December 16, 2011

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.

The expression "May you live in interesting times" is certainly popular today.  And while the origins and meaning of this expression are often debated (blessing or curse, Chinese or Western origin, etc), most people in the investment profession agree that we've seen enough "interesting times" over the past few years to last a lifetime. 

Fiscal year 2011 certainly produced its share of "interesting times" in the financial markets, but as the dust settled it was an excellent year for MPERS' investment portfolio.  MPERS' portfolio generated a 21.8% return for the year, which was the highest return since fiscal year 1986 and also outperformed the policy benchmark return by 5.1%.  Make no mistake about it, fiscal year 2011 was not a market for the faint of heart.  A massive Japanese earthquake and resulting tsunami led to the meltdown of a Japanese nuclear plant, an embarrassing U.S. budget debate ultimately led to the downgrade of U.S. Treasury obligations, and the ongoing European sovereign debt crises are just a few of the historical events that shaped the markets over the past year.  Each of these events resulted in large market downturns and growing fears of double-dip recessions across the world.  Fortunately, each and every downturn was offset by an even stronger rebound. The end result was one of the best investment years in the history of MPERS. 

Performance was strong across all five major asset classes. Global equities led the way with a 32% return.  Fixed income generated the lowest return, but still produced a healthy 8.5% return for the year.  MPERS' private equity portfolio was the only sector that did not outperform its respective benchmark.  The private equity portfolio remains very immature, yet was able to generate a healthy 17% return for the year.  We are optimistic about returns in this asset class going forward. 

Despite the strong returns over the past year, the memories of the 2008/2009 financial crisis remain fresh in the minds of investors.  Corporations have restructured their balance sheets and are flush with cash, yet the balance sheets of governments across the developed world (especially the United States and Europe) are in very poor condition.  These governments took on massive amounts of debt during the financial crisis to stimulate the economy, mainly in the form of bank bailouts and various stimulus programs.  Today, the overall government debt burden has grown to the point where future economic growth is being squeezed by the uncertainty of how to service this debt.  Reducing government debt means reducing government spending - the same spending that has supported the global economic recovery in recent years.  The future reduction of government balance sheets will be yet another headwind for investment markets and could certainly generate more "interesting times" in the years to come. 

While market uncertainty brings additional risk to the investment portfolio, it's important to keep in mind that pension plans are in the business of managing risk, not simply avoiding risk. The risk exposures in the investment portfolio enable the fund to earn an attractive return which helps provide the benefit payments promised to you, the members of the system.  Our goal in managing the investment portfolio is not to avoid risk altogether, but rather to manage risk in the best way possible to ensure your benefit payments are secure.  The asset allocation approved by the Board of Trustees is designed to protect the fund against the uncertainty that remains in the global economy, and should perform well across various market environments, not just when the stock market rallies.  This strategy should serve MPERS well as we navigate through the "interesting times" in the years to come.