The $7.2 billion Arizona Public Safety Personnel Retirement System boosted its investment returns twice in two years by disregarding market-value real estate appraisals it commissioned and, instead, using higher hypothetical valuations from the firm managing the portfolio, PSPRS documents show.
Pension officials ignored the appraisals by Ernst & Young, allowing Desert Troon Cos. — little known in institutional investor circles but with a two-decades-long relationship with PSPRS — to use hypothetical values for the approximately two dozen properties it holds in a joint venture with the Phoenix-based pension fund.
The difference between the hypothetical and market values in each of the last two years was more than $80 million, according to PSPRS financial statements.
The valuation dispute has put the Arizona public safety pension fund in the spotlight. At the request of trustees, the state auditor general is reviewing whether it was reasonable to let Desert Troon use the hypothetical valuations. Also, two lead portfolio managers and the fund's investment counsel have resigned, and the fund hired a law firm to investigate complaints by investment staff who alleged harassment over their questioning of the Desert Troon valuations and other issues.
The pension fund's board has had three special meetings in three weeks to discuss the law firm investigation and the job performance of James Hacking, fund administrator, and Ryan Parham, chief investment officer. Mr. Hacking and Mr. Parham declined to be interviewed for this story.
Doug Cole, a spokesman for the retirement system, said in an e-mailed response to questions that the fund's outside actuary determined the use of the Desert Troon valuation instead of that by would have “no material effect” on the pension fund.
Desert Troon manages the most real estate assets for the Arizona fund — $344.3 million (using the hypothetical valuation calculated by the firm as of June 30). That's about one-third of the system's real estate portfolio and around 4.5% of total assets.
The portfolio is an assortment of housing developments, commercial buildings, strip malls and vacant land, mostly in the Phoenix area, that saw severe price declines during the financial crisis.
In an Aug. 8 memo posted on the fund's website, Mr. Hacking said the portfolio was listed at a hypothetical value after pension officials elected not to sell at fire-sale prices, and so put the Desert Troon properties on the books at what Desert Troon expected to sell the real estate for after a market recovery.
In a letter to the auditor general, Mr. Hacking stated the system in 2006 initiated a policy of hiring independent real estate appraisers to provide a market value of the joint venture portfolio. An exception was made in 2010 after Desert Troon officials asked to use a hypothetical value, PSPRS e-mails show. The value would be based on an estimated future selling price, according to the e-mails.
Messrs. Hacking and Parham authorized the change, the e-mails show.
But the pension fund still hired the following year, and Messrs. Hacking and Parham continued to exempt Desert Troon from using market valuations.
In a July interview, Mr. Hacking said he believed Desert Troon executives were in the best position to value the assets because they were dealing with the properties on a daily basis.
The valuation difference between and Desert Troon allowed the Arizona system to reduce its overall investment losses in the fiscal year ended June 30, 2012, reporting a -0.79% return instead of what would have been -2.15%, according to an analysis by Pensions & Investments.
Preliminary data for the fiscal year ended June 30, 2013, show that using Desert Troon's calculation, the system was able to boost the overall gross return to 11.48% instead of what P&I calculates would have been 10.35% if the calculation had been used.
PSPRS officials would not provide historical returns for Desert Troon.