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PSPRS members: How to calculate what you paid in excess contributions to PSPRS

If you were wondering how much your refund from PSPRS was going to be, reader Rick Radinksy has discovered a relatively simple method of cal...

Friday, June 9, 2017

***Hall v. EORP is finally concluded and the lower pre-judgment interest awarded***

Judge Thomason has reached a decision in Hall v. EORP.  Plaintiffs will not receive the higher 10% rate as if the settlement were based on a loan, indebtedness, or other obligation.  There is not an actual interest rate attached to the judgment, but it should be around 5% based on the current prime rate.

This should end the Hall v. EORP case, unless the plaintiffs decide to appeal the interest rate decision, as attorneys' fees were awarded and the judgment was also upheld.  The final decision in this case should apply in Parker v. PSPRS as well, at least as it pertains to a pre-judgment interest rate.  I do not know if the plaintiffs will challenge the constitutionality of the change in the PBI/COLA formula implemented last year by Proposition 124.

You can read the full decision here.

Thursday, June 8, 2017

The lastest on refunds of excess contributions in the Hall v. EORP and Parker v. PSPRS cases (Update 2)

I would like to thank the anonymous commenter who provide information and a link in the last post.  The comment pertains to the rate of interest and references a May 11, 2017 appellate decision in Arizona State University Board of Regents v. Arizona State Retirement System (ASU v. ASRS).  The case in question has some interesting similarities and differences from Hall v. EORP that could influence the decision in Hall and Parker.

Like Hall and Parker, ASU v. EORP involves and overpayment of contributions, but the contributions in ASU v. EORP appear to be employer contributions for an unfunded actuarial liablity claimed by ASRS.  ASRS demanded a payment of over $1 million from ASU with a penalty of 8% annual interest on any amount not paid within 90 days.  ASU made the payment but sued ASRS over the claim and won.  This reversed the debtor/creditor relationship, and ASRS had to refund the payment.  As in Hall, the final sticking point was over how much interest to charge.  The Superior Court judge order the judgment rate of "the lesser of ten percent per annum or at a rate per annum that is equal to one percent plus the prime rate as published by the board of governors of the federal reserve system," rather than the ten percent per annum rate on "any loan, indebtedness, or other obligation."  The rate awarded at the time was 4.25%, less than half what would have been awarded on a loan, indebtedness, or other obligation.

ASU disputed this interest rate, in particular because it was based solely on a judgment.  They prevailed in this argument and have been awarded the ten percent rate.  The Appeals Court decision is only six pages long, but the gist of it is that ASRS treated the original demand for payment like an indebtedness, which included a punitive interest rate for any delay in remittance, that was required to pay an actuarial unfunded liability.  If this was the case when ASRS was the creditor, it was equally applicable when ASRS became the debtor and had to pay the same money back to ASU.  This certainly seems like a fair and reasonable rationale.

The question for us is would this be applicable in Hall and Parker?  While there was no formal demand for payment from PSPRS to employees for the extra contributions, employees had no choice but to pay them, and the extra money was just taken from them whether they consented to it or not.  Employees did not formally agree to give or loan money to PSPRS.  The government used its power to extract it from their paychecks.  As ASU did, employees paid it then went to court to challenge the additional amount.  If we look at page 14 of PSPRS' 2016 Consolidated Actuarial Valuation, it describes the additional 4% paid (the excess contributions) in that fiscal year as a "portion used to pay down unfunded liability."  So we see that PSPRS members unjustly had a part of their earnings taken (no threat of punitive interest was necessary as they had no choice in whether to make the additional contributions) to pay an unfunded PSPRS liability.  Now like in ASU v. ASRS, we see the script flipped and the debtor and creditor switching places.

However, this is no slam dunk for an award of ten percent per annum interest.  ASU v. ASRS was a dispute between two parties over a specific issue involving 17 individuals taking part in a termination program.  In the judgment of ASRS, ASU was in arrears to ASRS.  ASU disagreed and the court agreed with them.  In regards to the Hall and Parker cases, EORP and PSPRS were making no demands on their respective employees and were simply following the requirements of SB 1609, for which the Arizona legislature was responsible.  This major difference seems likely to reduce the chances that PSPRS members are awarded a ten percent per annum rate of pre-judgment interest.

This is all in the hands of Judge Thomason now.  The latest information on the Hall case says that the matter is under advisement, meaning the judge is making his decision.  Once again, I would like to thank the reader who referenced this case.  It is often difficult to keep up with everything that is going on, and any help that can be provided is greatly appreciated.

Wednesday, June 7, 2017

The lastest on refunds of excess contributions in the Hall v. EORP and Parker v. PSPRS cases (Update 1)

Here is the latest, albeit minimal, information on the Hall v. EORP case that was posted on PSPRS' Facebook page:
Hall-Parker non-update update: The issue of interest was not settled during yesterday's trial court hearing for the Hall lawsuit. The court is expected to issue an order in the following days although the ruling will pertain to EORP. 
Applicable interest for PSPRS members impacted by the Parker lawsuit is expected to be determined sometime next month. 
However, PSPRS is working to soon provide employers with itemized lists of impacted employees and the pre-judgment (without interest) amounts owed to each individual.
This paves the way for member refunds as soon as possible, followed by separate payments to cover any interest awarded by the court. 
PSPRS will continue to provide updates as they develop.
Obviously, the plaintiffs and EORP do not agree on what a fair interest rate should be.  It would be intersting to know how far apart the parties are and on what rationale each side is basing its proposed interest rate.  We previously discussed what a fair interest rate might be in this post, which as of the end of January 2017 was an annualized rate of 5.42%, which is what I estimated PSPRS had actually earned on members' excess contributions.  This would mean that PSPRS would neither lose nor gain money on the excess contributions during the period they were being taken.  The latest annualized rate will be somewhat higher since PSPRS earned over 1% per month in February and March 2017.  It is possible that the plaintiffs could be arguing for a much higher interest rate by pointing to the S&P 500 or some other stock index or combination of indices as a baseline for what they could have earned if the excess contributions had never been taken from members.  However, this would be unfair to several groups, including employers, taxpayers, PSPRS members, and PSPRS itself, all of whom had no responsibility for SB 1609, and should not be punished for following through on its implementation.

Today's PSPRS post says that a decision should be coming in "the following days," which could be tomorrow or anytime in the future.  I believe that a decision should be relatively quick, though, since it is a specific number that the judge believes will deliver a fair amount of interest.  I do not see any legal nuance to this, and the judge has already had time to review the motions from both plaintiffs and defendants and heard their oral arguments advocating their respective positions.

It appears that the pre-judgment interest rate for EORP plaintiffs will be used up until Judge Thomason issues his final ruling in Hall v. EORP and that post-judgment interest has not been accruing since the Arizona Supreme Court decision in November 2016.  The next scheduled court date in Parker v. PSPRS is on July 12, 2017.  Though there is a different judge presiding over that case, I do not see why that judge would order a different pre-judgment interest rate as EORP and PSPRS invest their contributions in the same large pool of investments.  Employers were just given the go-ahead to start refunding excess contributions on May 31, 2017, and assuming there is a final judgment in Hall prior to July 12, 2017, this gave employers only six weeks to set up a system for refunding excess contributions to affected employees and retirees before post-judgement interest, which can be as high as 10%, begins to accrue on employers.

