SONOMA COUNTY RETIREMENT BOARD

INVESTMENT COMMITTEE MINUTES

Wednesday, May 16, 2012

8:35 A.M.

Presiding: Chair Jerry Allen presided.

Present: Trustees Al Alys, Dianne Edwards, Tom Ford (left at 11:40 A.M.),
Greg Jahn, David Rabbitt, and David Sundstrom; Retirement
Administrator Gary Bei, Assistant Administrator Kelly Jenkins, Senior
Retirement Investment Officer Jim Failor, and Administrative Aide
Jennifer Howze.

Also Present: Principal John Lee and Senior Consultant Shane Schurter of Hewitt
EnnisKnupp; Co-Portfolio Manager Kathy Malitz and Product
Specialist Ted Koros of BlackRock Realty (both left at 9:38 A.M.);
and Partner Edward O’Reilly of Capula Investment Management
(arrived at 9:18 A.M. and departed at 10:55 A.M.).

Absent: Trustees Donna Beels, Kiergan Pegg and Kimber Williams.

I. MINUTES APPROVAL:
APPROVAL OF APRIL 11, 2012 MINUTES.

APPROVED as per the following:

Ayes 7 Noes 0 Abstain 0 Absent 2

II. PRESENTATIONS:
A. BlackRock Realty - Co-Portfolio Manager Kathy Malitz and Product Specialist
Ted Koros presented an update on the organization, the Granite Property Fund’s
positioning and performance, and the firm’s market outlook. Mr. Koros
introduced Ms. Malitz who was added to the portfolio management team on the
Granite Fund since BlackRock’s last meeting with SCERA’s Investment
Committee. It was noted that Ms. Malitz has worked with the other co-Portfolio
Manager on the Granite Fund, Andrew Piekarski, for 10 years. Prior to working
on the Granite Fund Ms. Malitz has managed other funds and separate account
real estate portfolios at BlackRock. In response to a staff request, BlackRock
reviewed the history of the Granite Fund noting that style drift had led to higher
leverage which was exacerbated from valuation write-downs and the use of
forward commitments with committed purchase prices established near the height
of the commercial real estate market. This higher leverage and the write-down of
forward commitments led to underperformance relative to peers in 2008 and
2009. The new portfolio management team since that time has realigned the
portfolio and moved the structure to be closer to that of other core real estate
funds with lower leverage and currently no use of forward commitments. Ms.
Malitz also reviewed how forward commitments would be used more
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SONOMA COUNTY RETIREMENT BOARD
INVESTMENT COMMITTEE MINUTES
May 16, 2012

II. PRESENTATIONS, cont.:

A. BlackRock Realty, cont.:

conservatively in the future, with a max exposure of 5%, if ever. Comment was
also made that they have looked very closely at their risk management constraints
and have tightened these limitations considerably. The BlackRock team claimed
that in three quarters, when 2009 drops off, their three year track record should be
strong on both an absolute basis and relative to peers.

Mr. Koros provided an update on the firm, noting BlackRock’s $3.7 trillion in
assets under management (AUM), 24 investment centers and offices in 67 cities
and 27 countries. Regarding BlackRock Realty, the organization manages both
public and private equity as well as debt and has $13.5 billion in AUM. He
emphasized the real estate group’s emphasis on major markets such as New York
City, Boston and San Francisco as well as the strong integration between market
research and portfolio management. Mr. Koros went on to review the US market,
including commercial real estate’s outperformance over the other major asset
classes in 2011 and the stronger performance of the apartment sector over other
commercial real estate sectors. He commented that Apartments have largely
recovered from the downturn but other sectors have further to go. The unevenness
by geographic region through the recovery was also discussed, noting that the
coastal markets have been the strongest. BlackRock expects continued
unevenness but total unlevered annualized US real estate returns in the 7%-9%
range over the next 3 years. Comment was also made that the real estate drop and
recovery thus far has been much faster than during the last cycle in the 1990s as
appraisers have been quicker to adjust property appraisals. They also discussed
the challenges to the continued recovery in real estate, including the slow
economic recovery in the US and the continued Euro crisis. Factors supporting
the real estate were also discussed including the flow of capital into the asset class
and the low level of construction which should cause even a modest increase in
demand to push pricing up. Debt issuance problems relating to commercial real
estate (CRE) were reviewed including the $1 trillion of CRE debt maturing in the
next 3 years, new regulations making it less profitable to lend and other problems
relating to previous excesses in real estate lending.

