“We’re No. 1,” crowed Jason Davis, a trustee of the Pennsylvania Public School Employees’ Retirement System, after a report on the firm’s $75 billion investment plan flashed on the screen at Friday’s public meeting.

Davis, a western Pennsylvania high school teacher who serves as vice chair of the system’s investment committee, was one of several trustees who cheered a report by consultant Aon showing that PSERS returned +1.14% during the first quarter of 2022, placing it among the top 1% of state pension plans. On average, state pension plans lost -3.58% as the stock market fell in the three months from Jan. 1 to March 31, according to Aon.

PSERS’ strong quarter compared to other plans also boosted average returns for 12-month and 3-year periods toward the top for all state pension funds, and even boosted 10-year returns, which had lagged, into the top half of all plans for that longer period.

A word of caution

But under questioning by trustees, PSERS staff warned members that the PSERS results don’t include changes in valuation since Jan. 1 for private equity and real estate investments, which make up an unusually large part of the PSERS portfolio.

Unlike publicly traded stock prices, PSERS’ top-performing assets — private equity and private real estate — were measured, not for changes in their valuation in early 2022, but for late 2021, before the largest decline in stock prices and rise in interest rates slammed asset valuations across markets.

“Some of this” apparent strong first-quarter PSERS performance “is about the lagging,” acknowledged Claire Shaughnessy, a partner at Aon Investments USA, the consultant that measures PSERS’ asset values. “I would expect next quarter you are going to see some of the negativity flow through.”

“If you see Tesla and [other leading stocks] going down, the private companies are also going to see those markdowns,” in later periods, she added.

PSERS and other funds have long delayed reporting for private assets for a quarter, citing the challenge of collecting information, though officials have said they hope to cite more current data in the future. State Rep. Frank Ryan (R., Lebanon), a past critic of private-asset valuations and fees, asked if PSERS couldn’t use “a more stable methodology” to value assets at their current or more recent prices, instead of using last year’s numbers from when stock prices were still going up.

“You’re right, for the second quarter, more will be down,” as PSERS finally reports the impact of the first-quarter drop in investment values, agreed Darren Foreman head of private equity investments for PSERS.

Still, Foreman was hopeful private-equity values won’t decline as much as the stock market did: If the S&P has declined 20% in recent months, private equity “we think may be down 14%,” for a lower loss, at least until stock markets recover — whenever that may be.

To avoid larger losses, “we focused on hiring private-equity funds that have sustainable, endurable investment strategies,” Foreman added, avoiding private energy and chemical investment funds whose values may be more likely to crash.

PSERS vindicated?

PSERS has been under investigation by federal prosecutors based in Philadelphia since March of 2021, after admitting it had adopted a report exaggerating investment returns from 2011-2020 using data from Aon. The plan is also under investigation by the U.S. Securities and Exchange Commission, which wants to see if gifts from some of its hundreds of outside money managers affected investment decisions. No one has been charged with wrongdoing. PSERS has been changing some oversight practices after its own reviews by outside consultants.

Two of Davis’ fellow teachers on the board were quick to call the quarter’s returns a vindication of PSERS’ policy over the last decade, under executives who stepped down from the system last year, to invest more heavily in high-fee Wall Street private equity and real estate funds, instead of publicly traded stocks.

That policy enriched hundreds of private equity and real estate fund managers who invested Pennsylvania pension money, but also caused PSERS to miss out on the long bull market that began in 2009.

Defenders of the policy said it was made for moments such as this, when stock values are plunging instead of rising, and other assets have not been marked down as sharply.

“It finally works, and we were a long time waiting for it,” said trustee Mel Vogler, retirees’ representative on the board. She added that she does not want to see a reversal of the board’s more recent policy of selling hedge funds and some other other low-yield investments and slowly boosting its stock holdings.

Trustee Sue Lemmo, an art teacher in Curwensville, Pa., said the recent valuations showed teachers are able to successfully oversee their own investments. “This portfolio is doing what it was designed to do,” she said.

“It’s kind of a boring approach, and we’ve been slammed in the press a lot,” agreed trustee Eric DiTullio, who represents school board members. “We were the least risky,” and now returns in a down market have justified that approach, he added.

That low-risk claim was previously skewered by state banking secretary Richard Vague, who noted the volatility number PSERS and its consultants use as a crude measure of risk was itself artificially low, because private-asset values, unlike stocks, aren’t revised daily; by such a broad definition, private assets would always be “low risk,” even if returns are poor and some private investments lose some or all their value.

On Friday, Vague called the first-quarter returns “superb,” while noting that the current economic environment is “putting downward pressure on all assets.”

Other growing commodities

While privately managed asset valuations from last year accounted for most of PSERS’ claimed first-quarter 2022 gains, staff said it also did well with investments internally managed by PSERS staff, which are less expensive than many funds managed by outside professionals.

PSERS also benefitted from its investments in gold and other commodities, which gained value, especially after Russia invaded Ukraine in February.

One other asset class especially boosted PSERS returns: oil and gas, through “Master Limited Partnerships,” an asset category the board had voted to reduce to nothing over the next few years, after managers collected high fees but scored poor returns when gas and oil were cheap during the Trump and Obama administrations.