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Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?

In this blog I and multiple commenters have broached the subject of the suspect constitutionality of PSPRS' replacement of the old perma...

Thursday, February 8, 2018

PSPRS to members: Keep calm and don't think about annualized returns

As we discussed in the last post, we will not know for about another two months if PSPRS' investment strategy will show the success of its more conservative approach.  (The Russell 3000 dropped about 3.65% today and is down 8.33% for the month of February 2018.)  However, PSPRS will not wait that long to see evidence.  They came out with a press release on February 6, 2018 which boasts that "the current PSPRS portfolio is 72 percent less volatile than the Standard & Poor (S & P) 500 Index."  This kind of public relations is what you buy with the $95,000 a year taxpayers shell out to PSPRS spokesman Christian Palmer and the $72,000 paid to an outside consultant.

As PSPRS is wont to do, they only present half the picture.  While controlling volatility is part of the picture, PSPRS still has to balance this with maximizing returns.  The time frame PSPRS used to graph its volatility ran from May 2008 to November 2017.  This period starts with the market crash in 2008 and runs to the latest investment returns PSPRS reported.  I wanted to compare PSPRS' returns with those of the PSPRS Cancer Insurance Plan (CIP), Arizona State Retirement System (ASRS), the Standard & Poor (S&P) 500 Index, and a Vanguard 3 Fund Portfolio that Ben Carlson uses to measure endowment performance at his blog, A Wealth of Common Sense.  This Vanguard 3 Fund Portfolio is a  mix of 53% US stocks, 27% foreign stocks, and 20% bonds.  The time period for the following table is for the period ending June 30, 2017, which is necessary for consistency purposes.  Here are the annualized rates of return for the various portfolios over one, three, five, and 10 years:

1-year 3-year 5-year 10-year
PSPRS 11.85% 5.27% 7.95% 3.98%
CIP 10.12% 4.34% 7.64% 5.36%
ASRS 13.90% 5.70% 9.60% 5.60%
S&P 500 16.80% 7.72% 12.96% 4.86%
Vanguard 14.90% 7.00% 8.30% 6.50%

PSPRS' annualized returns over the 10-year period is lower than all the other funds.  It might be fairer to look at the 5-year returns since PSPRS had not fully implemented its strategy ten years ago.  During the 5-year period, PSPRS still lags all but its own CIP, a fund that consists of 50% US and foreign stocks, 45% bonds, and 5% commodities.  ASRS bested PSPRS by 1.65% over the five year period, and the S&P 500 bested PSPRS by 5%.  A 5% annual return on a $9 billion portfolio would earn nearly $2.5 billion over five years, so while the S&P 500 was more volatile, it also earned a significantly higher return for that added risk.

If we include reinvested dividends in the 5-year period that ended June 30, 2017, the S&P 500 earned 15.28%.  This extra annualized return of 7.33% would have earned PSPRS an additional $3.82 billion.  We all know that there is a correlation between risk and reward, but it is deceptive of PSPRS to point only to the volatility of the S&P 500 without acknowledging that the S&P 500 had nearly double the return of PSPRS' portfolio.  Even the less impressive additional 0.88% annualized return over ten years would have earned PSPRS an additional $824 million.  With reinvested dividends, the S&P 500 had an annualized 10-year rate of 7.10%.  This additional 3.12% per year would have earned PSPRS an additional $3.24 billion over ten years.  Unfortunately, there are no volatility numbers for the other portfolio.  Regardless, it is clear that the volatility/return tradeoff has been favorable for the S&P 500, but PSPRS does not want members to see this full, honest picture

While PSPRS likes to make absurdist claims on incomplete and cherry-picked information, we should not do that as well.  It is not realistic to solely compare PSPRS against the S&P 500, as no pension or endowment would ever be 100% invested in a single market index, or even the Vanguard 3 fund portfolio.  A fairer comparison would be against another pension fund like ASRS that deals with the same risk/reward conundrum.  Over the five and ten year periods, ASRS has bested PSPRS by 1.65% and 1.62%, respectively.  The extra 1.65% would have earned PSPRS an additional $767 million over five years; the extra 1.62% would have earned an additional $1.57 billion over ten years.

