODCE Index

3%


Portfolio LiquidityAs of December 31, 2020

10

Market Value

Note: Level 1 Liquidity = T+3; Level 2 = T+3 to 12 Months; Level 3 = 12 to 24 Months; Level 4 = Greater than 24 Months

Market Value + Unfunded

Level 15%

Level 223%

Level 31%

Level 471%

Level 14%

Level 218%

Level 31%

Level 477%


Current Inflation Environment

11Source: Minutes of the Federal Open Market Committee; December 15-16, 2020

Federal Reserve’s uncertainty around growth and inflation remain elevated



12

Inflation Breakeven Rates

CPI Year over Year Change

1.4%

Source: Federal Reserve Bank of St. Louis

2.1%2.1%

1.4%

A widening gap between breakeven expectations and CPI may suggest a convergence to come

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Headline CPI Core CPI

0.00

0.50

1.00

1.50

2.00

2.50

3.00

10-Year Breakeven 5-Year Breakeven


Current Inflation Environment: Labor

13Source: Federal Reserve Bank of St. Louis

Vacancies vs. Unemployment

Average Hourly Earnings – YoY Change

5.4%

Despite the initial pullback, the labor market appears to be fairly tight again overall

Average Weekly Hours – Private Sector

0.0

5.0

10.0

15.0

20.0

0

2,000

4,000

6,000

8,000

Total Nonfarm Job Openings (Thousands) Unemployment Rate (%)

0.0

2.0

4.0

6.0

8.0

10.0

33.633.834.034.234.434.634.835.035.2


Housing Market Review

Sources: Federal Reserve Bank of St. Louis, Bloomberg

U.S. Months’ Supply of Houses

9.5%

Housing Affordability Index

Home Price Appreciation

U.S. Household Owners’ Equity in Real Estate

5,0007,500

10,00012,50015,00017,50020,00022,50025,000

Billi

ons o

f Dol

lars

3.0

5.0

7.0

9.0

11.0

13.0

Mon

ths'

Supp

ly

-20-1001020

050

100150200250

S&P/Case-Shiller U.S. National Home Price Index

Year Over Year Change (%)

Housing is supported by constrained supply and low rates, boosting household balance sheets

14

5075

100125150175200225



15

Commodity prices have rallied back strongly and demand has caused some supply disruptions

-60

-40

-20

0

20

40

60

80

100

0

1

2

3

4

5

6

Natural Gas (Left) WTI Crude (Right)

0

200

400

600

800

1,000

1,200

0

50

100

150

200

250

300

350

400

Copper (Left) Lumber (Right)

Source: Bloomberg



16

5,000

6,500

8,000

9,500

11,000

12,500

14,000

15,500

17,000

18,500

20,000

80

85

90

95

100

105

110

115

120

125

130

Billi

ons o

f Dol

lars

Trade Weighted U.S. Dollar Broad Index (Left) M2 (Right)

Unprecedented levels of liquidity have weakened the Dollar, which may lead inflation higher and should continue to be supportive of commodity prices and real asset valuations


Risks to the Current Inflationary Outlook

17

Downward Pressure

• Technological advancement

• Innovation in the Global Supply Chain (i.e., E-commerce, operational efficiency)

• U.S. Energy Independence

Uncertain

• Geopolitical unrest• New fiscal policies• Unresolved U.S./China

Trade War• Further economic

impact from the Coronavirus

• K-Shaped Recovery

Upward Pressure

• Federal Reserve and Central Banks remain accommodative

• US Housing Demand• Recovering / tightening

labor market• Supply Chain

Disruptions• Weaker Dollar• Potential Increased

Regulatory Environment


Strategic Considerations for 2021

1) Rationalize current manager lineup; focus on high conviction opportunities

2) Maintain vintage and strategy diversification

3) Add strategies that are linked to inflation where there are currently gaps in the portfolio combined with opportunities for attractive valuations

18


Strategies of Interest for 2021

19

Energy

• Energy Transition

• Renewables• Storage &

Intermittency Management

• Private debt across multiple sectors

• Midstream

Technology & Data

• Cell Towers• Data Centers• Fiber• Music

Royalties

Logistics and Other Essential Infrastructure

• Transportation (i.e., leasing assets)

