According to the Boston College Center for Retirement Research, state and local pensions now have on average 77% of their pension assets in equities or alternative investments, such as private equity and real estate. This is a dramatic change from 2001 when the average plan only had 67%. The significant move into equity-like strategies is likely fueled by the need to boost returns in a challenging environment for increasing contributions. Unfortunately, the increased exposure guarantees more risk, but not necessarily the corresponding return.
Who knows whether or not this lengthy bull market for equities is nearing its end (I certainly don’t), but pension systems that are in significantly negative cash flow conditions cannot afford the consequences from another devastating market correction. By converting the current fixed income exposure to a cash flow matching strategy designed to match the nearest benefit payment as far out as the exposure will permit, a plan can significantly reduce the negative impact of a market decline on the equity exposure that no longer is a source of liquidity.
It makes no sense to continue to put all your chips on the table when just a little tweak to the portfolio can help reduce the risk of a major correction crushing the plan’s funded status. Public pension systems’ contribution rates are already testing taxpayer resolve in a number of situations. Let’s not give them more fuel for their fire!