Ms. Malitz went on to review the Granite Fund. In reviewing the composition of
the Funds’ portfolio she discussed the geographical distribution, which is largely
coastal and urban, and the sector diversification which is 37% Office, 23%
Apartments, 23% Retail and 15% Industrial. Ms. Malitz reviewed the Fund’s
strategy which includes emphasizing the income component of the total return,
20%-30% leverage, overweighting major/primary coastal and urban markets and
submarkets and emphasizing sub-types Central Business District Office, Urban
Apartments, Trade Industrial and Necessity Retail. The team has worked hard to
increase the occupancy of the Fund over the last couple of years with the
occupancy currently at 91.2% versus the ODCE peer universe at 89.6%. The Fund
currently has 4% in non-core assets. Ms. Malitz reviewed performance which has
been strong on an absolute basis and above the ODCE universe for the last two
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II. PRESENTATIONS, cont.:

A. BlackRock Realty, cont.:

years but under the ODCE universe and slightly negative over three and five years
due to the downturn in 2008/09 and the impact of leverage and forward
commitments as discussed above. She went on to discuss property type and sub-
type positioning in further detail giving examples of those sub-types the Fund is
emphasizing. It was also stated that the Fund has 83% of their investments in
major markets while the peer universe has 73% in such markets. BlackRock
expects the major markets to continue to recover more strongly as the economy
gains momentum. The structure of the Granite Fund’s debt was reviewed,
including loan maturities and the types of loans such as floating versus fixed-rate.
Ms. Malitz reviewed the history of the Fund’s leverage, noting that the Fund’s
loan-to-value measure reached a maximum of 44% in the third quarter of 2009, is
30% currently, and is planned to be well down into the 20s in the next several
quarters. First quarter dispositions were reviewed which were at prices close to
their most recent appraisals and which helped reduce the Funds overall leverage.
Last, Ms. Malitz commented on a New York City office property which is being
acquired and already has a buyer at a price that will realize a significant gain. Mr.
Koros and Ms. Malitz were thanked for their presentation. After BlackRock left
the meeting comments were made confirming satisfaction with the move to a
more conservative investment strategy for the Granite Fund, consistent with other
core real estate funds. There was, however, no suggestion to modify SCERA’s
plan for a full redemption from the Granite Fund.

B. Capula Investment Management – Edward O’Reilly, Partner and Managing

Director presented on the management of the firm’s global macro hedge and tail
risk strategies. Mr. O’Reilly introduced himself and his firm, commenting that the
company is based in Greenwich Connecticut, that it was founded by Yan Huo in
2005 and that most of the investment team has been working together for 15
years. Capula has four main products including their Tail Risk Fund with $2.3
billion in assets under management (AUM) and their flagship product the Global
Relative Value (GRV) Fund with $6.9 billion in AUM.

The GRV Fund has delivered an annualized return of 11.7% since 2005 with an
annualized volatility of 5.2% and a Sharpe Ratio of 1.75. Mr. O’Reilly discussed
macro trading, the type of trading employed by the GRV Fund, more generally
commenting that guidelines are typically very broad and they trade in a wide
variety of instruments including fixed income, currencies and commodities in
both developed and emerging markets. At Capula liquidity of the instruments
used is especially important and their trading is driven by research on shorter-term
issues such as market movements. The positions they take are not generally
company specific. For Capula’s GRV Fund bond positions turnover in a number
of days to months but average approximately 15-20 days. He also commented that
they put great emphasis on risk management given the wide latitude in the
investment guidelines. Regarding risk management Mr. O’Reilly stated that there
were generally two “flavors” including those driven by a firm CIO and those with
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May 16, 2012

II. PRESENTATIONS, cont.:

B. Capula Investment Management, cont.:

more dispersed enforcement. He suggested that as we evaluate managers we

emphasize understanding each manger’s risk limiting system and ask to be
informed of situations in which the manager implemented risk reductions in
response to losses exceeding specified limits. At Capula the investment team
conducts weekly meetings to discuss strategies and risks, both where more risk
could be taken and where it should be trimmed.

