1. Time-weighted rate of return. For comparisons among investment managers, among funds, or to compare fund or manager performance to returns offered by the market, time-weighted returns are the accepted industry standard. In investment manager presentations, use of time-weighted rates of return rather than other forms of returns are required by Association of Investment Management and Research (AIMR) presentation standards and by the Securities and Exchange Commission (SEC). Minnesota law mandates use of time-weighted rates of return for public pension fund performance reviews. A time-weighted rate of return measures the return earned on assets invested for the entire period. By filtering out the effects on return caused by a board’s decisions to give additional assets to a manager during a period under study, or a board’s decision to withdraw assets from a manager to cover benefit checks or other operating expenses, the time-weighted rate of return procedure removes the impact of events over which the investment manager has no control.

Most individuals familiar with mutual funds have used time-weighted rate of return information, although they may not be aware of it because the returns were not identified by the formal name. Mutual funds commonly report returns to shareholders for the various investment portfolios offered by the mutual fund family. In presenting these returns, the report may include a comment indicating that the returns reflect the growth rate (positive or negative) of a single $1,000 investment made at the start of the period. Any other uniform assumed starting value could have been used, since there would be no impact on the computed return. This is a description of time-weighted returns, although the technical term was not used. Since the returns were computed using the time-weighted methodology, the returns can be compared to the time-weighted returns of any similar investment offering.

2. Annualized returns. To review long-term performance, it is often useful to summarize several years of annual returns by computing multi-year average returns. The process is called "annualizing." If a fund had a 3.2 percent time-weighted rate of return in the first year, a 22 percent return in the second year, and a 6.5 percent return in the third, it can be shown that this variable three-year stream produces the same asset growth as a constant 10.3 percent return in each year. This 10.3 percent return is the three-year annualized return, summarizing the three-year performance of the fund. Annualized returns can be computed for any time period and can be compared between funds. Mutual funds commonly report returns for one, five, and ten year periods. The one year return is the time-weighted return for the most recent year, while the five and ten-year returns are multi-year time-weighted annualized returns. Since annualized returns are a form of average returns, we will use the terms "annualized returns" and "average returns" interchangeably in this presentation.

3. Index returns. Rates of return can be computed for the stock, cash, bond, and real estate markets, for portions of those markets, or for any asset grouping being followed. The market segment being followed is the index, the return on those assets is the index return. For instance, the Wilshire 5000 is a commonly used stock index. The Wilshire 5000 includes all domestic stocks for which daily prices are available, weighted by market value. The name comes from the company that compiles the index and from the approximate number of companies initially included. At the present time, there are actually over 7,000 stocks incorporated into the Wilshire 5000. Another commonly used stock index is the Standard and Poor’s 500 (S&P 500), an index composed of 500 of the largest traded companies.

4. Benchmarks. Pension plan boards expect a certain level of investment performance from each asset class and from the total portfolio. These performance objectives are often called benchmarks and they serve as a target or dividing line between performance that is deemed acceptable and performance that is not. For stocks, pension boards often use the Wilshire 5000 or S&P 500. Long-term stock returns which approximate or exceed the applicable index return reflect acceptable performance, while returns below the benchmark suggest a need for further review and possible remedial action. Pension investment administrators typically adopt several benchmarks for use by their fund, one or more indices for each manager, each asset class, and for the total fund. The expectation is that the manager, asset class, and total portfolio’s performance will equal or exceed the respective benchmark.

The most common asset class indices used as benchmarks by Minnesota public pension plans follow:

For cash equivalent investments:

• 90-Day Treasury Bill Return. The return earned on 90-day treasury bills is often used as a benchmark for a pension fund’s cash-equivalent investments.

For domestic stock investments:

• Wilshire 5000. The Wilshire 5000 is the return earned on all domestic stocks for which daily price quotes are available.
• S&P 500. The S&P 500 is the stock return earned by the roughly 500 largest traded companies.

Pension funds may also use stock indices which measure returns earned by some portion of the total stock market, such as value stocks, growth stocks, or specific capitalization ranges (small cap, mid-cap, or large cap).

For domestic bonds:

• Lehman Brothers Aggregate Bond Index. The Lehman Brothers Aggregate Bond Index is the return earned on all domestic investment-grade bonds, treasury and agency securities, and mortgage obligations with maturities greater than one year.

Other bond indices restricted to corporate securities or reflecting non-investment-grade securities are also used.

