Earlier this month, I addressed the Oregon Investment Council to sound a warning about a dangerous asset allocation that makes PERS Investments vulnerable to a large decline when the economy softens and markets decline.

Here is a transcript of my remarks.

My name is Douglas Berg from Eugene.

You may recall I addressed you in August 2018, to express my concerns about the poor OPERF returns over the last decade and their negative impact on the PERS unfunded liability. I return today to reiterate those concerns and to sound an urgent warning about OPERF’s substantial downside risk as the economy weakens.

After your Public Equity Annual Review in October 2018, I studied the makeup of the public equity portfolio in some detail. Considering public equity is OPERF’s core portfolio, it was very concerning to see that you manage the entire portfolio under a single all-world benchmark. This means you allocate about half your public equity to foreign stocks. This allocation is as inexplicable as it is dangerous and likely is the biggest single reason your public equities have done so poorly since 2008.

Starting with the last recession (2008), the annualized rate of return on your public equity portfolio through 2018 is under 4 percent, while the S&P 500 and Russell 3000 annualized returns for the same period are about 7.5 percent. 

Note that I am referring to the 11 plus year period starting in 2008, not to the current 10-year returns reported on your website, which reflect only the long bull market in stocks. Any analysis of OPERF’s long-term return potential must include a full economic cycle, but the information on your website is decidedly unhelpful as you recently scrubbed it of return details prior to 2009.

After my review of the public equities portfolio, I wrote you a letter expressing my concerns, in which I said “You have perfectly positioned this portfolio to get clobbered when the next recession hits, since few foreign economies have fully recovered from the 2008 financial crisis, including most of the largest economies in Europe.”

As it turned out, 2018 provided a glimpse as to how vulnerable your public equities are in falling markets. In 2018, the public equity portfolio lost over 10 percent, while the S&P 500 lost about 4.5 percent. So on a percentage basis, your public equities lost almost 2 ½ times the S&P, a truly horrifying performance. And this while we are still in a bull market. Yes, you beat your benchmark, but that only underscores how completely inappropriate this benchmark is.

We all know a recession is coming. If we extrapolate your 2018 public equity losses to losses that are typical in broad markets during a recession, such as a 20 percent loss in the S&P 500, your public equities will indeed get clobbered. Thirty or 40 percent is not out of the question, based on 2018’s performance, perhaps erasing as much as $10 billion from OPERF, exploding PERS’s unfunded liability, and creating a crisis for the state of Oregon.

You must not ignore the warning in 2018. You must act now to correct your bizarre asset allocation in public equities.

I understand the need for diversity in investing. But allocating half of your public equities to foreign investments is way outside normal diversification. If you had been using a more sensible allocation of 25 percent foreign stocks since 2008, you could have realized about $10 billion more in returns, close to half of the current PERS unfunded liability.

I call on you to change your policy so that the public equity portfolio is managed using two benchmarks, one for U.S. equities and one for foreign equities, and to set the U.S. equity allocation to a much safer and more normal 75 percent of equities.

Continuing on your current path should not be an option.

Thank you.