PSPRS investment returns through September 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for September 2015, the third month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 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%
7/31/2015	0.13%	0.13%	1.67%	1.67%
8/30/2015	-1.43%	-1.31%	-6.04%	-4.47%
9/30/2015	-1.02%	-2.31%	-2.91%	-7.25%

There is usually about a two-month lag in PSPRS reporting its investment returns.  PSPRS again outperformed the Russell 3000 in a negative month, suffering about 35% of the loss of the Russell 3000.  As in August, both US and non-US equity were the big September losers with US equity down 3.04% and non-US equity down 4.63%.  The Russell 3000 returned an incredible 7.90% in October 2015, and through November 24, 2015, the Russell 3000 has a more modest 0.80% return.  It will be interesting to see what PSPRS' returns are in October 2015 and how much it recoups of the current year's losses, particularly in comparison to the Russell 3000.

Looking at PSPRS' annualized 5-year rate of return, we can see that during the first quarter of the current fiscal year it has dropped from the 9.2%, gross of fees, that it had as of June 30, 2015 to a current rate, gross of fees, of only 7.04%, well below PSPRS' expected rate of return (ERR) of 7.50%.  Since November 2014, this is the first time the annualized 5-year rate has dropped below the ERR.  It does not bode well for the future if PSPRS cannot achieve its ERR during a 6 1/2 year long bull market in which the Russell 3000 earned 13.28% over the same annualized 5-year period.

* 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% and 3.68% for fiscal years 2014 and 2015, respectively.

PSPRS investment returns through August 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for August 2015, the second month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 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%
7/31/2015	0.13%	0.13%	1.67%	1.67%
8/30/2015	-1.43%	-1.31%	-6.04%	-4.47%

There is usually about a two-month lag in PSPRS reporting its investment returns.  As can be seen, PSPRS outperformed the Russell 3000 in a negative month, suffering less than a quarter of the loss of the Russell 3000.  Out of its ten asset classes, seven had losses and three had monthly gains with real estate being the biggest monthly gainer at 2.91% and non-US equity the biggest loser at -6.39%.  Through October 22, 2015, the Russell 3000 is up 6.56%, with another big gain today (October 23) that will further offset the combined losses of August (-6.04%) and September (-2.91%).  Hopefully PSPRS will do better than it did in July, when it captured only about 8% of the gains of the Russell 3000, if October ends the month with a significant gain.

* 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 one-half of a percent.  Returns net of fees were 13.28% and 3.68% for fiscal years 2014 and 2015, respectively.

PSPRS investment returns through July 2015 and a look at investment fees paid last year

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for July 2015, the first month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 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%
7/31/2015	0.13%	0.13%	1.67%	1.67%

There is usually about a two-month lag in PSPRS reporting its investment returns.  As can be seen, PSPRS trailed the Russell 3000 in a positive month, capturing less than 8% of the gain in the Russell 3000.  PSPRS will need as many positive months as possible this fiscal year since the markets have already had two very bad months this fiscal year.  The Russell 3000 had a monstrous 6.04% loss in.August 2015 and another loss of about 3.00% in September 2015.  The good news is that, through October 12, 2015, the Russell 3000 is up 5.17%, which has offset some of the losses from August and September, but who knows how the month will end.

The following table shows a breakdown of what PSPRS paid in fees for each of its asset classes:

		Gross		Net
Asset Class		Returns		Returns		Fees
US Equity		6.70%		6.32%		0.38%
Non-US Equity		-4.58%		-4.79%		0.21%
Private Equity		14.05%		12.72%		1.33%
Fixed Income		2.31%		2.19%		0.12%
Credit Opportunites		5.36%		4.82%		0.54%
Absolute Return		5.80%		4.86%		0.94%
GTAA		6.34%		6.28%		0.06%
Real Assets		-3.55%		-4.24%		0.69%
Real Estate		5.33%		4.32%		1.01%
Risk Parity		0.94%		0.87%		0.07%
Short Term Investments		0.13%		0.02%		0.11%
PSPRS Total		4.21%		3.68%		0.53%

An explanation of the different asset classes can be found on PDF page six of this paper, which includes among its co-authors several members of PSPRS's staff.  Fees are relative, and paying 1.33% on an investment that nets you 12.72% is a good value, while paying nearly 85% of of your gross returns in fees to get a paltry .02% return seems like a bad one.  Fortunately, short-term investments make up only 3.85% of PSPRS' portfolio and is the most liquid of the asset classes. The high proportion of fees paid may have to do with the high turnover in an asset class that is likely used as a temporary parking place for money waiting to be invested in other asset classes.