To review total fund performance, one approach pension fund boards can use is to compare their fund’s returns to those of other comparable funds. For this type of comparison, data from the Trust Universe Comparison Service, or some comparable database, can be used.

• Trust Universe Comparison Service (TUCS) Universe Median balanced fund return. A pension fund can compare its return to the median return from balanced funds reported by the TUCS Universe, a data bank of time-weighted rates of return earned by a few hundred public and private tax-exempt investors.

To determine whether a pension fund is meeting its own performance standards, pension funds create composite portfolios, and then compare the composite portfolio return against the return earned on the actual total portfolio.

• Composite portfolio. A composite portfolio is constructed by assuming that each asset class earns the benchmark return for the given asset class, and each asset class is weighted in the total portfolio by the target asset allocation as indicated in the pension fund’s investment policy statement.

If the pension fund’s asset mix has not deviated from the target asset mix specified in its investment policy statement, and if each asset class is meeting its performance objective (its asset class benchmark return) the pension fund total portfolio return will match the composite portfolio return. Any differences between the two can be traced to the underperformance or overperformance of the asset classes relative to their benchmarks, and to any over-weighting or under-weighting of the various assets classes compared to the target allocation.

In this section we use the State Board of Investment (SBI) Combined Fund as a comparable-fund benchmark for other large Minnesota public pension funds, and we explore the cost implications for these pension funds of underperformance or overperformance relative to the returns earned by the SBI Combined Fund. The SBI Combined Fund is the combined assets of the SBI Basic Fund, which invests the pension assets of active employees in statewide public pension funds, and the SBI Post Retirement Investment Fund, which invests the assets of retirees in those same statewide funds.

The following analysis updates by one year an investment performance review appearing in an LCPR staff report to the LCPR, Large Fund Pension Investment Policies and Performance: Second Consideration, dated September 25, 1998. The analysis in the 1998 report showed the impact of this relative performance from calendar 1994, the first year in which the SBI Basic Fund and SBI Post Fund were invested with fairly similar objectives and in a combined portfolio format, through 1997. In May 2000, the Office of the State Auditor (OSA) completed the report, Minnesota Public Pension Funds Investment Disclosure Report For The Fiscal Year 1998. Using calendar year 1998 rate of return information provided in that OSA report, it is possible to update the earlier LCPR staff analysis through 1998.

The comparison that follows approximates the cost, positive or negative, of maintaining pension funds separate from SBI. Asset growth through strong investment performance is a substitute for state aid and employer contributions. When assets to cover a plan’s liabilities are not generated by investment returns, they must be covered over time by state aid and further employer contributions. Retirees in the non-SBI managed funds may also be hurt if the fund pays performance-based post-retirement adjustments. Lower returns cause lower post-retirement benefit increases. At the current time, MERF, MTRFA, StPTRFA, DTRFA, and the two Minneapolis local relief associations provide performance based post-retirement adjustments, where the size of the post-retirement benefit adjustment depends on the level of the fund’s long-term average investment return.

The first column of the table lists the SBI Combined Fund and the larger local Minnesota public pension funds. The second column lists the actual assets (in millions of dollars) in each of these pension organizations on the starting date of the period under review, January 1, 1994. The third column shows the five year average return earned by each fund over the 1994 through 1998 period. Given the assets in each fund at the start of 1994, we can take that 1994 asset value and let it grow, as indicated by the pension fund’s rates of return over the 1994 through 1998 period. We can also take those 1994 assets and assume they grow at rates indicated by SBI Combined Fund returns from 1994 through 1998. In effect, this amounts to estimating the asset value that would have occurred by the end of 1998 if SBI had managed that portfolio starting in 1994. The fourth column in the table shows the difference for each fund between those two projections—the difference between the expected 1998 year end asset value under local plan investment management and the expected 1998 year end asset value under SBI investment management. If the local plan returns are lower than those of SBI, providing less growth than would have occurred under SBI management, the difference is shown in the fourth column as a loss. If the local plan returns provide more growth, that difference is shown as a gain due to local plan management, indicated with a plus sign.

Table 1 suggests that for the 1994 through 1998 period (calendar 1998 being the most recent year for which we have data), every pension fund except Minneapolis Fire would have been better off if SBI had managed their assets. For those local pension plans in the table with less assets due to local plan investment management, the total shortfall is estimated as $378 million. For the period, Minneapolis Fire had higher returns than SBI, creating a gain for that fund of about $19 million compared to the expected result under SBI management. When that gain is netted against the shortfall of the other plans in the group, the result is a net loss of $358.87 million.

