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Market Summaries

September 2016

Table of Contents Domestic Equity Market Summary......................................1 International Equity Market Summary.................................3 Public Real Estate Market Summary...................................4 Private Real Estate Market Summary.................................6 Private Equity Market Summary.........................................7 Fixed Income Market Summary.........................................8 Hedge Fund Market Summary.........................................9 Private Infrastructure Market Summary............................10

Domestic Equity Market Summary September 2016

Volatility returned to the U.S. equity markets in September as most of the major indices posted gains early in the month, only to sell-off because of interest rate concerns as the prospect of the Federal Reserve (Fed) raising the discount rate in September came back into play. Hawkish commentary, particularly commentary coming from the dovish head of the Boston Fed, instigated an equity market sell-off on September 9th as the S&P 500 declined 2.5% on this day. Markets recovered in late September when the Fed did not raise rates, but the recovery was tempered by U.S. Presidential election jitters finally starting to impact equity markets. The Dow posted a loss of 0.5% to close at 18,308.15 while the S&P 500 posted a slight loss of 0.12% to close at 2,168.27. Breadth within the S&P 500 was negative in September as 233 of the components increased with an average gain of 3.6%, but this was outweighed by 270 issues falling with an average loss of 3.4%. The technology-heavy NASDAQ and small cap stocks both fared better in September. Both of these indices hit new all-time highs in September, slightly besting the marks set in August. The NASDAQ set a new high of 5,339.50 on the 22nd before it declined slightly the rest of September.

The NASDAQ posted a gain of 1.91% to close at 5,312.00. Domestically-oriented small cap stocks continued to outperform large cap stocks as the U.S. economy’s prospects were expected to remain somewhat more favorable than those of the rest of the world. The benchmark S&P 600 hit an alltime high of 765.47 on the 7th before it declined and recovered the rest of September. The S&P 600 posted a gain of 0.51% to close at 756.90. Another influence on equity markets in September was crude oil, which strengthened 6.5% in September. The strengthening helped boost energy stocks. This was largely caused by OPEC agreeing to drop cartel crude production, the first production cut in eight years. Sector breadth within the S&P 500 was also negative in September as only three of the eleven economic sectors had a positive return. Energy and Information Technology, particularly hard disk drive and semiconductor companies, led the way with both sectors rising well over two percent. Utilities were also slightly positive. Financials, Consumer Staples, and Real Estate (in its debut as a new GICS economic sector) turned in the worst returns in September. Financials declined almost three percent as the prospect of rates remaining low for a longer period of time

Benchmark Returns September 2016 Index Dow Jones Industrial Avg. S&P 500 S&P 500 Value

Price Change (%)



2168.27 938.80

Total Return (%)

Price Change (%)

Total Return (%)












S&P 500 Growth






S&P 400 Mid Cap
















S&P 600 Small Cap NASDAQ



Calendar Year To Date

Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

Domestic Equity Market Summary (Concluded) September 2016

S&P 500 Economic Sector Returns September 2016 Sector Energy Information Technology Utilities Industrials Consumer Discretionary Health Care Telecom Services Materials Consumer Staples Real Estate

Calendar Year To Date Price Change (%)

2.95 2.40 0.12 -0.27 -0.42 -0.65 -0.95 -1.48 -1.75 -1.81


Energy Telecom Services Utilities Information Technology Materials Industrials Real Estate Consumer Staples Consumer Discretionary Health Care

Price Change (%)

16.04 13.79 13.09 11.12 9.59 8.92 5.57 5.42 2.41 0.07

Daily Price Change S&P 500 Index - September 2016

Source: Bloomberg, Wall Street Journal, New York Times

Employees Retirement System of Texas • September 2016 Investment Summary • Market Comments & Risk Reports


International Equity Market Summary September 2016

The International stock markets, as measured by the Morgan Stanley Capital International (MSCI) ACWI ex U.S. Index, improved 1.0% in September, following a slight increase in August (+0.4%) and an increase in July (+4.6%). International Indices MSCI ACWI ex U.S. MSCI Europe MSCI Pacific MSCI Emerging Markets

Monthly Return % 1.0% 0.8% 1.3% 1.1%

MSCI ACWI ex U.S. - % Information Technology Materials Energy Cosumer Staples Industrials Utilities Consumer Discretionary Health Care Financials Telecom Services

3.2% 2.9% 2.3% 1.8% 0.7% 0.5% 0.4% 0.3% -0.2% -0.6%

Information Technology (3.2%) led all sectors in September, followed by Energy (2.3%) and Material (2.0%). Telecom Services (-0.6%) and

