According to The Pew Charitable Trusts, there are approximately 29 million Americans who are expecting retirement benefits provided through a state public pension system. Data compiled by the U.S. Census Bureau in its 2019 Annual Survey of Public Pensions: State & Local Tables, estimated that 50% of these benefits rely on earnings generated by almost $4 trillion in assets held in trust by these systems. Further, two-thirds of those assets are allocated to what some regard as risky investments. These include publicly-traded stocks (equities) and alternative investments such as private equity, hedge funds and real estate. For pension fund administrators and fiduciaries, extra vigilance is warranted in the monitoring of current market trends and their effect on pension fund performance.
Experts from The Pew Charitable Trusts are projecting pension funds to achieve average returns of approximately 6% over the next few years with the likelihood that return assumptions will continue to decline. Keep in mind that a 1% drop in annual returns on the $4 trillion in assets held in a trust by the state public pension system equals a reduction in pension assets of $40 billion.
Another concern is that some of the alternative investments incur high fees. For example, Pew estimates that private equity investment fees are triple the average fees across other asset classes and since just a few states require disclosure of these costs, they are largely unknown. Pew, however, approximates unreported private equity fees to be a minimum of $5 billion annually.
From 1950s to the 1990s, we have seen many public pension funds transition from safe investments such as bonds to more risky equities. In more recent years, they have moved to even riskier alternative investments.
A 2019 comprehensive review of annual and quarterly reports, state treasury reports, and data collected from plans found that state public pension funds across the nation rely on very similar investment strategies. The Pew Charitable Trusts found that nearly three quarters of these funds invest at least 65% of their assets in equities and alternative investments. Of course, this means that while the higher allocations to riskier investments could lead to higher returns, they can also be subject to market volatility and the potential for significant losses. We are currently witnessing extreme market volatility, with some forecasts projecting a recession over the next two years. These conditions should signal a red flag to pension administrators and fiduciaries.
Proceed with Caution
Today’s challenging market conditions demand extra caution on the part of plan administrators, trustees and government sponsors. They should educate themselves on the latest technologies to track and monitor their investments’ performance and fees and consider the most prudent course of action. It also important to have high quality pension administration is in place and if necessary, they can rely on a qualified third party administrator with experience in pension funds.