Asset Allocation Study

Transcription

1 Asset Allocation Study The Metropolitan St. Louis Sewer District August 2016 Pavilion Advisory Group Inc. 227 W. Monroe Street, Suite 2020 Chicago, IL Phone: Fax:

2 Process Inputs Run Optimizer Illustrate Portfolios Asset Classes Efficient Frontier Assumptions Return Current Portfolio A Portfolio B Portfolio C Portfolio D Portfolio E Portfolio F Constraints Risk The purpose of mean variance optimization is to determine the asset allocations that will be modeled stochastically. 1

3 Potential Asset Allocations Model Portfolios Portfolio E (no hedge funds and Portfolio F (Current Policy ex real assets) Asset Class Current Policy Portfolio A (more conservative) Portfolio B (no hedge funds) Portfolio C (more aggressive) Portfolio D (most aggressive) real estate) Domestic Equity International Equity Emerging Mkts Equity Total Equity Market Duration Fixed Income Global Fixed Income Total Fixed Income Multi-Strategy HFOF Long/Short Equity HFOF Real Estate Real Assets REITS Private Equity Total Alternatives Total Portfolio Expected Return 6.4% 6.3% 6.4% 6.8% 7.1% 6.4% 6.6% Standard Deviation 9.4% 8.1% 9.7% 10.2% 11.5% 11.2% 9.1% Return per Unit of Risk (Sharpe) Maximum 1-Year Loss (95% Probability) -7.8% -5.9% -7.9% -8.0% -10.1% -9.8% -7.1% 1. Assumes a risk free rate of 1.5% 2

4 Peer Asset Allocations Comparison to Peer DB Plans Current Greenwich: Greenwich: Asset Class Policy All Public <$500M MOLAGERS 1 MOSERS 2 MPERS 3 SLC ERS 4 PSRSMO 5 Domestic Equity 26.0 International Equity 10.0 Emerging Mkts Equity 4.0 Total Equity Core Fixed Income 26.0 Global Fixed Income 9.0 Total Fixed Income Hedge Fund of Funds Real Estate Real Assets Private Equity Total Alternatives Total Portfolio Expected Return 6.4% 7.3% 7.2% 7.2% 6.3% 7.4% 7.0% 7.2% Standard Deviation 9.4% 13.2% 13.3% 12.9% 10.3% 12.1% 11.6% 12.1% Return per Unit of Risk (Sharpe) Maximum 1-Year Loss (95% Probability) -7.8% -11.9% -12.2% -11.7% -8.5% -10.0% -10.0% -10.2% 1. Missouri Local Government Employees Retirement System ($6 billion). 2. Missouri State Employees Retirement System ($8 billion). 3. MODOT & Patrol Employees Retirement System ($2 billion). 4. St. Louis County Employees Retirement System ($730 million). 5. Public School Retirement System of Missouri ($38 billion). 6. Assumes a risk-free rate of 1.5%. Note: Portfolios shown above are approximations of peer plans asset allocation based on publicly available information and therefore may be different than the allocations currently in place. 3

5 Total Fund Balance ($ Millions) Year th 75th 95th Current Portfolio A Portfolio B Portfolio C Portfolio D Portfolio E Portfolio F

6 Funded Status Year th 75th 95th Current 77.4% 59.9% 39.8% Portfolio A 76.7% 61.8% 43.5% Portfolio B 77.9% 59.5% 38.6% Portfolio C 81.5% 61.7% 39.0% Portfolio D 84.4% 62.1% 36.5% Portfolio E 77.7% 57.5% 35.1% Portfolio F 79.2% 61.9% 41.7% 5

7 Observations The portfolios with the highest expected returns perform best at the 50 th percentile outcome. Thus, Portfolio D has the largest projected fund balance at the 50 th percentile outcome followed by Portfolio C. The Current Portfolio and Portfolio B have similar long-term expected returns and standard deviations and therefore similar projected fund balances at the 50 th percentile outcome. Portfolio A s projected balance is modestly lower. Portfolio F, which has the same allocation as the Current Portfolio but excludes real assets, has a higher expected return and lower standard deviation than the Current Portfolio. The 75 th percentile outcome represents a transition point between high expected return portfolios and high Sharpe ratio portfolios. Sharpe ratios are a risk adjusted return, reflecting both the return and standard deviation of the particular asset allocation. Sharpe ratios are a measure of portfolio efficiency, with high Sharpe ratios equating to more efficient asset allocations. Portfolio A has the best Sharpe ratio at 0.59, followed by Portfolio F at Next is a tie between the Current Portfolio and Portfolio C at At the 75 th percentile, Portfolio s A, C, D and F have the highest fund balances. At the 95 th percentile outcomes, high Sharpe ratios prevail. Portfolio A has the largest projected fund balance at the 95 th percentile followed by Portfolio F. Portfolio E, which excludes hedge funds and core real estate, has the lowest balance. 6