In response to a question regarding 2008 and the GRV Fund Mr. O’Reilly
commented that 95% of their capital is Tier 1, the most liquid, and they
emphasize deep and very liquid fixed income markets. In the summer of 2007
they were worried about excessive credit globally and, as a result, they began to
reduce their risk exposure by putting on CDS (Credit Default Swap) credit
protection. In March of 2008 they increased liquidity and reduced risk further as
the credit crisis expanded. At that time their performance year-to-date (YTD)
through March 2008 was approximately “flat”. By the end of the year their return
for 2008 was up approximately 10%. Because of the liquidity of their positions
AUM dropped throughout 2008 from $4.4 billion to $2.4 billion as investors used
Capula as a source of liquidity. All redemption requests were satisfied over a
period of three quarters.

Mr. O’Reilly went on to discuss Capula’s Tail Risk Fund (TRF) which uses
equity put options to create tail hedges. The tail hedges are implemented
tactically, not continually, when the perceived probability of downside risk is
higher to minimize the cost of carry (i.e., the cost of financing the protection). Mr.
O’Reilly enumerated some of the types of tail hedging they utilize including
hedges on duration risk, interest rate spreads, credit risk, equity volatility and
currency and commodity volatility. Currently 82% of the capital is in
unencumbered cash and leverage in this strategy is 6 to 12 times at the Fund level.
He also commented that risk can be easily and quickly moved around in response
to market changes because of the high level of liquidity of the instruments
employed. In responding to a question about the Dodd Frank Act Mr. O’Reilly
stated that it had caused the “prop desks” (proprietary trading desks) at the banks
to exit or substantially reduce their trading activity and this has been Capula’s
greatest competition. Further, due to the barriers to entry in the business he did
not expect this competition to be resurrected any time soon. This has also been an
opportunity for firms like Capula to add some of the best “talent” that has been let
go as the banks get out of the business. In response to a Trustee question
regarding the speed with which Capula would expect to identify “rogue” trading it
was noted that their risk management system monitors trades in real-time so if
risk limits were exceeded it would be recognized immediately. Capula’s funds are
priced monthly by an independent administrator and daily and weekly by Capula.
With regard to where a firm like Capula might be placed in an institutional
portfolio structure he claimed that they provide a steady and uncorrelated return
and that they could be placed in a separate allocation “bucket” or in an enhanced
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INVESTMENT COMMITTEE MINUTES
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II. PRESENTATIONS, cont.:

B. Capula Investment Management, cont.:

fixed income bucket. Management fees and the calculation of the incentive fee
were also discussed. Capula has an institutional fee that is lower than their
standard fee but requires a three year commitment. The presentation ended and
the Chairman thanked Mr. O’Reilly for his presentation.

C. First Quarter 2012 Investment Performance Report – Principal John Lee and
Senior Consultant Shane Schurter of Hewitt Ennis Knupp presented. Mr. Lee
began by reviewing the markets during the first quarter noting the strong
performance of equities with the Russell 3000 Index returning 12.9%, the MSCI
All Country World ex-U.S. IM (non-US equity) Index returning 11.6%, the BC
Aggregate Bond Index returning 0.9%, and the NCREIF ODCE (commercial real
estate) index returning 2.5% (preliminary). Within the US equity market
Financials and Technology lead while Utilities and Telecommunications trailed
for the quarter. Regarding US equity styles for the quarter growth outperformed
value. Outside of the US all of the major equity markets were up with Eastern
Europe and Latin America leading while the UK, Canada and Japan trailed but
still delivered strong positive returns. In reviewing the fixed income market Mr.
Lee noted that lower quality sectors outperformed as investors “risk appetite”
increased and interest rates rose during the quarter. Mr. Schurter continued the
presentation as he commented on the decline in equity market volatility over
recent months to a level at the end of the first quarter approximately in-line with
the long-term average. In discussing the return on commodities for the quarter he
noted that energy trailed other commodities as natural gas prices dropped 37%
during the quarter reaching historical lows.

