The New York City comptroller is the latest official to try to change laws aimed at limiting risk in retirement investments, as US state and local pension funds try to make up shortfalls in a low-return environment .
Comptroller Brad Lander, who oversees about $260 billion in retirement funds for city police, firefighters, teachers and other public servants, is asking New York lawmakers for more flexibility to invest in private markets, debt high yield and foreign equities. The state comptroller’s office, which oversees an additional $280 billion in retirement assets, views the idea favorably, with one representative saying such flexibility “is essential in times of market volatility.”
Pension funds, like household investors, face a relatively bleak environment for stocks and bonds, the bread and butter of a traditional retirement portfolio. Faced with historic inflation and the Federal Reserve’s efforts to contain it, these funds are finding that they can no longer rely on bonds to rise when stocks fall and vice versa. In the first quarter of this year, the S&P 500 returned minus 4.6% while the Bloomberg US Aggregate Bond Index returned minus 5.93%.
“These two things taken together are the scary thing: the prospect of both falling at the same time,” said Steve Foresti, chief investment officer at Wilshire Associates, which advises large public pension funds. Retirement portfolio managers, he said, ask “in this environment, do I have anything that’s actually going up?”
Fourteen states have laws in place limiting how public servants’ retirement money can be invested.. According to a study by the National Association of State Retirement Administrators, constraints include imposing maximums on the share of retirement assets that can be parked in the stock market, the amount that can be invested outside the United States, or the amount that can be allocated to alternatives.
These laws are generally aimed at containing risk, as stocks can crash in a downturn and illiquid investments in private markets can be difficult to cash out if pension funds need money to pay benefits. But many public pension systems are increasingly increasing risk in an effort to fill large funding gaps and meet return on investment targets of around 7%.
“Investment advisors and managers will [pension] boards and saying there’s no way to meet the return assumption if you have these handcuffs,” said Kevin Leonard, a partner at NEPC, which advises public pension funds.
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The Texas legislature in 2019 decided to make permanent a 2011 decision to temporarily increase the amount the state teachers’ retirement fund can invest in hedge funds from 5% to 10%. The Georgia Teachers’ Pension Fund began investing in private markets for the first time in fiscal year 2021 after the passage of a bill allowing the fund to diversify beyond stocks and shares. obligations.
“I just felt like it wasn’t a prudent investment strategy to be so ultra-conservative,” said one of the sponsors, retired Senator Ellis Black. However, more than a third of lawmakers opposed the measure. “Any time people promise bigger returns, it naturally comes with higher risk,” said retired senator Steve Henson.
In New York, riskier assets such as high-yield debt, private equity, hedge funds and private loans cannot represent more than 25% of a pension fund’s assets. The law also caps non-US stocks at 10%; any additional foreign equity counts towards the 25% limit. Mr. Lander wants to raise that limit to 35% or raise the cap on foreign stocks that don’t count toward the 30% limit.
The current law, which was last amended in 2006, “does not reflect the realities of the modern investment world,” Lander, a Democrat, told lawmakers in February, according to a copy of his remarks. . Gov. Kathy Hochul, also a Democrat, “will consider this request with the legislature,” a representative said.
Mr Lander, who was elected in November, struck a somewhat different tone during his campaign, saying in his strategic plan that he would consider reducing the city’s pension fund allocation to private equity and hedge funds, citing the high fees these investments often incur.
A study conducted for the Comptroller’s Office by Rocaton Investment Advisors found that under Mr. Lander’s proposal, pension assets could be modified to increase returns by up to eight tenths of a percent without increasing volatility, said a representative.
New York City pension funds serving police, city employees and teachers say they have just over three-quarters of the assets needed to pay future benefits, about the national average. That compares to 94% of the city’s fund serving other school workers and 63% of the firefighters’ fund. These actuarial calculations are based on 2019 holdings and do not reflect significant gains in fiscal 2021.
The funds’ annualized private equity returns for the five years ending in 2021 range from 18.8% to 19.7%. That’s slightly higher than their domestic stock returns, which ranged from 17.1% to 18.2%. Wilshire and other consultants predict that private equity returns will outpace equities by several percentage points over the next decade.
Public pension funds get their money from three sources: government employees, the state and local governments that employ them, and investment returns. Adding investments with higher return expectations generally avoids or limits cost increases for these employers and employees.
But if investments end up underperforming, governments and workers can end up with an even higher bill. During a panel on inflation risks for the state and cities on Thursday, Les Richmond, an actuary with municipal bond insurer Build America Mutual, worried aloud that pension plans for States and locals will push more into risky assets to increase returns.
“Which we would consider negative,” Mr. Richmond said.
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