Despite the whining and excuses of PSPRS Board of Trustees Chairman Brian Tobin and PSPRS Chief Investment Officer (CIO) Ryan Parham, ASRS has consistently outperformed PSPRS while operating in the same market conditions.  Yet Mr. Parham, who was paid $268,000 in 2016, is the second highest paid in employee in the Arizona state government (Note: this does not include Arizona university system employees).  Who was the highest paid Arizona state government employee?  Why it was Paul Matson, the Director of ASRS, who made $285,230 in 2016.  For some perspective, Karl Polen, the CIO of ASRS, made $201,420 in 2016, while Jared Smout, PSPRS Administrator, made $210,000 in 2016.

So Mr. Matson, who has successfully run ASRS for 15 years, makes only $17,230 more than Mr. Parham.  Even more perplexing is how Mr. Parham is paid $57,000 more per year than ASRS' CIO.  The combined salary of Mr. Matson and Mr. Polen is $486,650.  The combined salary of Mr. Smout and Mr. Parham is $478,000.  Looking at the millions and billions in higher ASRS earnings, I think that the $8,650 more paid to Mr. Matson and Mr. Polen is the bargain of the century.

The difference in performance and management between ASRS and PSPRS is stark, and while ASRS continues along its steady path of stronger earnings, PSPRS has to blow smoke.  Until PSPRS has some evidence to show us that their strategy is working, they might do something useful for members, like getting their software working properly so members can get retirement estimates.  I think seven months is enough time for members to wait for this to be fixed.

Tuesday, February 6, 2018

PSPRS investment earnings through November 2017 (with some discussion about COLA's)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through November 2017, which is the fifth month of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%

7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%
10/31/2017 0.64% 3.38% 2.18% 6.85%
11/30/2017 1.28% 4.70% 3.04% 10.10%

There is usually about a two-month lag in PSPRS reporting its investment returns.

PSPRS' Board of Trustees published its January 2018 meeting materials last week, but in light of the market conditions over the past several days, it is nice to discuss them now, rather than earlier.  The Russell 3000 is down 6.00% for the month of February 2018 as of February 5, 2018, so this will possibly be the first real test of PSPRS' investment strategy.  I say "possibly" because we are only five days into February with quite a bit of time for the market to recoup its loss or even end with a gain.  Regardless, we will have to wait two months to find out the end-of-month (EOM) results for February 2018.

In the meantime, the November 2017 EOM results provide us with a picture of the market since the election.  For the current FY, PSPRS has earned 46.50% of the Russell 3000 (4.70% vs. 10.10%, respectively).  From December 1, 2016 through November 30, 2017, PSPRS' did a little better, earning 53.40% of the Russell 3000 (10.66% vs. 19.93%, respectively).  This tracks with what has been PSPRS' usual pattern, earning 50-60% of the Russell 3000, with last fiscal year being an exception. 

For some perspective, PSPRS' Cancer Insurance Plan (CIP) has earned 5.85% FY-to-date and 15.03% over the preceding 12 months.  These earnings were net of fees as opposed to PSPRS', which are gross of fees, making the CIP's earnings even more impressive compared to PSPRS'.  The Arizona State Retirement System (ASRS) has earned 3.5%, net of fees, through September 30, 2017, which is the latest number available on ASRS' website.  This handily beats PSPRS' return, gross of fees, through the same period.  Whether PSPRS' conservative strategy pays off remains to be seen, but through November 2017, PSPRS has lagged both the CIP and ASRS.

