The downward spiral: PSPRS to drop its assumed rate of return to 7.50%; employer rate to go up 3%

For your consideration is the following correspondence from PSPRS Acting Administrator Jared Smout that appeared on PDF page 109 of the June 17, 2015 PSPRS Board of Trustees meeting materials:

From: Jared Smout

Sent: Thursday, June 11, 2015 9:30 PM

To: Jared Smout

Subject: Assumed Rate Discussion from May Meeting

Trustees,

I’ve been meaning to clarify some of the discussion surrounding the change in the assumed rate from 7.85% to 7.5% at the last meeting.  I apologize for any confusion caused by my attempts to explain the timing of this change to when it will be seen in the employer rates.

As it stands, the motion last month made the change to the assumed rate effective July 1, 2015.  This is obviously consistent with past practice and is necessary to set the interest rate for those in Tier 1 of the DROP for the next fiscal year.  However, also consistent with past practice, but not necessarily understood to be intentional, there will be a two-year lag before this change is reflected in the employer rates.  With the change in the assumed rate being effective July 1, 2015, past practice will dictate that this rate change will not be incorporated into the annual actuarial valuations until June 30, 2016, which means it will not be effective in the employer rates until July 1, 2017—ergo, the two‐year lag.

In my opinion, June 30 is only the snapshot for the data in order to perform the valuations and it doesn’t make sense to wait two years for the change in the assumed rate to become effective, thereby losing one year that could have a meaningful impact to the funding levels.  The sooner a change in an actuarial assumption can be implemented, the better, and our actuaries agree and support this approach.  Therefore, I believe the Board of Trustees can change this practice through a motion to allow any change in the assumed rate to be reflected in the annual actuarial valuations being performed during that fiscal year it is effective, regardless of the date of the data.

Another thing to consider is if the Hall case gets upheld on appeal, the earliest it would be reflected in the valuations would be as of June 30, 2016.  It is estimated the impact of the Hall case will have a 6 percentage point increase in the aggregate employer rate.  Additionally, it was shared last month that the change in this assumed rate will have a 3 percentage point increase in the aggregate employer rate. Therefore, if we continue with past practice as to the timing of the assumed rate being effective, the June 30, 2016 valuations (for July 1, 2017 implementation) could reflect the Hall case and the change in this rate, thereby causing a combined increase of 9 percentage points on the aggregate employer rate two years from now.  However, allowing the change in the assumed rate to be incorporated into the June 30, 2015 valuations (effective in the July 1, 2016 rates) could permit that extra year of increased  assets due to a lower assumed rate, which could help soften the adverse effects of Hall should it be upheld.

I just wanted to make sure everyone understood the timing and if there is any desire to discuss this further, I will agendize it for discussion and possible action.

Jared A. Smout

Acting Administrator

This is taken verbatim from the meeting notes with the exception of the boldface type in the fourth paragraph, which I added for emphasis.  Mr. Smout had previously discussed at the spring employer seminars the 6% increase in the aggregate employer rate that will occur if the Hall case is decided completely in the plaintiffs' favor.  However, the lowering of the assumed rate of return from 7.85% to 7.50% and its 3% increase to the aggregate employer rate is new information.  On PDF pages 106-108 of the May 2015 PSPRS Board of Trustees meeting materials is a letter from PSPRS' actuary, Gabriel Roeder Smith & Company (GRS), that explains the rationale for lowering the assumed rate.  Though I do not completely understand the methodology, what I can gather is that eight investment consultants gave estimates on PSPRS' expected returns, and from these estimates, a range between the geometric and arithmetic returns is produced.  Using this method, the current 7.85% assumed rate was essentially equal to the higher 7.84% average arithmetic estimate, while the average geometric average estimate was only 7.10%.  GRS recommended that PSPRS move to the new 7.50% assumed rate to bring it more into the middle range of the two estimates.

The aggregate employer rate, which represents PSPRS as a whole, for the current fiscal year (FY) is 32.54% and will increase to 41.37% in the FY that starts July 1, 2016.  Each individual employer has its own employer rate that can be higher or lower than the aggregate rate.  The large increase from FY 2014 to FY 2015 is due to the Fields case being finally settled by the Arizona Supreme Court in favor of the plaintiffs.