While the last column in the table puts dollar estimates on the cost imposed by lower returns by the non-SBI funds, the direction of the result is evident by scanning the third column, the five year average returns for these funds. Except for Minneapolis Fire, every fund had a lower five year average (annualized) return than SBI. Those local funds were therefore less successful at generating assets through investment than SBI.

Cumulative Gain or Loss Compared to SBI Combined Fund Returns, 1994 Through 1998

When LCPR staff last made the above comparisons, in the LCPR report on large fund pension investment policies and performance dated September 25, 1998, the estimated impact of maintaining the separate local funds was $251 million. That estimate was based on 1994-97 data. Adding 1998 to the time period caused the net result to grow by more than $100 million. A key reason for that large growth in the estimate is that SBI, during calendar 1998, again had higher returns than any of the included funds except for Minneapolis Fire. The separate 1998 returns are noted in Table 2. The Minneapolis Fire return was 21.9 percent. The SBI return was 16.1 percent. The remaining funds trailed SBI, some by large margins.

Calendar Year 1998 Total Portfolio Returns

Most pension funds have the majority of their assets in equity investments, with 50 percent or more in domestic stock investments. Given the importance of domestic stocks in these portfolios, total portfolio rate of return differences between the various funds included here are strongly influenced by how the fund administrators choose to structure the pension fund stock portfolio, and upon each fund’s success in capturing the returns offered by the markets. SBI has attempted to design its domestic stock portfolio to produce stock rates of return mirroring the stock market as a whole. Some of the other pension funds have chosen to weight their stock portfolios toward some portion of the stock market. That strategy seems likely to result in stock portfolio returns which are more variable than a stock portfolio structured to follow the broad stock market. Whether that approach will provide long-term stock returns in excess of those provided by the stock market as a whole is far from certain. The DTRFA and MTRFA have tended to weight their stock portfolios during this period toward small cap stocks. That portion of the market lagged the stock market as a whole, pulling down their returns. On the other hand, the Minneapolis Fire Relief Association stock portfolio was weighted toward large cap growth stocks. That portion of the stock market considerably outperformed the broader stock market during much of the 1990s, explaining much of the results noted here regarding Minneapolis Fire total portfolio returns. As time passes and other sectors of the stock market come into favor, the fortunes of these various pension funds may reverse. We do have some post-1998 return information for DTRFA, obtained from board meeting materials, indicating high returns. Recent MTRFA Board meeting materials also indicate recent improvements in relative performance.

In the 1998 LCPR staff investment performance review, we attempted to include all the remaining freestanding local police and paid fire relief association pension plans. There are four freestanding local paid fire and police relief association plans. Those are the Fairmont Police Relief Association, Virginia Fire Relief Association, in addition to the Minneapolis Fire and Minneapolis Police Relief Association pension plans discussed above. We could not include the Fairmont Police Relief Association in our investment performance review because they did not provide any rates of return, although they did provide some asset mix information. The Virginia Fire Relief Association did not respond at all to our information requests.

At the current time, we are able to provide some review of the Fairmont and Virginia relief associations based on 1997 and 1998 rates of returns computed by the OSA and appearing the most recent OSA investment disclosure report. Table 3 below is similar to Table 1 above, but it is based only 1997 and 1998 data rather than 1994 through 1998. The 1997 and 1998 returns for the Fairmont Police Relief Association and Virginia Fire Relief Association appear in Table 3 below, along with comparable SBI Combined Fund returns for those two years. The SBI Combined Fund had considerably higher returns than those provided by either association, suggesting both would be better off if SBI had managed their portfolios. The Fairmont Police Relief Association had $5.81 million in assets at the start of 1997. That asset value would grow at 12.4 percent per year during 1997 and 1998, given the actual returns provided by the relief association investments. The 1997 assets would have grown at a much higher rate, 18.7 percent per year, given SBI Combined Fund rate of returns. The difference amounts to $845,988 by the end of 1998. Similarly, Virginia Fire’s portfolio could have generated another $489,952 under SBI management, compared to the growth rates (returns) provided by that relief association.

