No Need For The Volatility

The following graph highlights the fiscal year returns for the Mississippi Public Employees Retirement System. I would hazard a guess that this pattern differs only marginally from the “average” public pension system, since most plans continue to focus on the ROA as the primary objective and they all tend to be 7% and greater. This volatility is neither necessary nor helpful, as it leads to big swings in both the funded status and contribution expenses.

The chart begins with the year that equity investing was first permitted. I have no issue with plans investing in a variety of asset classes and products provided that the primary objective is to secure the pension plan’s promised benefits. To that end, we recommend that you don’t have all of your assets as alpha generating assets. It is imperative that the near-term pension liabilities be defeased allowing for a longer investing horizon for the true alpha assets to generate excess returns versus future liability growth.

As we demonstrated in a recent post, the volatility associated with short time frames is difficult to manage (see above chart), but by extending the investing horizon to 10-year time frames the probability of success is greatly enhanced.

Also, in the article where I came across the fiscal year returns for Mississippi PERS they mentioned that the plan’s funded ratio was only 60%. I realize that there are many factors that go into why a plan’s funded status may be a certain level – contributions, benefits changes, returns, expenses, etc. – but I always find it interesting when an annualized return over some long period reveals outperformance versus the ROA objective only to have the plan’s funded status be so poor. It just highlights that achieving the ROA is not the answer to solving the DB pension problem.

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