MSRA Takes on Latest MPPI Analysis
Those who in the past have claimed that our assumed rate of return of 7.7% was too high, now criticize us for having earned 14.4% in the most recent fiscal year. The latest report published by The Maryland Public Policy Institute makes several mischaracterizations about the Maryland State Retirement and Pension System that warrant clarification. The report begins by describing Maryland's investment performance for the year ending June 30, 2014 as sub-par. Over this time period, the fund earned a return of +14.37% net of fees, exceeding the actuarial assumed rate of return of 7.70%. These returns have resulted in greater progress toward full funding of the System than was projected last year. In fact, returns have been strong for the five years ending June 30, 2014, generating a net annualized return of 11.68% versus the actuarial target return of 7.75%.
The report also incorrectly attributes the fund's peer ranking to the level of management fees paid to active managers. The correct way to assess whether active management is adding value is to compare the returns earned by the fund in fiscal 2014 to returns earned by the fund had it been an all-passive portfolio. By doing this we see that for the year ending June 30, 2014, the fund's 14.37% return outperformed the returns for an all-passive alternative at 14.16% by 21 basis points. This equates to roughly $90 million in value generated by active management. Active management has added value over a longer time period as well. For the five years ended June 30, 2014 the fund has exceeded its policy benchmark by 90 basis points on an annualized basis, resulting in roughly $1.9 billion in value creation. It is inappropriate and misleading to refer to management fees as "high-priced advice" without including a comparison against an all-passive alternative.
While much of the report is flawed and not supported by facts, it does correctly highlight that the fund's peer group ranking is unimpressive. However, the reason for this ranking is not due to active management and fees. After the financial crises of 2008-2009, the Board determined that the fund had too much exposure to public equities, which historically has been one of the riskiest, most volatile asset classes, and wanted a more balanced and diversified portfolio. As a result, assets have gradually been re-allocated away from public equities and into other asset classes. While the current long-term target allocation to public equities is significant at 35%, it represents an underweight to this asset class relative to the peer group. During a time period when public equities generate unusually high rates of return, as they have for the last five years, the fund can be expected to underperform peers who have higher allocations to public equities. However, the reverse should be true when public equities experience negative returns. Over a full market cycle, the fund's positioning should provide a more diversified return stream, which should provide less volatility and greater reliability over the long term, for our members and the taxpayers of the state.
While MPPI's thesis that the fund's return of 14.4% for fiscal 2014 is now costing taxpayers $1.16 billion is provocative, it is also myopic and perhaps even a bit misleading. Fiscal 2016 employer contributions to the fund are projected to increase by $129 million over fiscal 2015 employer contributions. To suggest that this increase of $129 million is due entirely to investment returns is deceptive. A recent study by the System's actuary revealed that the increase of $129 million (not $1.16 billion) to the employer contribution is not as a result of the System's strong investment returns. Indeed, the System's actuary listed the funds 14.37% investment return as the leading cause for reducing the increase to the taxpayer funded employer contribution.