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

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

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.