Tuesday, September 23, 2014

The effect of Desert Troon on PSPRS' investment returns

On September 3, 2014 PSPRS released this press release, Public safety pension gains for 2014 near $1 billion.  Being a press release, it is, of course, a self-serving piece, but after the last two years the PSPRS staff has the right to tout good news when it has some.  PSPRS' financial returns were covered in the September 4, 2014 post, "How did PSPRS' investment do in the fiscal year that just ended?", so there is really nothing new to discuss in regards to the press release.

What I was interested in was the document attached at the end of the press release.  The PSPRS 2014 Investment Summary ("the Summary") is a type of document that I have never before seen on the PSPRS website.  If they have released them in the past, I have not been able to find them on the website.  I suspect that this is not the type of document they would post to the website when PSPRS lost money in the prior fiscal year, but hopefully it will now be part of their regularly disclosed reports.  The Summary covers the fiscal year that ended June 30, 2014 and was produced by NEPC, LLC, an independent investment consulting firm.  The Summary breaks down all of PSPRS' investments, not just by asset class, but gives the portfolio of investments within each asset class as well.  This allows us to see what funds and firms PSPRS has invested with, how much, and the returns earned from each of them.

I was most interested to get a more detailed look into PSPRS' real estate portfolio.  In particular, I wanted to see exactly what effect the investments committed to Desert Troon had on PSPRS' overall performance.  If you go to page 50 of the PDF document, you can see a breakdown of PSPRS entire real estate portfolio.  At the end of the past fiscal year, PSPRS' total real estate portfolio had a market value of $873,820,740.  This accounts for 10.8% of PSPRS' $8,127,506,488 total market value.  The 10.8% allocation falls just about right in the middle of PSPRS' target range for real estate investments of 6-16% of the total investment portfolio.

The Desert Troon commitment to the real estate portfolio is $297,862,000.  This makes up 34% of the real estate portfolio and 3.7% of PSPRS' total investment portfolio.  The next largest real estate investment is in "Blackstone Rep IV" at $90,006,272, which makes up 10.3% of the real estate portfolio and 1.1% of the total portfolio.  The real estate portfolio is made up of 22 total separate investments with only two others valued at over $50 million.  So we can see that Desert Troon has a grossly disproportionate share of PSPRS' real estate portfolio.  Even more concerning is that Desert Troon's 3.7% of the total PSPRS investment portfolio is higher or equal to all but three other investment commitments: SSGA International Equity at 9.7% of the total portfolio, SSGA US Equity at 6.5%, and Black Rock Core Active at 3.7%.  The first two are index funds that are parts of the international and domestic equity portfolios.  The third is a bond fund that is part of the fixed income portfolio.

The total real estate portfolio had a -0.6% return for the past fiscal year.  This compares to the benchmark National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index return of 11.2%.  Real estate was the only asset class to have a negative return for the past fiscal year.  The Desert Troon commitment had a return for the past fiscal year of -16.4%.  16 of the 22 real estate investments had an annual return that surpassed the 11.2% benchmark, three had returns of 8-10%, one had no returns shown, perhaps because it was made in June 2014, and two had negative returns.  The other one that suffered a loss was "OWH Berkana Hld," which lost 24.8% and shows a market value of about $13.15 million.  If we do the math, the Desert Troon investment had an annual loss of $58.43 million, while the OWH Berkana investment had an annual loss of $4.34 million.  For perspective, the Blackstone Rep IV, the second highest real estate commitment, had a return of 32.6% and earned $22.13 million.

If we look at the three-year returns, 15 out of the 17 investments that have been held that long have a positive return, with nine meeting the benchmark.  Desert Troon is one of the two to have a negative three-year return (-3.1%), though it beat the other negative returner which had a -22.4% return.  Five-year returns show that 6 out of the12 that have been held that long show a positive return, with four meeting the benchmark.  Desert Troon is one of the six with a negative five-year return (-4.7%), though it bested three of the other six negative returners.  Desert Troon did have the dubious distinction of being the only real estate investment held for at least five years that had negative returns for one, three, and five years.  I guess they get some credit for consistency.  Even the other annual loser, OWH Berkana, managed a positive return over the three-year period.

If the total real estate portfolio of $873,820,740 had a return of -0.6%, this would equate to a loss of about $5.27 million for the fiscal year on a beginning year market value of $879,095,312.  If the Desert Troon investment had broken even, the total gain on the real estate portfolio would have been about $53.16 million.  This would have produced an annual return on the real estate portfolio of 6.05%, so the Desert Troon commitment dragged the real estate portfolio down by 6.11%.  If the Desert Troon investment had earned a modest 5% for the year, approximately $17.81 million, the real estate portfolio would have returned about 8.07%.  The total PSPRS investment beginning year portfolio value was $7,246,805,889, so the $58.43 million loss on the Desert Troon investment represents a 0.8% loss on the total PSPRS portfolio.