Fairmont Police Relief Association, Cumulative Loss
Relative to SBI Combined Fund Returns, 1997-1998

D. Review of Total Portfolio, Stock, and Bond Returns.

a. Total Portfolio Returns. Table 4 provides the total portfolio returns for all the funds included in Table 1 plus separate return information for SBI’s Basic and Post Funds. Starting in 1994, the Post Fund was invested for high returns; rather than high, consistent yield. At that point the investment approaches underlying the Basic and Post Funds became comparable, and SBI began making extensive use of investment portfolios which combined assets of those funds for investment purposes. SBI began reporting not only Basic Fund and Post Fund returns, but Combined Fund returns also. Prior to 1994, Combined Fund returns are not available.

The table indicates the total portfolio return for the most recent available full calendar year, 1998, along with the three year, five year, and nine year average (annualized) returns. The nine year return provides a summary of performance over the entire period for which data are available, 1990 through 1998. The 1998 return data is from the most recent OSA investment disclosure report. The data for earlier years is computed from returns appearing in 1998 and earlier LCPR public pension plan investment performance reports.

An earlier table, Table 1, indicated in dollar terms the financial implications of SBI’s total portfolio performance compared to other larger Minnesota public pension funds during the 1994 through 1998 period. Those results are a reflection of the five years average returns for the 1994-98 period shown in Table 4 below. The SBI Combined Fund had higher annualized returns for that period than any of the non-SBI pension funds in the table, except for the Minneapolis Fire Relief Association fund. Therefore, SBI was a more potent asset growth engine than retention of the local pension funds during that period (except for Minneapolis Fire). The same result is true for the entire nine-year period, as reflected below in the annualized returns for 1990-1998. The SBI Funds, considered separately or in combination, provided average returns above 13 percent. The SBI Basic Fund and the SBI Post Fund both had returns above 13 percent; if one wished to consider constructing an SBI Combined Fund return, it would be slightly higher than 13.2 percent. Except for Minneapolis Fire, all the other funds had average returns for that entire nine-year period which were below 13 percent, in some cases, noticeably below.

1, 3, 5, and 9-Year Total Portfolio Returns

A more detailed presentation of total portfolio returns, from 1990 through 1998, including annualized returns for every multiple-year period, appears below.

Annualized Total Portfolio Returns Calendar Years 1990-1998

b. Stock Portfolio Returns. Information provided below on stock and bond asset class returns does not include 1998. The OSA investment disclosure report for 1998 did not consistently report asset class returns. For some of the pension funds, manager-specific returns are reported rather than asset class returns. Since a pension fund may use several stock investment managers and also numerous bond managers, it is not possible from the information displayed in that OSA report to determine, with any confidence, the 1998 asset class returns (the aggregate result from the stock managers as a group, and the bond managers as a group, etc.). Therefore, the stock and bond tables that follow are taken from the our last presentation of results from the LCPR report, covering 1990 through 1997.

The stock asset class returns are provided for various funds in Table 6. Two common indices are included, the Wilshire 5000 returns and the S&P 500 returns. Comparison of a pension fund’s domestic stock returns to the Wilshire 5000 or S&P 500 indicate how successful a pension fund is at capturing the returns offered by the stock market. Historically, most Minnesota pension funds relied heavily on active stock managers—managers who selected individual stocks in an effort to beat the market. Typically, the pension fund divided its stock portfolio among many equity managers, shielding the fund from the risk that any of the managers would seriously underperform. While this shields the fund from the full impact of managers who underperform, it also waters down the impact of those managers with above average returns, creating a regression toward the mean. This diversification effect, combined with the high cost of active managers, often resulted in net stock portfolio return to the pension fund below that available from a simple index fund strategy.

In recent years, many pension funds have moved away from full reliance on active stock managers to invest the stock portfolio. It is now common for pension funds to index much of their stock portfolio, supplementing that core with active managers in an effort to add value. SBI, MERF, and MTRFA are among the funds which make heavy use of index managers. This structure causes total stock portfolio returns which more closely follow those of the index the pension fund uses for its stock benchmark, and with less variability than would be the case using solely active management. This effect is reflected in the returns for recent periods indicated in Table 6. Whether this combination of active domestic stock managers coupled with index funds can lead to higher returns than an index fund alone is worthy of review. In some recent years, active managers have helped increase the overall stock portfolio returns, only to lose ground in a following year compared to a pure index strategy.

