Page 1 Item 5a, Attachment 1, Page 1 of 13

2017 10-Year Capital Market Assumptions

June 19, 2017

Page 2 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 2 of 13

Steps to Obtain Policy Portfolio in ALM Workshops

Liabilities

Forecast growth in liability

Create simulated liabilities,

contribution and payroll costs

Calculate the decision factor scores for each portfolio

Investment Committee votes on decision factors and these votes are combined with

decision factor scores to rank the portfolios

Investment Committee chooses a portfolio based on discussions and staff

recommendations

Step 4

Step 5

Step 6

Liabilities

Forecast growth in liability

Create simulated liabilities,

contribution and payroll costs

Illustrate key risk considerations for each portfolio package

Board members vote to express risk preferences which will lead to the selection of

the most appropriate portfolio package

Investment Committee chooses a portfolio based on discussions and staff

recommendations

Step 4

Step 5

Step 6

Assets

Determine CMAs

Create simulated annual returns for

each efficient portfolio

Create efficient portfolios using MVO

Step 1

Step 3

1

2

1 Capital Market Assumptions

2 Mean-Variance Optimization

Page 3 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 3 of 13

Building Blocks Approach

Various Fundamental Valuations Models

Predictions on valuation metrics, such as earnings yield, credit spread and capitalization rate

Industry survey

Methodology for Expected Returns

Page 4 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 4 of 13

Wilshire Forecasts through Time Return prospects have been declining for decades, following the

downward trend in interest rates

U.S. Stocks

U.S. BondsCash

Real Estate

Inflation

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Retu

rn A

ssu

mp

tio

n (

%)

Source: Wilshire

Page 5 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 5 of 13

Core Fixed Income Forecasts Remain Low

Fixed income assets (and return prospects) are anchored by current interest rates (i.e. the “going in” yield)

Risk premium for every other asset classes is anchored relative to fixed income assets

Core Treasury

LT Treasury

3-5 Yr Treasury

7-10 Yr Treasury10-20 Yr Treasury

0.00

1.00

2.00

3.00

4.00

5.00

0 5 10 15 20 25 30

Yie

ld (%

)

Maturity

Dec-16 10-yr Avg 20-yr Avg Dec-15

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Ann

ualiz

ed R

etur

n (%

)

Core Bond Yield Next 10 Years

Source: Wilshire

Page 6 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 6 of 13

Range of Surveyed Expected Returns

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Global Equity Private Equity Fixed Income Real Assets Inflation Liquidity

Exp

ecte

d C

om

po

un

d R

etu

rn

Range of Survey Median Proposed Compound Return

Page 7 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 7 of 13

Range of Surveyed Expected Volatility

0%

5%

10%

15%

20%

25%

30%

35%

Global Equity Private Equity Fixed Income Real Assets Inflation Liquidity

Exp

ecte

d V

ola

tilit

y

Range of Survey Median Proposed Volatility

Page 8 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 8 of 13

Asset

Class

Compound

Return

Volatility

(Std. Dev)

Correlation

Global

Equity

Private

Equity

Fixed

Income Real Assets Inflation Liquidity

Global

Equity 6.8% 17.0% 1.00

Private

Equity 8.3% 25.5% 0.81 1.00

Fixed

Income 3.0% 6.6% 0.01 0.00 1.00

Real

Assets 5.8% 12.6% 0.59 0.48 0.09 1.00

Inflation 2.8% 8.0% 0.39 0.33 0.40 0.21 1.00

Liquidity 2.0% 1.0% 0.00 0.00 0.31 0.00 0.08 1.00

U.S. Inflation Assumption: 2.00%

Proposed Capital Market Assumptions (CMAs)

Page 9 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 9 of 13

10-Year Expected Returns & Volatilities: 2017 vs. 2013 CMAs and 2016 Interim Expectations

0%

3%

6%

9%

12%

15%

18%

21%

24%

27%

30%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Vo

lati

lity

Exp

ecte

d R

etu

rn

2013 - Expected Volatility (Right) 2016 - Interim Expected Volatility (Right) 2017 - Proposed Expected Volatility (Right)

2013 - Expected Returns (Left) 2016 - Interim Expected Returns (Left) 2017 - Proposed Expected Return (Left)

CalPERS Long Term Discount Rate

Page 10 Item 5a, Attachment 1, Page 10 of 13

Appendix

Page 11 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 11 of 13

Most Common Expected Return Approaches Fixed Income

Yield-to-maturity plus spread adjustment Real Assets

Capitalization rate forecast adjusted for capex + cash flow forecast Risk premium between Equity and Fixed Income Inflation

Commodity estimated as a function of spot return + collateral return + roll return

TIPS and Global Linkers are a function of current yields and inflation expectations

Public Equity

Dividend Discount Model Inflation + Real Risk Free Rate of Cash + Risk Premium Private Equity

Private Equity is a weighted average of levered equity and fixed income index Public Equity plus illiquidity premium and other adjustments

Page 12 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 12 of 13

Risks and Correlations Estimation

Is largely based on observed historical asset class behavior and an understanding of the response of individual asset classes to changes in economic factors

Adjusts the historical asset class behavior to account for evident

trends and recent abnormalities

For correlations, mostly relied on the BarraOne risk system

Page 13 2017 Capital Market Assumptions Item 5a, Attachment 1, Page 13 of 13

Example Equity Forecast Historical results helped by valuation shifts plus higher

dividend yields and inflationary growth

Source: Wilshire

3.3% 3.5%

1.9% 1.8%

10.9%

2.2% 2.0% 2.0%

0.2%

6.5%

0%

2%

4%

6%

8%

10%

12%

Dividend Income Inflation Real EPS Growth Change in P/E Total Return

IGV Components: History vs. Forecast

History Forecast