HomeMy Public PortalAbout2016-08 DB Plan AA Study AbbreviatedAsset Allocation StudyAugust 2016Pavilion Advisory Group Inc.227 W. Monroe Street, Suite 2020Chicago, IL 60606Phone: 312-798-3200Fax: 312-902-1984www.pavilioncorp.comThe Metropolitan St. Louis Sewer District
ReturnRiskEfficient FrontierAsset ClassesAssumptionsConstraintsCurrent Portfolio APortfolio BPortfolio CPortfolio DPortfolio EPortfolio FInputs Run Optimizer Illustrate PortfoliosThe purpose of mean variance optimization is to determine the asset allocations that will be modeled stochastically.Process1
Potential Asset Allocations1. Assumes a risk – free rate of 1.5%2Asset Class Current PolicyPortfolio A (more conservative)Portfolio B (no hedge funds)Portfolio C (more aggressive)Portfolio D (most aggressive)Domestic Equity 26.0 23.0 31.0 29.5 32.5 31.0 26.0International Equity 10.0 9.0 12.0 11.0 12.5 12.0 10.0Emerging Mkts Equity 4.0 3.0 4.5 4.5 5.0 4.5 4.0Total Equity40.0 35.0 47.5 45.0 50.0 47.5 40.0Market Duration Fixed Income 26.0 31.0 30.0 22.0 17.5 30.0 26.0Global Fixed Income 9.0 9.0 12.5 8.0 7.5 12.5 9.0Total Fixed Income35.0 40.0 42.5 30.0 25.0 42.5 35.0Multi-Strategy HFOF 7.5 7.5 0.0 7.5 7.5 0.0 7.5Long/Short Equity HFOF 7.5 7.5 0.0 7.5 7.5 0.0 7.5Real Estate 5.0 10.0 10.0 10.0 10.0 0.0 10.0Real Assets 5.0 0.0 0.0 0.0 0.0 0.0 0.0REITS 0.0 0.0 0.0 0.0 0.0 10.0 0.0Private Equity 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total Alternatives25.0 25.0 10.0 25.0 25.0 10.0 25.0Total Portfolio100.0 100.0 100.0 100.0 100.0 100.0 100.0Expected 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)10.52 0.59 0.51 0.52 0.49 0.44 0.56Maximum 1-Year Loss (95% Probability) -7.8% -5.9% -7.9% -8.0% -10.1% -9.8% -7.1%Model PortfoliosPortfolio E (no hedge funds and real estate)Portfolio F (Current Policy ex real assets)
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.Peer Asset AllocationsAsset ClassGreenwich: All PublicGreenwich: <$500M MOLAGERS1MOSERS2MPERS3SLC ERS4PSRSMO5Domestic Equity 26.0International Equity 10.0Emerging Mkts Equity 4.0Total Equity40.0 50.0 59.0 49.0 9.0 30.0 49.0 42.0Core Fixed Income 26.0Global Fixed Income 9.0Total Fixed Income35.0 27.0 27.0 22.0 45.0 25.0 24.0 30.0Hedge Fund of Funds 15.0 4.0 4.0 4.0 15.0 15.0 10.0 6.0Real Estate 5.0 9.0 7.0 8.0 0.0 10.0 12.0 7.0Real Assets 5.0 2.0 0.0 10.0 9.0 5.0 5.0 4.0Private Equity 0.0 8.0 3.0 7.0 22.0 15.0 0.0 11.0Total Alternatives25.0 23.0 14.0 29.0 46.0 45.0 27.0 28.0Total Portfolio100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Expected Return 6.4% 7.3% 7.2% 7.2% 6.3% 7.4% 7.0% 7.2%Standard Deviation 9.4% 13.2% 13.3% 12.9% 10.3% 12.1% 11.6% 12.1%Return per Unit of Risk (Sharpe)60.52 0.44 0.43 0.44 0.47 0.49 0.47 0.47Maximum 1-Year Loss (95% Probability) -7.8% -11.9% -12.2% -11.7% -8.5% -10.0% -10.0% -10.2%Current PolicyComparison to Peer DB Plans3