In summary, there appears to be an over-weighting of the real estate portfolio in Desert Troon while the portfolio itself has been consistently underperforming over the past five years.  In addition, if we go to the Desert Troon website, we can see that their properties are heavily concentrated in Arizona, though the website does not indicate what, if any, of the properties featured there have PSPRS funds invested in them.  In fairness to both Desert Troon and PSPRS, I would like to have seen 10-year and 20-year rates of return to determine if there was a long-term profitable relationship, but the current Summary is all that is available.  Regardless, it does appear that the relationship will need to change so that PSPRS can diversify its real estate portfolio and not have its returns so closely tied to a single company.

After hearing for over a year about Desert Troon, allegations that over-valuations were done to pad staff bonuses, federal investigations, and whether subpoenas should be made public, it is nice to see some actual investment numbers.  There are some who are really interested in that issue, but I am not one of them.  The valuation of real estate often appears to be more art than science when you are dealing with properties that are held for development purposes, and the valuations seems to change depending on the criteria used and who is doing the valuation.  I am more interested in how such a close relationship between PSPRS and Scottsdale-based Desert Troon developed.  I want to know why no one saw red flags with committing so much money with a single company that was so heavily dependent on the Arizona real estate market.  I am curious as to why REIT's or real estate index funds were not considered as a smarter, safer, and less costly real estate investment option.   None of this implies anything inappropriate, but rather, speaks to the need to examine the past behavior so it is not repeated.

Monday, September 22, 2014

***Corrected information on PSPRS COLA's for fiscal year 2014-15***

PSPRS posted this corrected information about COLA's (aka permanent benefit increases) for fiscal year 2014-15.  The previous post should be disregarded.  This post has additional information and makes it clear that the monthly COLA for PSPRS retirees, who meet the criteria under the "old law," will be $65.20 per month, not $32.60 as I wrote in the last post.  In PSPRS' previous information, I read the $65.20 amount to be the retroactive COLA's for July and August 2014.  I apologize for this mistake (and thanks to the commenter that noted this in the last post).   Following in boldface type is the information PSPRS posted on 9/19/2014:

INFORMATION REGARDING THE JULY 2014 PBI PAYMENT (PAYABLE IN SEPTEMBER 2014)  FOR ELIGIBLE RETIREES 

The retroactive permanent benefit increase (PBI) will post to your account payable for Friday, September 19, 2014.  This payment is for the two month timeframe of July and August 2014. The regularly scheduled benefit payment on September 30 will incorporate the new pension amount going forward from September 30, 2014 through June 30, 2015.  Please note that for the majority of our membership this two month payment may be very small in comparison, especially to the payment for the 3 year retroactive adjustment made in June. 

Below are the average payments for each system/plan:
PBI CRITERIA FOR MEMBERSHIP
If membership (hire) date with current employer was before 1/1/2012 (“OLD” LAW) and RETIRED on or before 7/1/2011 plus retired for 2 years (by July 1), or age 55 and retired for 1 year (by July 1)
PSPRS $65.20 monthly increase Monies available in reserve account
CORP
1.59% increase Monies available in reserve account
EORP 4.00% increase Monies available in reserve account
 
If membership (hire) date with current employer was before 1/1/2012 (“NEW” LAW) and RETIRED on or after 8/1/2011 plus retired for 2 years (by July 1), or age 55 and retired for 1 year (by July 1)
OR
If membership (hire) date with current employer was after 1/1/2012 (“NEW” LAW) plus age 55 by July 1, or if receiving a survivor/disability retirement for 2 years (by July 1)
PSPRS No increase available Investment return based on prior fiscal year and current funding status of the Plan
CORP
0.81% increase Investment return based on prior fiscal year and current funding status of the Plan
EORP No increase available Investment return based on prior fiscal year and current funding status of the Plan

Remember: This retroactive payment is separate from your regular September benefit payment which will occur on September 30.

Please create a Members Only account (Click Here) if you have not done so in order to view your own personal record. 

This should mean that the retroactive COLA for July and August will be $130.40 ($65.20 X 2), and this should have already been paid out September 19th to PSPRS retirees meeting the criteria under the "old law."  The $65.20 COLA represents a raise of 2.17% for someone with a $3,000 monthly benefit and a 1.63% raise for someone with a $4,000 monthly benefit.  According to InflationData.com, the annualized inflation rate for the 12-month period ending August 2014, the latest listed, is 1.70%.

