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How Pa. school pension beat 2014 target

PSERS returns 8.8%, vs 6.4% at SERS

"We were very pleased" with 2014 pension investment returns," writes James Grossman, chief investment officer at the Pennsylvania School Employees' Retirement System (PSERS).

PSERS says its investments yielded 8.83%, beating its yearly target of 7.5%, besting both the state pension system (SERS), which reported 6.4%, missing its target; and also Montgomery County, which in 2013 dumped its SERS- and PSERS-style mix of stock, bond and private-investment managers and bought a bunch of low-fee Vanguard index funds last year to score a 7.7% return, slightly above target (more on SERS and Montco here). ALSO: New Jersey Division of Investment returned 7.27% for 2014, see here.

What gave a boost to PSERS's 2014 returns? The system will put out more detail in its yearly Budget Book soon, but here's what yielded above average: "Real estate (up 17.2%), Master Limited Partnerships (up 16.3%), private markets (up 10.4%), fixed income (up 10.3%), U.S. equities (up 11.7%) [though that trails the S&P 500's 13.7%], and risk parity [a portfolio designed to reduce volatility] (up 10.2%)."

Also, the PSERS board's "decision to hedge a portion of our foreign currency exposure in late 2013 added significant value this past year and that decision is continuing to add value in 2015," added Grossman. But he warns that "returns for all asset classes are expected to be lower" for the next 10 years or more (not just next year, as I put in an earlier version of this item.)

UPDATE: I asked how PSERS did so well from MLP's, which are mostly energy-related investments, while SERS, the separate state-workers fund, blamed energy investments, in part, for lower-than-target results. PSERS' Evelyn Williams sent this statement:

"PSERS' diversified asset allocation, which uses both active management and passive indexes, helped performance this past year.

"Some differentiation in performance is due to the foreign currency hedge PSERS instituted in August 2013. During the spring/summer, PSERS had numerous discussions with its strategic partners who were recommending that we consider instituting a foreign currency hedge on developed market currencies (primarily Euro, Yen, and Pound). PSERS essentially hedged 100% of this exposure in the public equity portfolios. The hedge added about $375 million in performance during 2014 and has been adding significant value so far in 2015.

"MLPs also had a very good year. There are different types of MLPs. The two most prevalent types are upstream MLPs that have more direct commodity exposure and mid-stream MLPs that operate as toll roads moving and storing oil and natural gas and have little direct commodity exposure.

"For the calendar year, the S&P MLP Index was up 7.66%. PSERS, however, uses active management in this part of the asset allocation as we believe that the market is very inefficient. As a result of that active management decision PSERS outperformed the S&P MLP Index by 8.64%. PSERS was up 16.30% net of fees for the calendar year.

"MLPs did have a very bad fourth quarter due to the precipitous decline in oil. The S&P MLP Index was down 12.02% as a result. The S&P MLP Index was down partly due to the upstream MLPs being hurt by the falling oil prices.

"The other part can probably be attributable to a re-rating of growth expectations for mid-stream MLPs as U.S. energy production is expect to fall as the marginal cost of extracting oil in the U.S. in many places is above the spot price of oil (balancing out an excess of supply vs. demand). Energy and exploration companies will be hesitant to enter into 20 year contracts for the transportation of product that may not even be extracted from the ground; hence, the reduction of forward growth expectations. Mid-stream MLPs generally won't build new pipelines unless sufficient take away capacity is sold to be profitable over the next 20 years.

"Commodities had a very difficult year. PSERS uses the Bloomberg Commodity Index which has a more balanced exposure to energy, industrial metals, precious metals, and agriculture. Some funds use the Goldman Sachs Commodity Index which has a much heavier weighting to energy. In particular, PSERS' commodity allocation is 67% in the Bloomberg Commodity Index and 33% in Gold. The commodity allocation for PSERS had a very poor year as it was down about 18.05% for the calendar year."