If we look at the PSPRS Return of Contributions Memo from the May 31, 2017 Board of Trustees meeting, it includes a legal opinion about how to return excess contributions from both Hall and Parker.  That legal opinion is dated May 25, 2017, only six days before the meeting and over six months since the Arizona Supreme Court decision in Hall.  PSPRS' post from today states that they are "working to soon provide employers with itemized lists of impacted employees and the pre-judgment (without interest) amounts owed to each individual."  So PSPRS has not yet gotten individual amounts to employers, even though employers will soon begin accruing post-judgment interest on unpaid excess contributions?  PSPRS also advises employers to give employees a chance to change their withholding rates and contribution amounts to tax-deferred accounts.  Nevermind, the time necessary for consultations to take place between employers and their union representatives, who then have to get answers out to their membership.

We once again see the unprofessional and shabby treatment by PSPRS of its stakeholders.  To be so out of touch with the realities faced by PSPRS local boards, employers, and union locals, those they are supposed to serve, is a disgrace.  PSPRS needlessly imposes costly financial deadlines on employers and administrative burdens on local boards and union locals all while they dilly-dally and move with no sense of urgency on their end.  PSPRS literally had years to figure out what they were going to do if Hall was decided in favor of the plaintiffs, but they never established any timelines to aid this process once the decision came down.  Of course, if you really want to get a true picture of PSPRS' management and Board of Trustees, we can always look to their own words.  This appears in the Return of Contributions Memo:
Furthermore, it is my recommendation that should an employer choose to utilize contribution credits that we allow pre-judgment interest to be included in those credits.  However, due to the complexity of tracking and coordinating the amounts with the employers, I do not recommend that post-judgment interest be included in the credits so as to entice the employers to return the excess contributions as quickly as possible. (italics mine)
I do not know who the "I" in this passage, but it takes an especially arrogant and clueless individual to imply that employers, who will be doing all the hard work of getting refunds out to employees and were given a short timeframe to do so and very little assistance from PSPRS, need to be incentivized to do the right thing.

Wednesday, May 31, 2017

The lastest on refunds of excess contributions in the Hall v. EORP and Parker v. PSPRS cases

In case you have not seen this, PSPRS posted this to their website today:

Board of Trustees takes action on Hall-Parker payments
PSPRS to pay PBIs and provide refund amounts
The PSPRS Board of Trustees today voted to recommend that employers begin refunding employee contributions related to the Hall and Parker lawsuits. The decision impacts certain active and retired members of EORP and PSPRS, but does not settle what interest will be owed to members of either plan.

Per federal regulations, the refunds cannot be paid back by PSPRS to members, but instead must be done by the employers. However, PSPRS will allow for employer contribution credits in the amount to be paid back to help employers who need to use that method to free up funds. PSPRS will soon provide employers with the names of impacted employees and retirees, as well as itemized lists of contribution amounts owed to each individual. When determined, pre-judgment interest will be allowed in the employer contribution credits, but post-judgment interest will not.

In the interim until individual contribution amounts are provided, the PSPRS Board of Trustees also strongly recommended that employers work closely with their Local Boards to decide on the method and manner of repayment that is in the best interest of the employees and employers.

Additionally, all contributions being returned are considered wages and must be taxed as such. However, the forthcoming interest payments are not considered wages and do not need to be taxed by the employer, provided the employer receives a Form W-9 for each affected employee. Therefore, it is strongly recommended that employees be given the opportunity to adjust their tax withholdings and deferred compensation arrangements.

Furthermore, the Board directed staff to pay out the retroactive permanent benefit increases for those PSPRS, CORP and EORP retirees entitled to increased benefits before the end of June. Again, these retroactive increases will not include any interest at this time.

PSPRS will continue to provide pertinent updates to members, employers and local boards. Interest rates to be applied to Hall-Parker lawsuit contribution refunds and retroactive permanent benefit increase may or may not be settled through a June 6 Maricopa County Superior Court hearing.
Please see the following document for the in-depth report provided to the PSPRS Board of Trustees on this issue.
There is a 22-page report linked to this message, so there will be more to talk about this after we all have a chance to take a closer look at it.  My immediate takeaway is that this is a recommendation to employers and, based on the steps PSPRS is encouraging employers to take during this process, there still seems to be a lot more work to do before money can even begin to start coming back to effected PSPRS members.  While the PSPRS Board of Trustees crows that they are taking "action on Hall-Parker payments," this seems like another case of PSPRS blindsiding employers and local employee representatives with a sudden decision that leaves them scrambling to get this completed.

Wednesday, May 3, 2017

Smouting off: The PSPRS Administrator shows Arizona how arrogant and out of touch he is

PSPRS Adminstrator Jared Smout has taken his crybaby act public with his May 1, 2017 editorial in the Arizona Republic.  Mr. Smout is again complaining about the Pew Charitable Trust's April 12, 2017 report on state pensions' use of alternative investments, and in particular, the Arizona Republic's article about the Pew report.  He takes issue with how the Republic interpreted data in the Pew Report and feels that this gave a misleading impression of PSPRS' investment performance.  This is funny coming from the leader of an organization that routinely cherry-picks data to make its performance look good and self-selects which peers to compare itself against and what date ranges to assess its returns.  Mr. Smout apparently got upset when a news organization took what an independent organization found and reported it to its readers, rather than taking what PSPRS says as the only "real" version of the facts.

However, we should be fair to Mr. Smout and PSPRS and look a little closer at the data in the Pew Report.  If we go to the Public Pension Investment Metrics table ("the metrics table") on pages 4-10 of the report, we see what are the most important numbers, the 10-year annualized returns through FY 2015.  These returns allow us to see how the 73 state pension funds, which represent 95% of all state pension fund investments, compare to each other on the most objective metric.  The only problem with the metric table is that not all of the returns are reported net of fees.  Mr. Smout makes a big deal about this problem in his editorial writing, "A full one-third of the 73 pensions examined didn’t even bother to report their fees," so I wanted to see how much this affected PSPRS' ranking among the 73 funds.

The Republic appears to get its third-worst ranking from Figure 11 on page 22 of the report, which ranks those plans that reported returns, net of fees.  Figure 12 on the next page ranks plans that reported returns, gross of fees.  Using the metrics table, irrespective of whether 10-year annualized returns were gross or net of fees, we can see that there are actually five state pension funds that performed worse than PSPRS.  27 state pension funds reported returns gross of fees, including the Retirement Systems of Alabama, which was one of the five that did worse than PSPRS.  11 of the 27 had returns at 7.00% or higher, 12 of the 27 had returns between 6.00% and 6.99%, and 4 of the 27 had returns between 5.00% and 5.99%.  PSPRS' 10-year annualized return, net of fees, was 5.22%

Since we cannot determine from the Pew report how fees affected each of these 27 state pensions' returns, we will have to utilize our own method.  Since PSPRS has the highest percentage of alternative investments and likely the highest percentage of returns paid out in fees, we can look at PSPRS' fees to get a number we can use.  In FY 2014, 2015, and 2016, the difference between PSPRS' gross and net returns was 0.54%, 0.53%, and 0.43%, respectively.  To be safe, let's use 0.60% as the percentage in aggregate fees paid by those state pensions that did not report returns, net of fees.