For anyone who falls under the criteria of the "new law" (i.e. SB 1609), no COLA will be paid.  It is important to remember that the February 2014 Fields decision only covered those who were already retired when SB 1609 went into effect.  Those who retired after that date are still covered under the provisions of SB 1609, which requires a minimum funding level of 60% and a minimum 10.5% rate of return for the previous year.  For the past fiscal year, PSPRS easily exceeded the 10.5% return but did not meet the minimum funding level of 60%.  CORP is better funded than either PSPRS or EORP and met both the required benchmarks to pay a COLA.

There a still two pending cases, the Hall case against the Elected Officials' Retirement Plan (EORP) and the Parker case against PSPRS, which were filed by employees who were still active when SB 1609 went into effect.  These cases are challenging the constitutionality of both the change in the COLA formula and the increase in contribution rates for active employees hired before 2012 .  The issues in the cases are essentially identical, so a decision in either will cover both cases.  A decision in favor of the plaintiffs would mean those covered under the "new law" would have to be paid COLA's for fiscal year 2014-15.  Unfortunately, I do not know the current status of these cases.

Thursday, September 18, 2014

SEE CORRECTED POST on 9/22/2014 ***Latest update on PSPRS COLA's for the current fiscal year***

SEE CORRECTED POST ON 9/22/2014; THIS POST REMAINS UP ONLY FOR COMPARISON PURPOSES.

Following in boldface is the latest information taken from the PSPRS website on COLA's (aka permanent benefit increases) for the 2014-15 fiscal year:

INFORMATION REGARDING THE JULY 2014 PBI PAYMENT (PAYABLE IN SEPTEMBER 2014) FOR ELIGIBLE RETIREES 

The retroactive permanent benefit increase (PBI) will post to your account payable for Friday, September 19, 2014.  This payment is for two month timeframe of July and August 2014. The regularly scheduled benefit payment on September 30 will incorporate the new pension amount going forward from September 30, 2014 through June 30, 2015.  Please note that for the majority of our membership this two month payment may be very small in comparison, especially to the payment for the 3 year retroactive adjustment made in June. 
Below are the average payments for each system/plan:


PSPRS: $65.20 payment
CORP:
(Tier 1)
1.59% increase
CORP:
(Tier 2)
0.81% increase
EORP: 4.00%

Remember: This retroactive payment is separate from your regular September benefit payment which will occur on September 30.

Please create a Members Only account (Click Here) if you have not done so in order to view your own personal record.  

It appears that the monthly COLA for PSPRS retirees is a modest $32.60 per month for the 2014-15 fiscal year, and all eligible PSPRS retirees should see a permanent $32.60 increase to their monthly benefit starting with the next scheduled payment on September 30, 2014.  There is always a lag for COLA's while PSPRS calculates its final returns for the prior fiscal year that ends on June 30, and the $65.20 to be paid September 19th is a separate retroactive payment for the July and August benefit checks

This COLA amount represents a 1.09% raise for someone with a $3,000 monthly benefit, and a 0.81% raise for someone with a $4,000 monthly benefit.  According to InflationData.com, the inflation for the 12 month period ending August 2014, the latest listed, is 1.70%. 

Thursday, September 4, 2014

How did PSPRS' investments do in the fiscal year that just ended?

PSPRS' consolidated annual financial report (CAFR) is usually not available until November or December, and the consolidated and individual employer actuarial reports are usually not available until September or October.  However, for those interested in seeing how PSPRS' investments did for the fiscal year (FY) that ended June 30, 2014, you can go to PDF page number nine of the August 27, 2014 Board of Trustees Meeting Materials.  Following is a brief synopsis of the investment returns for FY 2013-14.

For the fiscal year, PSPRS' total fund earned 13.82%, gross of fees.  If we subtract 0.50% (last year's amount) for fees paid to outside investment firms, we get an estimated annual return, net of fees, of 13.32%.  This 13.32% annual rate of return beats PSPRS' expected rate of return of 7.85% by nearly 5.5%, and it surpasses the 9.00% threshold for adding money to the Reserve for Future Benefit Increases ("the Reserve").  This means that half of the 4.32% over the 9% threshold will go into the Reserve to be used to pay COLA's in the future.