Financials (-0.2%) were the laggards. Brent crude increased 4.3% to finish at $49 a barrel. OPEC met in Algiers on September 28, 2016 and prospectively agreed to modest output cuts. EUROPE: The European Central Bank kept policy rates unchanged and did not extend its asset purchase program, which pushed yields higher and markets down. In sector movement, Technology (+4.4%) was the leader and Telecom Services (-0.8%) the laggard (-.8%). PACIFIC: Bank of Japan committed to expand the monetary base while keeping purchases at the same level and introducing quantitative easing with yield curve control. In sector movement, Consumer Staples (+6.0%) was the leader and Consumer Discretionary (-1.1%) the laggard. EMERGING MARKETS: China’s economic data continued to improve throughout the quarter. India passed the Goods and Services Tax Bill, signaling conviction in India’s 8% Gross Domestic Product growth projection. At the same time, geopolitical tensions increased as the Indian government announced strikes on terrorist camps in Pakistan occupied Kashmir. Moody’s downgraded Turkey’s credit rating to Ba1. In sector movement, Technology (+3.6%) was the leader and Utilities (-3.2%) the laggard.

MSCI Index – September 2016

Source: Bloomberg, Morgan Stanley


Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

Public Real Estate Market Summary September 2016

The global real estate securities markets, as measured by the FTSE EPRA / NAREIT Developed Index, had a volatile month and dropped 0.9% in September, following last month’s decrease of 2.6%. The markets underperformed the broader equity market (MSCI World), which gained 0.6% in September. Asia (USD +1.3%, local +0.0%) was the best performing region, which benefited from stronger foreign currencies. Continental Europe (USD -1.1%, local -2.0%), North America (-1.8%), and the United Kingdom (USD -2.5%, local -1.7%) lagged. Central bank policy continued to dominate investor sentiment. The European Central Bank left policy on hold in early September and its commentary was overall less dovish than the market expected. The U.S. Federal Reserve officials sent mixed signals regarding possible interest rate increases and global bond yields subsequently backed up and equities sold off until around mid-September. The U.S. Federal Reserve left interest rates unchanged in late September as expected and bond yields settled lower. Subsequently the global real estate securities staged a moderate recovery. In the Asia market, the Bank of Japan refrained from cutting interest rates further and instead unveiled a plan to anchor yields on 10-year bonds around zero. Sentiment toward the JREIT market was weak because of uncertainty surrounding the interest rate policy. Japan declined 0.8% in local currency terms and increased 1.3% in USD terms in September. Australia (USD -2.6%, local -2.4%) sold off in September on concerns of bond yield increases on the back of U.S. interest rate speculations. The AREIT market clawed back some of the losses in late September. Australia posted a decent second quarter Gross Domestic Product at 3.3% year-over-year. The Australian Dollar strengthened in September. Hong Kong posted a decent return of 4.0% in September. Hong Kong enjoyed a strong rally of 43% since its February lows and returned 20.0% year-todate. Further appreciation might be challenging because of concerns about rising U.S. interest rates. Singapore had a decent gain of 2.8% in September. The Singapore office names performed well thanks to the pick-up in leasing activity among the new office projects, which was better than expected. The rental decline was slower than expected while the third quarter rental markets continued to deteriorate.


FTSE EPRA/NAREIT Developed Index Country Total Return (USD) September Calendar Year Country 2016 % To Date % Norway Austria Hong Kong Singapore Netherlands Japan Spain Belgium Israel* Switzerland Ireland Canada Global France Finland USA Sweden United Kingdom Australia Germany New Zealand Italy

5.80 4.10 4.00 2.80 1.40 1.30 1.10 0.60 0.50 0.40 -0.30 -0.60 -0.90 -1.00 -1.00 -1.80 -2.10 -2.50 -2.60 -2.70 -3.00 -3.80

41.10 19.80 20.00 15.80 -1.20 8.60 -3.50 16.70 20.30 16.20 -1.00 24.10 11.00 13.10 14.50 11.60 12.90 -19.80 20.20 22.20 21.00 -18.20

*Index contains only one name. United Kingdom REITs underperformed their global peers again, which declined 2.5% in September and declined 19.8% year-to-date. The sentiment was weak with the possibility of a “hard exit” from the European Union. Continental Europe declined 1.1% in USD terms and declined 2.0% in local currency terms. The German names saw some profit taking on valuations and were among the worst performers in the region. Austria (+4.1%) was among the strongest performers in the region as the relative valuation gap widened between Austria and Germany. Italy (-3.8%) lagged in September as affected by the macro concerns of its banking sector. Spain’s news flow relatively improved, where the likelihood of a new government forming has increased.

Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

Public Real Estate Market Summary (Concluded) September 2016

T h e U . S . R E I Ts d e c l i n e d 1 . 8 % i n S e p t e m b e r a s hawkish rhetoric from several members of the Federal Reserve earlier in September prompted investors to take profits. Nevertheless, the market recovered from the lows after the Federal Reserve decided to remain on hold and left interest rates unchanged. The market continued to exhibit volatility as two of the worst performing sectors on a calendar year-to-date basis, Residential (+1.2%) and Self-Storage (+0.1%), outperformed the broader REIT market as investors sought to gain exposure to lower duration and less interest rate sensitive REIT names. The Industrial (+1.0%) and Data Center (Data Centers are within the Diversified sector, which declined 1.2% in September) REITs offered medium to long-term duration exposure. The two sectors have some of the most attractive earnings revisions trends, which was no surprise why the REIT sectors outperformed in September. The Lodging/Resorts (-9.1%) sector was the worst performing sector in September as investors looked to reduce exposure going into earnings season in October after the sector had a relief rally subsequent to a fairly resilient performance post second quarter earnings. The Healthcare (-2.1%), Retail (-2.8%), and Office (-3.0%) REITs underperformed the market.

The Retail sector came under pressure when Simon Property Group (SPG) and General Growth Properties (GGP) decided to invest capital into Aeropostale, a distressed retailer, in order to help it avoid liquidation. Although the investment was quite small relative to the market capitalization of the two Class A mall REITs, the transaction went against management messaging that demand for Class A mall space is quite robust. Despite strong quarterly earnings results (especially in the context of S&P 500 earnings revisions expectations) year-to-date and favorable supply/demand dynamics in the real estate sector, diverging central bank policy, the U.S. elections, and credit market concerns continued to create volatility in the REIT space. US Sector Total Return September Calendar Year Sector 2016 % To Date % Residential Industrial Self Storage Diversified US All Sectors Healthcare Retail Office Lodging/Resorts

1.2 1.0 0.1 -1.2 -1.8 -2.1 -2.8 -3.0 -9.1

4.0 28.9 -8.6 21.2 11.6 19.2 13.1 12.5 3.2

FTSE EPRA/NAREIT Index Daily Price Change - September 2016

Source: Bloomberg

Employees Retirement System of Texas • September 2016 Investment Summary • Market Comments & Risk Reports


Private Real Estate Market Summary September 2016

The net asset value as of September 30, 2016, was approximately $1.73 billion. For the month, the private real estate program called in approximately $35 million in capital. Since inception of the program to date, total capital called is approximately $2.3 billion. General partners returned approximately $1.3 billion in the form of income, capital gain or return of capital. The new

System did not close on any commitments in S e p t e m b e r.

The commitment target for fiscal year 2017


is $0 with a range of $0 to $250 million. The private real estate portfolio is at 6.8% of the o v e r a l l S y s t e m ’s a s s e t s , w h i c h i s j u s t b e l o w the 7% allocation. The near term focus continues to be on renewed commitments to fund managers in which the System has investments, commingled “club funds” with significant potential to drive terms and conditions, niche property sectors, co-investments, and select international i n v e s t m e n t s . S i n c e i n c e p t i o n , t h e S y s t e m ’s total commitment in the private real estate program is approximately $2.9 billion.

Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

Private Equity Market Summary September 2016

The System closed on one new investment during September (Deal 1 in the table below). The System committed $25 million through September 30, 2016. The System’s target for commitments for fiscal year 2017 is $750 million with a range of $563 million to $938 million. As of September 30, 2016, the Private Equity portfolio Net Asset Value was $2.64 billion, or 10.3% of the System’s assets.

From program inception through September 30, 2016, the System closed on 74 funds and 25 co-investments with commitments totaling $6.2 billion (adjusted for currency exchange rates). In addition, ERS holds LP Advisory Committee seats on 44 active funds and two fund LP Advisory Observer seats.

ERS Private Equity - Deals Closed During Fiscal Year 2017 Deal # 1

Fund Name Co-Investment #25

Fiscal Year 2017

Total PE Commitments - FY 2017

Geography / Strategy SS - Energy


Commitment (Local Currency) $








Footnotes: (1) Foreign exchange rates as of:

September 30, 2016





Employees Retirement System of Texas • September 2016 Investment Summary • Market Comments & Risk Reports


Fixed Income Market Summary September 2016 Economy The Citi economic surprise index declined 18 points to end at -5.10 in September, indicating that broad economic data generally missed consensus estimates. However, the data continued to show improvements in the overall economy. Investors’ expectations for a rate increase remained firm in September. The market implied probability of a December Federal Funds rate increase remained at 59% as of September 30th. Going forward the Federal Reserve will remain particularly focused on the labor market and inflation when considering whether to raise rates in December.

in rates led intermediate treasuries to outperform longer treasuries. The Intermediate Treasury Index returned 0.17% while the longer duration U.S. Treasury Index returned -0.17%. Credit returns were skewed towards riskier credit. U.S. IG Corporates returned -0.25% while Emerging Markets and High Yield returned 0.19% and 0.67%, respectively. For High Yield this marks the 8th consecutive month of positive returns. The calendar year-to-date return is 15.11%.