Total Fund Balance ($ Millions)Year 2026450th 75th 95thCurrent279 215 143Portfolio A276 222 157Portfolio B280 214 139Portfolio C293 222 140Portfolio D304 223 131Portfolio E280 207 126Portfolio F285 223 150
Funded StatusYear 2026550th 75th 95thCurrent77.4% 59.9% 39.8%Portfolio A76.7% 61.8% 43.5%Portfolio B77.9% 59.5% 38.6%Portfolio C81.5% 61.7% 39.0%Portfolio D84.4% 62.1% 36.5%Portfolio E77.7% 57.5% 35.1%Portfolio F79.2% 61.9% 41.7%
��T h e p o r t f o l i o s w i t h t h e h i g h e s t e x p e c t e d r e t u r n s p e r f o r m b e s t a t t h e 5 0 t h p e r c e n t i l e o u t c o m e . ��T h u s , P o r t f o l i o D h a s t h e l a r g e s t p r o j e c t e d f u n d b a l a n c e a t t h e 5 0 t h p e r c e n t i l e o u t c o m e f o l l o w e d b y P o r t f o l i o C . T h e C u r r e n t P o r t f o l i o a n d P o r t f o l i o B h a v e s i m i l a r l o n g - t e r m e x p e c t e d r e t u r n s a n d s t a n d a r d d e v i a t i o n s a n d t h e r e f o r e s i m i l a r p r o j e c t e d f u n d b a l a n c e s a t t h e 5 0 t h p e r c e n t i l e o u t c o m e . P o r t f o l i o A s p r o j e c t e d b a l a n c e i s m o d e s t l y l o w e r . ��P o r t f o l i o F , w h i c h h a s t h e s a m e a l l o c a t i o n a s t h e C u r r e n t P o r t f o l i o b u t e x c l u d e s r e a l a s s e t s , h a s a h i g h e r e x p e c t e d r e t u r n a n d l o w e r s t a n d a r d d e v i a t i o n t h a n t h e C u r r e n t P o r t f o l i o . ��T h e 7 5 t h p e r c e n t i l e o u t c o m e r e p r e s e n t s a t r a n s i t i o n p o i n t b e t w e e n h i g h e x p e c t e d r e t u r n p o r t f o l i o s a n d h i g h S h a r p e r a t i o p o r t f o l i o s . S h a r p e r a t i o s a r e a r i s k a d j u s t e d r e t u r n , r e f l e c t i n g b o t h t h e r e t u r n a n d s t a n d a r d d e v i a t i o n o f t h e p a r t i c u l a r a s s e t a l l o c a t i o n . S h a r p e r a t i o s a r e a m e a s u r e o f p o r t f o l i o e f f i c i e n c y , w i t h h i g h S h a r p e r a t i o s e q u a t i n g t o m o r e e f f i c i e n t a s s e t a l l o c a t i o n s . ��P o r t f o l i o A h a s t h e b e s t S h a r p e r a t i o a t 0 . 5 9 , f o l l o w e d b y P o r t f o l i o F a t 0 . 5 6 . N e x t i s a t i e b e t w e e n t h e C u r r e n t P o r t f o l i o a n d P o r t f o l i o C a t 0 . 5 2 . ��A t t h e 7 5 t h p e r c e n t i l e , P o r t f o l i o s A , C , D a n d F h a v e t h e h i g h e s t f u n d b a l a n c e s . ��A t t h e 9 5 t h p e r c e n t i l e o u t c o m e s , h i g h S h a r p e r a t i o s p r e v a i l . P o r t f o l i o A h a s t h e l a r g e s t p r o j e c t e d f u n d b a l a n c e a t t h e 9 5 t h p e r c e n t i l e f o l l o w e d b y P o r t f o l i o F . P o r t f o l i o E , w h i c h e x c l u d e s h e d g e f u n d s a n d c o r e r e a l e s t a t e , h a s t h e l o w e s t b a l a n c e . O b s e r v a t i o n s 6