Using this 0.60% fee percentage, 23 of the 27 of the pension funds reporting returns, gross of fees, still outperformed PSPRS, as they earned at least 6.00%.  Of the remaining four pension funds that reported returns, gross of fees, three had returns lower than PSPRS' 5.22%, one of which was the aforementioned Retirement System of Alabama.  In total, regardless of whether returns were reported gross or net of fees, a total of seven state pension funds performed worse than PSPRS in 10-year annualized returns.  Two state pension funds, the Pennsylvania State Employees Retirement System and the Vermont Teacher Retirement System, were just barely being beaten by PSPRS by 0.02% and 0.05%, respectively.  (In reality, though it is likely my 0.60% fee percentage estimate is too high and means they almost certainly outperformed PSPRS as well.)  So, using the Public Pension Investment Metrics table, if we want to correct the Arizona Republic, we can see that PSPRS is actually the eighth-worst performing state pension fund, although I did not see Mr. Smout mention this in his editorial.  

By my count, 53 of the 73 state pension funds had, at least, a 10-year annualized return of 6.00%, net of fees.  (As earlier, subtracting 0.60% from any pension fund that reported returns, gross of fees)  Of the 65 state pension funds that outperformed PSPRS, 53 outperformed PSPRS by over 0.78%.  For some perspective, if that additional 0.78% was compounded annually over 10 years on PSPRS' $9 billion fund, it would have earned PSPRS an additional $650 million.  If PSPRS had earned the 6.90% 10-year annualized returns of the Arizona State Retirement System, PSPRS would have earned an extra $1.045 billion.  Once again, Mr. Smout fails to bring this up in his editorial.

I think we can all see the bigger problem here.  Despite all his indignation and outrage, Mr. Smout can only criticize the Republic for its different interpretations of parts of the Pew report, not any deliberate falsehoods or misrepresentations, and make more tired excuses for PSPRS' poor returns.  At best, he can now proclaim that PSPRS is actually only the eighth-worst state pension fund in America, not the third-worst as the Arizona Republic reported.  In his own whiny way, Mr. Smout shows the neutral stance of the Pew report, which made no conclusions about the efficacy of alternative investments or what, if any, amount of alternative investments was ideal.  It gave recommendations and objective data for readers to interpret and draw conclusions.  It is from this objective data that we get the negative picture of PSPRS, and that is what the Republic reported.
When we see the arrogant, defensive, and hair-splitting reaction of the leader of PSPRS, we can get a window into the culture of PSPRS management.  The editorial written by Mr. Smout did nothing to prove anything, except that the writers and staff of the Republic should question the credibility Mr. Smout, other members of the PSPRS administration, and its Board of Trustees.  If you want another peek into that culture, look at the reaction the Republic got when they initially questioned PSPRS spokesman Christian Palmer about the Pew Report:
When Republic reporter Craig Harris asked Palmer about higher fees and more specifically which company gets the highest fee for its performance for the trust, Palmer said the reporter’s question “ignores a fundamental of alternative investments” and referred The Arizona Republic to an online tutorial on investing.
The reality is that PSPRS' managment is failing PSPRS members, taxpayers, and employers.  The Pew report is just more evidence of that.  Yet, according to Mr. Smout, "Great things are happening at PSPRS as we leave the past behind and move forward. We invite you to join us."  I suppose if I was completely out of touch and made $200,000+ a year, regardless of my job performance, things would look pretty great to me as well.  I guess he was told by someone to try to end to his editorial on a positive note.  Maybe it was the ghost of Marie Antoinette.

Sunday, April 30, 2017

PSPRS investment returns through February 2017

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through February 2017, the eighth 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%

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

PSPRS had another 1%+ return for February 2017, and fiscal YTD has earned 8.78%.  However, the Russell 3000 has pulled more than 6% ahead of PSPRS.  For the fiscal YTD, PSPRS is earning 58.68% of the Russell 3000.  This fits the recent performance of PSPRS, which has usually earned 50-60% of the Russell 3000. 

Based on calendar date YTD returns, it looks as if the Russell 3000 had a small gain in March 2017, but it was up another 1.06% percent in April 2016.  Looking at this month's returns, private equity returned only 0.11% and has earned 11.51%, gross of fees, for the fiscal YTD.  This is funny timing, considering how much effort PSPRS just put into explaining how great their private equity returns have been.  One would expect private equity returns to show higher returns in a bull market, and PSPRS uses the Russell 3000 + 100 basis points as its benchmark.  The lag between PSPRS' private equity returns and the Russell 3000 gives us an indication of how unpredictable and risky private equity investments can be.

 * 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, and 0.63% in FY 2016.

Friday, April 21, 2017

Smout's Pout: The PSPRS Adminstrator tries to explain why PSPRS is one of the worst performing pensions in the US

Most of you have probably already seen this April 14, 2017 Arizona Republic article by Craig Harris, "Study concludes Arizona public-safety pension fund among worst-performing in nation." The title pretty much tells you everything you need to know, but if you have not read Mr. Harris' article, I would recommend you read it, even if it is just to hear what PSPRS spokesman Christian Palmer has to say in defense of PSPRS' ranking by the Pew Charitable Trusts (Pew) as ". . . the third-worst performing government trust fund as measured over a 10-year period that ended in 2015":
This isn't magic or a testament to how great anyone is.  This is because PSPRS has the highest share of alternative investments. ... Our costs may look high compared to other systems that may not make the same efforts to report all fees and investment expenses.
It's not magic, huh?  That's good to know because I was wondering why PSPRS hadn't tried to hire Penn & Teller to manage their investments.  Nor is it a testament to anyone's skill, either?  That's funny since that is generally what rankings tell us, but I suppose those managing the 69 funds that outperformed PSPRS were just having an incredible run of luck for the ten-year period that Pew analyzed.

I do not mean to pile on Mr. Palmer as he is just the spokesman for PSPRS and may have not fully prepared a response to the Pew Report, but this is what he said in his official capacity for PSPRS.  I had not posted anything on the Pew Report since I was waiting for PSPRS to send out a more fully thought-out response.  That response finally came out to today.  This is PSPRS' response to both the Arizona Republic article and Pew Report.  I had expected another party line response from PSPRS Board of Trustees Chairman Brian Tobin, but this time PSPRS brought out some different people.  The response starts with a short statement from Allan C. Martin, a partner in the independent investment advisor NEPC, LLC.  I am assuming that the rationale for including Mr. Martin's statement is that he is an objective party.  He restates PSPRS' standard line about how they are in this percentile of these particular funds over this specific timeframe, which is kind of like assessing the performance of the Atlanta Falcons midway through the third quarter of Super Bowl LI.  The fact that PSPRS was 70th out of 72 funds and the Falcons lost the game are really not important if you just look at the numbers in just the right way.  This nonsense is what we continually hear from PSPRS to explain away its underperformance.

Before I finish discussing Mr. Martin's portion, I would like to point out a few more things about NEPC, LLC.  PSPRS' fiscal year (FY) 2016 annual report lists NEPC's fees as $436,848.  In FY 2015, PSPRS paid NEPC $321,332, FY 2014 $326,501, and FY 2013 $326,886.  This is the disclaimer NEPC places at the end of its reports to PSPRS:
This report may contain forward-looking statements that are based on NEPC's estimates, opinions, and beliefs, but NEPC cannot guarantee that any plan will achieve it targeted return or meet other goals.
The reader can reach his own conclusions about PSPRS and NEPC from this additional information.

