Bob Slater explains smoothing

From Bob Slater, March 12, 2007
Subject: RE: Definition of "smoothing"

Hello, Kathie.

Here is my attempt to explain asset “smoothing.” You might also hear this referred to as market-related value.

We start with market value of investments at the end of each fiscal year – June 30 for STRS. There are several types of investments owned by STRS, but let’s use our largest asset class, U.S. stocks, as an example. Market value of U.S. stocks is the trading price on the national exchanges; it does not mean that any money (cash) came into or left STRS. As you know, stock prices change every day. So market value “income” based on one particular day (June 30) can be subject to significant and temporary increases or decreases in stock market prices. “Smoothing” is simply a technique to spread this volatility over a longer period of time. In other words, it is intended to make investment returns more of a trend, rather than a spike.

Asset smoothing is very common among public pension plans. It is consistent with generally accepted accounting principles and actuarial standards. Most public pension plans smooth investment gains and losses over 3-5 years; STRS Ohio uses 4 years.

Here is how it works at STRS. We assume that the value of investment assets will increase 8% each year. Anything more than 8% is a gain, and anything less than 8% is a loss. Each year’s gains or losses are recognized evenly over the current and subsequent three years: 25% per year. The calculation is done every year, so it just rolls forward. Additionally, we do not allow the market-related value of assets to be less than 91% nor more than 109% of market value.

STRS Ohio has consistently followed this method since 1997. It was approved by the Retirement Board at that time.

I hope this is helpful. Please let me know if this is still not clear or you have additional questions.

Bob Slater