NCPERS’ Best Governance Practices for Public Retirement Systems include recommendations in key management areas including board practices, policies, risk oversight, strategic planning, reporting, measures and stakeholder communications. MCG’s Julian Regan collaborated with NCPERS on the initiative.

Read:

• 2012 Best Governance Practices (PDF)
• NCPERS Press Release

The government debt crisis in Europe is likely to persist for most 2012. New governments in Greece and Italy were appointed and have since passed legislation that will reduce government spending. However, bond investors want more structural reforms in employment and tax law in those countries, as well as in Spain and France, which will promote more economic growth. The rigidity in employment laws in Europe are keeping labor costs relatively high compared to those in the U.S., Asia, and Latin America, and the unemployment rates in Europe are much higher than in the U.S. As a result of government spending reductions, economic growth in Europe has slowed to near-recession levels. The currency has yet to decline enough to meaningfully stimulate exports. Consequently, economists currently cannot agree on the depth or breadth of this new recession in Europe. Contradictory comments are continually released by the politicians, maintaining a high degree of uncertainty regarding future policy decisions. Some of the most pessimistic economists are forecasting that Greece will exit the European Union later this year, and that Portuguese government debt may need to be restructured.

The dominant discussion topic for managers across asset classes has been the impact of government policy decisions on market returns, and the difficulty in forecasting the outcome of those decisions into various valuation models. As a result, equity market volatility had increased. In the U.S., Congress’ current practice of delaying votes on critical fiscal issues until the final hour is unlikely to change. In addition to the U.S., France and Russia also have presidential elections this year, the outcome of which could change the direction of those countries’ economic policies.

U.S. Economy

Despite improving U.S economic data during the fourth quarter, many strategists remain reluctant to forecast stronger economic growth for 2012. Economic forecasting is a combination of trend extrapolation, formal modeling, and the incorporation of a particular macroeconomic view of the world. The optimists are extrapolating that the currently improving economic data will continue to trend upward. However, the downside risks are significant and could result from the following actions:

• Americans continue to reduce their debt and rebuild their household savings; consumer spending continues at its current tepid pace
• U.S. housing market remains depressed with an increased supply of foreclosed homes
• U.S. economy is negatively impacted by a prolonged recession in Europe
• Legislative gridlock in Washington further reduces business confidence
• State and local governments continue to tighten their budgets.

However, thus far, the markets have rebounded in January, with the S&P 500 returning 4.5% for the month, emerging market stocks returning 11.2%, and developed markets outside of the U.S. returning 5.2%. Economic data continue to suggest that growth in the U.S. has some positive momentum. GDP grew by 2.8% in the fourth quarter, and the unemployment rate dropped from 8.6% to 8.3% in January.

The Institute, one of the year’s premier educational events for Trustees and executives, will focus on three themes of critical importance to benefit fund fiduciaries:

Commercial real estate notched another strong quarter of performance to finish out 2011, as the NFI-ODCE index returned 2.97% for the fourth quarter. Both the income return of 1.32% and the appreciation return of 1.64% continued to show positive strength, as the index followed up a very strong return of 16.32% in 2010 by returning 15.99% in calendar 2011.

Multifamily Housing

While multifamily housing continues to lead the industry, the modestly positive uptick in economic data towards the end of 2011 could provide further support to other sectors like office and retail in 2012 if they can be sustained. Given the strength of appreciation returns over the past two years, most are expecting those gains to moderate going forward. However, further positive developments in the U.S. economy could lead to an improvement in underlying real estate fundamentals like occupancy and rental growth, which may help to offset slower appreciation gains by increasing the income return.

While most multi strategy funds of hedge funds did manage to post positive results for the fourth quarter, the returns were below long term averages. November was the one month when hedge fund strategies and indices were notably down, and that was a result of losses suffered at month-end right after Central Banks announced they were lowering costs on dollar swaps to improve liquidity conditions.

