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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, January 20, 2015

PSPRS investment returns through November 2014

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for November 2014, the fifth month of the current fiscal year, with the June 2014 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%

7/31/2014 -0.67% -0.67% -1.97% -1.97%
8/31/2014 1.73% 1.05% 4.20% 2.14%
9/30/2014 -1.53% -0.49% -2.08% 0.01%
10/31/2014 0.40% -0.09% 2.75% 2.76%
11/30/2014 0.92% 0.82% 2.42% 5.25%

There is usually about a two-month lag in PSPRS reporting its investment returns.  I try to post the PSPRS returns each month, but there is a one-month delay because the PSPRS Board of Trustees did not have a monthly meeting in December 2014.  This table includes the returns for October and November 2014.

As of the end of November 2014, PSPRS' non-US equity portfolio, which makes up 14.23% of PSPRS' total portfolio, has returned -5.49%.  PSPRS' real assets portfolio, which makes up 7.33% of PSPRS' total portfolio, has returned -2.61%.  Every other asset class, including real estate, has shown a positive return through November 2014. 

The Russell 3000 is made up of the 3,000 largest US companies.  The US market has recently done much better than the rest of the world, and PSPRS' negative return on its non-US equity portfolio is in line with the non-US equity benchmark of -5.53%.  PSPRS' real assets portfolio is lagging its benchmark by 3.18%.  It should be pointed out that other assets classes have negative benchmarks but positive returns for PSPRS, so there is some tradeoff between asset classes.

The up-and-down fiscal year continues.  The Russell 3000 website shows a 0.0% return for the month of December 2014, so it is anybody's guess what PSPRS will earn for December.  Those next returns will mark the halfway point of the fiscal year.  By the end of 2013, PSPRS's fiscal year-to-date return had nearly reached its expected rate of return.  PSPRS will not be in the same enviable position at the end of 2014.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees, except on the final report of the fiscal year.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

Friday, January 9, 2015

Parham's Paradox: true confessions from PSPRS' Chief Investment Officer

One of the more remarkable things I have ever read about PSPRS is this piece by PSPRS Chief Investment Officer (CIO) Ryan Parham, "The truth about PSPRS investment performance," that appeared in the December 18, 2014 Arizona Capitol Times.

Whenever an interested party proclaims to tell you the "truth" about a matter in which they are involved, you should be suspicious.  However, I read this with an open mind since I do not reflexively believe that the PSPRS administration and staff are responsible for PSPRS' financial woes, and after reading it through, I can not really dispute Mr. Parham's points about the relative quality of PSPRS' recent investment performance, the punishing effect that permanent benefit increases (PBI), more commonly referred to as COLA's, have on PSPRS' funded ratio, and the need to change the current COLA formulaton.

However, the most amazing thing that Mr. Parham writes is this:
. . . it is important to remember our innovative, low-risk, moderate return strategy is by conscious design, due to a pension benefit that PSPRS alone must pay to pensioners. This benefit, called the Permanent Benefit Increase, or “PBI,” siphons and distributes half of all returns in excess of 9 percent to eligible retirees. Not only are these increased payment levels made permanent, the investment gains only serve to increase – not decrease – unfunded future liabilities.

This rang true in fiscal years 2013 and 2014, in which PSPRS net performances were a positive 11 percent and 13.3 percent, respectively, while the system’s funded ratio dropped on both occasions. The cruel irony of this is that unless the PBI is modified to allow the PSPRS to retain and reinvest all of its gains, it is unlikely that we will ever be able to significantly impact the decline in our funding ratio.
PSPRS wants its retirees to enjoy increases, but we are incentivized to seek lower returns in the range of 9 percent to maximize earnings that can be applied to cover – and hopefully reduce – unfunded liabilities. (italics mine)
This passage is astonishing, and I had to read this a couple of times to ensure that I understood what Mr. Parham was saying.  Incredibly, he is saying that PSPRS' investment strategy is not designed just to balance investment risk and reward, but is also consciously designed to target as closely as possible the 9% threshold that triggers the excess earnings transfer into the Reserve for Future Benefit Increases ("the Reserve").  This is a stunning admission that PSPRS is deliberately low-balling its potential investment returns in order to limit contributions to the Reserve from which COLA's are paid.  I would like reiterate that this information is coming directly from the chief investment officer, a man who probably knows more about PSPRS than anyone else working there, in a piece that is giving us "the truth about PSPRS investment performance."

If you are a retiree, this likely outrages you. The CIO just confessed that PSPRS is purposefully trying to minimize its ability to pay COLA's.  But for everyone, this situation is just perplexing.  Mr. Parham is saying that with the current COLA formulation, earning over 9% actually has a negative effect on PSPRS' finances.  How can that be?  50% of anything over 9% would seem to be better than nothing, but he does not give any numbers to explain this.  If I were to speculate, I would guess that this would be due to the compounding effect over time of increased benefits, but I would need to see a more detailed explanation by Mr. Parham to better understand this situation.  Regardless, with a current expected rate of return (ERR) of 7.85%, this gives PSPRS a pretty small window of 1.15% to work with to help increase its funding level.

We should note that Mr. Parham's piece appeared in the Arizona Capitol Times, a newspaper which describes itself as "your inside track to Arizona politics."  By publishing his piece in a newspaper geared toward Arizona's governmental/political class and not a more mainstream paper like the Arizona Republic, it appears that Mr. Parham is appealing to the state's movers and shakers with a bit of inside information about the real reason why PSPRS' returns are so low.  I guess the rest of us just could not contemplate the subtleties of such a complex strategy, so Mr. Parham did not even bother to place a link to this piece on the PSPRS website like they usually do with other pieces written by PSPRS staff and trustees.

In the end, I have no choice but to give Mr. Parham the benefit of the doubt that his information is correct and that investment gains over 9%, paradoxically, are harmful to PSPRS' financial condition.  Furthermore, if it helps to change the COLA formulation in a beneficial manner (i.e. NOT like the Professional Fire Fighters of Arizona (PFFA) plan of intergenerational theft), this will have been a good thing.  However, Mr. Parham has also implied that PSPRS could produce higher returns than it currently does.  His words should end up on the wall of every PSPRS trustee and state legislator, as well as the governor and state treasurer.  It should not be lost down a memory hole if PSPRS does not produce stellar returns when the COLA formula is finally changed.  Just imagine what PSPRS would look like if its investment staff actually tried to earn as much money as possible.  That's the standard Mr. Parham has set for the investment staff, so I hope they are ready to perform.