PSPRS investment earnings through November 2017 (with some discussion about COLA's)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through November 2017, which is the fifth month of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 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%
6/30/2017	0.22%	12.48%	0.90%	18.51%
7/31/2017	0.83%	0.83%	1.89%	1.89%
8/31/2017	1.06%	1.91%	0.19%	2.08%
9/30/2017	0.80%	2.72%	2.44%	4.57%
10/31/2017	0.64%	3.38%	2.18%	6.85%
11/30/2017	1.28%	4.70%	3.04%	10.10%

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

PSPRS' Board of Trustees published its January 2018 meeting materials last week, but in light of the market conditions over the past several days, it is nice to discuss them now, rather than earlier.  The Russell 3000 is down 6.00% for the month of February 2018 as of February 5, 2018, so this will possibly be the first real test of PSPRS' investment strategy.  I say "possibly" because we are only five days into February with quite a bit of time for the market to recoup its loss or even end with a gain.  Regardless, we will have to wait two months to find out the end-of-month (EOM) results for February 2018.

In the meantime, the November 2017 EOM results provide us with a picture of the market since the election.  For the current FY, PSPRS has earned 46.50% of the Russell 3000 (4.70% vs. 10.10%, respectively).  From December 1, 2016 through November 30, 2017, PSPRS' did a little better, earning 53.40% of the Russell 3000 (10.66% vs. 19.93%, respectively).  This tracks with what has been PSPRS' usual pattern, earning 50-60% of the Russell 3000, with last fiscal year being an exception. 

For some perspective, PSPRS' Cancer Insurance Plan (CIP) has earned 5.85% FY-to-date and 15.03% over the preceding 12 months.  These earnings were net of fees as opposed to PSPRS', which are gross of fees, making the CIP's earnings even more impressive compared to PSPRS'.  The Arizona State Retirement System (ASRS) has earned 3.5%, net of fees, through September 30, 2017, which is the latest number available on ASRS' website.  This handily beats PSPRS' return, gross of fees, through the same period.  Whether PSPRS' conservative strategy pays off remains to be seen, but through November 2017, PSPRS has lagged both the CIP and ASRS.

There was one other interesting bit of information in the meeting materials which will be especially pertinent to retirees. This is what it says about calculating the new cost of living allowance (COLA), which will be paid for the first time next fiscal year:

QUESTION: WHICH YEAR SHOULD WE USE AS THE BASE YEAR?

Since 2001, the Phoenix-Mesa CPI has been updated by the Bureau of Labor Statistics every 6 months.  Beginning later this year, the Phoenix-Mesa CPI will be updated every 2 months after each even month  (February, April, June, etc.). The results are typically available about two weeks after the end of the  month. For instance, the June, 2018 results will be available July 12, 2018. There are advantages and disadvantages of using the fiscal year vs. the calendar year as the basis for determining the COLA that
will be granted to benefit recipients each July 1st.

The biggest advantage of using the fiscal year as the base year (in other words, measure CPI from June 30 to June 30) is that the COLA is granted closer to the period of time the price of goods is being measured.  For instance, if the price of oil increases during the January to June timeframe, the COLA granted on July 1st will better reflect that increase.

The biggest advantage of using the calendar year is that staff would have enough time to calculate, communicate and process COLAs by July 1, as is required by statute. Any delays in the Department of Labor calculating and publishing the CPI would not have an effect on getting the COLAs processed timely. While we can’t comment on the intent of the legislature, it is important to note that typically when the statute refers to a fiscal year, it specifically states “fiscal year.” In the two sections of statute that refer to how the new COLA is calculated (§38-856.05 and §38-856.06), the statute does not specify “fiscal year” but rather states “year.” That may be an indication that the legislature intended us to measure the CPI on a calendar year basis. 

Recommendation: Staff recommends that we use the calendar year that precedes July 1 as the base year when calculating the amount of the COLA.

QUESTION: WHICH CPI SHOULD WE USE?

The Bureau of Labor Statistics publishes two measures of the Consumer Price Index—the CPI-U and the CPI-W. The CPI-U is the Consumer Price Index for all urban consumers. Approximately 89% of the population in the Phoenix metro area is included in this measurement. The CPI-W is the Consumer Price Index for a subset of the CPI-U population. It includes wage earners and clerical workers only, and represents approximately 29% of the population. Retirees who are not earning a “wage” are included in the CPI-U, but not in the CPI-W. Likewise, unemployed people are included in the CPI-U, but not in the CPI-W. In general, the CPI-W is more volatile because it uses a smaller sample population. According to the Bureau of Labor Statistics, in most cases across the country the CPI-W increases more than the CPI-U. In looking at the increases over the past 14 years in Phoenix, however, the CPI-U has outpaced the
CPI-W in 9 of those years. Because the CPI-U population coverage is more comprehensive, it is typically the measurement used in most escalation agreements.

Recommendation: Staff recommends that we use the CPI-U as the measurement when calculating COLAs since retirees are included in that population and it is less volatile over time.

Remember that the new COLA will be the lower of either the Phoenix-Mesa CPI or 2%.  The staff recommendations would have to be approved by the Board of Trustees, and they will almost certainly go along with their own staff's recommendations.  For retirees, the main issue is the rate of inflation.  The Phoenix-Mesa CPI-U annual average rate for the 2017 calendar year was 2.5%; for the FY that ended June 30, 2017, it was 2.25%.  Under either base year rate, retirees would be limited to the 2.0% COLA.  Historical rates for the Phoenix-Mesa CPI-U can be found on PDF page 212 of the meeting materials. 

If the Board of Trustees accept the staff recommendation on the base year, retirees will lag inflation by 0.5% in fiscal year 2019.  This may not seem like a lot, and for a retiree on a $50,000/year retirement, it would only amount to a "loss" of $250.  The "loss" is the amount of goods and services the retiree will no longer be able to afford in the second year.  However, the compounding effect over ten years of a 0.5% difference between the COLA and actual inflation will leave the retiree with only 95.7% of the purchasing power he had in the first year and a "loss" of  $2,689.  A 1.0% difference will leave the retiree with only 91.6% of purchasing power and a "loss" of $5,485 in the tenth year.  If one has another source of retirement income, such as a 457, Social Security, or an IRA, there will be some cushion against inflation.  This makes it all the more urgent that current workers utilize any and all retirement savings vehicles available to them.  I have bookmarked the Phoenix-Mesa CPI-U page at the US Bureau of Labor Statistics (BLS) for future reference.  

* 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, 0.63% in FY 2016, and 11.85% in FY 2017.