19 May 2022

Public Pension Earning More Than 8%

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The nation’s two biggest public pension funds are doing better in 2018. The problem: They don’t think it will last.

The California State Teachers’ Retirement System and California Public Employees’ Retirement System both earned more than 8% for the second fiscal year in a row, thanks to a robust performance by stocks and private equity. Together they manage $575 billion for 2.8 million public workers and retirees.

But the systems, known as Calstrs and Calpers, aren’t counting on that type of performance over the long term. Both rolled back their investment targets this year in an effort to be more realistic about what they can earn in the future. Calstrs dropped its future goal to 7%. Calpers initiated a multistep drop this year that will end at 7% in 2021.

Many other public pensions around the country are turning more cautious about future results following a nine-year bull market for U.S. stocks, which remain the single largest holding for most retirement systems. The funds rely on a combination of investment income and contributions from employees, states and cities to fund their mounting obligations to retirees.

For many decades these funds clung to a belief that stocks, bonds and other holdings could earn at least 8% and that those gains would fund hundreds of billions of dollars in liabilities.

But many are now trimming those assumptions to 7% and lower. The median assumed rate of return held by 130 public pension funds tracked by Wilshire Consulting dropped in 2017 to 7.25%. That median rate was still 8% as recently as 2012.

Lowered ExpectationsThe rates of return that states assume theywill earn on their pension investments havefallen over the past five years.Source: Wilshire Consulting

“We probably want to temper our enthusiasm when we have a year or two years of strong returns because one thing we know for certain is that there will be challenging years,” said Wilshire Consulting Chief investment Officer Steve Foresti.

Pensions long have been criticized for using unrealistic investment assumptions, which proved costly during the last financial crisis. Many funds recorded big losses in 2008 and 2009, pulling their long-term returns well below the 8% barrier despite the bull market that followed. As of June 2017 the 10-year annualized median return for all public pensions tracked by Wilshire Trust Universal Comparison Service was 5.57%.

“Over 10 years, we struggled,” Calstrs Chief Investment Officer Christopher Ailman said at a public meeting on Friday. Calstrs has returned an average annualized 6.3% over 10 years as of June 30.

But moving expectations below 8% isn’t just an accounting move. It has real-life consequences for systems that use those predictions to calculate the present value of obligations owed to retirees. Even slight cutbacks in return targets often mean budget-strained governments or workers are asked to pay significantly more to account for liabilities that are expected to rise as lifespans increase and more Americans retire.

In California, some local-government officials are concerned their costs will rise aggressively as Calpers lowers its expected return rate. Calpers has said the state and school districts participating in its system would have to pay at least $15 billion more over the next 20 years once the system’s assumed rate of return drops to 7%.

Pension fund officials in other parts of the country are making the same decision to drop their future targets even as they report strong results for fiscal 2018. The Maine Public Employees Retirement System earned 10.3% for the year ended June 30 but this year dropped its long-term goal to 6.75%. It has now reduced its rate of return assumption four times since 2009.

The moves mean the system now has more work to do if it hopes to fund all future benefits. Had the fund maintained its precrisis 7.75% goal, it could today report having enough assets to cover 91% of its liabilities according to executive director Sandy Matheson.  Instead it has 81%, she said.

“What we’re looking for is a rate that can endure through good economic times and not-so-good economic times and low-interest-rate environments and high-interest-rate environments,” Ms. Matheson said.

The Illinois State Board of Investment for years relied on an 8.5% assumed return rate for its state-employee retirement plan. In 2016 it dropped to 7%, one of many reasons it now has just 35% of what it needs to pay for future benefits.

“If we were still 8.5% it might be 50% or 60%—it would appear to be a lot better,” said Illinois State Board of Investment Chair Marc Levine. But it would be total nonsense because you still owe the same amount of money. You’re just fudging on the accounting.”

Click here for the original article from The Wall Street Journal.  

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