The rest of PSPRS' response comes from PSPRS Administrator Jared Smout.   There is a lot to say about Mr. Smout's statement, which comes in the form of him answering his own questions, but first we have to emphasize one very important thing.  As much as PSPRS tries to portray itself as a victim of Pew and the Arizona Republic, it was not targeted by either organization.  Pew analyzed 73 public pension funds and found PSPRS to be the third worst performing in the ten-year period ending in FY 2015, and the Arizona Republic just reported this fact.  The self-righteous indignation of Mr. Smout and other PSPRS cheerleaders does not change the fact that all the public pensions competed in the same financial markets as PSPRS and likely had their own unique problems to deal with.  Yet all but two performed better than PSPRS.  Now let's get to Mr. Smout's statements:
Why PSPRS paid the highest percentage of its investments in fees for outside investment management among the 73 largest public retirement systems in the country?
PSPRS had the highest percentage of alternative asset investments within their portfolio of every pension identified by the Pew Charitable Trusts study. These investments, which include private equity deals like buying and reselling companies or properties, require fees because they are not simple transactions like buying stocks or bonds. However, unlike fees for traditional investments like mutual funds, management fees are often reimbursed. PSPRS invests heavily in alternative asset classes as part of a deliberate strategy to minimize the risk of our portfolio, which has grown to more than $9 billion.
Additionally, the Pew report concluded – and even warned – that pensions are not reporting their fees accurately, or, in many cases, not reporting them at all. We, on the other hand, take the time and effort to report all of our investment expenses. A lot of plans don’t want to put in the work and they really don’t want to report totals when it is politically easier to keep them hidden. The Pew report advised that this exact type of disparity made their numbers unreliable for direct comparisons among pensions.
My response to this is: so what?  You pay a lot in fees, but you are still one of the worst funds in the nation.  That is the problem that is being highlighted here.  Most people would expect a positive correlation between higher fees and higher returns.  The saying "you get what you pay for" is generally not meant ironically, but apparently at PSPRS, it is.  Second, while it may be true that other pensions are not reporting their fees accurately, they are still outperforming PSPRS in the one number that matters, annualized returns.
Why in 2016, PSPRS spent nearly $129 million on investment management fees, while earning less than 1 percent return ($49 million) on it investments?
This question confuses “investment management fees” for investment expenses. There are two types of fees for alternative investments: management fees and performance fees. Management fees are up-front costs that are often – at least with PSPRS, which bargains its fees down with investment funds-reimbursed. For example, last fiscal year the trust paid approximately $87 million in management fees but we estimate that about $57 million of these fees will be paid back with interest in future years. PSPRS, like any institutional investor, must reward its investment managers for strong performance. The typical performance fee amounts to 20 percent of all profits above 8 percent. To be clear, achieving returns that trigger performance fees is a good thing. It means PSPRS is making money for the trust and selecting the right investments. Right now, PSPRS has private credit and private equity investment portfolios that are performing on an elite level compared to other peer pensions. These investments are making the trust money and lowering risk levels by diversifying our investments. For these reasons, alternative asset investments are worth the money for PSPRS and its members. Additionally, all public pension plans, not only PSPRS, had low investment returns last fiscal year ending June 30, 2016. Despite the tough environment characterized by struggling international markets, low interest rates, weak bond returns and geopolitical instability, PSPRS returns were among the top third of comparable pension funds. The PSPRS portfolio also assumed less risk than 96 percent of peer pension investments. Private equity investments generated a net of fee 11.3 percent return and outperformed all PSPRS asset classes
Once again, Mr .Smout is harping on fees paid to alternative investments.  Let me simplify what Mr. Smout is trying to say here.  Paying high fees is fine as long as the return surpasses those fees.  Would you rather pay $2 in fees to earn $3 or pay $20 to earn $40?  In the second case, you paid ten times the fees but returned twice as much, so strictly looking at the dollar amount paid in fees is not a fair measure of value because high fees in one asset class could be more than covered by even higher earnings in that asset class, and a loss in another asset class with low fees would eat into the profits of other asset classes with higher fees.  PSPRS earned 0.63% in FY 2016 and paid 0.43% in fees, so in aggregate, PSPRS did not pay more in fees than it earned on its investments.  This is a misperception left by the Arizona Republic article.  Of course, Mr. Smout still cannot help himself from making excuses about the same markets all the pensions were investing in or using his own special metrics to make PSPRS look good.
Why PSPRS paid fees of 2 percent to outside firms to manage its investments, while most state retirement funds paid less than one-half of 1 percent on management fees?
In 2015, PSPRS spent months conducting an in-depth fee analysis and shared the findings with the Republic. The examination of hundreds of funds revealed PSPRS paid about less than half the industry standard of 2 percent. Again, the Pew report warned that its data was unreliable and unfit for comparing pensions. 
The findings of the fee review were not published by the Republic. Also in 2015, an independent report contracted by the Arizona Auditor General found that PSPRS saved roughly $40 million on its investment fees by hiring attorneys to negotiate with investment fund managers.
Using PSPRS as an example, the challenge associated with fee reporting is that a pension can have several hundred alternative investments that were made and will end at different times. Some investments can take as long as 10 years or more to mature. This can make fee totals appear disproportionately high in years when a plan makes a lot of investments or in low return years like fiscal year 2016. On the flip-side, if a high number of investments mature in a particular year or generate many fee reimbursements, PSPRS could appear to pay very low fees. It is impossible to look at a reported fee total for one year to determine if a pension is overpaying for its alternative investments.
So PSPRS did its own in-depth fee analysis and the Arizona Republic didn't publish it?  Gee, I wonder why?  Probably for the same reason that news outlets didn't publish studies by the Tobacco Institute stating that cigarettes were not harmful.  It looks like the Republic was wise to not use PSPRS' numbers because Pew, a disinterested, independent organization, showed that they were wrong.  Pew had no incentive to misrepresent the fees PSPRS paid, while PSPRS did.  So does PSPRS pay 2% or "about less than half the industry standard of 2 percent"?  Mr. Smout never comes out and says that Pew is wrong and should retract its numbers.  He just gives a mealy-mouthed explanation of fees in the third paragraph.  And he is still perplexed as to why the Arizona Republic wouldn't trust his numbers?
Why PSPRS, a $9 billion trust, has only about half the money required to pay all current and future pension obligations to its members?
There are several reasons for this, all of which PSPRS has openly addressed for several years. Two global financial disasters – the “Dot.Com collapse and housing market crash – are a key factor, especially combined with the statutory formula for awarding pension increases to PSPRS retirees. The current PSPRS low-risk investment strategy that features greater reliance on alternative investments is a direct result of damages PSPRS suffered when it was heavily invested in public equities (stocks). (NOTE: This formula, the Permanent Benefit Increase, or PBI, was discontinued with the passing of Prop 124 in 2016.)
To a lesser extent, asset losses in legacy Arizona real estate investments were also steep enough to push overall investment returns down to below average levels. PSPRS has also been forced to reverse cost-saving pension reforms due to lawsuits and the costs associated with this have had a negative effect on funding levels. 
More vacuity from Mr. Smout.  Apparently, Mr. Smout doesn't realize that the dot.com and housing market collapse affected the entire world, not just Arizona, and that the other 72 other public pension had to deal with the same financial stresses.  Oh, and by the way, so did the Arizona State Retirement System (ASRS) and PSPRS' own Cancer Insurance Plan, both of which have outperformed PSPRS.  Yes, the PBI was a problem, but once again, what does this have to do with PSPRS' sub-standard returns?
Why the $36.2 billion Arizona State Retirement System for teachers and local and state employees ranks far better than PSPRS, settling among the top third when it comes to performance on investment returns?
ASRS has almost double the public equity exposure than PSPRS. Public equities are cheap but also volatile. If a fund can support short-term volatility then owning more public equities is a sensible strategy. An investor with a higher risk tolerance is able to seek higher investment returns. For many reasons, including the PBI and current funding levels, this level of volatility and risk are not acceptable for PSPRS. The explanation regarding our performance is simple; the trust was disproportionately harmed by legacy real estate investments. Even then, the Trust’s portfolio outperforms 75 percent of its peers on a 10-year basis through the end of 2016, net of fees, which most wouldn’t classify as “underperforming.”
And why ASRS paid less than half (about four-tenths of 1 percent) of what PSPRS paid on investment management fees?
The fees ASRS pays for their alternative investments is in line with what PSPRS pays for alternative investments. The difference between our total fee levels is explained by the percentage of assets that we each have in equities and alternative assets. PSPRS has a higher percentage of its assets in alternative investments, while ASRS has a higher percentage of its assets in public equities, which are inexpensive to buy. Many pension funds are increasing their allocations to alternatives, which they wouldn’t do if they thought it was an inefficient use of capital. 
These last two statements are Mr. Smout at his whiniest.  You would think he had walked in the door for the first time and just realized the sorry state of PSPRS.  In fact, he has worked at PSPRS for 20 years, becoming Deputy Adminstrator in 2011 and Adminstrator in 2015.   Are we supposed to feel sorry for Mr. Smout because of the self-perceived disadvantages vis-a-vis ASRS?  Maybe it's just possible that ASRS is better managed than PSPRS.  Perhaps Paul Matson, who has been Chief Executive of ASRS since 2003, could give Mr. Smout some pointers on how to run a pension.