The stock returns in Table 6 indicate that for 1997, SBI added some value above the broad stock market as measured by the Wilshire 5000, which SBI used as its performance benchmark. MERF’s returns also approximating that benchmark for 1997. DTRFA and MTRFA returns, both 1997 returns and the three-year average returns, were noticeably lower, perhaps reflecting a tilt toward small cap stocks, which were not favored in the market. MPRA also had a relatively low stock return in 1997, and low returns through the period. MFRA was the one fund with a stock return considerably in excess of the broad market, in 1997 and in the multi-year periods. That reflects a tilt toward large cap growth stocks, a segment of the market which has considerably outperformed the broader market throughout the 1990s. What is not clear, from current information, is whether MFRA stock managers were able to beat index returns reflecting the styles used by those managers.

For the 1990-97 periods as a whole, as reflected in the eight-year annualized returns below, a few of the funds fell noticeably short of matching a simple index fund strategy. MERF’s returns are noticeably low, reflecting the mismanagement of that fund and general turmoil during the 1980s and into the early 1990s. The Minneapolis Police eight-year annualized return is marginally lower than MERF’s. A pension fund’s stock portfolio is the engine that drives the overall total portfolio return. Most other asset classes are added to create more stability in the total portfolio returns. For the eight-year period as a whole, neither MERF’s engine or that of the Minneapolis Police Relief Association provided much "pop." MERF’s more recent returns, though, as indicated in the 1997 return and the three and five year average returns, reflect an effort to address performance problems. The more recent Minneapolis Police Relief Association returns, however, continue to noticeably lag most other funds, and remain well below the returns that would have been earned from a simple index strategy.

1, 3, 5, and 8-Year Stock Returns

c. Bond Portfolio Returns. The bond returns for the same funds included in the previous stock return table are included in Table 7, along with the Lehman Aggregate returns. Several of the pension funds were able to add some value above that obtainable from the investment-grade market as a whole (as indicated by the Lehman Aggregate index). The MFRA was one of the funds that had some trouble. Its 1997 return and its three and five year average bond returns are below those available from a bond index strategy. Lower bond returns offset some of the impact of its stock portfolio. The MPRA returns are low for all periods. That association’s returns are below those of all other funds for the 1997 and for the three-year and five-year periods. For the eight-year period as a whole, MPRA is tied with the MERF Active Fund for the lowest return. Again, while the MERF portfolios show noticeable improvement in performance moving to more recent periods, the MPRA portfolio does not.

1, 3, 5, and 8-Year Bond Returns

Over time, a pension fund’s total returns are almost entirely determined by its asset mix and the ability to capture the returns offered by the markets. Information on the past success of pension funds in capturing market returns are provided by previous tables, where an pension fund’s returns can be compared to total portfolio, stock, or bond benchmarks, as applicable. In this section we present some asset mix information. Unfortunately, there is not much information currently available which is consistent across these funds, particularly for longer time periods.

Table 8 is an effort to provide asset mix information on the larger Minnesota public pension funds based on information compiled by the Office of the State Auditor (Minnesota Public Pension Funds Investment Disclosure Report for the Fiscal Year 1997, and the similar report for 1998). Table 8 provides calendar year asset mixes for 1997 and 1998, where available. A few earlier State Auditor reports exist, but the asset class categories presented were not consistent across funds, and asset mix data from some funds was on a calendar year basis while others reflected a July 1 fiscal year.

Pension funds tend to have the majority of their assets in equity investments. SBI and several of the other funds here generally have 60 percent to 70 percent of the total portfolio in equities, sometimes more. This reflects an expectation that equities, particularly over long-time periods, will provide the highest returns.

It is reasonable to maintain a fairly stable asset mix over time. Maintaining a stable asset mix reflects a belief that investment markets, particularly equity markets, can make sudden major moves, and the timing of these market movements is difficult (some would say impossible) to predict. Given these long-term expectations and short-term uncertainties, many pension fund administrations conclude that it is important to maintain a fund’s exposure to the various markets over time in proportions indicated in the pension fund association’s investment policy statement. When the asset mix of the total portfolio differs noticeably from the mix recommended in the pension fund board’s investment policy statement (which is inevitable, because the different asset classes will grow at different rates, given the investment returns each class is earning) the portfolio is adjusted back toward the target percentages indicated in the investment policy statement. This process, called portfolio rebalancing, generally occurs at least annually. In some cases, directing incoming contributions to underweighted portions of the total portfolio is sufficient to rebalance the portfolio. In other cases, it may be necessary to shift assets that are already in the portfolio. For instance, given the large returns earned on stocks during the 1990s, it may be necessary to remove some assets from the stock managers and transmit it to bond managers, until the actual total portfolio asset mix approximates the target mix.