There was one other interesting bit of information in the meeting materials which will be especially pertinent to retirees. This is what it says about calculating the new cost of living allowance (COLA), which will be paid for the first time next fiscal year:
Since 2001, the Phoenix-Mesa CPI has been updated by the Bureau of Labor Statistics every 6 months.  Beginning later this year, the Phoenix-Mesa CPI will be updated every 2 months after each even month  (February, April, June, etc.). The results are typically available about two weeks after the end of the  month. For instance, the June, 2018 results will be available July 12, 2018. There are advantages and disadvantages of using the fiscal year vs. the calendar year as the basis for determining the COLA that
will be granted to benefit recipients each July 1st.
The biggest advantage of using the fiscal year as the base year (in other words, measure CPI from June 30 to June 30) is that the COLA is granted closer to the period of time the price of goods is being measured.  For instance, if the price of oil increases during the January to June timeframe, the COLA granted on July 1st will better reflect that increase.
The biggest advantage of using the calendar year is that staff would have enough time to calculate, communicate and process COLAs by July 1, as is required by statute. Any delays in the Department of Labor calculating and publishing the CPI would not have an effect on getting the COLAs processed timely. While we can’t comment on the intent of the legislature, it is important to note that typically when the statute refers to a fiscal year, it specifically states “fiscal year.” In the two sections of statute that refer to how the new COLA is calculated (§38-856.05 and §38-856.06), the statute does not specify “fiscal year” but rather states “year.” That may be an indication that the legislature intended us to measure the CPI on a calendar year basis. 
Recommendation: Staff recommends that we use the calendar year that precedes July 1 as the base year when calculating the amount of the COLA.
The Bureau of Labor Statistics publishes two measures of the Consumer Price Index—the CPI-U and the CPI-W. The CPI-U is the Consumer Price Index for all urban consumers. Approximately 89% of the population in the Phoenix metro area is included in this measurement. The CPI-W is the Consumer Price Index for a subset of the CPI-U population. It includes wage earners and clerical workers only, and represents approximately 29% of the population. Retirees who are not earning a “wage” are included in the CPI-U, but not in the CPI-W. Likewise, unemployed people are included in the CPI-U, but not in the CPI-W. In general, the CPI-W is more volatile because it uses a smaller sample population. According to the Bureau of Labor Statistics, in most cases across the country the CPI-W increases more than the CPI-U. In looking at the increases over the past 14 years in Phoenix, however, the CPI-U has outpaced the
CPI-W in 9 of those years. Because the CPI-U population coverage is more comprehensive, it is typically the measurement used in most escalation agreements.
Recommendation: Staff recommends that we use the CPI-U as the measurement when calculating COLAs since retirees are included in that population and it is less volatile over time.
Remember that the new COLA will be the lower of either the Phoenix-Mesa CPI or 2%.  The staff recommendations would have to be approved by the Board of Trustees, and they will almost certainly go along with their own staff's recommendations.  For retirees, the main issue is the rate of inflation.  The Phoenix-Mesa CPI-U annual average rate for the 2017 calendar year was 2.5%; for the FY that ended June 30, 2017, it was 2.25%.  Under either base year rate, retirees would be limited to the 2.0% COLA.  Historical rates for the Phoenix-Mesa CPI-U can be found on PDF page 212 of the meeting materials. 

If the Board of Trustees accept the staff recommendation on the base year, retirees will lag inflation by 0.5% in fiscal year 2019.  This may not seem like a lot, and for a retiree on a $50,000/year retirement, it would only amount to a "loss" of $250.  The "loss" is the amount of goods and services the retiree will no longer be able to afford in the second year.  However, the compounding effect over ten years of a 0.5% difference between the COLA and actual inflation will leave the retiree with only 95.7% of the purchasing power he had in the first year and a "loss" of  $2,689.  A 1.0% difference will leave the retiree with only 91.6% of purchasing power and a "loss" of $5,485 in the tenth year.  If one has another source of retirement income, such as a 457, Social Security, or an IRA, there will be some cushion against inflation.  This makes it all the more urgent that current workers utilize any and all retirement savings vehicles available to them.  I have bookmarked the Phoenix-Mesa CPI-U page at the US Bureau of Labor Statistics (BLS) for future reference.  

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.

Friday, December 1, 2017

PSPRS investment returns through September 2017 (with some information from PSPRS' FY 2017 actuarial report)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through September 2017, which ends the first quarter of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%

7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%

There is usually about a two-month lag in PSPRS reporting its investment returns.

Through the first quarter of FY 2018, PSPRS has reverted back to returning 50-60% of the Russell 3000, achieving 59.5%, gross of fees, of the return of the Russell 3000.  For FY 2017 PSPRS returned, net of fees, 64% of the Russell 3000, which was an improvement over the previous three fiscal years.  It will take several more fiscal years to see if FY 2017 was the start of a trend or just a blip, but 60% still seems to be the high end of the range for PSPRS in comparison to the Russell 3000.