To conclude this long post, Mr. Smout has provided the perfect closing line:
Many pension funds are increasing their allocations to alternatives, which they wouldn’t do if they thought it was an inefficient use of capital.
So if you are still unconvinced of the wisdom of PSPRS' investment philosophy, just remember PSPRS is just doing what everyone else is doing, only more so.  They have the highest percentage of alternative investments but the third lowest returns.  Herd mentality and underpeformance: there's a combination that will fill you with confidence.

Thursday, April 13, 2017

PSPRS investment returns through January 2017

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through January 2017, the seventh 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%

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

January 2017 was another good month for PSPRS.  For the month, PSPRS achieved about 55% of the return of the Russell 3000, but for the year, PSPRS has returned about 69% of the Russell 3000.  Since the election, PSPRS has so far earned at least 1% every month, and PSPRS has already exceeded its expected rate of return of 7.4%.

The calendar date YTD return of Russell 3000 as of April 12, 2017 is 4.93%, 3.05% higher than the the 1.88% earned through the end of January 2017.  With the a loss of 0.77% through the first 12 days of April, this means that the Russell 3000 will have a combined return in February and March 2017 of about 3.9%.  It will be interesting to see what PSPRS returns in those months.

If PSPRS collectively owes members $220 million in refunds as was estimated when Hall was decided last year, a 1% return will earn $2.2 million on members' excess contributions every month just on the principal alone.  A rate of 3.9% will have earned PSPRS over $8.5 million in February and March 2017.  If you are personally owed a $10,000 refund, a 1% return, $100 is what PSPRS will earn off your excess contributions each month; 3.9% is $390 earned off your money in February and March.  This is what PSPRS is earning off of the hard-earned money they should never have had in the first place.  Will PSPRS Board Chairman Brian Tobin and the other Trustees do what is right for PSPRS members, or will they side with PSPRS' administration like they have in the past and let members get cheated, treated as income sources rather than the system's beneficiaries?  Based on his past actions, I have little confidence in Mr. Tobin, but hopefully some of the new members of the Board will do what they can to make sure this is fairly settled.

 * 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, and 0.63% in FY 2016.

Thursday, April 6, 2017

Operation Overlong: When PSPRS members are likely to hear anything new on the Hall case

With thanks to the anonymous reader who alerted me to via a comment in the last post, it now looks like PSPRS members have their own D-Day to look forward to.  The next Maricopa County Superior Court date for Hall v. EORP will not be until June 6, 2017 at 2:00 PM.  The court calendar lists the presiding judge as the Honorable Timothy Thomason.  The case minutes from March 28, 2017 show that the judge to whom it was originally assigned, the Honorable Randall Warner, was recused due to having a personal stake in the outcome of the case.  Judge Thomason was not appointed to the bench until 2014 and is not affected by the Hall decision.

So there we have it.  Nothing is likely to happen until that date, though I believe that PSPRS could refund excess contributions now since that matter, like the lowering of contribution rates back to 7.65%, requires no adjudication.  PSPRS just needs to turn loose of the money.  If attorneys are still haggling over an interest rate and attorneys' fees, that can be taken care of at a later date.  There is no reason to hold back the principal owed to members.

We also have to remember that PSPRS members still have to wait for the resolution of Parker v. PSPRS, the case that actually relates to PSPRS members.  As I mentioned in a previous post, Rapplyea v. PSPRS was settled less than three weeks after Fields v. EORP.  However, I think that there may be an outstanding issue in Parker, namely the status of the old permanent benefit increase (PBI) formula, that was not addressed in Hall, but this should be discussed in a future post.  Regardless, I don't believe that the refund of excess contributions and interest payments should be delayed by any outstanding PBI issues.  The contribution rate issue was resolved by the Supreme Court, and PSPRS members should see that portion of Parker resolved soon after the final decision in Hall

Wednesday, April 5, 2017

Special interest: What would be a fair interest rate for PSPRS members on their excess contributions?

PSPRS has told us that among the issues still up in the air is the calculation of interest payments on excess contributions.  This makes sense, but it should have nothing to do with refunding excess contributions since there is no uncertainty as to how much members are owed.  If you want to know what your refund will be, you can calculate it using the method explained here.  These amounts could be refunded to members now, and though I do not know if it would require the Superior Court's approval, it does not seem likely, since PSPRS is lowering the contribution rates without having gone to court first.  So what could be the reason for the delay in refunding excess contributions?  If PSPRS is incurring interest, it would make sense that they would want to expedite repayment.  Let's start looking at this by first trying to get an idea about how much interest members will receive.

