As Public Pensions Pile on More Risk, Returns Fail to Keep Pace
(Bloomberg) -- Riskier assets like private equity, real estate and hedge funds haven’t provided a magic bullet for state and local government pensions seeking to cover trillions in retirement benefits for aging workers.
While public pensions have boosted their average allocation to high-risk equities and so-called alternatives to almost 80 percent, the median fund fell short of the 7- to 8 percent returns they count on each year to pay the ballooning costs of benefits. As they take on more risk, states and local governments are increasing their exposure to market volatility and the risk of contribution spikes in a market downturn.
“When you look at real estate, commodities and hedge funds, their performance has been in line with stocks, for some of them even worse," said Olu Sonola, a Fitch analyst and one of the author’s of the report. “The only exception to that is private equity."
Stock market volatility and persistently low interest rates are raising questions about how state and local pensions can manage through market turmoil, aging populations and rising fixed costs for retiree health-care. The combined shortfall for state and local pensions exceeds $2 trillion, according to Moody’s Investors Service. If the funds fail to meet investment targets that average about 7.5 percent annually, governments will need to make up the difference with higher payments, or cuts to services, to keep from losing ground.
Public pensions returned a median 6.2 percent for the 10 years between 2008 and 2017 and 6.4 percent between 2001 and 2017, Fitch said.
Average allocations to equities and alternative investments increased to 77 percent from 67 percent, while lower-risk fixed income and cash declined to 23 percent from 33 percent, according to a report Monday from Fitch Ratings.
As of 2017, Arizona’s allocation to equities and alternatives of approximately 86% was the highest among the states, while South Dakota’s 66 percent allocation to equities and alternatives was lowest.
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