PSPRS' November 2017 meeting materials also contained the draft of PSPRS' FY 2017 Actuarial Report.  Anyone interested can find that draft report starting on PDF page 298 in the meeting materials.  The aggregate employer contribution rate for Tiers 1 and 2 increased slightly to 51.93% from 51.84%, meaning that all the state's employers combined will contribute $51.93 for every $100 in pensionable wages for all the state's active Tier 1 and Tier 2 members.  Individual employer contribution rates for Tier 1 and Tier 2 employees vary widely and can be found on PDF pages 369-374.   If anyone wants to see if an employer's rate has increased or decreased from the previous FY, FY 2016' individual actuarial reports can be found here.  The employer contribution rate for my employer increased by almost 9%, creating more budget problems for my employer as several million more will have to be paid to PSPRS starting in July 1, 2018.

PSPRS' aggregate funded ratio decreased  to 45.30% from 46.00%.  Individual employer's funded ratios can be found on PDF pages 363-368.  These ratios run from a couple in the single digits to a few that are over 200% funded.  Once again, you can compare FY 2017 to FY 2016 by checking your individual employer report.  My employer's funded ratio dropped 0.10% but still remains under one-third funded.  Most of the major public safety employers, like DPS and those in the Phoenix Valley, appear to be 30-50% funded.

One last interesting tidbit in the meeting materials was the current breakdown of Tier 3 members who chose the defined benefit (DB) versus the defined contribution (DC) plan.  Out of 187 Tier 3 members, only twelve chose the DC plan, 6.4%.  As more Tier 3 members join the ranks and the DC plan becomes better established, it will be interesting to see if this percentage grows over time.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.

Tuesday, November 21, 2017

Parker v. PSPRS interest rate set at 5.25%: no timeline on payments to members

Here is PSPRS' press release on the settlement of Parker v. PSPRS:
PSPRS Chairman: 2011 changes cost system more than $220 million 
ARIZONA – Members of PSPRS impacted by the Parker lawsuit are entitled to collect 5.25 percent interest on excess contribution refunds, according to a Maricopa County Superior Court ruling entered today.

The decision applies the same rate to pre-judgment and post-judgment interest on contribution refund amounts, as well as any permanent benefit increase (PBI) amounts withheld due to 2011 pension reforms deemed unconstitutional.

“The Hall and Parker litigation serves as a good example of what can happen when pension reforms are not properly vetted,” said PSPRS Board of Trustees Chairman Brian Tobin. “This cost our system more than $220 million while Proposition 124, which was crafted and supported by all stakeholders, is expected to provide about a half a billion dollars in savings.”

The interest period for excess contribution refunds started July 1, 2011, for all PSPRS members and employers. Ending periods will vary according to when each employer refunded excess contributions to impacted members.

Employers must notify PSPRS of the final processing date of contribution refunds related to the Parker lawsuit if they have not done so already. PSPRS needs this information in order to accurately calculate interest owed to members affected by the litigation. Employers can provide this information by emailing activemembers@psprs.com or by calling 602-255-5575. Members should then be notified by their employer of their individual amount.

These dates are also necessary for employers who wish to claim PSPRS contribution credits for pre-judgment interest totals awarded in light of the Hall and Parker lawsuits.

Post-judgment interest must be separately applied by the employer to any contribution refund amounts not returned by November 21, 2017, which is the date of the official entry of Judge Rosa Mroz’s order that establishes the interest and concludes the lawsuit. As a reminder, employers are not allowed to take credits against post-judgment interest.

“This ends a difficult chapter in PSPRS history,” said PSPRS Administrator Jared Smout. “And it gives the fund the opportunity to build on the positive trajectory of the last fiscal year, when the fund gained more than $1 billion in value.”
You can read the actual judgment here. One interesting thing here is the final pre- and post-judgment interest rate of 5.25%, which is one percent higher than the pre-judgment rate in Hall.  The post-judgment rate is the same in both Hall and Parker.  The decision states:
The Existing Active Plan Members shall be paid prejudgment interest and postjudgment interest pursuant to A.R.S. § 44 -1201(B) and (F) at the rate of 5.25%.  Pursuant to paragraph 2 of this Judgment, the interest shall run on the amount of any Existing Active Plan Member’s employee contribution in excess of 7.65 percent, from the date each such amount was withheld from such member ’s paycheck until payment of the amount, whether before or after entry of this Judgment.  Pursuant to paragraph 3 of this Judgment, the same interest shall also run on the amount of any permanent benefit increase not paid to an Existing Active Plan Member, from the date on which the permanent benefit increase should have been paid until payment of the amount, whether before or after entry of this Judgment.
This portion I placed in boldface is key since it makes clear that interest runs from the time the excess contributions were taken.  This means that every excess payment a member paid has been earning 5.25% from the time each one was deducted all the way up to the day the aggregate excess was refunded.  If you are interested in a discussion of interest payments, please check this post.  Based on a refund of around $12,000, I calculated an interest payment for myself of about $1,200.  This one percent difference increases that interest payment by about $300.