Turning to the Plan’s performance Mr. Schurter commented that SCERA ended
the quarter with a market value of $1.881 billion and a quarterly net-of-fee return
of 8.7% which was 30 basis points over the Fund’s target policy. In US equities
the Plan’s active managers outperformed the asset class’ benchmark primarily due
to strong benchmark relative performance by Dodge & Cox and Systematic.
Dodge & Cox’ performance was aided by their stock picking in Financials and
Materials and their absence of holdings in Utilities. Systematic’s performance was
helped by their stock selection in Materials, Consumer Discretionary, Consumer
Staples and Information Technology.

In non-US equities the Plan’s managers outperformed the asset class benchmark
by 20 basis points due to strong performance by Arrowstreet and despite
underperformance by Artio and Templeton. Arrowstreet’s performance was aided
by their overweight to Consumer Discretionary and their stock selection in
Materials and Utilities. Templeton’s relative performance was hurt by their stock
selection in Consumer Staples and their overweight to Telecommunications. The
Plan’s global equity managers underperformed the asset class benchmark with all

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INVESTMENT COMMITTEE MINUTES
May 16, 2012

II. PRESENTATIONS, cont.:

C. First Quarter 2012 Investment Performance Report, cont.:

three managers, Calamos, GMO, and Templeton, underperforming. Calamos has

outperformed their benchmark by a significant margin since the inception of their
account in early 2011 but underperformed its benchmark by the greatest margin of
the global equity managers for the quarter. Calamos’ performance for the quarter
was held back by their exposure to convertible bonds, their stock selection in
Energy and their large underweight to Financials. It was noted that this manager
will tend to underperform in strong rising markets due to their use of convertible
bonds but outperform in flat to down markets for the same reason. GMO
underperformed due to its overweight to higher quality stocks, which
underperformed during the quarter, and due to the underperformance of most of
the underlying GMO funds to which it allocates. Templeton’s global equity
strategy underperformed due to its stock selection in Energy and its underweight
to Information Technology and it’s overweight to Telecommunications.

In fixed income all three of the Plan’s fixed income managers, Reams, Western
and PIMCO, outperformed due to their overweight to non-Treasury “spread”
sectors as investors sought-out risk. Reams and Western have now outperformed
over the trailing quarter, year, 3 & 5 years and since inception. PIMCO’s account
was incepted in early 2011 and has outperformed its benchmark over the quarter
and since inception. In real estate the Plan’s managers modestly trailed the
NCREIF ODCE benchmark for the quarter (which was the fourth quarter of 2011
as real estate is booked with a one quarter lag) but outperformed by 140 basis
points over the trailing year. The largest contributor to the quarter’s
underperformance was the UBS Trumbull Property Fund (TPF) which is the
largest real estate investment and trailed the benchmark due to its lower leverage
and the asset class’ robust return. Over the trailing one year period the real estate
portfolio outperformed due to the strong performance of the RREEF III Fund
which benefitted from its more aggressive positioning as a value-added fund
amidst a strong real estate market and, more specifically, the write-up of the
RREEF III development property in New York City, Riverside South.