��I f M S D w a n t s t o p u r s u e a m o r e a g g r e s s i v e a s s e t a l l o c a t i o n p o l i c y , P a v i l i o n r e c o m m e n d s M S D c o n s i d e r m o v i n g t o P o r t f o l i o C . T h e r e a r e s e v e r a l b e n e f i t s o v e r t h e C u r r e n t P o r t f o l i o : P o r t f o l i o C p r o v i d e s a l o n g - t e r m e x p e c t e d r e t u r n o f 6 . 8 % , w h i c h i s c l o s e r t o M S D s a s s e t r e t u r n a s s u m p t i o n t h a n t h e e x p e c t e d r e t u r n o f t h e C u r r e n t P o r t f o l i o ( 6 . 4 % ) . T h e S h a r p e r a t i o o f P o r t f o l i o C a n d t h e C u r r e n t P o r t f o l i o a r e t h e s a m e , i n d i c a t i n g a s i m i l a r l e v e l o f e f f i c i e n c y . P o r t f o l i o C p r o v i d e s p r o j e c t e d f u n d b a l a n c e s i n t h e 5 0 t h ( m e d i a n ) a n d 7 5 t h ( p e s s i m i s t i c ) p e r c e n t i l e e n v i r o n m e n t s t h a t a r e h i g h e r t h a n t h e C u r r e n t P o r t f o l i o , a l b e i t t h e p r o j e c t e d f u n d b a l a n c e f o r P o r t f o l i o C i n t h e 9 5 t h ( w o r s t - c a s e ) p e r c e n t i l e e n v i r o n m e n t i s s l i g h t l y l o w e r t h a n t h e C u r r e n t P o r t f o l i o . P a v i l i o n h a s w e a k i n t e r m e d i a t e - t e r m e x p e c t a t i o n s f o r f i x e d i n c o m e p e r f o r m a n c e a n d b e l i e v e s m a i n t a i n i n g t h e a l l o c a t i o n t o h e d g e f u n d s w h i l e s l i g h t l y i n c r e a s i n g e q u i t i e s s h o u l d p r o v i d e b e t t e r r e t u r n s t h a n t h e C u r r e n t P o r t f o l i o w i t h m o d e s t l y h i g h e r v o l a t i l i t y . ��I f M S D w a n t s t o c o n t i n u e t o d e - r i s k t h e a s s e t a l l o c a t i o n p o l i c y , P a v i l i o n r e c o m m e n d s M S D c o n s i d e r m o v i n g t o P o r t f o l i o A . T h e r e a r e s e v e r a l b e n e f i t s o v e r t h e C u r r e n t P o r t f o l i o : P o r t f o l i o A p r o v i d e s t h e l o w e s t v o l a t i l i t y o f 8 . 1 % ; T h e S h a r p e r a t i o o f P o r t f o l i o A i s t h e h i g h e s t o f a l l p o r t f o l i o s u n d e r c o n s i d e r a t i o n ; P o r t f o l i o A p r o v i d e s s u p e r i o r r e s u l t s i n t h e 9 5 t h p e r c e n t i l e a n d s t r e s s t e s t s c e n a r i o s d u r i n g w o r s t c a s e h i s t o r i c e v e n t s . ��T h e t r a d e o f f b e t w e e n P o r t f o l i o C a n d P o r t f o l i o A i s t h e r e t u r n o n a s s e t a n d d i s c o u n t r a t e a s s u m p t i o n . B y m o v i n g t o P o r t f o l i o C , w e b e l i e v e M S D c a n m a i n t a i n a 7 % r e t u r n o n a s s e t a s s u m p t i o n . I f M S D c h o o s e s t o m o v e t o P o r t f o l i o A , t h e r e t u r n o n a s s e t a s s u m p t i o n a n d d i s c o u n t r a t e w i l l h a v e t o b e r e d u c e d . ��I f M S D i s c o m f o r t a b l e w i t h t h e c u r r e n t a l l o c a t i o n , P a v i l i o n r e c o m m e n d s M S D c o n s i d e r e l i m i n a t i n g t h e r e a l a s s e t s a l l o c a t i o n a n d m o v i n g t h o s e f u n d s t o c o r e r e a l e s t a t e , w h i c h m o d e r a t e l y i m p r o v e s t h e r i s k / r e t u r n p r o f i l e . C o n c l u s i o n s 7
