Fiscal year 2011 was a year of transitioning for MPERS' investment portfolio, as we gradually shifted the portfolio to the new asset allocation targets approved by the Board of Trustees in June 2010.  We're pleased to report the majority of assets were transitioned by June 30, 2011, which is much sooner than initially forecast.  Thanks to the hard work of staff and MPERS' external consultants, and despite the market volatility and periods of transition, MPERS' closed fiscal year 2011 with an asset allocation in-line within the permissible ranges set forth in MPERS' investment policy.  Going forward, any deviance relative to target allocations will be a conscious decision based on our views of the market. 

Global Equity Allocation:

We began the year with a 41% allocation to global equities, considerably above the new targeted allocation of 30%.  We maintained this overweight throughout most of the year, on the belief that corporations had relatively strong balance sheets and should perform well in the current low-interest rate environment.  Throughout the year we gradually reduced this overweight as sovereign debt concerns began to impact investor confidence.  MPERS closed the year with a 31.5% allocation to global equities, just slightly above targets. 

 

Going forward, we expect to have a slight underweight to global equities, offset by an overweight positioning to the private equity portfolio. 

 

Fixed Income Allocation:

We began fiscal year 2011 with a 34.5% allocation to fixed income, however this included MPERS' allocation to hedge funds pursuant to the old asset allocation methodology.  The new asset allocation targets have separate allocations to traditional fixed income and hedge fund strategies, with fixed income having a 25% targeted allocation.  The fixed income portfolio, which underperformed drastically in fiscal year 2009, continued to rebound strongly in fiscal year 2011 generating a 8.5% return relative to a benchmark return of 4.8%.   

 

The new fixed income allocation includes allocations to long duration securities (target of 5% of assets), inflation protected securities (target of 5% of assets), and a core fixed income allocation (target of 10% of assets) benchmarked to the Barclay's Government/Credit Index.  MPERS also has a 5% targeted allocation to opportunistic debt strategies to take advantage of relative value opportunities in the fixed income sector.  Throughout the year we made considerable progress in funding the opportunistic debt and long duration allocations, but remain underweight to inflation protected securities given the negative real yields common throughout the sector.  Overall, we closed the books on June 30, 2011 with a 22.9% allocation to fixed income securities. 

 

Hedge Fund Allocation:

Effective June 30, 2010, MPERS' asset allocation includes a targeted allocation of 15% for hedge fund strategies.  Previously, all hedge fund strategies were housed under the fixed income category.  Throughout fiscal year 2011, we made a number of manager moves in the sector to position the portfolio towards the revised risk and return profile established in the asset allocation study.  Going forward, the portfolio is designed to generate a diversified return stream with relatively low risk (defined as volatility of returns) and a low correlation (i.e., moves differently relative) to the broad equity markets.  MPERS closed fiscal year 2011 with a 11.2% allocation to the hedge fund sector, which produced a solid 9.8% return for the year. 

 

Real Assets Allocation:

Fiscal year 2011 was a turning point for MPERS' real assets portfolio, as commercial real estate prices rebounded strongly after two years of negative returns.  We began the year with an 11.3% allocation to real assets, but thanks to strong investment returns and several new investment mandates, we ended the year with a 17% allocation.  Performance was strong across most sectors, with core real estate producing a 35% return, non-core (value added / opportunistic) strategies generating a 17% return, and listed REITS (real estate investment trusts) generating a 24% return.  MPERS' timber portfolio trailed the pack with a 1.3% return, suffering from the continued weakness in the housing construction sector.  Overall the asset class generated a 27.2% return for the year, and we remain optimistic about the return prospects going forward. 

 

Private Equity Allocation:

MPERS' private equity allocation rose from 12.1% of assets to 15.8% of assets during the course of fiscal year 2011.  Overall the portfolio generated a 17.6% return for the year, which is very respectable given the relative immaturity of the portfolio (MPERS started committing capital to private equity in 2005).  The portfolio once again trailed the benchmark return due to timing-related issues, as the "public equity plus" benchmark (S&P 500 + 3%) for the private equity portfolio remains extremely difficult to match during periods of strong public equity performance.  The underlying companies within the private equity portfolio continue to perform well, and we expect to maintain an overweight position to the asset class for the foreseeable future. 

 

Looking Forward:

With the majority of the portfolio transitioned to the new asset allocation targets approved by the Board of Trustees, going forward we expect to see more attention to smaller scale, "blocking and tackling" issues.  Listed below are a few key initiatives as we enter fiscal year 2012. 

 

The hedge fund portfolio is always a focal point of staff's effort and attention, and going forward will be no exception.  As part of the last asset allocation study, we made a conscious effort to shift risk from MPERS' equity portfolio to alternative asset classes, and the biggest impact will occur in the hedge fund portfolio.  We have transitioned away from market neutral oriented strategies and continue to migrate towards more event-driven and long/short equity strategies.  MPERS' hedge fund portfolio, all things considered, held up very well during the last downturn.  Going forward, we intend to focus more attention to this asset class to ensure it continues to perform well in the future. 

 

We also expect continued restructuring within the fixed income portfolio, as we look to reduce the risk that led to such wide performance swings from 2008-2010.  We intend to gradually allocate funds away from the existing manager base towards passive investment strategies in long duration fixed income, Treasury Inflation Protected Securities (TIPS), and a core allocation to the Barclay's Capital Government/Credit Index. 

 

The chart below lists the target and actual allocations to the various sub-asset classes within the overall portfolio (as of June 30, 2011).