In Table 8, the equity asset group is subdivided into domestic stocks, foreign stock, and venture capital. For the various pension funds, venture capital percentages tend to be insignificant, and some hold no venture capital investments, at least as reported and grouped in the State Auditor reports. Foreign stock holdings are more significant, while domestic stock is the dominant category. If the domestic stock, foreign stock, and venture capital categories are added together, into a general "equity" category, the equity exposure is similar across many of these funds. SBI, StPTRFA, MTRFA, and the Bloomington Fire Relief Association devoted approximately 70 percent of their portfolios to equities. The MERF and DTRFA equity allocation is about 65 percent of their respective portfolios.

It is not clear what activity is being captured by the MPRA and MFRA data. The data presents two snapshots, presumably showing the asset mix at year end 1997 and year end 1998. The asset mix on those dates may be a good reflection of the portfolio held throughout the year, but then again, it may not. The equity allocation for those two funds in 1997 seems consistent with expectations. The MPRA had 66 percent of its assets in equities, while the MFRA equity allocation was 61 percent of its portfolio. Both of these funds, however, show a radical change in the 1998 data. The data indicate a major shift out of equities and into cash. Cash holdings increase from a fairly insignificant percentage in 1997 to about one-third of the total portfolios in 1998. The 1998 allocation shown in the table may reflect an effort to time markets--an effort to predict which asset classes will perform well in the coming year, and to avoid those markets expected to be weak. While there is a payoff to correct guesses, there is also a considerable chance that these actions will place pension fund assets in the wrong place at the wrong time. Another possibility is that the MFRA and MPRA calendar year end asset allocation snapshot captured a brief, transitional step. These organizations may have been changing some investment managers or reorganizing their portfolios. If assets were liquidated to cash prior to allocating the assets to new managers, that could show up as a high, but temporary, cash position. The MFRA 1998 total portfolio return was very high, 21.9 percent. That return is highly improbable if the association held only 36 percent of its assets in equities during most of 1998, as suggested by the asset mix data. On the other hand, the MPRA 1998 total portfolio return was only 11.4 percent. That result seems more consistent with the 1998 MPRA asset mix data.

Large Minnesota Public Pension Funds
Asset Allocation, Calendar Years Ending 1997 and 1998

Large Minnesota Public Pension Funds
Asset Allocation, Calendar Years Ending 1997 and 1998

In an effort to provide some indication of how asset mixes have changed over longer time periods, asset mix data for selected funds for fiscal years 1990, 1995, and 2000, is shown in Table 9. MERF and first class city teacher fund asset mix information is derived from the actuarial reports for those funds provided by the actuary retained by the LCPR. In recent years, the actuarial firm is Milliman and Robertson; the 1990 reports where produced by the LCPR prior actuarial firm, the Wyatt Company. Data are derived from Table 1 in those reports, the Actuarial Balance Sheet. Corresponding SBI data are from applicable SBI Quarterly Reports. The asset class categories are those used in the actuarial reports. The actuarial reports provide a single "equity" category, presumably composed of domestic stock, foreign stock, and various other forms of equity investments that an applicable fund may hold. Real estate, however, which may include equity real estate investments, is listed separately. It was necessary to combine some of the more detailed equity categories in SBI reports to be consistent with the presentation in the actuarial reports.

MFRA, MPRA, and the Bloomington Fire Relief Association are not included in the table. Any actuarial reports for those funds are provided by other actuaries, and the presentation and level of detail differs. Annual financial reports also did not provide consistent, usable information. Those sources aggregate asset mix information into "cash" and "investments," with the "investments" category presumably composed of all forms of equity investments plus all bond holdings. The information is too aggregated to be useful for asset mix purposes.

In the table that follows, it is unclear whether there are any clear trends across all these funds. A few had very steady asset allocations. A few had asset mix variations over time which are difficult to explain. A few other funds significantly increased their equity allocations in more recent years, probably reflecting a change in laws governing post-retirement increase mechanisms, which favor placing a larger percentage of assets in equities.

