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

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Letter From CIO

September 23, 2020

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 staff’s view of the investment market in the years to come.

MPERS’ portfolio generated a -0.49% return in Fiscal Year 2020 (net of all management fees and based on time-weighted rates of return and market valuations). While MPERS’ longer-term returns remain excellent, it was a very difficult year for the investment portfolio. For the first time since the financial crisis, MPERS’ portfolio failed to outperform the actuarial return target, the policy index return, the median public fund return, along with a passive 60/40 stock/bond allocation. When examining investment performance, the first place to look is the plan’s asset allocation. A number of well-known studies suggest that roughly 90% of the variability in an investment portfolio is attributable to asset allocation. MPERS has a unique asset allocation that is designed for the long term, and includes a diversified mix of strategies to perform well throughout a wide range of investment markets. Fiscal Year 2020 was a particularly unusual year, dominated by the outbreak of COVID-19 and fears of a global economic shutdown. After ending calendar year 2019 at all-time highs, global equities dropped 21% in the first quarter of 2020 as businesses were forced to closed their doors and unemployment spiked. The uncertainty over future economic growth also sent interest rates to record lows, driving prices of government bonds to historic highs. Global banks and policy makers responded with an unprecedented amount of government stimulus, which stabilized markets and led to global equity markets rallying over 19% in the second quarter of 2020.

While nobody likes to underperform goals and objectives, it is hard to draw any hard conclusions during volatile short-term markets like those of Fiscal Year 2020. Diving deeper into the market’s recovery, there is a market dominated by a handful of growth companies positioned to benefit from the “new normal” brought about by COVID-19. As businesses and consumers migrated to working from home, technology stocks that helped citizens cope with the pandemic such as Zoom (ZM), DocuSign (DOCU), and Peloton (PTON) had extraordinary gains, while traditional industries such as airlines, hotels and restaurants struggled to stay afloat. In the case of U.S. equities, where the Russell 3000 index earned a total of 6.5% for the year, growth companies generated a 21.9% return while traditional value strategies lost 9.4% of their value during the year. In the end, Fiscal Year 2020 was an extremely volatile market but one that ultimately rewarded a concentrated portfolio of publicly traded stocks and high quality government bonds. That is essentially the complete opposite of MPERS’ total asset allocation, which relies more heavily on private markets and a mix of real asset strategies.

Keeping in mind all of the market uncertainty, MPERS’ Board of Trustees completed an asset/liability study during the course of Fiscal Year 2020 to determine whether or not changes to the current asset allocation were desired. While market uncertainty brings additional risk to the investment portfolio, it is 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 the members of the System. The asset allocation in place today is a culmination of 15 years of restructuring the portfolio with the goal of performing well across various market environments, not just when the stock market rallies. To date, those efforts have served the System well. MPERS’ 10-year return ranks in the top 21% of the public fund peer universe, with a risk profile (as measured by volatility of returns) in the bottom 1% of the same peer universe. A lower volatility portfolio also lowers the volatility of contribution rates for the employers, which smooths the overall pension cost structure during a difficult budget environment. That consistent return profile has kept employer contributions stable for eight consecutive years.

After reviewing a number of alternative portfolios, the Board ultimately reaffirmed the current asset allocation targets, along with granting staff the flexibility to utilize leverage within the investment portfolio. The leverage authority, which is capped at 20% of the portfolio value, offers greater liquidity and improved flexibility for investing during periods of market volatility. The additional flexibility is projected to increase MPERS’ annual investment returns as much as 0.7%, or roughly $16 million annually, and lower the total required employer contributions to the System by $277 million over a 15-year period. MPERS’ staff commends the Board of Trustees for its extensive review of this initiative, and is pleased to have the asset allocation reaffirmed and the leverage authority approved.

Looking to Fiscal Year 2021 and beyond, the ultimate impact of COVID-19 remains unclear. Unemployment has spiked and economic growth has stalled; however, governments and central banks are doing everything they can to support the current the economy. This tug of war will likely continue for some time, especially given the looming U.S. presidential race in November of 2020. Given that interest rates remain at historically low yields and the equity markets are trading at or near all-time highs (despite all of the market uncertainty), tempering return expectations and building liquidity seems to be a prudent investment strategy over the intermediate term. The added flexibility built into the leverage authority provides MPERS’ seasoned staff with more tools to manage MPERS’ investment portfolio, and maintain the path of progress the System has enjoyed over the past decade. Given the low return environment and the difficult budget situation, all of these tools are critical in maintaining the health and stability of the retirement system for MPERS’ current members and for generations to come.

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
Chief Investment Officer