III. INVESTMENT CONSULTANT & STAFF:

A. Staff Report on BlueCrest Follow-up Meeting – discussion regarding underlying
strategies employed in multi-strategy product. Mr. Failor commented that the
BlueCrest presentation at the April Investment Committee meeting may have
excluded some details in the interest of time and that he and Administrator Bei
have since had the opportunity to meet with Declan Ryan, a BlueCrest Product
Specialist, and obtained a more detailed review. Staff believed there may be some
value to the Board to review the highlights of this more recent meeting. He
commented that “All Blue” is the company’s multi-strategy product, that it has
approximately $7.7 billion in assets-under-management (AUM) and that it is

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INVESTMENT COMMITTEE MINUTES
May 16, 2012

III. INVESTMENT CONSULTANT & STAFF, cont.:

A. Staff Report on BlueCrest Follow-up Meeting, cont.:

composed of underlying strategies that are primarily credit and bond strategies
with little in the way of equity market exposure. The Emerging Markets
strategy, which is a part of All Blue, had historically included some equity
beta but had migrated to an emerging market fixed income and currency
strategy to, among other things, maintain a high level of liquidity. There is no
leverage at the All Blue strategy level but the underlying strategies have
leverage ranging from 2 to 10 times. Blue Trend, another of the underlying
strategies in All Blue, utilizes very liquid futures to capitalize on trends and,
as a result, had no liquidity problems during the Credit Crisis of 2008. Blue
Trend invests in equity, fixed income and commodity futures, performs best in
trending markets and is the largest of the underlying strategies in the All Blue
multi-strategy fund. The International Strategy which is also utilized by All
Blue invests in equity futures, was up 6% in 2008, holds 60%-70% cash with
the remainder used for futures margin. The Sacramento County Employees’
Retirement System is a new investor in the BlueCrest International Strategy.
The last of the All Blue underlying strategies discussed was Blue Matrix
which is a mean reversion strategy buying baskets of individual equities and
attempting to exploit short-term relative mispricings.

Transparency was also discussed with Mr. Ryan. He commented that investors
receive aggregated risk measures for the portfolio(s) but not individual
positions. Our consultant, Hewitt EnnisKnupp, may be allowed to view
individual positions when they perform on-site due diligence meetings in
BlueCrest’s offices. The BlueCrest funds are incorporated in the Cayman
Islands and as Delaware Limited Partnerships. Regarding the standard of care
they would agree to contractually it would likely be a “gross negligence”
standard. Regarding stress testing BlueCrest ensures that the strategy can
withstand an 8 standard deviation event in the P&L (Profit & Loss statement).
In addition, they assume that margin requirements are doubled. Regarding the
Credit Crisis in 2008 BlueCrest had no liquidity problems and no “gates” were
raised as they invest in highly liquid securities.

B. State Street Global Markets Post Trade Report on Artio Transition. Mr. Failor
reviewed the Post Transition Report from State Street Global Markets
(SSGM) and compared it to the Pre Trade Report discussed at the prior
Investment Committee meeting. He noted that that the goal of the transition
was to take securities in-kind from the Artio non-US equity commingled fund
in which SCERA had been invested and to restructure that portfolio to reduce
prospective tracking-error (TE) to +/-200 basis points annually in an interim
portfolio managed by SSGM. The total “cost” of the transition came in at 13.6
basis points (bps) or $113,649 which was slightly higher than the 10.9 bps
estimated in the Pre Trade Report but well within the estimated one standard
deviation range of +/-7 bps. Mr. Failor went on to review the sources of the
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INVESTMENT COMMITTEE MINUTES
May 16, 2012

III. INVESTMENT CONSULTANT & STAFF, cont.:

B. State Street Global Markets Post Trade Report on Artio Transition, cont.:

cost or “shortfall” including commissions, bid-ask spread, market impact,

currency trading spread costs, taxes & fees and opportunity cost. The
“shortfall” is measured as the difference between the performance of the
actual portfolio during the transition period and that of the target portfolio
assuming instantaneous and costless transition from the legacy portfolio to the
target portfolio at the beginning of the transition. The transition took place
from the open of April 13th to the close of April 20th with the vast majority of
the trading taking place on April 13th. Performance of the interim portfolio,
after transitioning, was also reported for the period from April 21st through
April 30th. During this period the SSGM interim portfolio returned 0.91%
while the benchmark, the MSCI All Country World ex-US IMI, returned
0.72%.

