US public pensions are going through tough times- the gaps between the assets and liabilities of public pensions are widening, and the investment outlook looks very grim.
Pensions are in trouble
According to Ben Meng, a chief investment officer of California Public Employees’ Retirement System, the expected rate of returns on a pension are 6.1% not 7% for the next 10 years. Calpers is the largest public pension in the US, valued at $366 billion. In 2016, it had lowered its long-term investment return target to 7%. The US has 129 pension funds, 85% of which have already cut their return targets.
The stock market has hit new bull records recently, but public pensions weren’t able to cash in the boom. In 2001, an average US plan had 100% funding available for its long-term obligations. That number dropped to just 72.5% in 2018.
The Center for Retirement Return at Boston College noted that investing decisions had hurt the pensions. Apart from this, lack of adequate government contributions, recessions, and generous benefit guarantees have allowed the pension funding gaps to grow manifold. Associate director Jean-Pierre Aubrey said that the bad plans said goodbye to equities after the 2008 financial crisis. As their exposure to the stock market was limited, they couldn’t take advantage of the recent rallies.
The best approach is to bet on equities, maybe
Wilshire Consulting president Andrew Junkin said that the funds that poured their money aggressively on stocks, especially the domestic companies outperformed others. The funds that invested in private equity and hedge funds remained relatively untouched by highs. But the strategy that works today may not be fruitful tomorrow. According to Phillip Nelson, asset allocation director at NEPC, a pension advisory firm, stocks may not be the right option for the next ten years. He said that profit margins by 50% from the current levels is highly unlikely.
Public pensions are constantly betting on private equities. Their allocations in this sector increased from 5.6% in 2008 to 10.2% in 2018. This positive outlook is expected to last for a few more years. Larger pension plans are hiring more people to handle alternative assets and private equity, and they are expecting better results than stocks.
For instance, the Texas Teachers’ Retirement System currently invests 40% of its portfolio in alternative assets. Their senior managing director Mohan Balachandran said that their pension liability duration is for 20+ years. Therefore, they can afford to lock up their funds for seven to 12 years with ease.