Equity markets soared the last few trading days of the month after the announcement was made resulting in losses particularly for long-short equity managers, most of whom were leaning short. For the full year, longshort equity managers, particularly Europe and Asia focused, were the largest detractors in multi strategy funds of funds portfolios. Managers in the event driven and distressed categories also detracted from performance, as their underlying positions in post reorg equities suffered from draw downs, while proving to be correlated with the public equity markets. For calendar year 2011, the HFRI Fund of Funds Composite index posted a loss of 5.64%.

Bond investors enjoyed positive returns for 2012. The Federal Reserve launched its latest quantitative easing program, called “Operation Twist,” in the fourth quarter. The Fed intends to sell $400 billion of shorter-term Treasury securities by June, 2012, and use the proceeds to buy longer-term Treasury securities, with an objective of lowering long-term interest rates to stimulate economic growth. This program, combined with the European debt crisis and fears of a global economic slowdown, caused long-term U.S. Treasury yields to fall dramatically.

During the second half of the year, the yield on the 30-year Treasury bond fell from 4.28% to 2.89%, and the yield on the 10-year Treasury note fell from 3.02% to 1.89%. 30-year fixed rate mortgage rates fell below 4%. Consequently, U.S. Treasury securities were one of the top performing fixed income asset class for the year. Falling Treasury bond yields encouraged bond managers to increase allocations to corporate bonds to earn any additional yield. As a result, the corporate bond, high yield, and global bond sectors all generated positive returns exceeding 5% for 2011.

2011 Returns By Asset Class

Source: Morningstar. Indexes: S&P 500, Russell Mid Cap, Russell 2000, MSCI EAFE (Unhedged), MSCI Emerging Markets, Barclays Capital U.S. TIPS, Barclays Capital High Yield, Citigroup Non-US WGBI (Hedged), JPMorgan EMBI Global, Composite, DJ UBS Commodities

Stock markets in Europe and emerging market countries had a much more muted rebound in the quarter, rising little more than 4%. While the solvency concerns for countries like Greece and Portugal remained unresolved, the concerns regarding liquidity in the European banking system were reduced due to the European Central Bank’s decision to lend over EU$ 500 billion to European banks at a rate of 1% for a period of three years, to replace much of the funding that had been provided by money market funds in the U.S. Many investors were surprised by the extent of the price declines in emerging markets equities last year, and the subsequent weak rebound in the fourth quarter. Even though the GDP growth rates in emerging market countries have decoupled from those of the developed world, emerging market stocks still remain sensitive to investor risk appetites and expectations for global economic growth.

Greece and Euro

Global stock market returns rebounded and decoupled, to a certain extent, in the fourth quarter, after generating negative returns ranging from -13.9% for the S&P 500 index, to -22.6% in the emerging markets during the third quarter. U.S stocks in all capitalization ranges jumped more than 12%, as newly released economic data suggested that growth in the U.S. was gaining some traction, reversing fears of a slowdown into recession. However, for the year, defensive sectors, including Utilities, Health Care, and Consumer Staples, significantly outperformed Financials, and other more cyclically-oriented sectors, such as Materials and Industrials. Auto sales increased 10% last year, with almost 13 million new vehicles sold, and the automakers announced plans to hire additional workers in 2012. Orders for durable goods also increased by 10% last year, with the strongest growth in primary metals, machinery and transportation equipment. The housing market showed some signs of stabilizing, with the supply of homes for sale falling to a post-2008 low of 6.2 months. Most notably, the number of workers filing new claims for jobless benefits fell to the lowest levels since 2008, and the unemployment rate fell to 8.6%.

2011 Returns by Asset Class

Source: Morningstar. Indexes: S&P 500, Russell Mid Cap, Russell 2000, MSCI EAFE (Unhedged), MSCI Emerging Markets, Barclays Capital U.S. TIPS, Barclays Capital High Yield, Citigroup Non-US WGBI (Hedged), JPMorgan EMBI Global, Composite, DJ UBS Commodities