Unfortunately, there is no deadline for payment.  The court has mandated that "the Plan shall undertake further efforts, in good faith and within a reasonable time, to achieve the Plan’s or the employers’ completion of such remedial actions."  PSPRS has shown time and time again that their definition of "good faith" and "reasonable time" are not based on any consideration of its membership.  It would not surprise me if PSPRS dragged its feet again as it can continue to make more by holding onto the interest payments than by paying them out as quickly as possible.  (The interest is simple, not compounded, so once a member has been paid, no more interest accrues.)  As usual, don't expect any help from Board of Trustees Chairman Brian Tobin, whose only statement in the press release is about rehashing a political argument, one, by the way, that could have easily gone the other way if a single judge had voted differently, and nothing about what the Board and PSPRS plan to do for members.  Something like "we'll being working to get members their payments ASAP" or "we expect all payments to be paid by such-and-such date" would have been nice to hear.  He is a members' representative, after all, but he went native along time ago and has been worthless as a member representative and as a board trustee.  Since we can't count on Million Dollar Man Brian Tobin to do anything for members, it will have to fall on one or more of the other three member representatives to actually work for the benefit of members and not PSPRS' administration this time around.

Thursday, November 9, 2017

Injunction, injunction, what's your function: Some speculation as to why there is not a final judgment in Parker v. PSPRS

PSPRS had its annual information seminar on November 7, 2017. The only update given on the Parker case were these bullet points on a Powerpoint slide:
  • Two of the three parties have informally agreed as to the form of judgment, the ball is in the third party’s court.
  • Formal agreement is done through legal documents and court filings, which have not happened yet.
PSPRS does not say which party has not agreed to the form of judgment.  The minute entry of the last status conference on September 22, 2017 said this:
The plaintiffs in the Hall case have decided not to appeal the trial court’s ruling regarding prejudgment interest.  Phoenix Law Enforcement Association (PLEA) has also decided to abide by the same prejudgment interest rate.  PSPRS has already paid members for the permanent benefit increases (PBI), except to the few members  ho are deceased.  PSPRS is also working with each employer to return the excess contributions to their employees.  There are many employers, each with its own issues. The parties will be discussing whether the issuance of a declaratory judgment will be sufficient to resolve the case.
So it certainly appeared at that time that a final judgment was imminent, as neither the plaintiffs nor PLEA were going to challenge the interest rates already set in the Hall case.  The only other outstanding issue would be attorneys' fees, and that issue would have no bearing on a final judgment on interest rates.  However, not being an attorney, I did not note the significance of the term "declaratory judgment."

I am speculating here, but it appears that one party does not agree with the final decision being in the form of a declaratory judgment alone, and not including an injunction.  You can follow the links if you are interested in reading more about those legal terms, but an injunction (i.e. injunctive relief) legally requires some type of action pertaining to the resolution delivered by the declaratory judgment.  You can get a little insight into this issue from this minute entry from Hall.  So in this case, the declaratory judgment would legally settle the interest rate question, as no parties object to the 4.25% pre-judgment/5.25% post-judgment interest rates set in Hall, but an injunction would be a further legal mandate on PSPRS to achieve final resolution.

Based on our experience of PSPRS' deliberate slow walking of the excess contribution refunds, my guess is that the third party (most likely PLEA) wants a definite deadline this time around when it comes to the payment of interest, which would include a penalty if PSPRS does not meet that deadline.  PSPRS spent months continuing to withdraw excess contributions after it was already declared unconstitutional by the Arizona Supreme Court, then they dragged out the process of paying refunds.  All the while PSPRS was earning interest well in excess of the 4.25% pre-judgment interest rate assigned in Hall.  It has been exactly a full year since the Hall case was decided on November 10, 2017 and the Russell 3000 has returned 21.80% in that time.  Even PSPRS' own annualized rate over the five years ending June 30, 2017 was 7.95%.

