Second Quarter 2017 Update
August 22, 2017
Fiscal year 2017 was exceptionally strong for PRIM. The PRIT Fund ended the fiscal year at $67 billion, a record high. The PRIT Fund was up 13.2% (gross of fees), outperforming its benchmark by 127 basis points. On a net-of-fees basis, the PRIT Fund was up 12.8%, outperforming its benchmark by 79 basis points. Six of the seven major asset classes outperformed their benchmarks. For the first time in several years, international equities outperformed domestic equities, though all equities were up strongly. As you know, we have maintained our relatively high exposure to international equities and this served us well in the fiscal year. We are especially pleased with our performance given that we have systematically de-risked our portfolio over the past several years.
Private Equity returned 21.3% for the year, Global Equities returned 20.9%, Value-added Fixed income returned 10.3%, and Hedge Funds were up 9.4% (net of fees). Real Estate and Timberland performed well, returning 6.8% and 8.3%, respectively, for the fiscal year.
We completed our first ever direct real estate acquisition, acquiring 21 acres of prime office space land in Santa Clara, California. Executing the transaction directly will save PRIM more than $11 million in management fees over the expected life of the investment. Project SAVE is alive and well, deeply imbedded in our DNA, and we have now identified over $160 million in value-enhancing strategies, well above our initial target of $100 million. We also have launched Project SAVE Phase II – a careful deployment of direct investing – under Investment Committee member Mike Even’s insightful supervision. We are very excited about Project SAVE Phase II, and will provide regular updates on its measured rollout.
At PRIM, we believe that any investment should be analyzed on three equally important parameters: return, risk and cost, and that it is incomplete to evaluate the success of any investment program on just one of those parameters. Too often in the investment world, we see investment programs evaluated solely on return, occasionally on cost, and very seldom, virtually never, on risk. We have noticed that few peer organizations can accurately measure and assess investment risk. At PRIM we have allocated resources to measuring and controlling risk, and any new investment at PRIM takes risk into account. In fact, every investment we make at PRIM takes all three parameters into account: return, risk and cost.
Over the past few years we have re-engineered our hedge fund portfolio, re-engineered the fixed income portfolio, and added significant risk-reducing strategies such as long-duration Treasury securities, agriculture, the put-spread-collar options strategy, and alternative risk premia harvesting strategies. We have reached an important milestone in the Hedge Fund portfolio, often a misunderstood investment strategy. Now, more than 50% of our direct hedge fund portfolio is invested in separately managed accounts, providing improved transparency, more control and lower fees than the commingled fund format that had been the norm. Many in the nation are now following our lead, and we should all be proud that the Hedge Fund group is a recognized leader. And as a great illustration of our attention to risk, the Hedge Fund portfolio returned 9.4% net of fees, 3.1% above the benchmark, while exhibiting extremely low realized volatility of approximately 1.5%. This realized volatility combined with a return of 9.4%, was the highest risk adjusted return in the entire PRIM portfolio.
In February, the Board approved the new asset allocation, based on the triennial comprehensive liabilities research conducted by PRIM staff and our consultant. We maintained the equity allocation at 40%, while implementing a put-spread-collar portfolio to increase equity exposure with lower volatility; we increased the Private Equity allocation to 11% from 10%; we repositioned the core fixed income portfolio to mitigate potential inflation and interest rate risk; we redeployed the Value-added Fixed Income investments and introduced Other Credit Opportunities. We combined Hedge Funds and Portfolio Completion Strategies into a single allocation to focus on delivering diversifying strategies. We believe these changes will enable our portfolio to perform well in all market environments.
Those are a few important highlights of our investment program: Solid results, a careful focus on returns, risks and costs, and continued nation-leading innovation across the program. Organizationally as well, fiscal 2017 was another outstanding year. Once again, we are pleased to report that no senior-level employees departed, and consistent with the Board-approved hiring plans, we filled seven staff vacancies with top talent. We are now nearly fully-staffed with exceptional investment and finance professionals and all our job postings attract literally hundreds of talented and well-qualified applicants.
We developed a Board-approved, multi-year staff hiring plan in each functional area to ensure that we are appropriately resourced going forward. Our team continues to be recognized around the nation for the success and innovation of our investment program and for the transparency and completeness of our financial reporting. We have never been stronger, but retention of key employees remains our primary concern. The employment environment in the nation and in the region, is strong – there are considerable time and effort on retention strategies for key PRIM employees. We all must be vigilant to ensure we provide a challenging and rewarding opportunity for all our employees, and a culture and work environment that our employees value.
To that end, in May we announced a series of personnel moves on the investment team. The changes provide stimulating new challenges for three strong professionals and will enhance PRIM’s role as a leading innovator and performance leader among public pension funds. This year we will look for similar opportunities for other deserving members on the investment staff and on the finance staff.