As we all know the stock market has had an incredible run over the past two years, so let's see how PSPRS' fiscal year returns compare with the Russell 3000.  (Note: in the past I have used the S&P 500 to compare PSPRS' returns against, but the Russell 3000 is what PSPRS uses in its own reports as a benchmark for its US equity portfolio, so henceforth I will use it as a standard benchmark as well.)  The Russell 3000 returned 25.22% for the year ended June 30, 2014, which is nearly 12% higher than PSPRS' 13.32% return!  However, PSPRS has a more diversified investment strategy and currently invests only 16.5% of its assets in US equity and only 14% in non-US equity.  The rest of PSPRS' portfolio is made up of fixed income, real estate, and other alternative investments, each of which has its own benchmark.  Both the US and non-US equity portions missed their benchmarks but each still returned over 20% for the fiscal year.  PSPRS' total fund benchmark was exactly 13.82%, so after fees the total fund will also miss its benchmark.

Readers can look through the returns of all the different types of investments if they like, but it is more difficult to get a sense of their final performance because they all have different fees attached.  Equity and fixed income investments tend to have lower fees, while the alternative investments have higher fees.  For example, last fiscal year total equity (32.26% of total fund) took only 0.18% in fees, real estate (13.36% of total fund) took 0.41% in fees, and private equity (11.30% of total fund) took a rather large 1.53% in fees.  The most glaring thing in the report is the real estate portfolio, which was the only category that lost money.  Real estate had a -0.62% return for the year versus a benchmark return of 11.21%.  PSPRS' real estate investments are the source of so many problems, so I guess we should not be surprised that these investments are still causing problems.  If real estate investments had achieved a return of just half the benchmark, the PSPRS total fund would have met its benchmark for the fiscal year.

We will have more when PSPRS post returns net of fees in the near future.

Wednesday, August 13, 2014

If you want to convince Arizonans to reform PSPRS, you don't go to New York

With thanks to a colleague who informed me of this article, Coaxing Fire and Police Staffs in Arizona to Cut Own Pensions, by Ken Belson in the August 11, 2014 New York Times, I was hopeful that there was going to be some new ideas from Professional Fire Fighters of Arizona (PFFA) President Bryan Jeffries, who recently took over for Tim Hill.  Unfortunately, the article was a disappointment.

The article details Mr. Jeffries' attempt to sell the PFFA reform plan, discussed in several recent posts, as a noble concession by Arizona's current firefighters to help PSPRS, and by extension, taxpayers and future firefighters.  The article has errors*, and the writer does not seem to be very familiar with PSPRS or its recent travails.  I am not sure how the New York Times got involved in this or why they found it newsworthy, but the Arizona Republic, which has done excellent reporting on PSPRS, would have certainly been more accurate and probably given the claims of Mr. Jeffries and others quoted in the article a little more scrutiny.

For me the key passage in the article is this:
To put the plan into effect, Mr. Jeffries wants to change the Constitution to allow for this one-time fix. This would reassure workers that lawmakers could not make even more drastic changes later.
I do not know if the second sentence is a paraphrased quote from Mr. Jeffries or inferred from the desire to embed the PFFA reform plan in the Arizona Constitution.  Either way, this statement rather boldly declares that the PFFA strategy is basically an end run around the Arizona legislature when it comes to PSPRS.  It is arrogant enough for the PFFA to present a final reform plan to the legislature as if it was the perfect solution.  It is another thing to go to the New York Times, hardly an Arizona-friendly paper, portray your organization as a protector of Arizona's taxpayers, and give the impression that you plan to treat the Arizona legislature as a non-entity in PSPRS reform.

As I detailed in recent post the PFFA reform proposal is no good.  I do not know how involved the PFFA was in the drafting of SB 1609 three years ago, but their public position was that no reform was necessary at the time.  Now they are all-in for reform but think that the legislature should just rubber-stamp their proposal, even though it is no improvement over the Arizona legislature's own bill, SB 1609.  So what was Mr. Jeffries' goal in talking to the New York Times?  I do not know, but if he thought a write-up in an elitist east coast paper would help PFFA's case, I think he is badly mistaken.

*PSPRS only takes half of any returns over 9% and places them in the COLA fund, and only part of SB 1609 was overturned, not the entire law.

Monday, August 4, 2014

A modest proposal for PSPRS COLA reform

I have spent several posts criticizing the Professional Fire Fighters of Arizona (PFFA) pension reform proposal, and I have pointed out the fundamental flaws with both SB 1609 and the current excess earnings model in how they calculate COLA's, especially when we consider the possibility of inflation.  (And, once again, for consistency I will again use the acronym COLA throughout instead of the less familiar but more accurate term permanent benefit increase (PBI).)  So what would I propose to do about COLA's?