Since we have already seen the pain inflicted by the Fields case, I think most everyone is already braced for another financial hit in the near future from Hall.  Whether it is 6% or, perhaps, less in the case of an incomplete victory for the Hall plaintiffs, there will be some negative effect to PSPRS' funded ratio and employer contribution rates.  I think very few are ready for this new blow to PSPRS, employers' budgets, and workers' and retirees' income.  GRS informed PSPRS on May 22, 2015 about the recommended changes to its assumed rate, and the Board of Trustees needs to decide when to implement this new assumed rate.  Mr. Smout is recommending that it be implemented on July 1, 2015 so that the 3% increase to employer rates does not occur in the same year as the up-to-6% increase that will be necessary after the final resolution of the Hall case.  PSPRS does not have its next Board of Trustees meeting until August, so we may not know what they decide for a couple months.  Regardless, the one thing we can count on is that the downward spiral of PSPRS will continue.

PSPRS investment returns through April 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for April 2015, the tenth 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%
3/31/2015	0.83%	3.42%	-1.02%	7.15%
4/30/2015	0.95%	4.40%	0.45%	7.63%

There is usually about a two-month lag in PSPRS reporting its investment returns.  April 2015 was the second consecutive good month for PSPRS.  I should say extraordinarily good because, if you remember, PSPRS' investment strategy is designed to balance risk and return by sacrificing some gains when the market is up in order to limit losses when the market is down, so outperforming  the Russell 3000 when it has a positive month is very good and producing a gain when the Russell 3000 shows a loss is outstanding.  An analysis of PSPRS' recent performance vis-a-vis its stated strategy is here.  Overall, PSPRS more than doubled the monthly return of the Russell 3000.  PSPRS' April 2015 returns were helped enormously by its non-US equity portfolio, which had a monthly gain of 4.22%.  The non-US equity portfolio had been the biggest laggard for PSPRS this fiscal year, but after this month, it is no longer the worst performing asset class at -1.43%.  That honor belongs to the real assets class which has a fiscal YTD return of -1.95% and is the only other asset class with a negative return YTD.

The Russell 3000 shows a 1.38% gain for May 2015.  As of June 16, 2015, the Russell 3000 has a loss of -0.17.  With that big gain in May and the pattern of the past two months, do we dare have hope that PSPRS might actually reach its expected rate of return (ERR) of 7.85% by the end of June? Taking into account the 0.5% in fees that must be subtracted from final fiscal year returns (the net of fee returns), PSPRS would have to earn about 4% over the last two months of the fiscal year to achieve its ERR.  I would like to remain optimistic, but if PSPRS is consciously trying to hit a narrow sweet spot of  annual returns between 7.85% and 9.00% in order to avoid paying PBI's, instead trying to earn as much as possible, it seems unlikely.

* 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.

A bad plan executed badly: The Professional Fire Fighters of Arizona's (PFFA) PSPRS pension reform plan

As the Professional Fire Fighters of Arizona's (PFFA) PSPRS pension reform "fix" continues along, we now have something a little more concrete to analyze in the form of the PSPRS pension reform draft bill, available at the PFFA website.   As of late, PFFA President Bryan Jeffries has been going around the state presenting a slideshow about the PFFA plan to employers and PSPRS members.  The version of the slideshow available at the PFFA website is here.  This slideshow has been altered from the initial slideshow the PFFA was presenting.  The older version, available at the League of Arizona Cities and Towns Pension Task Force ("the Task Force") website, is here under the 10-24-14 agenda, but you will need Powerpoint to read it.

As I have pointed out in multiple posts, the PFFA plan is shortsighted, unfair, and does not solve any of the root problems of PSPRS.  However, in this post I just want to go into the specifics of the PSPRS pension reform draft bill ("the draft bill").  The bill was drafted by Michele J. Hanigsberg, which the state government directory indicates is a member of the Arizona Legislative Council (ALC)-Legislative Services Wing.  The Arizona Legislative Council gives it function as the following :

The Council staff provide a variety of nonpartisan bill drafting, research, computer and other administrative services to all of the members of both houses of the Legislature.

 The ALC appears to be the body that does the actual grunt work of turning a proposal into a bill, and since this bill incorporates all the ideas of the PFFA plan and is linked from the PFFA website, it appears that this is the bill that the PFFA wants.  The devil, of course, is in the details, so let's see what the draft bill actually says and what it means for employers and PSPRS members.

This analysis of the draft bill had an inauspicious start when I first compared the two Powerpoint slideshows on the PFFA and the Task Force websites.  The older slideshow from October 2014 states the following about the new system for funding permanent benefit increases (PBI):

Employees only pay 4% into the PBI fund.

The underscoring of "employees only" is in the PFFA's slide.  Compare this to what is says in the slideshow on the PFFA website:

Employees pay 4% into the PBI fund.