- Eric R. Nierenberg, Ph.D., Director of Hedge Funds and Low Volatility Strategies, was named PRIM’s Chief Strategy Officer. In this new role, Eric will look across the entire $67 billion investment portfolio for innovative approaches to identify diversification strategies, enhance returns and reduce fees.
- Sarah N. Samuels, CFA, CAIA, will add responsibility for Hedge Funds to her current responsibilities overseeing Public Markets and investment research. Sarah was the first participant in PRIM’s Professional Development Program.
- Michael Bailey, Senior Investment Officer – Director of Private Equity, will be the second person to take part in PRIM’s Professional Development Program. As you may remember, the program rotates asset class heads through teams other than their own.
The organization has never been stronger or more innovative, not only in the investment arena but also in the finance, legal and operations area. Again, we were awarded the Government Finance Officers Association certificate for the completeness and transparency of our financial reporting, and as a result of our outstanding legal successes, our Deputy Executive Director and General Counsel, Chris Supple, has been reappointed to a second term as Chair of the Securities Litigation Committee of NAPPA, the National Association of Public Pension Attorneys. (Last term, Chris was co-Chair.)
There is no doubt our investment program is trend-setting and thoughtful, but without the finance and legal staff running in lock step with our investment program, none of PRIM’s success would be possible. They are a group of consistent enablers, they enable, they make possible, they implement, account for, measure, control, and document our innovative and diverse investment program. That is no easy task, especially considering that with over 100 clients expertly supported by Paul Todisco and his Client Service staff, we already have one of the most complex accounting and reporting structures in the country. We have the great luxury of this group’s professionalism and expertise and we don’t take them for granted.
Market and PRIT Fund Performance
Economic news is encouraging and the global economy is slowly improving. The U.S. economy and the Eurozone have gathered momentum while slightly lower growth in China may be offset by faster growth in other emerging markets such as Brazil and Russia. Furthermore, central banks across the globe generally remain accommodative, while the United States Federal Reserve held rates steady recently, after three rate hikes since December.
Inflation remains subdued even as Gross Domestic Product growth in the U.S. rebounded to 2.6% in Q2 from 1.2% (revised) in Q1, and labor markets continue to improve – the unemployment rate at 4.3% is the lowest in 16 years. Driving the improving GDP growth, real consumption was up 2.8% on strong consumer expenditures, business investments were up 5.2%, and equipment investment up 8%. June existing home sales fell 1.8% amid tight supply, while housing starts reached a 4-month high, generally higher than expectations.
In this environment, the PRIT Fund has performed well:
For the one-year ended June 30, 2017, the PRIT Fund was up 13.2% gross, outperforming its benchmark of 12.0% by 127 basis points. On a net-of-fees basis, the PRIT Fund was up 12.8%, outperforming its benchmark by 79 basis points.
- This performance equates to an investment gain of $7.7 billion, net of fees.
- This outperformance equates to $480 million of value above the benchmark return, net of fees.
- Six of the seven major asset classes outperformed their respective benchmarks.
- Net total outflows to pay benefits for the one-year ended June 30, 2017, were approximately $1.5 billion.
Phil Rotner, Chief Investment Officer of the Boston Children’s Hospital Foundation, was appointed to the Investment Committee and attended his first meeting on August 1.
Amaran Soja, my assistant for two years, informed us earlier this summer that she is leaving PRIM to take a position with a new law firm several friends of hers are forming. She was kind enough to extend her time with us through the current Board cycle to allow a smooth transition and we thank Amaran for her dedicated service and hard work. We wish her well in her new endeavor.
Grace Mamo will replace Amaran as my executive assistant, and she began on August 1. Grace earned a bachelor’s degree from the University of Rhode Island, worked for a Boston law firm as a paralegal, at New England Baptist Hospital helping run a nursing unit, and at the Massachusetts Eye and Ear Infirmary as a Practice Coordinator and Research Assistant. We are very happy to have Grace on board and look forward to her contributions. Please join me in welcoming Grace to PRIM.
Our summer internship program is thriving this year as we have welcomed five new interns who comprise an exceptional cohort. Kaitlyn Coyne is with us through Treasurer Goldberg’s Women in Finance program. Kaitlyn is entering her senior year at Smith College, where she is studying economics. She is working with the Public Markets team. Lareina Di, also with Treasurer Goldberg’s Women in Finance program, is entering her junior year at Wellesley College, where she is pursuing a double major in economics and political science. Lareina is also working with the Public Markets Team. Emma Ibrahim is with us through Girls Who Invest, a program in which Sarah Samuels plays an active role. Emma is entering her senior year at Wharton School at the University of Pennsylvania. She is working with the Private Equity team. Liu Liu is pursuing a master’s degree in finance focusing on STEM fields at the Brandeis International Business School. She is working with the Portfolio Completion Strategies team. Andres Uribe also is pursuing a master’s degree at Brandeis International Business School, and also is working with the Portfolio Completion Strategies team. Please join me in welcoming these ambitious and talented students to PRIM. We thank them for their interest in PRIM.