PSPRS pension returns vs. S&P 500

The following is  from the Arizona Auditor General procedural review of the Public Safety Personnel, Corrections Officer, and Elected Officials' Retirement System dated November 16, 2011:

From fiscal years 1991 through 2010, the System's total investement performance averaged just over 7 percent annual gains.  This performance was nearly 2 percent lower than the actuarially assumed return of almost 9 percent.  It was also nearly 1 percent lower than the rate of return achieved by the Arizona State Retirement System (ASRS), the state agency that manages the retirement benefits for the State of Arizona, school districts and charter schools, some cities and towns, all 15 Arizona counties, and numerous special districts.  During the same period, the ASRS slightly exceeded its own actuarially assumed rate of return of 8 percent.

The System's actual rate of return exceeded the actuarially assumed rate of return in some years but dropped below it in others.  The overall result is a cumulative rate of return of about 300 percent for fiscal years 1991 through 2010.  This means that each dollar in the fund in fiscal year 1991 earned $3.00 by fiscal year 2010 through the System's investment strategies.  To match the actuarially assumed rate of return during the period, however, each dollar in the fund in fiscal year 1991 should have earned about $4.50.  The System's underperformance resulted primarily from losses experienced in fiscal years 2001 through 2002 and 2008 through 2009. 

To put this in perspective, at the end of June 1990, the S&P 500 index was 358.02.  At the end of June 2010, it was 1,030.71 in June 2010.  This produces an average annual return of 5.7% over the 20 year period.  This reflects only the actual change in value of the S&P 500 and does not include any dividends paid (I could not find historical data on dividend yields) or savings in fees and commissions.  The S&P 500 closed today at 1,413.49, and the S&P 500 depository receipt (SPDR) currently yields 1.98%.

So a large, professionally managed system with access to multiple investment vehicles and advisors returned only a little more than a passive index fund and may have actually returned less when dividends are figured in.  While the report explains that overconcentration in stocks, particularly in certain sectors, caused some of the biggest losses, this shows that individual investors are not the only ones who find it difficult to beat the market.  This is also why many financial planners believe passive investing in broad exchanges is the only way individual investors can realize gains on their portfolios.  A study by two Maryland think tanks (States Pensions Get High Fees, Low Profits -- Study) concurs with this belief in regards to pension funds as well.  Their study finds that underperformance of money managers combines with their high fees to cost pensions billions.

PSPRS has altered its investment portfolio significantly over the last few years, moving more of its largest stock holdings out of individual stocks and into mutual and exchange traded funds and lowering its percentage invested in stocks from 67.79% at the end of FY 2008 to 35.90% at the end of FY 2011.  However, PSPRS has also diversified into hedge funds and private equity firms, the types that the Maryland study criticizes.  Time will tell if these investments will pay a percentage high enough over passive investments to justify the increased fees.