No underscoring and the elimination of the "only" are slight changes, but they mean a great deal for employers and active PSPRS members, because this is what the draft bill states:

In addition to an employer's contributions to the fund pursuant to this subsection, each employer shall contribute an amount equal to one percent to its employees' compensation to the cost-of-living adjustment account maintained within the fund for future benefit adjustments for retirees and survivors pursuant to Section 38-856.02.

It is even worse than this because the draft bill also states that employers will have to continue to pay 1% into the PBI even after an employee enters the Inflation Protection Program, the rebranded Deferred Retirement Option Plan (DROP), of which we will talk more about later.  When looking at the wording of the draft bill, we can see how disingenuous the change in the wording between the two slides is.  A more forthright wording would be:

Employees pay 4% into the PBI fund, and employers pay 1% into the PBI fund.

This 1% extra cost to employers is in addition to an increase in the minimum employer contribution level from 8% to 10%, meaning that employers will now pay at least 11% of their employees' pensionable wages, instead of 8%.  This many not seem like a big deal for those employers who are already paying sky-high contribution rates, but it will be a huge cost for those employers who do not have big unfunded liabilities and are at or under the current 8% minimum.  Furthermore, the increase of the minimum employer contribution is permanent, regardless of the future funding status of PSPRS.

For retirees, there is a crucial provision in the draft bill that is not addressed in the Powerpoint slideshow.  In addition to the three-year freeze on all PBI's, seven-year or 60 year-old waiting period for PBI's, a 2% maximum PBI, and a 25% dispersal limit from the PBI fund, there is this:

The annual maximum percentage adjustment to the base benefit is the lesser of two percent or the percentage change published by the United States Bureau of Labor Statistics of the consumer price index for all urban consumers, using the United States city average, unadjusted, for all items, during the twelve months ending July of the year in which the benefit is to be paid.

While I am a strong advocate of an adequately funded PSPRS paying true cost of living adjustments (COLA) based on some measure of inflation, this is another case of an egregiously bad formula for PBI's.  This provision means that, regardless of the funding level of the PBI fund and/or the rate of inflation, retirees can only get a 2% maximum PBI per year, but in any year that the CPI is less than 2%, regardless of the funding level of the PBI fund, they could get less than 2% all the way down to nothing at all.  The same inexcusable lack of foresight that burdened us all with the current, unsustainable excess earnings PBI formula exists in this PBI provision.  Retirees can see one year of 5% inflation and receive a 2% PBI, but the next year see 0% inflation and get no PBI, despite the fact that they are still 3% behind in their purchasing power.  It this post you can see recent COLA's paid by Social Security.  The four-year period from 2009 to 2012 show two years of 0% inflation in 2010 and 2011 bookended by 5.8% and 3.6% inflation in 2009 and 2012, respectively.  Under this PBI provision, a retiree would have received 4% in PBI's against 9.4% inflation, leaving him a 5.4% difference.  (These percentage amounts are non-compounded for simplicity but would be worse if they were.)  If the PBI fund was adequately funded, a 2% PBI each year would have left him only a 1.4% difference.

The most blatant misrepresentation by the PFFA relates to the new Inflation Protection Program (IPP).  As stated earlier, the IPP is the new name for the DROP, the ill-conceived program born of PSPRS' brief period of overfunding during the late 1990's and early 2000's, that has garnered bad press because of the huge payouts received by some PSPRS retirees.  The Powerpoint slideshow on the PFFA website says the following about the IPP:

The DROP will become the Employee Self-Funded Inflation Protection Program.

• Tier 1 (members with 20 or more years on the job as of 1/2015)
• No contributions
• Interest rate = assumed rate of return for PSPRS

• Tier 2 (everyone else)
• Contributions during the program period
• Interest rate = minimum 2% or 7-year average of PSPRS investment returns (whichever is greater)
• Return of member contributions

The statements about member contributions are expressly contradicted by the draft bill which states:

A member who elects to participate in the Inflation Protection Program shall make member contributions to the the fund and the separate cost-of-living adjustment account in an amount equal to the member contributions required pursuant to Section 38-843, Subsections E, F, and G.  Member contributions made pursuant to Section 38-843 during the Inflation Protection Program participation period are not eligible to be refunded to the member.

