November 10, 2010

To the Members of the MoDOT & Patrol Employees' Retirement System:

It is my pleasure to provide you with the investment section of this year's comprehensive annual financial report. This section is a supplement to the comprehensive report and provides an overview of developments and performance within the investment portfolio.

Perhaps the title of this year's report should read "What a difference a year makes!"  One year ago as I wrote the fiscal year 2009 report, the global economy was on the verge of collapse, and we were on the brink of the next Great Depression. The S&P 500 had dropped 41% since October of 2007, home prices had dropped over 20% from their peak, and the banking industry was on life support and needed a number of government stimulus programs to avoid collapse.  The end result for fiscal year 2009 was that MPERS' investment portfolio had suffered a -24.7% return - the worst performance ever recorded since the fund was established in 1955.

Fortunately, the government stimulus programs launched in 2009 began to generate their desired effects, and stability returned to the financial markets during fiscal year 2010.   Investors realized the world was not coming to an end, the housing market began to stabilize, and financial markets across the globe rebounded.  As the economy found its footing, MPERS' investment portfolio responded by generating a healthy 12.9% return for the year.  Many of the strategies that performed poorly in fiscal year 2009 rebounded strongly in fiscal year 2010 with the improved economic environment.  This was most evident in MPERS' fixed income portfolio, which returned 22.9% for the year.  The equity portfolio also had a strong year, delivering a 16% return.  The real estate portfolio continued to drag down overall results and was the only asset class to generate a negative return for the year.  Signs of stabilization are emerging in this sector as well, and we're optimistic about real estate returns going forward.

Despite the overall improvement, looking forward the economy remains very fragile.  While the housing market is showing signs of stability, mortgage delinquency rates remain extremely high and a record number of foreclosed and unsold homes remain on the market.  The government stimulus programs were successful at stabilizing the markets, but a key concern going forward is whether the economy can continue to grow as this support is gradually withdrawn.

MPERS' Board of Trustees, with all the uncertainty in the markets in mind, completed a review of the current asset allocation strategy during the course of fiscal year 2010.  With the help of outside consultants, each and every facet of the asset allocation process was reviewed to determine if changes were necessary to the current asset allocation mix.  Details of the study will be discussed in greater depth throughout the investment section, but the predominant theme was to reduce the amount of risk in MPERS' portfolio.  Risk takes on a number of different meanings to different people, but the risk we are focused on is the amount of exposure to equity markets.  To that end, in the coming years MPERS will gradually shift assets away from publicly traded stocks and increase exposures to traditional fixed income, real estate, and private equity structures.  The intent is to protect the corpus of the fund against all the uncertainty that remains in the global economy, and to construct a portfolio that performs well across various market environments, not just when the stock market rallies.