Nominal ReturnNominal VolatilityNominal ReturnNominal ReturnNominal VolatilityNominal ReturnGeometric Arithmetic Geometric ArithmeticLarge 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%3-5 Year Assumptions Long-Term AssumptionsPavilion Advisory Group 2016 Capital Markets Assumptions8
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.60% 5 Years 40% Since 1996SP500R2000EAFEEAFE SCEMBC AGGBC LONG G/CBC 1-3 G/CBC MULTIVERSEMLPPENCREIFCAMBRIDGE VA REREITsTIMBERLANDHFRI FofFL/SMULTI-STRATBC HYBC EMUS TIPSCOMMCPIWGBIUS TBILLSACWISP5001.00 0.92 0.83 0.74 0.77 -0.40 -0.44 -0.21 0.00 0.54 0.76 -0.17 0.04 0.64 0.13 0.77 0.87 0.640.71 0.51 -0.19 0.37 0.08 -0.22 -0.06 0.94R20001.00 0.83 0.78 0.77 -0.38 -0.43 -0.15 0.03 0.49 0.75 -0.11 0.05 0.69 0.15 0.76 0.86 0.64 0.73 0.49 -0.14 0.40 0.07 -0.22 -0.07 0.91EAFE1.00 0.96 0.89 -0.36 -0.45 -0.04 0.22 0.42 0.77 -0.14 -0.01 0.490.130.800.890.740.730.61-0.070.510.17-0.020.060.96EAFE SC1.00 0.86 -0.41 -0.60 0.11 0.23 0.34 0.71-0.35 -0.19 0.39 0.15 0.84 0.92 0.79 0.67 0.53 -0.11 0.58 0.29 -0.04 0.09 0.90EM1.00 -0.30 -0.40 -0.02 0.27 0.46 0.72 -0.17 -0.24 0.49 0.080.790.860.740.770.740.090.560.20-0.070.010.90BC AGG1.00 0.92 0.67 0.53 -0.05 -0.35 0.18 -0.04 0.05 -0.03 -0.36 -0.43 -0.29 -0.09 0.14 0.83 -0.10 -0.11 0.63 0.04 -0.38BC LONG G/C1.00 0.40 0.34 -0.11 -0.43 0.13 0.11 -0.02 0.01 -0.43 -0.52 -0.39 -0.20 0.02 0.70 -0.21 -0.22 0.52 -0.03 -0.46BC 1-3 G/C1.00 0.58 0.04 0.01 0.31 -0.30 -0.02 -0.03 -0.07 -0.09 0.02 0.12 0.24 0.58 0.14 0.13 0.55 0.21 -0.11BC MULTIVERSE1.00 0.11 0.24 0.10 -0.01 0.12 -0.24 -0.07 0.050.030.330.620.670.540.350.940.300.15MLP1.00 0.48 -0.16 -0.35 0.40 -0.16 0.47 0.48 0.56 0.66 0.41 0.14 0.52 0.34 -0.07 0.06 0.50PE1.00 0.16 0.16 0.42 0.29 0.76 0.82 0.67 0.69 0.53 -0.08 0.53 0.24 -0.09 0.08 0.81NCREIF1.00 0.96 -0.02 0.03 -0.15 -0.18 -0.16 -0.13 -0.09 0.30 -0.02 0.23 0.09 0.07 -0.16CAMBRIDGE VA RE1.00 0.06 0.41 -0.07 -0.12 -0.31 -0.40 -0.26 -0.20 -0.04 -0.01 0.06 -0.16 -0.03REITs1.00 0.09 0.43 0.48 0.43 0.60 0.470.17 0.24 0.04 -0.02 -0.06 0.58TIMBERLAND1.00 0.30 0.18 0.14 0.04 -0.02 -0.24 -0.12 -0.42 -0.17 0.09 0.13HFRI FofF1.00 0.93 0.87 0.64 0.52 -0.23 0.49 0.22 -0.30 0.04 0.83L/S1.00 0.80 0.70 0.57 -0.20 0.53 0.23 -0.22 0.07 0.93MULTI-STRAT1.00 0.75 0.52 -0.15 0.56 0.39 -0.23 0.09 0.74BC HY1.00 0.73 0.24 0.62 0.27 -0.01 -0.02 0.77BC EM1.00 0.58 0.54 0.21 0.22 0.08 0.62US TIPS1.00 0.28 0.25 0.67 0.10 -0.10COMM1.00 0.58 0.24 0.11 0.49CPI1.00 0.09 0.18 0.15WGBI1.00 0.16 -0.11US TBILLS1.00 0.01ACWI1.00Capital Markets Correlations9