Arizona PSPRS Consolidates 10 Asset Classes into 3

The Arizona Public Safety Personnel Retirement System’s board approved a consolidation of its asset categories into three from 10 at its June 26 meeting.

The $10.5 billion pension fund will re-sort the investment portfolio into the three new classifications to simplify operations, according to Chief Investment Officer Mark Steed. The portfolio’s 10 existing asset categories will shift into either Capital Appreciation, Contractual Income, or Diversifying Strategies relative to the behavior of each classes’ market.

Capital Appreciation will hold US and international equities and private equity, with 20%, 18%, and 23% targets, respectively. Contractual Income will consist of core bonds (3%) and private credit (22%). Diversifying strategies will host hedge funds (12%), which have an array of different approaches. The remaining 2% of the full investment portfolio will be in cash.

“The first step is to sort of re-categorize our asset classes so that we have a better chance of optimizing returns while keeping risk in check,” Steed told CIO. “To do this, we wanted to be as honest and careful as possible to categorize between uncorrelated types of returns. From these three distinct categories, the idea is to have the asset classes and investments compete for capital.”

Steed further explained the behavioral logistics of why these assets will be moved into their respective categories.

“There’s things that you buy and sell to other people for more than you bought them and that’s capital appreciation,” he said. “Then there are investments that generate a  contractual return, like a loan with principal. Then, there are investments that have nothing to do with either of those and they’re just idiosyncratic strategies and that’s diversifying strategies.”

Getting the OK

Steed said convincing the board wasn’t as difficult as it might be for other pension plans, as its members, while fairly new, all have some sophisticated financial knowhow.

Many funds don’t have that luxury, especially when laws or policies limit trustee appointments to officials or designees who may lack the knowledge or experience to prudently evaluate investment policies and goals.

“Their requirements are really stringent,” Christian Palmer, Arizona PSPRS’s communications director, told CIO. “Our board is really sharp and they also believe that pension reforms have lowered the system’s long-term liabilities enough to allow a responsible shift from almost pure risk aversion to generating higher returns.

Steed said despite he and the board not having much history, as its most senior members have only been there about two years (some have only served six months), he sought to present something simple that made sense. “That’s why we came up with three super categories to keep our goal of reduced correlation while we reevaluate investments that won’t help us hit our assumed earnings rate over long periods of time,” he said.

The new allocation targets and classifications were Steed’s top priorities since becoming CIO last October. He next wants to bring more staff in-house.

“We’re thinking to build out the analytics complex,” he said. “If you can build out analytics and your team is fluent in predictive analytics and AI and all those buzzwords, then it’s very privy to the team because you can put up guardrails and you can use your judgment to inform the decisions.”

The fund’s asset mix as of December 31, 2018, was 15.88% credit opportunities, 15.26% US equity, 13.86% private equity, 13.83% non-US equity, 11.14% global trading strategies, 8.81% real assets, 8.18% real estate, 5.06% fixed income, 4.01% short-term investments, and 3.99% risk parity strategies.