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Monday, April 20, 2015

Invested in it: Chief Investment Officer Ryan Parham, PSPRS' investment strategy, and investment returns through February 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for February 2015, the eighth 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%
12/31/2014 -0.18% 0.64% 0.00% 5.25%
1/31/2015 0.01% 0.65% -2.78% 2.32%
2/28/2015 1.91% 2.58% 5.79% 8.25%

There is usually about a two-month lag in PSPRS reporting its investment returns.  There is not much new to report here.  PSPRS still lags the Russell 3000 and will be hard-pressed to achieve it 7.85% expected rate of return (ERR) by June 30, 2015, especially when we consider that the Russell 3000 lost one percent in March 2015.

I suppose now is as good a time as any to take stock of PSPRS' new investment strategy, which moved away a domestic equity-heavy, stock-picking portfolio to a more diversified and balanced approach.  In the 2012 Annual Report Summary, Chief Investment Officer Ryan Parham wrote:
Recent stress tests of on our portfolio indicate that we will capture approximately 70% of a strong up-market but only approximately 40% of a strong down-market.  Preventing that see-saw of returns produces a superior long term compounded return.This has been a key feature of the endowment investment universe which has historically produced better returns than public pensions.
Is the new strategy working as Mr. Parham's stress tests predicted?  Yes and no.  For fiscal year (FY) 2014, PSPRS captured 54.80% of the Russell 3000.  This is not 70%, but we must remember that PSPRS was never 100% invested in US equities, so it is not fair to compare it 100% vis-a-vis the Russell 3000.  Mr. Parham wrote in the 2013 Annual Report Summary , "At times more than 70% of the total fund was invested in U.S. large cap stocks." The maximum appears to be at the end of FY 2000 when PSPRS was 77.61% invested in common stock of what looked to be all US companies.  With this in mind, the 54.80% captured may be considered successful. 

However, for the current fiscal year to date, PSPRS is only capturing 31.27% of the Russell 3000 and failing to work as predicted.  In the three months that had a negative return, two were less than 40% of the monthly loss of the Russell 3000.  The third month grossly exceed the loss threshold at 73.55%.  In the four months that had a positive return, the highest was only 41.19% of the monthly gain of the Russell 3000. Depending on whether you consider the month in which the Russell 3000 had a zero return a loss or gain, PSPRS could have succeeded or failed.

While it may be too early to tell about the long-term prospects of PSPRS' new strategy, it did not stop Mr. Parham from boasting about the new strategy in the 2014 Annual Report Summary:
The Trust’s portfolio returns for the fiscal year ending June 30, 2014 continue to come from many diversified sources (10 separate asset classes.) We expect that diversification to help us to capture most of strong positive markets and to protect us from the worst of devastating negative markets. This was demonstrated in 2014 where we captured almost 3/4 of the returns of stock heavy portfolios. But in Q3 2014, when stocks were hard hit we had only 1/3 of the losses of those portfolios.
So if we extrapolate from Mr. Parham's rosy assessment of FY 2014, the Russell just needs to average to 14.32% every year in order for PSPRS to reach its 7.85% ERR (54.80% of 14.32%) every year.  In order to reach 9%, the Russell 3000 needs to just average 16.42% each year.  No problem, right?  The current 10-year annual rate of return on the Russell 3000 is 8.80%.  It will be interesting to see what new excuses Mr. Parham makes in the 2015 Annual Report Summary when PSPRS cannot even achieve its ERR for the current fiscal year.

* 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.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

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