The big sore thumb sticking out here is the real estate asset class, which makes up nearly 10% of PSPRS' portfolio.  Real estate was the only asset class, other than the much more profitable private equity, that had fees over 1.00%, but it really stands out because it lagged its benchmark by the most of any of the classes.  Only three asset classes did not meet their benchmarks: US equity by 0.97%, real assets by 6.42%, and real estate by 8.66%.  Even non-US equity bested its benchmark 0.47%, despite having a loss for the year.  At 12.98%, real estate had the highest benchmark return of any asset class, and PSPRS paid 1% in fees to achieve a return just one-third of the benchmark.  It would be interesting to know what, if any, effect the Desert Troon investments are still having on PSPRS' bottom line or if more recent real estate investments have been more profitable because PSPRS, unlike last fiscal year when it lost 1.26%, at least had a positive return on its real estate portfolio.  Unfortunately I have been unable to find any information about the fiscal year 2015 real estate investments in any of the recent Board of Trustees meeting materials. 

* 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 one-half of a percent.  Returns net of fees were 13.28% and 3.68% for fiscal years 2014 and 2015, respectively.

Not in the best of hands: The PSPRS Board of Trustees summed up in one revealing passage

In case you missed it, the Arizona Auditor General released its "Performance Audit and Sunset Review of the Public Safety Retirement System" on September 18, 2015.  The Arizona Republic distilled the Auditor General's conclusions in this September 23, 2015 editorial, Public-safety pensions, summed in 1 bad word.

That bad word would be "deteriorating."  I would also like to point out another report from the Arizona League of Cities and Towns ("the League") entitled, "The Yardstick: A Tool to Evaluate Proposed Reforms of Arizona's Public Safety Personnel Retirement System (PSPRS)."  This report was released on August 18, 2015, and like the Auditor General report, does some myth-busting about PSPRS and confronts issues that need to be dealt with if PSPRS is to survive.

If the Arizona Republic would like to summarize the Auditor General report in one word, I would like to point to one particular passage in the League's report that shows one of the roots of PSPRS' problems.  The following appears on page 8 of the League's report:

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)

Unfortunately the League does not get into more specifics about why the Board ignored their own actuaries or what internal actions or discussions took place within PSPRS to address (or downplay) the issue.  However, the Republic does give PSPRS Administrator Jared Smout's take on the issue, "By design and structure, that (pay-out formula) depletes money out of the system faster than you can replace it with investment returns.”  The Republic does not give any explanation from PSPRS lifer Jared Smout as to why PSPRS never recognized the huge costs of the PBI's, even though they were told about them several years ago, and knew the damage they were doing to PSPRS' bottom line.

Of course, Mr. Smout is beholden to the Board of Trustees for his job, and it seems unlikely that he would publicly acknowledge mistakes by either the Board or him and his staff. When the Arizona Republic was hyping the alleged improprieties of real estate valuations to enhance staff bonuses and the Arizona Police Association was requesting a criminal probe of PSPRS, the danger was that these bogus charges would divert attention from the actual, serious problems with PSPRS.  PSPRS and its staff were rightfully exonerated of the ridiculous and unfair charges of wrongdoing in its Desert Troon real estate valuations, but now there seems to be little interest now from the same media and labor organization accusers about the general incompetence and lack of oversight by PSPRS' Board of Trustees.

The Board, ostensibly the watchdog of PSPRS, failed to deal with a problem that Mr. Smout now characterizes as a permanent financial drain on PSPRS, despite being aware of the problem "several years ago."  I now see why the League wants to alter the structure and personnel makeup of the PSPRS Board.  The individuals on the Board of Trustees (or Fund Managers, as they used to be called) has changed over the years, but their ability to make horrible decisions has remained consistent.  Approving bad investment choices, whether in individual stocks, real estate, or an underperforming low-risk portfolio, has been their usual modus operandi.  However, ignoring their own actuaries and knowingly excluding the costs of PBI's in contribution calculations is a new low for the Board.

Why would the Board do this?  Were they hoping that a defendant victory in the Fields case would make dealing with the actuaries' disclosure unnecessary since a new PBI structure would then be in place?   I don't know.  Your guess is as good as mine.   The fact that the PBI's were never included in the contribution calculations (which passed them on to future employees and taxpayers) before the disclosure is disturbing enough and makes one lose confidence in the actuaries (see this blog post for more about actuaries), but delaying any action until the 2015-16 fiscal year gives one zero confidence in the current Board of Trustees.  My guess is that a similar situation in a publicly-traded company would generate a queue of law firms at the courthouse filing class action lawsuits against the company.  As I have said before, it looks like it might be time for Governor Ducey to replace some or all of the Trustees.

I hope that the same groups who so breathlessly pursued PSPRS over bogus charges will, at least, do some follow up, on this.  There is a lot more to discuss about both the League's final report and the Auditor General's audit and review.  Please stay tuned.