The Arizona Supreme Court awarded pre-judgment interest, which is covered under under A.R.S. 44-1201 (A) and (B).  They state:
44-1201. Rate of interest for loan or indebtedness; interest on judgments
A. Interest on any loan, indebtedness or other obligation shall be at the rate of ten per cent per annum, unless a different rate is contracted for in writing, in which event any rate of interest may be agreed to. Interest on any judgment that is based on a written agreement evidencing a loan, indebtedness or obligation that bears a rate of interest not in excess of the maximum permitted by law shall be at the rate of interest provided in the agreement and shall be specified in the judgment.
B. Unless specifically provided for in statute or a different rate is contracted for in writing, interest on any judgment shall be at the lesser of ten per cent per annum or at a rate per annum that is equal to one per cent plus the prime rate as published by the board of governors of the federal reserve system in statistical release H.15 or any publication that may supersede it on the date that the judgment is entered. The judgment shall state the applicable interest rate and it shall not change after it is entered.
I have no idea how the judge might rule, but I think that PSPRS members would be covered under subsection B.  PSPRS did not sign off "any loan, indebtedness or other obligation" and was simply following the laws enacted by the Arizona Legislature.  There was no intent on their part to ignore or violate a binding contract.  This was the reason why the trial court judge initially turned down the plantiffs' request for interest.

Of course, this does not mean members should have to suffer financially either.  They were faultless and are the wronged party in this case, and they should be remunerated for the lost buying power and/or potential earnings on their back wages.  This is why subsection B seems like the most likely remedy for PSPRS members due a refund.  It would make members whole on their money but not be a punitive measure directed against PSPRS.  This, of course, leaves us to figure out what a fair interest rate would be.

If we consider subsection B to be the likely remedy, it would be interesting to see what the interest rate might be under different scenarios.  I have been paying the higher rate since it was raised in July 2011, and my total overpayment through January 2017 was $11,177.  The breakdown of my fiscal year overpayments is as follows:

Fiscal Excess
Year Paid
2012     $695
2013   $1,294
2014   $2,029
2015   $2,280
2016   $3,047
Jan 2017   $1,832
Total $11,177

The following table shows PSPRS' actual fiscal year rates of return and what they have earned year-to-date through January 2017. Even though we are in April 2017, the rate of return through January 2017 is the latest information available from PSPRS' meeting notes.  The table also shows the actual prime rate during those fiscal years.  I lowered PSPRS' fiscal 2017 year-to-date rate by 0.52% to account for investment fees:

Fiscal PSPRS Prime
Year Actual Rate
2012 -0.79% 3.25%
2013 10.64% 3.25%
2014 13.28% 3.25%
2015 3.68% 3.25%
2016 0.63% 3.25-3.50%
2017 7.00% 3.50-4.00%

I was interested to see what PSPRS actually earned on my overpayments versus what they would actually pay me in interest if they used the subsection B formula, which is the prime rate plus 1%.     The prime rate was unchanged at 3.25% for seven years between December 2008 until December 2015.  It was raised in December 2015 (3.50%), December 2016 (3.75%), and March 2017 when it reached its current rate of  4.00%. 

For ease of calculation, I broke down each full fiscal year overpayment into 12 equal payments and compounded them monthly at four different interest rates.  For fiscal year 2017, I broke the overpayment into seven equal payments.  Here is what I found:

Payout Interest
Overpayment  $11,177           - 
PSPRS Actual  $12,869    $1,692
Prime + 1%  $12,487    $1,310
Fixed 5.00%  $12,725    $1,548
Fixed 10.00%  $14,559    $3,382

If we use a strict interpretation of the prime rate plus 1% formula stated in subsection B of A.R.S. 44-1201, this would use the prime rate + 1% in effect at the time of each overpayment.  This would produce an interest payment of $1,310.  If we used the current prime + 1% (5.00%) and fix it retroactively to July 2011, we get an interest payment of $1,548.  As can be seen, both of these interest payments are less than what PSPRS actually earned on the overpayments.  A fixed 10% payment would produce an interest payment much higher than what PSPRS actually earned.  The annualized rate for PSPRS actual returns was approximately 5.42%

So what would be a fair interest rate?  As of January 2017, I would say that 5.42% would be fair.  This would be a wash for both parties.  It would not be right for PSPRS to keep the gains earned off members' money they should not have had in the first place.  Conversely, PSPRS should not be punished for simply following the conditions imposed on it by SB 1609, though PSPRS as an entity will not be punished, as any interest in excess of what they actually earned will hurt employers and employees long-term via higher contribution rates. Of course, this 5.42% interest rate will change depending on what PSPRS earns between January 2017 and whenever the excess contributions are finally refunded to members.

Since we do not know what is going on, we are once again left to speculate.  Will the judge just mandate an interest rate?  Will each side's attorneys argue for the rate most favorable to their clients?  If I was the plaintiff's attorney, I would be willing to accept the actual annualized rate up through March 31, 2017 since this was when the Supreme Court returned the case to the trial court judge.  (This actual annualized rate is likely to be higher than the 5.42% we mentioned earlier.) However from April 1, 2017 onward, I would only accept an interest rate that is the higher of either the actual annualized rate as of March 31, 2017 or PSPRS' real rate of return.  This would force PSPRS to pay members what it actually earns on their money, but it would prevent PSPRS from passing on to members any losses it might incur in the interim.

In answer to the question we asked earlier, the only logical reason for PSPRS to delay refunds to members would be if they were currently earning more than they expect to pay in interest.  For fiscal year 2017, PSPRS is earning nearly 1% per month through January 2017.  If this rate were to continue for the next five months, PSPRS would have a fiscal year rate of return of about 12.40%.  This is why it is critical that conditions are created where PSPRS has an incentive to return members' money as soon as possible.  They are earning a lot on our money right now, and members need protections to keep them from being cheated.

Wednesday, March 29, 2017

PSPRS members: Another update on the Hall case

There is some new information from PSPRS, which appears directed at employers, not PSPRS members.  I don't know if it was sent out to everyone, so here is what came out today:
Notice to EORP, PSPRS employers on Reversion of Member Contribution Rates
The Arizona Supreme Court issued its mandate in the Hall v. EORP lawsuit for the Superior Court to begin implementing the remedies afforded by the ruling and it has been determined by the Board of Trustees that those remedies will also apply to the Parker lawsuit.
Therefore, effective immediately by Board action this afternoon, the employee contribution rates for all members hired on or before July 19, 2011, are to revert to the following rates at the beginning of the first complete pay period on or after April 1, 2017, or as soon as practicable after that.
  • EORP (Hall):  7.00%
  • PSPRS (Parker):  7.65%
Please notify our Active Member Department (ActiveMembersGroup@psprs.com) of which pay period will feature the lower contribution rates for impacted members. It is crucial that the rate revert at the beginning of a complete pay period as we will not be able to determine any excess contributions that would need to be refunded if the employee contribution rate is not reverted for an entire pay period.
It is still unknown as to when the excess contributions will be returned to impacted members but it cannot happen before the parties agree in Superior Court to a rate of interest, the time period for which that interest applies, and the methods for which the contributions may be returned.
However, reverting the contribution rates to the above amounts is the crucial first step before any calculation of excess contributions can be calculated. We will work with each employer, on an individual basis as necessary, to that successful end. Therefore, please contact PSPRS if you need help identifying those members who are affected.
Please remember that all EORP members hired on or after July 20, 2011, will continue to contribute at 13.00% and the employer will continue to contribute at 23.50% for all elected officials. Also, this change does not affect any of your members in the Elected Officials' Defined Contribution Retirement System.
For PSPRS members hired on or after July 20, 2011, the employee contribution rate will remain at 11.65% while employers must continue to pay their current individual employer contribution rate.
For any employers who may have members in the Corrections Officer plan, their employee contribution rate was never increased, so they are not affected by either lawsuit or entitled to refunds of excess contributions.
The Hall and Parker lawsuits will also result in retroactive permanent benefit increases (PBI) for impacted retirees in all three plans. However, the issue of interest must also be settled at the trial court level before retroactive payments can be made.
We will continue to provide information regarding the return of excess contributions to impacted members and the payment of retroactive PBIs to retirees as updates continue to develop.
Thank you for your help,
PSPRS Administrator Jared Smout