As the DROP stands now, PSPRS members with at least 20 years of service as of December 31, 2011 (aka Tier 1) pay no member contributions and receive a variable interest rate based on PSPRS' returns with a minimum of 2% per year.  Those who were PSPRS members as of December 31, 2011 but did not have 20 years of service (aka Tier 2) receive the same interest rate as Tier 1 members, but they continue to pay member contributions.  (The DROP is not available to those hired in 2012 or later.)  These member contributions are refunded when the member leaves the DROP along with 2% interest.  The PFFA slide about the IPP appears to copy these provisions, even though the draft bill is very clear that IPP participants will pay contributions, and these contributions will not be refunded to them.  The draft bill also does not categorize Tier 1 and Tier 2 employees.  Conditions are the same regardless of  when a member joined PSPRS, and all will be paid the variable interest rate with the 2% minimum.

An employee averaging $70,000 per year for the five years in the IPP would make over $40,000 (11.65% employee contribution rate) in member contributions to PSPRS, so we are talking a significant amount of money.  The PFFA is selling the IPP to active employees as if it were no different than the current DROP, even though it will cost them thousand of dollars.  The draft bill gives an end date on the DROP program of December 31, 2016, so active members may want to consider their financial options beforehand.  If this does get approved by the voters in 2016, you will have less than two months to decide if you want to participate in the DROP before it disappears forever.

Unlike Obamacare, we don't have to pass this draft bill in order to see what's in it.  I appreciate that the PFFA has posted the draft bill on their website, but I do not understand why their are selling their "fix" in a way with incomplete and, in at least one major way, blatantly incorrect information.  While I do not believe that they are deliberately trying to deceive anyone, the fact that they started this reform process without a fully formed plan as to what they wanted to do does not inspire confidence.  The PFFA presented its slideshow to the Task Force on October 24, 2014 and this bill was drafted on January 9, 2015, yet in less than three months, they produce a bill that has significant changes and undisclosed provisions that were not presented to the Task Force.  You have to know where you want to go first before you try to lead.  It is no wonder the Task Force has created their own competing proposal for PSPRS reform, which we will cover in the next post.

PSPRS investment returns through March 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for March 2015, the ninth 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%
3/31/2015	0.83%	3.42%	-1.02%	7.15%

There is usually about a two-month lag in PSPRS reporting its investment returns.  March 2015 was a particularly good month for PSPRS, and not just because it had a positive return. Overall, PSPRS bested the Russell 3000 by a whopping 1.85%, and if we look at the individual returns for each of the eleven different asset classes, PSPRS did better than the Russell 3000 in all eleven.  The March 2015 returns ranged from -0.73% in its non-US equity investments to 3.58% in its private equity investments.  PSPRS had positive returns for March in all its asset classes, except US and non-US equity.  Of course, this is only one month's worth of returns, and while it will still be a stretch for PSPRS to reach it expected rate of return of 7.85% by the end of June 2015, this is a bit of good news during some rather discouraging times.

The Russell 3000 shows a 0.45% gain for April 2015.  The May 2015 return for the Russell 3000 has not yet been posted, but daily returns through June 9, 2015 show that the Russell 3000 has gained another 0.31% since the end of April.  Today (June 10, 2015) the markets are having another big day with the DJIA up about 1.30% and the NASDAQ up about 1.25%, so it is anyone's guess how the markets will end on June 30, 2015 when PSPRS' fiscal year ends.

* 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.

Belling the PSPRS cat: a fable brought to you by the League of Arizona Cities and Towns PSPRS Pension Task Force

Back in February, I attended one of the PSPRS employer seminars.  It was among one of several that PSPRS and the League of Arizona Cities and Towns PSPRS Pension Task Force ("the Task Force') put on in different locations throughout the state.  The handouts from these seminars are available here at the Task Force website.

The seminar was broken into two parts, the first part presented by PSPRS and the second by the Task Force.  The PSPRS was handled mostly by PSPRS' Acting Administrator Jared Smout and covered a broad range of topics, ranging from general discussions about pensions and PSPRS to more specific discussions about the causes of PSPRS' underfunding, COLA's, and the lawsuits challenging SB 1609.  I was interested in two particular issues when it came to the PSPRS presentation.  The first was what is the status of Hall v. EORP (CV2011-021234), which is challenging the SB 1609 changes to the COLA formulation for EORP members who were still active when SB 1609 became law and the increase in employee contribution rates.  The successful Fields decision only challenged the change in the COLA formulation, as the plaintiffs in that case were already retired.  There is a shadow case against PSPRS, Parker v. PSPRS, that is challenging PSPRS on the same grounds as Hall.  The decision in the Hall case will settle both cases, so it has great relevance to any PSPRS member who was active when SB 1609 went into effect.

