Unlike the “Jeffersons” who were moving on up, public pension systems return on asset assumptions (ROA) are moving on down! Since 2010, 90% of the 129 public pension plans monitored by the National Association of State Retirement Administrators (NASRA) have reduced their annual ROA target. The median objective is now 7.25%, which is down 25 basis points since 2015 and nearly 0.75% since 2010 as reported in a P&I article.
This is a move that is overdue and should be applauded as a step in the right direction, as the lower annual objective will mean that public entities have to contribute more each year to make up for the lower return target. The lower ROA objective should also lead to more conservative asset allocations and investment structures since an 8% objective would naturally lead sponsors and their consultants to invest more heavily in equity and alternative investments.
Given that we are now 10+ years into a bull market recovery for equities and a roughly 35+ year bull market for bonds, the probability of generating an 8% annualized return during the next decade has likely been diminished. Let us hope that the ability to move forward with a more conservative asset allocation will help plans weather potential market turmoil should a weakening global growth environment lead to a recession in the U.S. at some point.
Now, if one wanted to help insulate the portfolio from this potential development, one could always cash flow match the plan’s Retired Lives chronologically from the nearest benefit payment on out (possibly 1-10 years), which will provide the fund with an extended investing horizon for those assets in the portfolio that benefit from the passage of time. This strategy would also help to improve the plan’s liquidity needs, reduce interest rate volatility while stabilizing the funded status and contribution expenses. Intrigued? Please don’t hesitate to reach out to us to learn more.