The WSJ has published an article today that highlights Wilshire’s TUCS universe performance for public pension systems. The gist of the article is that public pension systems established a 22-year record for positive performance during the second quarter – great – but there is no time to celebrate. Yes, the median public pension generated a whopping 11.2% return for the 3-months ending June 30, 2020, but the 12-months through the second quarter produced only a 3.2% return for the same universe of plans, which dramatically undershoots their target return of roughly 7.2%.
Once again we find these plans riding the asset allocation roller coaster to ruin. Despite the terrific second quarter result, plan sponsors are still facing massive funding shortfalls that will continue to grow, as many states and municipalities deal with the consequences of falling revenues and escalating costs associated with the Covid-19 crisis making the full payment of this year’s ARC nearly impossible. Sure, no one saw this coming, but then again, do we ever see Black Swan events before they’re thrust upon us?
Adopting a different approach to asset allocation is imperative at this time. We would highly recommend splitting the assets between beta (cash flow matching retired lives liabilities) and alpha (growth assets to meet future liabilities) enabling the plan to maximize the efficiency of the asset allocation. We’ve discussed this subject in previous blogs and in Ryan ALM research that can be found at RyanALM.com.
We remain huge fans of the traditional defined benefit plan, but have never been fans of the focus on the return on assets assumption (ROA) as the primary pension objective. Public pension systems cannot afford the volatility that the current approach produces, especially in this environment. Adopt this strategy that was once the only game in town and you will improve liquidity to meet benefit payments, eliminate interest rate risk, reduce the volatility of the funded status and contribution expenses, while extending the investing horizon for all of the alternative assets that have been injected into these plans.
Let’s stop riding that asset allocation roller coaster before we are all wet. Oh, as I sit at my desk in New Jersey today, I am reminded that the picture above was from Super Storm Sandy (October 2012). Ironically, we are under a tropical storm warning from Isaias. Stay safe, everyone.