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Tuesday, January 8, 2013

The lost decade of PSPRS

Ryan Parham, the Chief Investment Officer for the Arizona Public Safety Personnel Retirement System (PSPRS), gives an interesting update to the investing activities of PSPRS in the FY 2012 Consolidated Annual Financial Report, starting on page 50.

Mr. Parham gives this historical perspective about the past decade and how brutal the market can be:
A quick review of the portfolio’s historic returns from the year 2000 up to and including 2009 shows the damaging effects of having “our eggs” concentrated in the equities basket.

We had six positive return years during this period including a positive 17.05% in 2007, a positive 14.95% in 2004 and a positive 12.29% in 2000. We also had four negative years. The net of the ups and downs produced a total compounded return over the total period of only 0.25%. With the old portfolio we see clearly the distinct possibility of big “ups” but also big “downs” and the compounding effects of that risk have produced poor returns.
The period from 2000 and 2009 was a lost decade of returns for PSPRS.  The pain of this lost decade can not be emphasized enough since a defined benefit pension lives or dies on its investment returns.  The money not earned during that decade can never be earned again.  If, as in FY 2012, PSPRS pays out more than it takes in that year, net assets (i.e. principal) are reduced, making it all the more difficult to make up past losses since it has less to invest the next year.

A lack of vigilance by past Trustees, or Fund Managers as they used to be called, and a false sense of security created by two decades of good returns caused many of PSPRS' current problems.  The current Board of Trustees, administrators, and investment officers have diversified PSPRS' portfolio to improve its ability to withstand market fluctuations, and all of them should be commended for saving the PSPRS from even greater losses.  Mr. Parham writes that PSPRS' portfolio would have lost 30% in 2009, instead of 17.73%, if diversification efforts had not already been started that year.

Mr. Parham writes that the average endowment had a return of -0.30% last year, which he compares to PSPRS' -0.79% return to show that PSPRS was not out of line with other similar investment pools.  However, most endowments, like those that fund private colleges and charities, do not have the large, guaranteed obligations that pensions have.  During a down market, endowments can cut their current expenses and postpone future obligations until the market improves.  This is not an option available to a defined benefit pension, which must continue paying its current retirees while incurring more future obligations.   In the previous post, Assumed rates of return can make an ass out of you and me, we saw how higher risk investments are not appropriate for defined benefit pensions like PSPRS. 

There are limits to the safety diversification can provide, and a market in a liquidity crisis like in 2008-09 can produce losses across many asset classes.  Unfortunately, PSPRS is trapped in a situation where it needs higher risk investments to get it out of the hole it is in, even though higher risk investments were one of the reasons it got in the hole in the first place.  Here's hoping that 2013 is the start of a sustained bull market.

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