Unfortunately, the case still remains in the courts and the latest information shows it is under appeal.  This case will have to be settled by the Arizona Supreme Court, so we are still stuck in a holding pattern.  My amateur interpretation and prediction from an analysis of the Fields decision is that the plaintiffs will win on the question of COLA's but lose on the question of employee contribution increases.  The COLA question is a slam dunk for the plaintiffs and was already addressed in Fields.  COLA's were deemed a pension benefit and could not be changed per the Pension Protection Clause of the Arizona Constitution.  The question of employee contribution rates will depend on how the Arizona Supreme Court interprets the Contracts Clause in the state and federal Constitutions.  The Fields decision did not consider the Contracts Clause, but a reading of the decision shows that the question of employee contribution rates has no clear precedence and may not be covered under the Pension Protection Clause.  We will all have to wait and see how the justices rule.

The second issue I was hoping the PSPRS presentation would deal with was simpler: what a victory by the Hall plaintiffs would cost PSPRS.  According to PSPRS' esitmates, a plaintiff victory would cost PSPRS $931 million and drop PSPRS' aggregate funding ratio 4% and raise its aggregate contribution rate 6%.  He did not break down what would happen if the plaintiffs only won on just one of their questions, so this appears to be the cost of a total victory by the plaintiffs.  Remember that if the plaintiffs succeed on the question of employee contribution rates, anyone active at the time SB 1609 went into effect will be owed a refund of all contributions they paid in excess of 7.65%.  For the current fiscal year alone, that would 3.4% of pensionable income.  This would be a significant refund due of $2,040 for someone who had $60,000 in pensionable income in the current fiscal year.

I was more interested in what the Task Force had to say.  This portion was conducted by members of the Task Force, including former Tucson Chief Financial Officer and Deputy City Manager Kelly Gottschalk, who has since been hired to run the Dallas Police and Fire Pension System.  To say that their presentation, and particularly their recommendations to cities and towns dealing with pension costs, was a disappointment would be a huge understatement.

The Task Force was set up in June 2014 and made up of 15 members, mostly high-ranking municipal finance and administrative officials from throughout Arizona.  Last summer and fall, they had several meetings where they received presentations from various stakeholder groups and others with pension expertise.  There is a wealth of information on the Task Force website, and I was encouraged that finally something worthwhile was being done regarding PSPRS.  I thought that those municipal officials dealing with the harsh consequences of PSPRS' financial woes would finally have a chance to come together, brainstorm, and come up with some great reform ideas to present to the Arizona Legislature.  Boy, was I wrong.

Following are the Task Force's seven recommended practices for employers:

1. Budget contributions for DROP members
2. Prepay your budget contributions
3. Do not defer the Fields case
4. Review local board practices
5. Prepare a comprehensive study
6. Pay off unfunded liability (debt) earlier
7. Create a pension funding policy

If we eliminate the three practices (numbers 4, 5, and 7) that are essentially administrative tasks, the other four come down to telling employers to pay more.  Of all the recommended practices, the first is the most ridiculous of all.  Recommended practice number 1 tells employers to budget for and continue to pay contributions for members who have entered the Deferred Retirement Option Plan (DROP).  However, the DROP was supposed to be a "win-win" for employees and employers where experienced employees remained on the job but neither employees nor employers would have to pay pension contributions for up to five years while the employee was in the DROP.  The Task Force is now saying that employers should continue to pay pension contribution for employees once they enter the DROP, meaning the employer gets no financial benefit from the DROP.  The most logical recommendation would have been to advocate for the complete elimination of the DROP, a program that has been starving PSPRS of funding for 15 years and will continue to do so as long as it remains active.

Recommended practices numbers 2, 3, and 6 all advise employers to pay money they do not have.  I agree with recommendation number 3 because it sets a bad precedent in a state where employers have always paid their full, required contributions.  Not paying full, required contributions is one of the surest ways to put a city on the path to financial ruin.  However, no one is advising employers to defer the additional costs imposed by the Fields decision, but Phoenix, Tucson, and other cities chose to do so because their elected leaders feel like they have no other choice since they simply can not afford the higher contributions right now.  Prepay your budget contributions?  Pay off the unfunded liability earlier?  With what funds?  If the cities had the extra money to do what the Task Force recommends, they would already being doing it.

The Task Force's recommended practices amounts to belling the cat.  The Task Force had a chance to offer some bold proposals and recommend some necessary reforms to PSPRS.  They did neither and wasted a valuable opportunity to have their voice heard.  Instead, they provided a list of embarrassingly impractical recommendations.  The work of the Task Force will be ignored by anyone serious about reforming PSPRS.

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.