The 2013 NCPERS Public Retirement System Study conducted jointly by the National Conference on Public Employee Retirement Systems and Cobalt Community Research in October 2013 reviewed public funds’ financial standing and their readiness to meet future liabilities.

The study covered 241 government funds that had assets over $1.4T and memberships (both active and retired) of 12.4M.

Key insights from the study

Funds showed heightened confidence in the future, became more cost effective and went ahead with operational reforms to make objectives more reachable. Investment returns improved over selected time frames though funding levels fell a tad compared to last year.

Overall confidence on being able to address retirement-related issues in the future improved to a reading of 7.8 from 7.7 in 2012.

1-fund-confidence pension

Overall expenses showed a nearly 22% decline to 57.3 bps from 73.1 bps in 2012. Investment management expenses were 41.8 bps while administrative expenses accounted 15.5 bps.

2-expenses pension

Fund returns have been healthy across the 1-year, 3-year and 20-year time frames but are dragging on the 5-year span due to the financial crisis.

3-returns pension

Asset allocations point to a predominant emphasis on domestic equity, though it is down a percentage point compared to 2012. Taken with the international equity allocation of 17%, funds have, on average, allocated 52% assets to equity.

Additionally, funds appear to have taken on riskier investments such as PE/Hedge Funds/Alternative assets (8%) and Real Estate (7%). It is interesting that the ‘Others’ class of 5% includes assets such as timberland, emerging market equity and debt, mortgage backed securities, infrastructure and master limited partnerships. (See views on pension fund risks below).

4-asset-allocation pension

Funding levels were a robust 71.5% in 2013 compared to 74.9% in 2012. The authors ascribe the fall to market volatility.

5-funding-ratio pension

On the continuing debate regarding improving funding levels, members responded with a gamut of likely strategies that could be adopted. Some examples:

  • Increased years of service
  • Benefit reductions
  • Changed benefit levels/closed plans for future hires
  • De-risk portfolio to reduce volatility
  • Increase contribution from employer
  • Use strong performing asset managers
  • Issue Pension Obligation Bonds
  • The City dedicates future Parking Tax Revenue to fund pension plans
  • Property transfer from City as additional contribution
  • Enact legislation that will trigger automatic increase/decrease in contributions based on actuarial valuation of liability
  • Asset allocation strategies that use more of alternative investments
  • Go direct with some alternative investments to save on fees

Are pension funds taking on too much risk?

It is clear from the above study that public funds have benefited in recent years due the excellent performance of the stock markets. It is also clear that enthused fund administrators, looking to close the funding ratio gaps, are going a step further into riskier avenues such as alternative assets.

In January we reported that Dow Chemical’s pension fund (a corporate fund, but the trend is significant) had 20% of its $16.1B assets concentrated in alternatives.

Yesterday Bloomberg cited a report by Cliffwater LLC that said CALPERS had invested almost $20B in alternative investments, according to its 2012 report.

But in April of this year the IMF drew attention to the potentially dangerous levels of risky investments, such as in hedge funds and derivative instruments, built up by U.S. public pension funds and life insurance companies (as reported by the WSJ).

The IMF said pension funds should take steps to close future funding gaps “without delay,” such as through “restructuring benefits, extending pensioner’s working years and gradually increasing contributions to close funding gaps.”