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Missouri Department of Transportation & Missouri State Highway Patrol Employees’ Retirement System

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Letter From CIO

September 5, 2018

To the Board of Trustees and System Members:

It is my pleasure to provide you with the investment section of this year’s Comprehensive Annual Financial Report (CAFR). This letter provides an overview of investment performance over the past year and our view of the investment market in the years to come.

Looking back over the past year, the most understated story has to be the “economic boom that nobody expected”.  The year began with a host of natural disasters that caused over $300 Billion in damages across the United States, geopolitical tensions with North Korea that included the threat of nuclear outbursts, and lingering political concerns in Europe over how to implement the Brexit vote.  There was also the constant bickering between President Trump and Congress, both of whom were at risk of losing momentum on their various policy initiatives.  As the U.S. economy entered its ninth year of economic expansion, very few investors envisioned what ultimately unfolded over the coming months.

Seemingly overnight, President Trump and the Republican Congress were able to set aside personality differences and push through a comprehensive tax reform package.  The combination of tax reforms and a more business-friendly regulatory environment created somewhat of a “Goldilocks” environment for the financial markets, producing steady economic growth but not strong enough to produce any meaningful signs of inflation.  The improved economic outlook led to yet another rally in most risk-based asset classes, while safe havens such as U.S. Treasuries lost value as interest rates rose on the improved growth outlook.

While this latest economic boost was somewhat of a surprise, we will gladly take the results as the investment portfolio had an excellent year.  The overall portfolio generated a 9.42% return (net of all management fees and based on time-weighted rates of return and market valuations), which outperformed the actuarial hurdle of 7.75%, the policy benchmark of 7.72% (the return you would earn by investing passively across the targeted asset allocation), and the median public fund return of 7.61%.  MPERS’ one year return ranked in the top 2% of the public fund universe, while our three and five returns rank in the top 18% and 3% of the universe, respectively.  Those numbers look even better on a risk-adjusted basis, as MPERS’ portfolio continues to maintain a lower risk profile than 75% of our peer group (with risk measured by standard deviation of returns over the past ten year period).

For the second consecutive year, each individual asset class delivered a positive return, led by MPERS’ private equity portfolio which produced a 17.2% return.  The opportunistic debt portfolio (in its first full year since being carved out of the broader fixed income portfolio) generated a 12.0% return, followed by the real estate portfolio with a 10.6% return, global equities with a 9.0% return, hedge funds with a 7.8% return, and the fixed income portfolio which grinded out a 2.0% return despite the overall fixed income benchmark being negative for the year.  Relative performance was also very solid, as the 1.7% outperformance relative to the total fund policy benchmark was the best result since fiscal year 2014.

As we look ahead to fiscal year 2019, the market remains full of skeptics.  As I write this report, we face a contested Supreme Court Justice nomination, the Federal Reserve contemplating how much (not if) to raise interest rates, and increased rhetoric around whether the use of tariffs will lead to a global trade war.  Given the hostility around these domestic policy issues, the upcoming mid-term elections in November will likely dominate the news headlines in October and November.  While investors have proved adept at filtering out the political rhetoric, if Democrats manage to overtake the House or Senate in November it could have a lasting impact on President Trump’s legislative agenda.  Any one of these (or yet another unforeseen event) can send markets to a selloff.  We’re also in the record tenth year of the economic expansion since the financial crisis, and while I will reinforce my personal belief that expansions don’t die simply from old age, you have to be mindful that a slowdown or correction is coming.  On the flip side, there is a renewed sense of optimism that the recent tax reforms and regulatory relief will provide further market gains.  Whether you like his style or not, President Trump’s policies have been beneficial to the business climate and the U.S. economy up to this point.  For now, the global economy continues to improve, and perhaps this relatively “balanced” mix of viewpoints suggest the markets have additional room to grow.

Thank you for the opportunity to serve as your Chief Investment Officer, and I hope you enjoy this year’s annual report.

Sincerely,

Larry Krummen, CFA