I suppose someone might ask why continue to litigate when the litigation itself is acting to prolong the delay in paying interest, but the response to that is why would there be any objection to setting an exact date on when the interest will be paid.  PSPRS has known that these payments were required for a year now, and it seems unlikely that there are anymore outstanding excess contribution refunds to be made.  This means interest is ready to be paid today, but of course, why should PSPRS be in a hurry to pay members if PSPRS benefits financially from dragging its feet?  Only a strict deadline with a penalty for non-compliance will force PSPRS to act ethically and for the benefit of its members.

The next status conference in Parker v. PSPRS is January 22, 2018.

Sunday, September 24, 2017

The continuing tragedy of PSPRS' investment returns

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through June 2017, the final month of the current fiscal year (FY), with the FY end 2014, 2015, and 2016 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%

7/31/2016 1.62% 1.62% 3.97% 3.97%
8/30/2016 1.76% 3.40% 0.26% 4.23%
9/30/2016 0.71% 4.14% 0.16% 4.40%
10/31/2016 -0.27% 3.86% -2.16% 2.14%
11/30/2016 1.17% 5.07% 4.48% 6.71%
12/31/2016 1.30% 6.43% 1.95% 8.79%
1/31/2017 1.03% 7.52% 1.88% 10.84%
2/28/2017 1.17% 8.78% 3.72% 14.96%
3/31/2017 1.06% 9.93% 0.07% 15.04%
4/30/2017 0.75% 10.76% 1.06% 16.26%
5/31/2017 1.33% 12.24% 1.02% 17.45%
6/30/2017 0.22% 12.48% 0.90% 18.51%

There is usually about a two-month lag in PSPRS reporting its investment returns.  PSPRS' August 2017 Board of Trustees meeting included returns from both May and June 2017 because PSPRS did not have a meeting in July 2017.

PSPRS' FY 2017 return, net of fees, was 11.85%.  For comparison, PSPRS' own Cancer Insurance Plan (CIP) earned 10.12%, net of fees.  The CIP is a simple mix of approximately 25% US equity, 25% non-US equity, 30% fixed income, 10% inflation-linked bonds, 5% commodities, and 5% short-term investments.  The Arizona State Retirement System (ASRS) has not given its FY 2017 returns yet, but an Arizona Republic article from July 19, 2017 stated that it will be around 13.6%, net of fees.  We should keep in mind, though, that this same article also said that PSPRS' FY 2017 returns, net of fees, were going to be 12.5%, so the ASRS estimate might be inaccurate as well.

PSPRS is already crowing about the FY 2017 return and are again using their own particular data set to make their returns look like something special.  However, if we go here to ASRS' page on its rates of return, we can see PSPRS' true mediocrity in comparison to ASRS.  The numbers presented by ASRS do not even do ASRS justice as they do not include the most recent FY return of 13.6%, and yet ASRS still beats PSPRS by 2% (6% to 4%) in the 10-year annualized rate.  On a $9 billion fund, the additional 2% annualized returns over 10 years would generate nearly $2 billion in additional earnings.  PSPRS also lags the CIP by 1.40% in the 10-year annualized rate.

Even more telling is ASRS' historic rates of return, which go back over 35 years.  This is data, by the way, that PSPRS conspicuously does not provide on their webpage.  I suspect that this is because similar PSPRS data would make past PSPRS Administrator Jim Cross look too good in comparison to the succession of mediocrities that have run PSPRS since his departure.  Mr. Cross is the favorite scapegoat of PSPRS' current administration and Board of Trustees, as well as state union leaders, because of some bad investment choices he made during the dot.com bust, but these same people conveniently fail to mention the years of stellar returns he produced prior to those last couple of years of his career as PSPRS Administrator.  I believe that his good years were just in line with the overall markets at the time and not the sign of any particular investing acumen, but it is unfair to look at only his last couple of bad years and not give him credit for his many prosperous years.

