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

Thursday, April 26, 2018

PSPRS investment returns through February 2018 with a recommendation to the Arizona Legislature on how to better oversee PSPRS

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through February 2018, the eighth month of the current fiscal year (FY), with the past four FY end 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%
12/31/2017 0.66% 5.39% 1.00% 11.20%
1/31/2018 2.35% 7.86% 5.27% 17.06%
2/28/2018 -1.37% 6.38% -3.69% 12.74%

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

We finally have data from February 2018, which was an extremely volatile month for the markets with the Russell 3000 losing 3.69%, versus a loss of 1.37% for PSPRS.  This means PSPRS suffered only 37.13% of the monthly loss of the Russell 3000.  On the other hand, PSPRS only captured 44.60% of the gain in January 2018.  In the latest information provided by the Arizona State Retirement System (ASRS), ASRS' fiscal YTD return through April 17, 2018 is about 9.0%.  PSPRS' Cancer Insurance Plan (CIP) has earned 6.42%, net of fees, fiscal YTD.  The Russell 3000 had another loss of about 2.5% for the month of March 2018, and as of April 25, 2018, the Russell 3000 is up about 1% for the month of April with two trading days left.  It will be a close call whether PSPRS achieves its assumed rate of return (ARR) of 7.4% by the end of June.

For the fiscal YTD, PSPRS has captured almost exactly 50% of the gains of the Russell 3000.  This once again fits PSPRS' pattern of returning 50-60% of the Russell 3000.  At this capture rate, the Russell 3000 must earn between 12.33% and 14.80% in order for PSPRS to earn 7.4%.  PSPRS' actuaries are recommending that PSPRS lower this rate to 7.3% based on an experience study from last year.  Tier 3 members have an ARR of 7.0%.  Any decrease in the ARR will increase current liabilities as investment earnings going forward will be lower, which means contribution rates for Tier 1 and Tier 2 members will have to increase.  This will cause an increase in employer contributions as Tier 1 and Tier 2 members' contribution rates are fixed at 7.65% and 11.65%, respectively.

There was a bill that was attempting to tie PSPRS' ARR to the 3-year rolling average of the 20-year treasury constant maturity rate.  The bill would have forced PSPRS to adopt an ARR that was not more than 2% higher than this rate.  PSPRS would have been forced to drop the ARR 0.25% every year until that target was reached.  Fortunately, this bill was amended, and the language was changed to limit PSPRS from raising its ARR unless PSPRS was at least 80% funded.  This original bill was foolish, as it would have forced PSPRS to drop its ARR down to somewhere around 5%, which would have devastated every employer in the state and hit Tier 3 employees in the defined benefit pension especially hard.  These Tier 3 employees are required to split normal costs and unfunded liabilities 50/50 with employers, and once the ARR dropped below 7%, they would see increases in their pension contributions.  There is no way that this could have worked.

If the Arizona Legislature wants to impose more control over  PSPRS, it should start by giving another state agency, such as the Office of the State Treasurer or the Auditor General, the authority to select PSPRS' actuaries, pension consultants, and accountants.  We know that PSPRS' Board of Trustees and senior management cannot be trusted.  See this passage from The League of Arizona Cities and Towns PSPRS Task Force Report from August 2015:
It is also important to point that prior to FY 2015-16, the cost of the PBI (permanent benefit increase) was not included in the employer contribution rate. Excluding the PBI from the calculation effectively underestimated the normal cost of the pension plan, causing it to manifest itself in the unfunded liability. This issue was identified by PSPRS actuaries several years ago, but the PSPRS Board did not take action to address it. (boldface mine)
Despite this, the PSPRS Board of Trustees is still allowed to contract for these services.  It would be far better if the actuaries, consultants, and accountants were reliant on another state agency to award these contracts.  Their work would be more independent and not influenced by concerns over continued business with PSPRS, if they shined a negative light on the Board or senior management. Their reports and recommendations would also circulate outside of PSPRS for review and analysis.  The PSPRS Board and senior management would then be under pressure to adopt the recommendations of these independent companies or justify to the Arizona Legislature why they cannot.  If PSPRS repeatedly ignored the recommendations without justification, the Legislature or Governor could make personnel changes at PSPRS or pass legislation to force good policies.  This would be a good first step in holding PSPRS accountable.

* 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.

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