If you are a believer that managing a pension system is about generating the highest return then you may appreciate a recent WSJ article that referenced Wilshire Trust Universe Comparison Service (TUCS) data highlighting growing exposure among public pension plans to domestic and international equity. However, if you believe like I do that managing a pension system is all about meeting the promise (benefits) at the lowest cost, you may be very concerned about the data shared by Wilshire.
The TUCS data indicates that public pension systems have seen their public equity exposure grow to 59% from 57%. Now it is very likely that this is just the result of good equity market returns relative to other asset classes, but it none-the-less highlights the fact that these systems are willing to roll the dice on equity market returns rather than derisk these plans as the bull market ages (now nearly 9 1/2 years). In addition, alternative investment allocations are growing, especially for pension plans with more than $5 billion in assets. In fact, the alternative allocations are now greater than fixed income allocations for the $5+ billion systems.
The focus on the return on asset assumption (roughly 7.25% to 7.5% for the average public plan) is forcing asset consultants and their plan sponsor clients to build these aggressive allocations, especially if the funding status is weak. But, will they be rewarded with enhanced returns or are they just injecting more risk than necessary this late in the market cycle?
In addition to the public and private equity allocations, Wilshire is reporting that the allocation to fixed income is declining. Now, most of you will say that a reduction is warranted given the “likely” economic growth, inflation, and rising interest rates that we are about to witness, but bonds play a very important part in pension management – they provide cash flow to meet required benefit payments.
Given the nearly 80% equity and alternative allocation for large public systems, are we about to repeat what transpired in the 2007-2009 Great Financial Crisis when liquidity was at a premium and equity market returns were negatively impacted by forcing liquidity where it wasn’t naturally available? It sure looks to be the case. Can these systems, their employees, and the taxpaying public endure another dramatic hit to a system’s funded status? Not likely! We have an alternative approach to this return-chasing game. Reach out to us and we will be more than happy to share our insights.