ASRS' historic rates of return show that in 37 years, dating back to FY 1981, ASRS had only five years of negative returns.  One negative year was way back in FY 1984 (-5.2%).  The other four were in FY 2001 (-6.7%), FY 2002 (-8.2%), FY 2008 (-7.6%), and FY 2009 (-18.1%), and we all know what happened during those years.  During that same period, PSPRS had negative returns in eight years in FY's 1984 (-2.45%), 1988 (-1.10%), 1994 (-0.71%), 2001 (-16.86%), 2002 (-15.07%), 2008 (-7.27%), 2009 (-17.72%), and 2012 (-0.79%).  This PSPRS data had to be gleaned from annual reports and is not openly available like it is on ASRS' webpage.

We can see that PSPRS had losses that were nearly double what ASRS had during the dot.com bust.  This makes sense because of the individual stock investment strategy that was being followed at that time by Mr. Cross.  An index-based approach would not have produced such large losses, though some type of market crash was unavoidable when the internet bubble finally popped.  During the Great Recession ASRS' and PSPRS' losses are not much different with ASRS' losses only about 33 basis points greater than PSPRS' losses.  This is because that crisis was systemic and took down everything.  It would not have mattered where one was invested, except strictly in cash or in Big Short-type bets on the housing crash.  You were going to suffer some type of loss.  There was virtually no way to avoid that. 

The point here is that we now have the brain trust at PSPRS trying to develop a strategy for two recent past events that were either caused and/or exacerbated by bad policy (i.e. stock picking during a bubble) or major market downturns (i.e. an investment bubble popping and/or a global liquidity crisis).  This is why they continually highlight data about how the current portfolio would have done in the past during specific crises, but, of course, anyone could retroactively design a better strategy when they know what the markets actually did.  Bad investment policies are easy to deal with by simply getting rid of them, but what about market crashes?

PSPRS is selling the idea that they have found a strategy for mitigating market crashes with its Modern Pension Diversification, but the strategy has yet to be put to the test in an actual market downturn.  Even if we buy into PSPRS' theory, there is the other side of the coin: how much would PSPRS have foregone in higher returns during the past had it utilized this investment strategy? PSPRS, of course, do not provide this information, and we are left with an incomplete picture, as if PSPRS' only goal was to mitigate the effects of market downturns.

The goal for PSPRS should be to produce steady gains over the long term.  ASRS has done this over the past 37 years, absorbing losses during the inevitable market downturns but more than making the losses during the subsequent bull markets.  This has been a success for ASRS, and if PSPRS wants to implement an effective investment strategy all they need to do is study and mimic what ASRS has done.  Or better yet, place PSPRS' investment portfolio in the hands of ASRS.

What is even more unsettling is that PSPRS does not see the policy pitfalls in its own strategy.  By my count, PSPRS has 74 private equity investments, 53 real asset investments, and 39 real estate investments listed its 2016 Consolidated Annual Financial Report (CAFR).  This compares to only a total of 22 US and non-US equity investments listed.  At what point does their strategy become just another form of individual asset picking, especially with private equity (PE), which makes up about 14% of  PSPRS' total portfolio?  While I do not know exactly how PSPRS may be invested with each PE firm, we can see that the PE firms themselves have a multitude of investments.  Just looking at the first three PE firms listed in the CAFR, Abry Partners, Avalon Ventures, Baring PE Asia, we can see each has numerous companies in their PE portfolios.  So you have PSPRS picking dozens of PE firms which each have dozens of companies in their portfolios.  What will happen to all these companies, and PSPRS's stake in them, if there is another market crash?

It has never made sense for PSPRS to invest separately from ASRS, just based on economies of scale alone, and when PSPRS decided last decade to move away from one-man rule over its investment portfolio, its Board should have looked to the established, proven team that had already been successfully running ASRS to take over its investments, or at the very least, for guidance in getting PSPRS back on track.  Instead of PSPRS turning things around after 15 years, we still have second-raters like Jared Smout, Ryan Parham, and Brian Tobin whining and making excuses about PSPRS' failings in both its management and investment performance.  What a tragedy it is that PSPRS, which is not even five miles distant from ASRS, was so incompetently led down such a different and broken financial road, a road from which there seems no exit.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.