The Stuart Smalley world of PSPRS: they're good enough, smart enough, and doggone it, their strategy is working

On September 9, 2015 we were given another of PSPRS' self-serving press releases:

PSPRS fund realizes 4.2 percent gross returns

Stability, $210 million in growth during year of market volatility

PHOENIX – The state’s Public Safety Personnel Retirement System fund realized a 2015 fiscal year investment return of more than 4 percent, placing the $8.3 billion system among top public pension performers during a year marked by high stock market volatility.

The system’s 4.2 percent gross-of-fees returns fell below the assumed earnings rate of 7.5 percent, but still showcased a strong 14.1 percent net return for the PSPRS private equity portfolio. In recent years, PSPRS increased its private equity investments – and decreased holdings in stock market-traded equities – as part of its strategy to minimize risk through a broad diversification across asset classes.

The 4.2 percent gross of fees performance of PSPRS places the system within the top 18 percent of 92 comparable public pension funds, according to Allan Martin, of NEPC, the Fund’s Investment Advisor.

“Our portfolio is designed to deliver earning potential while providing significant protection on the downside,” said PSPRS Chief Investment Officer Ryan Parham. “In a world where treasuries are earning less than 1 percent and stocks are flat or down, our 4.2 percent gross of fee returns shows the true value of diversification.”

When adjusted for measurable levels of investment risk taken, PSPRS outperformed 94 percent of its comparable peer pension funds, while the system has shown dramatic overall peer-to-peer performance ranking improvement over the course of the last 3, 5 and 10-year periods.

“The past year, and especially recent weeks, provide a clear example of the type of rocky environment this portfolio is built to withstand and even perform under,” said Martin. “For five years now, PSPRS has ranked well within the top 5 percent of its peers in terms of risk-adjusted returns, while earning 9.2 percent per year in gross-of-fee returns.”

The gross-of-fees performance of PSPRS exceeded that of peers by roughly 1 percent, according to Martin. PSPRS calculations indicate the additional 1 percent return resulted in producing more than $82 million to the PSPRS trust in fiscal year 2015.

The comparable returns on a net-of-fee basis are 3.7 percent for one year and 8.7 percent per year for the five-year period, respectively. On a net-of-fee basis, the fund increased in value during the 2015 fiscal year by $210 million and is now valued at more than $8.3 billion.

The PSPRS trust along with the Corrections Officers Retirement Plan (CORP) and the Elected Officials Retirement Plan (EORP) provides retirement, disability and survivor benefits to approximately 50,000 retired and active members.

Apparently, PSPRS thinks everything is going great.  Their paid pension consultant, NEPC, seems to agree, so why should any of us trust what we read with our own eyes?  After all, it's just our current and future income, security, and quality of life we're talking about here, right?

Let's start off with the obvious problems.  First, the headline states that PSPRS earned 4.2% gross returns for the fiscal year, which is not particularly great to begin with, but it is better than what PSPRS actually earned, 3.7%.  Of course, this does not appear until the penultimate paragraph, just in case people do not read the release all the way through.  Earning less than half your assumed rate of return (ARR) might make people think that you do not really know what you are doing.

This brings us to the glaring misrepresentation about PSPRS' ARR.  PSPRS' ARR was 7.85% last fiscal year.  PSPRS just lowered its ARR to 7.50% this fiscal year, so actually PSPRS fell even further below its ARR last year than the press release indicates.  But once again, why trouble PSPRS members with such details since it would reflect even more badly on its investment performance.

Now we get to the numbers, PSPRS' favorite embellishment tool.  Shouldn't we all see that PSPRS is doing quite well versus its "comparable peer pension funds?"  I do not know what qualifies as a peer pension fund.  Are the 92 peers based on assets, membership, investment strategy, or some other criteria?  In the last post, we saw that PSPRS surpassed the 3.2% average return of 265 public plans with more than $1 billion in assets by about a half-percent, but the referenced Pension & Investments article does not give enough information to rank PSPRS or place it in a percentile.  Is PSPRS still in the top 18% among the 265 funds?  Who knows, maybe PSPRS is better, maybe worse, but there are 173 other public plans not included in NEPC's calculations.  Ultimately, it means nothing to compare one's returns to a particular subset of public plans and highlight your performance against them, unless they are the well-funded, ARR-besting plans worthy of emulation.  It is like a perennially 8-8 NFL team comparing itself against all the teams with losing records, instead of the teams that regularly have double-digit wins and make the playoffs every year.  In this press release, PSPRS' comparative numbers are essentially worthless.

The press release also highlights PSPRS' five-year returns of 8.7%, net of fees.  This is fine until we look at last year when it was 10.68%, net of fees.  This two percent decrease, year-to-year, is conspicuously omitted, and this decrease was during the best five-year market PSPRS is likely to ever see.  It really can only get worse from here on out, as August 2015 showed.  PSPRS' ten-year returns are only about 5%, well below the ARR ,regardless of which ARR PSPRS chooses to use.

