Pension Fund Investments Are Up, but Gaps Persist
|Photo illustration by Danny Dougherty, Stateline.org|
A year after suffering record investment losses, many of the nation's largest public pension plans are reporting double-digit percentage gains for the budget year that ended June 30.
Although the improved returns in fiscal 2010 did not wipe out the damage funds suffered in the previous two years, the figures confirm how the financial industry has been stabilized and liquidity has increased since the Wall Street crisis battered state pension plans.
A review by Stateline of 20 public employee pension plans in 19 states shows preliminary returns ranging from 10.8 percent for the Nevada Public Employee Retirement System to 18.7 percent for the South Dakota Retirement System . Meanwhile, Wilshire Associates , a California-based investment adviser, reports a 13.09 percent median return among public plans with more than $1 billion in assets for fiscal 2010, compared to an 18.76 percent loss in fiscal 2009. Most state public pension systems assume an annual yield of about 8 percent.
Public pension system managers say they are encouraged by the increases in the market value of their funds. But they are hardly sanguine; nationally, the unemployment rate is still high, home sales are declining and economic growth overall has slowed, according to statistics released Friday (August 27). The Dow Jones Industrial Average has lost 3.5 percent this year, and many state funds are seeing modest losses for the past few months.
"Long-term return numbers are still achievable but the intermediate future may be difficult," says Craig Slaughter, executive director of the West Virginia Public Employees Retirement System, which earned 16 percent on its investments in fiscal 2010. "The economy still needs a few years to recover from the global recession."
West Virginia's experience puts the fiscal 2010 gains in perspective. Its retirement system holdings recorded a combined 22.1-percent loss in fiscal 2008 and 2009, requiring the Legislature to contribute $211 million to shore up the system. The funding ratio, or the proportion of assets to liabilities, of West Virginia's state employee retirement fund is 65.9 percent, while its teacher retirement fund is 41.3 percent. Most experts suggest an 80 percent funding ratio.
Major public plans in at least 21 other states were below the 80-percent benchmark at the end of 2008, according to an analysis by the Pew Center on the States ( Stateline 's parent organization). The report concluded that the underfunding of public pension plans began before the recession, but was worsened by the downturn.
Now, pension costs are stressing state budgets already strained by three years of declining revenue. Meantime, the number of retirees increases each day as the largest generation in U.S. history, the Baby Boomers born between 1946 and 1964, are beginning to collect pensions.
A deep hole to climb out from
Other state pension officials reported up-and-down figures similar to West Virginia in fiscal 2010. The New Hampshire Retirement Fund , which covers teachers, public safety workers and others, gained 13.7 percent in its portfolio for the year that ended June 30, but officials said the value of the fund still was 20 percent below its 2007 peak. North Dakota's state employee pension funds rose 13.2 percent in fiscal 2010 but fell 24 percent the year before. The Maryland State Retirement and Pension System returned 14.1 percent on its investments in fiscal 2010, coming off a year with 20-percent losses.
"We have a portfolio headed in the right direction," says Mansco Perry, chief investment officer of the Maryland retirement agency. The 14-percent gain was almost double the state's 7.75 percent assumed rate of return.
Public pension fund managers diversify investments across several categories — stocks, bonds, hedge funds, private companies, real estate and safer fixed-income holdings. Generally, stocks outperformed other classes in most plans reporting fiscal 2010 results. West Virginia reported a 17.6-percent gain in international stocks. The North Carolina Retirement System said it returned 14.3 percent on stocks, compared to 13.2 percent for fixed income. The Massachusetts public pension fund said its fixed-income holdings rose 32.8 percent, its highest return.
Real estate performed the worst over the year; the Florida Retirement System says it lost 10.2 percent in that investment category, while the California Public Employees Retirement System , or CalPERS, says its real estate holdings dropped 37.1 percent.
CalPERS, the nation's largest public retirement fund, is tracked carefully by pension managers across the country because of its $205 billion portfolio. The California fund and the $130 billion California State Teachers' Retirement System have been at the vanguard of restructuring their assets during the recession and recovery to replace low-performing funds with those that offer long-term growth.
CalPERS reported an 11.4 percent return for fiscal 2010, exceeding its 7.75-percent target. Its board is developing a new investment plan that includes stocks, bonds, fixed income, private companies, real estate and inflation-linked assets such as commodities, buildings and forest land. CalSTRS says it has been shifting about 10 percent of its holdings in international stocks to fixed income, real estate, private companies and real or inflation-linked assets. "We've taken steps to position the portfolio for long-term growth but we're not out of the woods yet," says CalSTRS chief investment officer Christopher Ailman. CalSTRS' holdings returned 12.2 percent in the 2010 budget year.
Some investment advisers are recommending that state pension plans shift a portion of their money into inflation-linked real assets, which hold up over time. Rumi Masih , managing director of J.P. Morgan, says pension fund managers should target the worst performing 5 percent of their portfolios — much like CalSTRS does — and consider real assets, in part because global economic powers China and India want to buy gold, commodities and other assets to stimulate future growth.
"The growing demand for real assets is motivated by the assets' link with the world's most significant markets," Masih told a recent conference of state treasurers in Williamsburg, Virginia. Too often, he says, pension funds do not reflect the changes in the economy. The days of reliable 8 percent or more returns on stocks are over, he says. "It's time to change your game."
Public pension fund overseers are entangled in a debate over whether to lower their investment-return assumptions to reflect a more accurate view of the market in a fragile economy. The National Association of State Retirement Administrators points out that over the 25-year period that ended December 31, 2009, the median investment return for public pension plans was 9.25 percent. But some analysts say that number is skewed by the extraordinary stock market returns of the 1990s, and that growth going forward will be much lower.
The $133 billion New York State Common Retirement Fund , the third-largest after California's, recently said it was considering cutting the 8 percent assumed rate of return on its investments to 7.75 percent or lower after a consultant advised state officials to take a more conservative approach because of the stock market's recent performance. Utah and Pennsylvania public pension plans reduced their return assumptions in recent years, and several states, including Colorado and Minnesota, are discussing similar moves.
Investment returns are one of three revenue sources for public pension plans: State employees make contributions, and state agencies put taxpayer dollars into funds.But 60 percent of revenue is from investments, so any change in the assumption could mean a significant increase in the amount that employees or taxpayers would have to contribute.
Retirement Systems of Alabama officials told the state pension board earlier this month that even if the funds' investment holdings increase by the assumed 8 percent rate of return per year, the state's cost of meeting its retirement obligations still would jump by additional 77 percent by 2019. At 4 percent per year growth in earnings, Alabama would have to spend $1 billion more annually.
No state can afford those kinds of increases, so many are looking at reducing costs. This year, about 20 states have enacted cost-cutting reforms, such as increasing the retirement age, freezing cost-of-living increases, tightening benefit calculations and eligibility and cracking down on abuses. The pattern is continuing: Alabama, Montana and North Dakota officials are preparing pension reform proposals for their lawmakers to consider in January.
"A lot of plans are finding that investment returns alone won't be enough to restore their long-term sustainability," says Keith Brainard, research director for the National Association of State Retirement Administrators.
Julia Bonafede, president of Wilshire Consulting, says she is hopeful that over time, public plans can recover providing they are proactive addressing investments and employee and employer contributions. "With modifications in all three areas, we think that with enough time they can get back to where they were."
Stateline's Victoria Kleger contributed to this report.