October 24, 2019
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.
MPERS’ portfolio generated a 6.84% return in Fiscal Year 2019 (net of all management fees and based on time-weighted rates of return and market valuations). For the second consecutive year, each individual asset class delivered a positive return, led by MPERS’ private equity portfolio which produced a 16.22% return. The real estate portfolio also delivered a double-digit return of 10.49%. The traditional fixed income portfolio generated an 8.61% return, followed by the opportunistic debt with a 7.46% return, real assets with a 6.48% return, and public equities with a 1.23% return. The overall fund return of 6.84% ranked in the top 32% of the public fund universe. Longer term, MPERS’ three-, five-, and ten-year returns rank in the top 32%, 9%, and 7% of the peer universe, respectively. Those numbers look even better on a risk-adjusted basis, as MPERS’ portfolio continues to maintain a lower risk profile than 99% of our peer group (with risk measured by standard deviation of returns over the past ten-year period).
Looking deeper into Fiscal Year 2019 performance, it was certainly a tale of two halves for the financial markets. The first half of the year (the second half of calendar year 2018) saw equity markets fall significantly following concerns over falling economic growth and the escalating trade tensions between the U.S. and China. The fourth quarter of 2018 was especially challenging, as global equities fell over 12% in the quarter which left equities down over 9% for the calendar year. As we turned to calendar year 2019, market sentiment seemingly turned positive overnight as the Federal Reserve and central banks across the globe once again stepped in to support the markets. The pivoting of the Federal Reserve to a more accommodative stance (signaling future interest rate cuts) sent bond yields tumbling lower and investors rushing back to the equity markets. Global equity markets subsequently rallied over 16% in the first half of 2019, erasing the losses from the prior six months and ending Fiscal Year 2019 with positive returns.
The market volatility in Fiscal Year 2019 highlights the rationale behind MPERS’ restructuring of the investment portfolio that started over 15 years ago, and how alternative investment structures can be utilized to diversify investment portfolios across market cycles. As equity markets struggled in the fourth quarter of 2018, the median public fund lost 8.0% while MPERS’ portfolio lost only 2.8%. The reverse was true in the first quarter of 2019 when equity markets rallied, as the median public fund gained 8.7% while MPERS only gained 4.1%. Over that six-month period (fourth quarter 2018 and first quarter 2019), the median public fund lost 0.1% in value and experienced a tremendous amount of volatility. Meanwhile, MPERS’ portfolio gained 1.1% in value over the same timeframe with considerably less volatility. Over this volatile period, MPERS outperformed the average public fund and took far less risk in the process (as measured by volatility of returns). The same message holds true over longer periods of time, as MPERS’ ten-year return ranks in the top 7% of the peer universe while our portfolio risk ranks in the bottom 1% of the peer universe. That combination has produced one of the highest Sharpe ratios (a measure of return per unit of risk) across the entire peer universe. A lower volatility investment portfolio also lowers the volatility of contribution rates for the employers, which smooths the overall pension cost structure during a difficult budget environment.
The volatility in the markets over the past year are a stark reminder that markets are always changing. As we assess the current environment, the falling yields in traditional fixed income markets leave a big dilemma for pension investors going forward. At the time of this report, the 30-year Treasury had a yield of roughly 2.0%, while government bonds across most of developed Europe were trading at negative yields. Bond markets are clearly expecting minimal growth out of the global economy for the foreseeable future. The dilemma is that for every dollar invested in a U.S. Treasury bond that earns 2.0%, another dollar must be invested in “something” that earns 12% to meet MPERS’ actuarial return target of 7.0%. With the economy entering the “late-cycle” by most any metric, and bond markets predicting limited economic growth going forward, very few strategies have the potential to generate those types of returns.
With that in mind, MPERS’ is currently performing an asset/liability study to determine what, if any, changes should be made to the System’s asset allocation or actuarial return assumptions. The study will review a wide range of asset allocations, calculate projected returns for those portfolios, and then forecast how those returns would impact the expected employer contributions and the funded status of the plan. MPERS’ current asset allocation has served the system well, and we are in a position to make significant improvements in our funded status over the coming years. But as the financial markets change, we must always look forward and evaluate whether the current portfolio is appropriate for the markets going forward. Regardless of whether a change in strategy or allocation is implemented, our goal is always to deliver strong risk-adjusted performance for the members of the System.
Thank you for the opportunity to serve as your Chief Investment Officer, and I hope you enjoy this year’s annual report.
Larry Krummen, CFA
Chief Investment Officer