I think the solution is simple and does not involve any significant change to PSPRS.  It would simply be to eliminate COLA formulas and allow the PSPRS Board of Trustees ("the Board") to determine the next year's COLA based on input from its actuary.  This is such a basic idea that I find it hard to believe that I am the first to propose it, so if someone has already floated this idea in the past, I apologize.

The main opposition to this idea would be that the Board could not be trusted to award fair and appropriate COLA's.  The Board might favor employers (and taxpayers) over employees and retirees, or vice-versa.  In its current statutorily mandated makeup, the Board is made up of two employee representatives--one fire and one law enforcement, two employer representatives--one state and one local, an elected official or judge, and two citizen representative, all appointed by the governor.  As can be seen, the Board is constituted to have representation from all stakeholders in PSPRS: employees, employers, politicians or judges, and taxpayers.  This allows for a diversity of opinion and interests and forces some give-and-take from Board members.  Furthermore, the Board is already responsible for other more critical decisions, particularly how and where funds are invested, so entrusting them to decide COLA's seems reasonable.

The Board would also be required to take input from its actuary, whom they already rely on for the other critical decisions they make.  The actuary does the number-crunching, simulations, and projections that determine funding ratios and annual required contributions.  Within a certain range based on the actuarial calculations, the Board could be restricted in how large or small a COLA could be awarded, and this is where the give-and-take among the Board members could take place and would not allow them to award COLA's based on unrealistic assessments or personal bias.

If we take a historical perspective, this method would have worked fine in the past.  When PSPRS was overfunded and returns were high, COLA's would have been more generous (even exceeding the rate of inflation) and allowed the benefits of excess earnings to be distributed equitably among retirees, current employees, and employers.  However, as PSPRS became more and more underfunded and returns over time were not sufficient to recoup past losses, COLA's could have been reduced or eliminated.  Looking ahead, if PSPRS begins to recover and inflation becomes a problem, COLA's could surpass the 4% or 2% thresholds in place or proposed.

This method of awarding COLA's would avoid the long-term mistakes engendered by hard formulas put into law or, even worse, into the Arizona Constitution.  COLA's would be based on the current financial condition, not from when times were better or worse.  Unions that negotiate for employees have a vested interest in having wages and benefits determined by hard formulas.  These hard formulas create certainty and stability in their contracts that do not allow the negotiated terms to be changed arbitrarily by elected officials.  This works fine with a collective bargaining agreement (CBA) that may last only one or two years, but the use of hard formulas becomes a problem when you are talking 20 or 30 years.  Inflation and returns fluctuate over time and setting in stone a COLA formula based on only your most recent experiences is short-sighted and dangerous.  Would unions accept a 20-year CBA based on the economic conditions that exist now?  Of course not, so why would they think that locking down a permanent, unchangeable COLA formula is a good idea?

The PFFA proposal is bad, and I am thankful that the Governor did not call a special session to consider it.  It is a shame that PSPRS wasted money on an actuarial analysis of such an absurd proposal.  I know that there are multiple labor organizations representing Arizona law enforcement, and I was not sure their feeling about this proposal.  However, a letter copied in Tucson City Council Member Steve Kozachik's Ward 6  June 18, 2014 newsletter indicates support for the proposal from at least one law enforcement organization, the Arizona Lodge of the Fraternal Order of Police (FOP).  The letter says, "Those of us who have worked on the issue believe the Firefighter's proposal has merit and may protect our members from more draconian measures.  This proactive effort represents the best chance for public safety to protect important benefits, our employers, our pension fund, our retirees, our actives, and our future members."  It is disheartening to know they were on board with the PFFA proposal.

While the PFFA pension reform proposal looks dead for now, it was important to analyze it closely to show its flaws.  Even if it never rises again, the PFFA proposal served a useful purpose in exposing the chronic myopia that afflicts the PFFA leadership and, possibly, law enforcement union leadership as well, when it comes to PSPRS.  For someone who is already in the DROP or close to retiring, dedicating 4% of your future career earnings to retirees may not seem like a sacrifice.  If you have many years left to retire or are just starting your public safety career, it will greatly affect the financial well-being of you and your family.  For someone who is expecting a six-figure DROP payout, committing to 2% COLA's in the future may not seem like a hardship.  For someone who retired before the DROP went into effect, a 2% COLA could mean your retirement benefit could get eaten away by inflation.  Looking at pension reform only from the perspective of someone with 20-30 years of time in PSPRS and access to the DROP is not only financially perilous, it is grossly unfair.  Unless the PFFA leadership can start looking at the cost and benefits of reform from the perspective of all affected constituencies, no reform effort proposed by them should ever be taken seriously.