The Maryland State Retirement Agency defended the performance of its $50 billion pension fund that lagged behind peers amid a booming stock market, explaining its use of a conservative investment strategy and partially blaming the Trump administration.

The Maryland State Retirement and Pension System returned 10.02 percent on investments for its 2017 fiscal year, beating its benchmark but lagging behind peers. The returns of several asset classes also lagged behind their specific benchmarks. In a letter responding to a report by state legislative analysts, the retirement agency said its funds are not as exposed to the U.S. stock market, which soared last year. It also said its investments in currency struggled due to a weakening of the dollar in the second half of 2017 because of questions about the ability of President Donald Trump's administration to pass legislation.

The performance of the fund's public equity asset class trailed its benchmark by 1.1 percent. The retirement agency said in its response that most of the shortfall can be explained by the fund's use of long and short equity hedge funds.

"These strategies allow the managers to generate returns by buying stocks they believe will rise in value, and selling stocks they believe to be overvalued and expected to decline," the agency said. "These off-setting trades result in total exposures to the stock market that are less than a more traditional stock manager whose returns are dependent on stock prices rising."

The fund's exposure to public equity is about 10 percent less than the median of its peer group. The strategy aims to protect the fund from losses when the stock market declines, but means it does not benefit as much when the stock market booms like it did in 2017.

The Dow Jones Industrial Average had its biggest year ever adding 5,000 points to surpass 24,000.The Nasdaq composite was up more than 29 percent and the Standard & Poor's 500 index was up about 20 percent.

"The System should perform better during periods of market stress and public equity drawdowns," the agency said. "Over time, the System’s portfolio is expected to provide similar average returns as peer portfolios, but generate more wealth because of the lower volatility characteristic."

The Maryland Public Policy Institute has been critical of the state pension system, claiming it missed out on another potential $1 billion by failing to match the average returns of its peers.

A currency hedging program used by the fund also detracted by public equity returns. The program aims to provide protection against a strengthening U.S. dollar and reduce the volatility of the currency portion of the fund's non-U.S. public equity investments over the long term. It produced $41 million loss because the dollar weakened during the second half of 2017.

"The dollar weakened as doubts emerged as to whether the newly elected president and his administration would be able to implement policies that would stimulate the U.S. economy," the agency said.

The agency went on to say that its investment division staff identified U.S. public equity as a sub-asset class with "a fundamental structural problem" in 2016. During fiscal 2017, the agency restructured the portfolio, as well as its Terra Maria program. The Terra Maria program was started by the pension system in 2007 to give "emerging" fund managers more experience.

Another asset class that struggled was the system's Absolute Return portfolio, which returned 3.31 percent, compared to its 6.16 percent benchmark The agency said a "benchmark misfit," low returns provided by managers; and "a high degree of turnover" in the staff all contributed to the underperformance. In June, the portfolio only had one person seeing it because two other people left for jobs in the private sector.

The agency also noted that hedge funds like those comprising the Absolute Return portfolio perform best in more chaotic markets. The markets have been calmer and less volatile over the last few years because global central banks have adopted "unconventional monetary policies" to lower interest rates.

"As central banks unwind these policies and raise interest rates, it may reverse the trend and create a more favorable environment for hedge funds," the agency said. 

Other asset classes like the natural resources and infrastructure portfolio also fell slightly short of benchmarks because of mismatches.