I also wanted to post this helpful comment from reader Dave Christian:
With respect to the actual mechanics of the refund, PSPRS is going to expect employers to refund the excess contributions once we have a calculation on the interest component. As you said, the excess contributions themselves are easy enough to calculate. Then the employers will get a 'credit' to use against remittance of current payroll. So the employers will put the funds on the employee paychecks. This means that they will be treated as a 'bonus' and taxed at a much higher tax rate. It will be up to the employer to facilitate employee's wishes to roll the money into another qualified plan. As a finance manager for a large fire district, I am currently in a holding pattern. There will be a ton of communication I need to get out to our employees about their options and I am anxious to get started. The waiting game never seems to end on this issue.
I would like to express my thanks to Mr. Christian for sharing this.  Once again, I am perplexed and disappointed, though not surprised, by the PSPRS administration and Board of Trustees.  If this is what PSPRS is telling employer representatives it seems to contradict what they say in their official missive, which says that the Superior Court must determine, "the methods for which the contributions may be returned."  I understand that interest payments will be an issue for debate.  However, it seems they already know how they plan to return active members' excess contributions to employers, and instead of being honest with PSPRS members, whose money it is they are holding, they prefer to play coy and leave members in the dark.  They know what they are going to present to the Superior Court judge when it comes to refunding excess contributions.  There is no reason to withhold this information from PSPRS members.

Certainly, what Mr. Christian details seems to be the easiest way to refund excess contributions to active PSPRS members.  With so many different agencies, it would simply be too cumbersome and complicated for PSPRS to handle it themselves.  I, for one, would be relieved to have this done at the employer level with coordination and input from union locals to best meet employees' needs and desires, be they lump sum payments, transfers to tax-deferred accounts, payments over time, etc.  Active PSPRS members will be better off trusting those who actually have a history of trying to help them.  The PSPRS administration and Board of Trustees have been chronically contemptuous and dismissive of PSPRS members.  PSPRS members have good reason not to trust them.

Tuesday, March 28, 2017

PSPRS members: The wheels of justice are slowly turning in the Hall case (updated)

So we can finally see some movement in the Hall case at the Superior Court level.  The Maricopa County Superior Court case, CV2011-021234, shows the first update since June 2015.  On March 24, 2017, an "order of mandate" was filed.  As I always like to point out, I am not a lawyer, so I went to the Online Law Dictionary to get a definition.  Here is how it defines a "mandate":
A Judicial command or precept proceeding from a court or judicial officer, directing the proper officer to enforce a judgment, sentence, or decree. Seaman v. Clarke, 60 App. Div. 416, 69 N. Y. Supp. 1002; Horton v. State, 63 Neb. 34, 88 N. W. 146. In the practice of the supreme court of the United States, the mandate is a precept or order issued upon the decision of an appeal or writ of error, directing the action to be taken, or disposition to be made of the case, by the inferior court In some of the state jurisdictions, the name “mandate” has been substituted for “mandamus” as the formal title of that writ.
The term has different meanings in relation to other legal concepts, but the aforementioned definition appears to be the one relevant to the Hall case, especially when it shows the order came from the Arizona Supreme Court.  This appears to be the official document telling the Maricopa County Superior Court to enforce the judgment in the Hall case.  So what does this mean?  I think this means that there will be court dates set for the litigants to meet and agree to a resolution.  I have put in links in the sidebar to the Hall and Parker cases, as well as the latest Fields case.  As I mentioned in this March 14, 2017 post, the Rapplyea case was settled just 17 days after the first Fields case.  I expect that Parker will follow the same pattern and be quickly settled (for the most part) after Hall is finally resolved.

Speaking of Fields, I have to correct an error from the referenced post.  Here is a comment from a reader about the new Fields case:
The new Fields case revolves around the funding of the old EORP plan which was closed a few years ago not properly 124. The nuts and bolts are that when the plan was closed the legislatures artificially capped the max employer rate at around 27% even though the real rate needed is much higher. He is suing to force the state to pay the real costs and not allow the plan to go insolvent.
So thank you to that anonymous reader for his insight, and I apologize for the incorrect information.  My error is even worse since Proposition 124 does not even cover EORP, so Mr. Fields would have no reason to litigate it.  Here is the relevant portion of the EORP annual actuarial report warning about the future funding status of EORP:

The reversal of some of the provisions in SB1609 due to the Fields decision in 2014 resulted in a significant increase in the contribution rate. The statutory contribution of 23.50% of aggregate payroll was instituted prior to the Fields decision.  We recommend that the 23.5% statutory rate be reviewed to reflect the court rulings regarding benefit provisions.  If pending litigation in the Hall case is ruled in favor of the plaintiffs, contribution rates will increase again next year.  Absent the receipt of increased contributions, the System is expected to run out of money in 13 years.
The retired lives are less than fully funded on a funding value of assets basis, but are much less than fully funded based upon the market value of assets.  It is most important that this Plan receive contributions at least equal to the rates shown in this report
I do not believe that PSPRS has this problem, so the outcome of this case should not affect PSPRS members.  If there will be a constitutional challenge to Proposition 124's replacement of the old permanent benefit increase (PBI) formula with a capped COLA, it will have to come from a PSPRS member.  It is likely that in fiscal year 2017 PSPRS will exceed the 9% threshold that triggered PBI's under the old methodology.  Also, inflation has well exceed the new 2.0% cap on COLA's and is currently running at 2.7% for the past 12 months.  This could provide a lot of incentive for a PSPRS member, active or retired, to challenge Proposition 124.

Of course, we already have a PSPRS member suing over the change, the Parker case, so it will be interesting to see if this issue is brought up when Parker returns to the trial court as that court originally decided in favor of the Hall plaintiffs when it came to the PBI issue for employees active when SB 1609 went into effect.  Parker never went to trial at the Superior Court level and was stayed pending the Hall decision.  This was prior to the passage of Proposition 124, which allowed a one-time exception to the Pension Protection Clause.  The Hall case did not have to consider the Contracts Clause of the Arizona Constitution since Proposition 124 did not affect EORP members, and the Supreme Court panel declined the motion for reconsideration that would have looked at the constitutionality of benefits changes when considered under the Contracts Clause.  I have no idea what could happen with this issue when the trial judge considers it, and it should probably be the subject of a future post.  I suppose worst case scenario would be that the judge in Parker declares the post-retirement benefit changes of Proposition 124 unconstitutional under the Contracts Clause, and the case has to work its way back up to the Arizona Supreme Court again for another decision.  Regardless, it should not affect the highest priority issue for most members, the refund of excess contributions, which should go forward regardless of the status of PBI's and COLA's.

I would recommend that everyone interested in Hall and any future litigation involving PSPRS read  the comments in that March 14, 2017 post.  Some of the information is interesting and may help you plan for the near future.  Of course, we are still waiting for something official from PSPRS, so stayed tuned.