• Storage• Traditional

Infrastructure• Real Asset

Focused Secondaries

• Agriculture

Health Care

• Dental• Vision• Primary Care• Veterinarian• Drug Royalties • Real Estate for

Medical Practices

Real Estate

• Single Family Rentals

• REITS• RMBS• Residential

Whole Loans• Timberland

Research Alternative

Stores of Value

• Currencies• Gold• Silver• Industrial

Metals & Mining


Team Overview

20

Ronald Funderburk, CFADirector

12 years with IMD

16 Years Industry Experience

Ty Powers, CFAPortfolio Manager

4 years with IMD


Renee Guerin, CFAPortfolio Manager

4 years with IMD



Appendix

21


Impact of K-Shaped Recovery Unknown

22Source: https://tracktherecovery.org/



23

Inflation Surprise Index

Source: Bloomberg

-50.00

-40.00

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

Major Economies United States


CPI Composition

24Source: U.S. Bureau of Labor Statistics (BLS), as of November 30, 2020

All Urban Consumers (CPI-U) U.S. Average

42%

15%

15%

9%

7%

6%3% 3%

Housing

Transportation

Food and Beverages

Medical Care

Education and Communication

Recreation

Other Goods and Services

Apparel


Portfolio History

25*Source: BofA Merrill Lynch, used with permission; see disclaimer on page 23

June 2009

• Legacy investments from PE & RE Portfolio (No new investments)• Campbell timber written down by 30% in Sept 2010

• Added Private Natural Resources

• Added diversifying strategies• Natural Resources Direct

Lending• Infrastructure• Other real assets (railcars,

copyrights, etc)

Phase 1 Phase 2 Phase 3

• Commodity futures investments ($2.1 billion) made over 10 month period to four different managers

Long Commodities allocation as a diversifier for the broader Plan

Diversified Real Asset Portfolio with

Commodities focusPortfolio Goal:

Benchmark: CPI + 300 bpDynamically weighted;

Bloomberg Commodities Index + Cambridge Energy Index

Key Events:

January 2011 July 2011 July 2014

Phase 4

33% BoAML 1-3 Year US TIPS Index* + 17% Bloomberg Commodities

Index + 50% dynamically weighted combination of benchmarks of

investments classified as Private Natural resources or Other Real

Assets and Diversifiers

• Allocation target changed from 4.5% to 6.0%• Sub-strategies expanded to include Inflation Linked Bonds• Reduced Public Natural Resources• All legacy asset history moved into Portfolio; Timber assets moved into the Portfolio

Diversified Inflation Sensitive Portfolio


Inflation Portfolio IRR by Vintage YearAs of December 31, 2020

26

Vintage Year Inflation-Linked Bonds

Publicly Traded Natural Resources

Private Natural Resources

Other Real Assets and Diversifiers All

1993 - - 9.38 - 9.38

2006 - - 0.32 - 0.32

2007 - - -8.19 - -8.19

2008 - - -6.29 - -6.29

2010 - -7.19 -29.36 - -9.16

2011 - -10.33 -1.75 3.22 -6.62

2012 - - 3.41 7.70 5.44

2013 - - 1.92 6.91 5.70

2014 - -3.98 6.73 8.48 6.68

2015 1.44 - 5.93 11.17 4.75

2016 4.07 - - - 4.07

2017 - - -3.48 - -3.48

2018 - - - 18.24 18.24

2019 - - 36.90 - 36.51

2020 - - - - -

All 3.64 -8.35 0.77 7.39 0.79



27Note: Correlation data is based on quarterly return data

Inflation Sensitive Portfolio Correlation

Total Pension Plan Public Equity Private Equity Non-Core

Real EstateOpportunistic Fixed Income

Investment Grade Fixed

Income

Core Real Estate

Multi-Strategy

3-Year Correlation 0.12 0.02 0.77 0.51 0.79 (0.65) 0.59 0.38

5-Year Correlation 0.17 0.06 0.54 0.45 0.82 (0.57) 0.55 0.44


Notes:All data presented are based on currently available information at time of publication and may be revised subsequently.

The Inflation Sensitive Benchmark is the dynamically weighted combination of the ICE Bank of America Merrill Lynch 1-3 Years U.S. Inflation-Linked Treasury Index (Inflation-Linked Bonds)*, the Bloomberg Commodities Index (Public Natural Resources), and a combination of the benchmarks of investments classified within Private Natural Resources or Other Real Assets and Diversifiers.

The Private Natural Resources Benchmark is the dynamically weighted combination of the benchmarks of investments classified within Private Natural Resources.

The Other Real Assets and Diversifiers Benchmark is the dynamically weighted combination of the benchmarks of investments classified within Other Real Assets and Diversifiers.

The Inflation Sensitive asset class (G.S. 147-69.2(b)(9a)) was created by the General Assembly in June 2009. It included some investments that were previously authorized under other provisions of G.S. 147-69.2.

*Source: BofA Merrill Lynch, used with permission. See disclaimer on next page.

28


DisclaimerBOFA MERRILL LYNCH IS LICENSING THE BOFA MERRILL LYNCH INDICES “AS IS,” MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THESUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE BOFAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVEDTHEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THEIR USE, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND THE DEPARTMENT OFSTATE TREASURER, OR ANY OF ITS PRODUCTS OR SERVICES.

29

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