• Labor Market:: The U.S. economy added 156k

jobs in September, slightly below the median survey of 172k. The unemployment rate unexpectedly increased from 4.9% to 5% as there was an increase in labor force participation. The report did show continued improvement in the labor market and positions the Federal Reserve for a rate increase in December.

• Inflation: The Federal Reserve’s broader gauge

of inflation, Core PCE, met expectations of a 1.7% yearly increase. The figure marked a slight uptick from the 1.6% August number. However, the September number was still below the Federal Reserve’s 2% target.

Barclays Capital Intermediate Credit Barclays Capital Intermediate Treasury U.S. Treasury U.S. Agency Corporate Securitized U.S. Corporate High Yield Emerging Markets

Total Return September %

Total Return Calendar Year 2016 %





-0.13 0.09 -0.25 0.25

5.07 3.42 9.20 3.86





• Housing:

Existing home sales surprisingly declined 0.9% in September as a lack of supply continued to weigh on sales. Sales of new single family homes remained relatively strong and homebuilder sentiment surveys indicated builders believe conditions would continue to be supportive.

• ISM Non-Manufacturing: The ISM non-manufacturing

report showed a surge in September. The index increased to 57.1 from 51.4 and beat analyst expectations of 53. This was a positive sign for economic growth and jobs in the second half of 2016.

• Durable Goods: Durable goods orders increased 0.1% in September, the second consecutive monthly increase. This was a positive sign for the factory sector, which has struggled.

• Auto Sales: Auto sales rebounded after a month of losses as sales increased from an annualized rate of 16.91 million units to 17.7 million units.

• Retail Sales:

Retail sales experienced a disappointing 0.1% decrease in September. The negative figure highlighted the ongoing concern over consumer spending.

The Bond Markets The yield curve steepened very slightly as the 30 year key rate moved a couple basis points (bps) wider and shorter rates compressed. The 2-year note and 10year note yield spreads widened to 83 bps. The move


Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

Hedge Fund Market Summary September 2016

The Absolute Return Portfolio posted an estimated gain of +2.10% in September. The target return of 90-day T-bills + 400bps reached +0.55% over the same period.

+3.00%, +1.38%, and +1.62%, respectively. The only loss in September was in Castle Creek, a convertible bond strategy. The manager posted an estimated loss of -0.08%, respectively.

September was a mixed month across most major asset classes. Volatility remained relatively subdued and most markets traded in a range bound manner despite a Federal Open Market Committee meeting, a monetary policy decision by the European Central Bank, and concerns in the financial sector regarding a large German bank. The European Central Bank ultimately elected to keep their monetary policy unchanged while the Federal Reserve decided to keep rates on hold. The two decisions by the respective central banks caused small reversals in the underlying markets. Performance during September was positive, but mixed across strategies. Performance was led by relative value strategies such as Northwest, event driven strategies such as Taconic, and global macro strategies such as Pharo. The three managers posted estimated gains of

The graphs below indicate current and historical strategy positioning of the Absolute Return Portfolio. A clear overweight to Event Driven and Relative Value strategies remains. There is a notable underweight to Macro strategies of 9%. This underweight is below the guideline minimum weight of 10%. The underweight is both a factor of strategy return weakness as well as a deliberate underweighting of the strategy. It is the intention of the hedge fund team to cover this underweight in Q4 of 2016.

Historical Strategy Exposure

Robert Lee resigned as Director of Hedge Funds in September. Anthony Curtiss was promoted to the position of Interim Director of Hedge Funds and has taken over Robert Lee’s responsibilities. The rest of the Hedge Fund team remained unchanged.

Current Strategy Exposure

Employees Retirement System of Texas • September 2016 Investment Summary • Market Comments & Risk Reports


Private Infrastructure Market Summary September 2016

The System closed on one new transaction during September, a $100 million co-investment. The System is targeting total commitments for fiscal year 2017 of $250 million with a range of $187.5 million to $312.5 million. Since inception, Private Infrastructure closed


on ten co-investments and three funds with commitments totaling $658.1 million (adjusted for currency exchange rates). The System holds an LP Advisory Committee seat on three funds. As of September 30, 2016, the Infrastructure portfolio Net Asset Value was $348.7 million, or 1.4% of the System’s assets.

Market Comments & Risk Reports • September 2016 Investment Summary • Employees Retirement System of Texas

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