Friday, March 17, 2017

Brian's Song: Why the PSPRS Board of Trustees Chairman toes the line for PSPRS' administration

Before we get into other issues, let's talk about PSPRS' returns.  The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through November 2016, the fifth 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%

There is usually about a two-month lag in PSPRS reporting its investment returns.   Another good month for both PSPRS and the Russell 3000.  PSPRS lags the Russell 3000, but a 6.43% return for the first half of the fiscal year is terrific.  As of yesterday the Russell 3000 is, coincidentally, up exactly 6.43% for the first two and a half months of 2017, so there should, hopefully, be more gains for PSPRS in February and March 2017.  The only question is how closely PSPRS' gains will correlate to the Russell 3000's.

The handful of readers who have followed this blog for the past few years know that most of my criticism is directed at state-level union leaders and the PSPRS administration and Board of Trustees.  This is because they are the ones who are supposed to be looking out for PSPRS members.  While I do criticize state and local politicians, they have other constituents, namely taxpayers and citizens, whose interests they are supposed to take into account.  This is not so with union leaders and PSPRS' administration and Board of Trustees, who primarily have PSPRS members as their only constituents.

This is why it is so disappointing to see this editorial by PSPRS Board of Trustees Chairman Brian Tobin that appeared in the March 10, 2017 Prescott Daily Courier newspaper.  According to PSPRS' biographical blurb, Mr. Tobin joined the Phoenix Fire Department in 1983 and has been a Deputy Chief since 2007.  He is also a past president of the Professional Fire Fighters of Arizona (PFFA), the state-level firefighters' union, and the brother of former Arizona House Speaker and current Arizona Corporate Commissioner Andy Tobin.  Brian Tobin's position on the Board of Trustees is as one of the employee representatives for the state's firefighters.

In his editorial Mr. Tobin repeats the company line that we continually hear from PSPRS' administration: PSPRS is doing very well when we look at their own self-chosen metrics.  Mr. Tobin puts no hard numbers in his piece, but I do not doubt that, in any economic environment, he and PSPRS' administration can handpick the necessary data to show that PSPRS is doing great.  However, the rest of us would like to see a more objective measure of PSPRS' performance, rather than take on faith what PSPRS and the Board of Trustees has to say.

Let's start by referencing this excellent article, How the Bogle Model Beats the Yale Model, by Ben Carlson, CFA from his blog, A Wealth of Common Sense.  I recommend reading his short piece for yourself, but to summarize, Mr. Carlson used fiscal year-end data as of June 30, 2016 to compare the 3-year, 5-year, and 10-year annualized returns of more than 800 college and university endowments against the returns of a portfolio of three Vanguard index funds he calls the Bogle model after Vanguard founder John Bogle.  What he found is that the Bogle model not only beats the average endowment returns but even the top decile of endowments as well.  Mr. Carlson points out that many of these endowments are run by top-level investment professionals who utilize complicated, non-traditional, multi-asset strategies.  The following table shows Mr. Carlson's numbers as well as returns from other funds closer to home, the Arizona State Retirement System (ASRS) and PSPRS' own Cancer Insurance Plan (CIP), as of June 30, 2016:
Fund 3-year 5-year 10-year
PSPRS 5.71% 5.40% 4.45%
CIP 6.24% 5.49% 5.69%
ASRS 7.10% 7.10% 6.00%

Average 5.20% 5.40% 5.00%
Top quartile 6.30% 6.20% 5.30%
Top decile 6.60% 6.60% 5.40%
Bogle Model 6.40% 6.50% 6.00%

Looking at all these returns, we see that PSPRS' returns most closely match those of the average endowment.  However, what is most disturbing is how much PSPRS lags both ASRS and its own CIP.  The CIP is a very simple portfolio made up of approximately 25% US Equity, 25% non-US equity, 30% fixed income, 10% inflation-linked securities, 5% commodities, and 5% short-term investments.  No private equity, no real estate, no global tactical asset allocation, etc.and yet, this portfolio beat PSPRS in every time period.  ASRS, a more actively managed fund, bests PSPRS by even larger margins.  The three-index fund Bogle model also outperforms PSPRS in all three periods.

The 10-year period is most instructive since it includes both a horrendous downturn and an extended bull market, and any strategy utilized during that time will have been tested at both market extremes.  PSPRS has the worst 10-year annualized returns.  So we can see Mr. Tobin does not need to look far and wide for comparative data; he can just look in PSPRS' own offices or cross town at ASRS.  He does not need to selectively choose data to produce a measure of PSPRS' performance; Mr. Carlson has already given him a good baseline to use.  And for goodness sake, he and PSPRS should stop giving comparisons of how much better PSPRS' portfolio would have done than the actual portfolio during past market downturns.  This is idiotic. Anyone could design a better portfolio if he or she knows what is going to happen in the future.  The numbers do not lie, and objective criteria shows that PSPRS performance is mediocre at best.  Even against simple index funds, PSPRS lags behind.  So why would Mr. Tobin offer such a full-throated defense of PSPRS' investment strategy?

For those of you who are interested, you can the find a theoretical foundation of PSPRS' current investment strategy in a paper entitled Modern Pension Fund Diversification, which among its authors are current and former members of PSPRS' administration.  The abstract alone is very complicated, never mind the entire 16-page paper that you can download.  That uneasy feeling you may be getting right now is understandable when you realize that your future paychecks and future retirement security are based on an academic experiment conducted by individuals whose own paychecks and retirements are unaffected by the results of the experiment.  This might explain the bizarre, unshakable insistence by PSPRS' administration that everything is going well with their strategy.

I make no claim of understanding Modern Pension Fund Diversification, but should we take it for granted that Mr. Tobin or any of the other Trustees do either?  It would seem that one would need an extensive background in mathematics, statistics, finance theory, and/or economics to even begin to understand it.  The PSPRS employee representatives on the Board of Trustees know law enforcement and firefighting, not finance theory, so they are overly dependent on PSPRS' staff for information and guidance.  This traps the Board in an environment in which the people they are tasked to oversee have become the de facto decision-makers.  When comes to investment decision, PSPRS' administration is insulated from oversight behind an intellectual moat that the Board is unable to cross.

This could explain the defensive and arrogant tone of Mr. Tobin's editorial since he can only parrot what the PSPRS administration tells him and trust that it is accurate.  PSPRS' investment strategy is working because PSPRS' administration says it is working, and he has no other choice but to concur with that assessment.  The natural, common sense questions that the layperson might ask are dismissed as ignorant and naive.  If someone were to ask, "Why hasn't PSPRS performed as well as the CIP or ASRS over the years?," Mr. Tobin can only respond with bits of insight like this:
". . . our investment returns are elite among pensions that operate with a similar risk-averse strategy." 
"We outperform index funds (even after fees), in which we also invest."
"Our plan also stacks up well against private sector investment funds."
 "PSPRS, like any institutional investor, suffered heavily from Dot.Com crash of 2001-02 and the housing market crash of 2007-2008."
I will leave it to the reader to judge the accuracy, relevance, and/or usefulness of those statements.  Does Mr. Tobin speak for the entire Board of Trustees?  If he does, it appears the Board has relinquished its oversight role of PSPRS, at least when it pertains to investments.  I can only hope that the new members who have recently joined the Board will not allow themselves to be co-opted by the PSPRS administration like Mr. Tobin has.  PSPRS members need watchdogs to look our for their interests, not cheerleaders for the PSPRS administration.