The SBI Basic Fund had a consistently high equity exposure in each year shown in Table 9, presumably reflecting an SBI decision to maintain high, consistent exposure to the equity markets throughout this period. The MFTRA also had a consistently high equity exposure.

Data on other funds suggest greater movements. The SBI Post Fund information shows a major jump in equity exposure between 1990 and 1995. In 1990, only 9.6 percent of Post Fund assets were in stocks, while the percentage jumped to 61 percent by 1995. That change reflects an SBI Post Fund policy change, and the corresponding changes in post fund law. During the 1980’s, SBI post retirements adjustments were derived from realized returns, causing bonds to be a major component of that portfolio. In the late 1980s and early 1990s, legislation changed the nature of SBI post-retirement adjustments, basing the adjustments on portfolio total return. That lead to a shift to stock, with its higher long term growth potential. That change is also apparent in the SBI Combined Fund information, which results from combining the SBI Basic and Post Funds. If those funds are combined for 1990, the Combined Fund would hold only 41.2 percent equity. By 1995, that percentage increased to 66.4 percent.

For StPTRFA, the data suggest that the association devoted increasing percentages of its assets to the equity markets over time. In 1990, equities were 31 percent of the total portfolio, growing to 50 percent in 1995 and to 70 percent in the most recent year. This pattern may reflect changes in the post retirement adjustment mechanism used by the fund. In 1990, StPTRFA’s post retirement adjustment procedure consisted of a one-percent-of-asset distribution to retirees, providing that "fund income" was at least six percent. If fund income included only recognized income or gains, that may have caused the board to tilt the fund toward a high cash and bond allocation. Later legislation changed the post retirement increase to a system based on total returns, leading to increases in the fund’s equity allocations.

MERF’s fund structure is patterned after SBI’s. MERF’s Active Account (Deposit Accumulation Account) contains the assets and investment earnings for active employees. At the time that an individual retires, assets transfer from the Active Account to the MERF Retired Account, to provide sufficient reserves to support the annuity payments. This process is identical in nature to the transfer between the SBI Active Account and SBI Post Fund that occurs at the time of retirement for employees covered by the state-wide plans with asset invested by SBI. The MERF portfolios could also be combined to present MERF Total Fund results, given sufficient data.

For MERF, the presentation in the actuarial valuations permitted us to derive only MERF Active Account results. MERF is a closed fund, and the remaining active members will be eligible to retire in the next several years. The MERF Active Account information in Table 9 indicates a steady allocation to equities through at least 1995, with a slight drop off more recently. A few different factors may be combining to produce the fiscal year 2000 MERF asset mix numbers. The percentage of equity fell from a little above 60 percent to 53 percent, according to the categories used, but the "other" category increased. It is possible that the "other" category contains some equity investments, leading to an understatement of MERF Active Account equity investments. The drop in MERF’s active account equity percentage, to the extend that it is real, may reflect a decision to reduce equities in the Active Account due to the short time horizon of the Active Account, and the need to transfer assets at retirement. It is also possible that the MERF Active Account fiscal year 2000 asset mix numbers capture some short-term effects of assets being transfer among managers.

The results for the last fund, DTRFA, are rather puzzling. For this fund, when asset mix information is presented in Table 8 for 1997 and 1998, the DTRFA asset mix showed almost no change between those two years. The longer-term view, as depicted for this fund in Table 9, suggests significant changes in its asset mix over time. In 1990, 34 percent of DTRFA assets were devoted to equities. In 1995, equities were 55 percent of the portfolio, an allocation more in line with the typical percentages expected by a pension fund. The increase from the early 1990 may reflect change in DTRFA post fund law. The equity allocation in 2000, however, is only 29 percent. The drop is difficult to explain. Possible causes are transitional effects of transfers among asset managers. Some of the change may reflect market timing efforts. During the 1980s, this pension fund engaged in modest market time efforts, and that policy may continue. Another possibility is that some assets more commonly thought of as equities are included under bonds. DTRFA is one of a few pension funds included here which have explored and may be using some newer strategies to meet or beat equity index fund returns. Rather than buying or creating an equity index fund account, it is possible to create the same effect, and possibly beat the index, using futures contracts. If that approach is being used, it is possible that the assets related to that effort were included under the DTRFA bond portfolio, rather than under equity.

Selected Large Minnesota Public Pension Funds
Asset Allocation, Fiscal Years Ending June 30, 1990, 1995, and 2000