Lastly, we have to discuss the puffery from PSPRS Chief Investment Officer (CIO) Ryan "9%" Parham.  Yes, your diversification strategy seems to be minimizing risk on the downside, but PSPRS still needs, at the very least, to earn its ARR over the long run, even if you are claiming that PSPRS' disappointing earnings are caused by the incentive to lowball returns so as not to pay out COLA's to retirees.  Your strategy seems only to be halfway working.  This past fiscal year was not a flat or down year.  The Russell 3000 earned about 7.3% and even an equal dollar weighting of foreign (down 5.26%) and domestic stocks would have still earned about 2%, just 1.7% below your actively managed PSPRS portfolio.  If this past year is Mr. Parham's definition of success, we are all doomed.

If PSPRS dryly stated the facts of what happened last fiscal year, there would be no problem with this press release.  PSPRS did do a little better than average and did better than the Arizona State Retirement System, both good things that should be known in order to put PSPRS' performance in perspective.  However, this is all that needs to be said, not a bunch of misleading, happy talk about how a substandard year is some great success, if you just look at it the right way.  I am happy that PSPRS replaced the dangerous stock-picking strategy of past years, but that was not a justification to swing completely in the other direction to the point where you are so conservative that you can only earn your ARR in years when the markets are producing returns of 14% or more.  The danger in the past was that people were blinded by good PSPRS returns to the point that they did not see that those returns were unnecessarily risky and could have just as easily been produced by a much safer passive investment strategy.  The good returns were a factor of an extended bull market and had nothing to do with what individual stocks were chosen or who was making the choices.  Anyone can be a genius in a bull market.  However, the danger to PSPRS' portfolio was not an illusion and became very apparent when the dot.com market crashed and took a lot of PSPRS' individual stock picks down with it.  A mirror version of the same problem could just as easily happen if the only metric you look at is managing downside risk, and you cannot see that you have made it virtually impossible for PSPRS to ever earn an adequate return.  You are only supposed to play prevent defense when you are protecting a lead at the end of a game.  PSPRS is about five touchdowns behind late in the fourth quarter.

PSPRS is fond of presenting stress test models of how their current strategy would have lessened the losses of past financial crises, but they do not throw in a third comparison using a passive index fund strategy as a neutral baseline.  Also, they do not show how much lower the returns under the current strategy would have been in the years when PSPRS was doing well, such as during the bull market years of the 80's and 90's.  Lower returns in those good years, especially the 80's and 90's when the ratio of workers to retirees was much higher, would have had a negative compound effect over time that should be factored into any fair comparison of strategies.  Does PSPRS really know if their "nationally recognized" strategy is working, or are some people so personally invested in it that they can not objectively assess it?

In the end, applying the strategy is not the goal, consistently earning at or above your ARR over the long run is.  I am sure there was a "successful" strategy in place in 1999 when PSPRS was investing heavily in technology stocks and a "successful" strategy in place in the mid-2000's when PSPRS was investing heavily in real estate with Desert Troon.  We know how those turned out for all of us, but we can all take solace in the fact that PSPRS feels good about how they are doing now.

PSPRS takes the Pension Territorial Cup from ASRS this year

As we had discussed earlier here and here, there will be no permanent benefit increase (aka COLA) this fiscal year (FY) for PSPRS retirees.  This was confirmed by PSPRS Administrator Jared Smout in this message on the PSPRS website.  The only new information in the message is the disclosure of the final FY rate of return, net of fees: 3.68%.  This means that PSPRS missed its expected rate of return (ERR) by about 4% and the COLA threshold by about 5.3%.

According to this August 10, 2015 article, High-return era ends for big public pension plans, by Randy Diamond in Pension and Investments magazine, for this past FY, the median return for public plans with over $5 billion in assets was 3.4%, and the average return for the 265 plans with over $1 billion in assets was 3.2%.  PSPRS surpassed the median by 0.28% and the average by 0.48%.

PSPRS even gets state bragging rights versus the Arizona State Retirement System (ASRS) this year.  ASRS' FY 2015 return was 3.2%, beaten by PSPRS by almost a half-percent.  ASRS also has a higher ERR than PSPRS at 8.0%.  So some congratulations are in order for PSPRS, though these should be qualified by the fact that ASRS has soundly surpassed PSPRS' returns in the three-year, five-year, and ten year averages.  ASRS also returned 18.60% last year versus 13.82% at PSPRS, more than making up the difference for any lagging returns this year.  Most importantly, ASRS is much better funded than PSPRS and has much lower employer and employee contribution rates at 11.47% apiece.

I cannot wait to see the first few months of returns for the current FY.  They should be very interesting.