C. SCERA Quarterly Returns For The Past 30 Years. Mr. Failor discussed the
tables and charts handed-out which provided quarterly Plan returns over the
last 30 years as well as 20 year rolling returns. These were in response to a
Trustee question regarding how longer period returns might be impacted over
the coming quarters as old quarters roll-off from 10 and 20 years earlier. It
was noted that there were large negative returns in the second and third
quarter of 2002 and, as a result, the Plan’s 10 year performance numbers
would be increasing over the next couple of quarters as those returns roll-off
of the 10 year return calculation, assuming the new returns over the second
and third quarter of 2012 are relatively better. Mr. Failor also commented that
one of the distributed charts with quarter-by-quarter and rolling 20 year
returns would be included in the monthly Performance Highlights package
which is discussed at the monthly Retirement Board meetings.

D. Hewitt EnnisKnupp Client Advisory Board and Client Conference Agendas.

Mr. Failor commented that he would be attending Hewitt EnnisKnupp’s
(HEK’s) Client Advisory Board (CAB) meeting in Chicago in late May and
he and Mr. Bei would be attending HEK’s Client Conference which would
follow. He also summarized the comments he intended to share at the CAB
meeting regarding SCERA’s view of HEK’s investment consulting services
and the impact of the Aon-Hewitt-EnnisKnupp merger. Mr. Failor went on to
solicit any additional views the Investment Committee would like shared at
the CAB meeting.

E. Updated 2012 On-Site Due Diligence Schedule. Mr. Failor briefly discussed
the updated 2012 due diligence schedule which now included specific dates
for site visits with Reams, State Street California and PIMCO. The next due
diligence meeting will be with Reams in Columbus Indiana on June 1st. The
Trustees were invited to attend any of the due diligence meetings their
calendars would permit.
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SONOMA COUNTY RETIREMENT BOARD
INVESTMENT COMMITTEE MINUTES
May 16, 2012

III. INVESTMENT CONSULTANT & STAFF, cont.:

F. Managers on “Watch” – April 2012 updates.
1. BlackRock Granite Fund – review. Given that BlackRock had
provided a full review earlier in the meeting there was nothing
additional to report.

2. RREEF America III Fund – review. Mr. Failor stated that the most
notable issue was the development of Deutsche Bank’s (DB’s) effort
to sell their investment management operations which includes the
RREEF real estate group. It was explained that it was now public
that DB was in exclusive negotiations with Guggenheim Partners
and that the negotiation had narrowed to the purchase of RREEF
alone, excluding the other investment functions of DB. It was being
reported that an exclusive agreement could be announced in the
coming weeks. The RREEF III Board, with a majority of
independent trustees, has met with Guggenheim’s senior
management and, thus far, Guggenheim was expressing “all the right
things”, namely that the value of the RREEF franchise was primarily
in the talent of the investment team. Further updates will be provided
if, and when, this potential sale moves forward.

IV. COMMUNICATIONS:
A. Investment Benchmark Summary – April 2012.

B. Email from Mike Bazdarich of Western Asset, “Sonoma Follow up – Job Loss
Numbers”, April 11, 2012.

C. FUNDfire, “Big Losses Continue in Artio’s Flagship Products”,

April 27, 2012.

D. FUNDfire, “Interest Growing for Agricultural Investments”, April 30, 2012.

V. GENERAL DISCUSSION MATTERS:

None.

VI. PUBLIC COMMENT:

None.

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SONOMA COUNTY RETIREMENT BOARD
INVESTMENT COMMITTEE MINUTES
May 16, 2012

VII. NEXT MEETING:

Scheduled for Wednesday, June 13, 2012 at 8:30 A.M. in the SCERA Board Room
located at 433 Aviation Boulevard, Suite 100, Santa Rosa, CA. The presentations
scheduled for this meeting include a review by Systematic Financial Management.

VIII. ADJOURNMENT:

The meeting was adjourned at 12:21 P.M.

JERRY ALLEN
COMMITTEE CHAIR

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