8 Conclusions If MSD wants to pursue a more aggressive asset allocation policy, Pavilion recommends MSD consider moving to Portfolio C. There are several benefits over the Current Portfolio: Portfolio C provides a long-term expected return of 6.8%, which is closer to MSD s asset return assumption than the expected return of the Current Portfolio (6.4%). The Sharpe ratio of Portfolio C and the Current Portfolio are the same, indicating a similar level of efficiency. Portfolio C provides projected fund balances in the 50 th (median) and 75 th (pessimistic) percentile environments that are higher than the Current Portfolio, albeit the projected fund balance for Portfolio C in the 95 th (worst-case) percentile environment is slightly lower than the Current Portfolio. Pavilion has weak intermediate-term expectations for fixed income performance and believes maintaining the allocation to hedge funds while slightly increasing equities should provide better returns than the Current Portfolio with modestly higher volatility. If MSD wants to continue to de-risk the asset allocation policy, Pavilion recommends MSD consider moving to Portfolio A. There are several benefits over the Current Portfolio: Portfolio A provides the lowest volatility of 8.1%; The Sharpe ratio of Portfolio A is the highest of all portfolios under consideration; Portfolio A provides superior results in the 95 th percentile and stress test scenarios during worst case historic events. The trade off between Portfolio C and Portfolio A is the return on asset and discount rate assumption. By moving to Portfolio C, we believe MSD can maintain a 7% return on asset assumption. If MSD chooses to move to Portfolio A, the return on asset assumption and discount rate will have to be reduced. If MSD is comfortable with the current allocation, Pavilion recommends MSD consider eliminating the real assets allocation and moving those funds to core real estate, which moderately improves the risk/return profile. 7

9 Pavilion Advisory Group 2016 Capital Markets Assumptions 3-5 Year Assumptions Long-Term Assumptions Return Volatility Return Return Volatility Return Geometric Arithmetic Geometric Arithmetic Large Cap Equity 7.3% 19.0% 8.88% 7.5% 19.0% 9.12% Small Cap Equity 6.9% 23.0% 9.26% 7.8% 23.0% 10.14% Int'l Developed Equity 7.0% 22.0% 9.11% 7.5% 22.0% 9.65% Int'l Dev. SC Equity 6.8% 23.0% 9.11% 7.8% 23.0% 10.14% Emerging Mkts Equity 8.3% 28.0% 11.67% 8.5% 28.0% 11.87% Global Equity 7.2% 21.4% 9.29% 7.6% 21.4% 9.64% Tbills 0.5% 1.0% 0.50% 1.3% 1.0% 1.25% Fixed Income Short 1.7% 4.0% 1.76% 2.3% 4.0% 2.33% Fixed Income Market 1.4% 7.0% 1.67% 3.0% 6.5% 3.20% Fixed Income Long 2.0% 10.0% 2.45% 3.2% 10.0% 3.68% High Yield 7.1% 12.0% 7.74% 7.3% 12.0% 7.96% TIPS 1.4% 6.0% 1.61% 2.5% 6.0% 2.67% Emerging Mkts Fixed Income 5.5% 14.0% 6.36% 5.5% 14.0% 6.41% FI Multiverse 0.5% 8.0% 0.79% 3.0% 8.0% 3.31% WGBI 0.5% 8.0% 0.79% 2.5% 8.0% 2.81% Hedge Fund of Funds 5.0% 7.5% 5.27% 5.0% 7.0% 5.23% Long/Short Equity 5.8% 11.3% 6.39% 6.7% 11.0% 7.26% MultiStrat 7.7% 6.3% 7.86% 7.2% 6.0% 7.37% MLP 7.6% 18.0% 9.10% 7.9% 20.0% 9.69% Private Equity 11.3% 30.0% 14.99% 11.3% 30.0% 13.97% Private Debt 6.0% 9.0% 6.38% 6.0% 9.0% 6.38% Real Estate 6.3% 12.0% 6.92% 6.8% 12.0% 7.42% Value Added RE 6.8% 14.0% 7.65% 7.8% 14.0% 8.69% REITs 7.1% 20.0% 8.85% 8.0% 20.0% 9.79% Timber 6.0% 12.0% 6.67% 7.0% 12.0% 7.66% Commodities 4.3% 18.0% 5.76% 4.0% 18.0% 5.51% 8

10 Capital Markets Correlations 60% 5 Years 40% Since 1996 SP500 R2000 EAFE EAFE SC EM BC AGG BC LONG G/C BC 1-3 G/C BC MULTIVERSE MLP PE SP R EAFE EAFE SC EM BC AGG BC LONG G/C BC 1-3 G/C BC MULTIVERSE MLP PE NCREIF CAMBRIDGE VA RE REITs TIMBERLAND HFRI FofF L/S MULTI-STRAT BC HY BC EM US TIPS COMM CPI WGBI US TBILLS ACWI 1.00 NCREIF CAMBRIDGE VA RE REITs TIMBERLAND HFRI FofF L/S MULTI-STRAT BC HY BC EM US TIPS COMM CPI WGBI US TBILLS ACWI Correlations are based on historical data with a greater emphasis placed on near-term relationships. We have used slightly higher correlations for some asset classes with limited data or smoothed valuations. 9