Asset allocation changes that chief investment officers and boards of trustees have made at U.S. public pension funds since the market crisis of 2008 could be the difference in whether the funds will be able to meet benefit payments over the next 10, 20 or 30 years.
Consultants say public fund executives diversifying their portfolios — away from equities to manage downside risk and adding more investment return potential through increases in illiquid, alternative asset classes — likely will be in good shape when the next generation of retirees and those that follow begin to tap their benefits in ever larger numbers.
But that's true only for public funds with healthy funding ratios now (generally 80% or higher) and that expect to receive future annual required contributions — the cost of benefits accrued in the current year plus the money needed to amortize unfunded liabilities — so they can afford to lock up as much as 20% or 30% in alternative investments.
For investment executives overseeing public plans now suffering from poor funding ratios and insufficient future contributions and a bleak outlook for future, the need to provide liquidity to pay benefits over the next few decades will mean they can't increase or even maintain existing allocations to real estate, private equity, timber, hedge funds and other alternative asset classes, sources maintained.
Just last week, the $24.4 billion Pennsylvania State Employees' Retirement System became one of the first large, mature pension plans to radically alter investment of the fund in anticipation of liquidity shortfalls over the next 10 years.
At their Dec. 1 meeting, PSERS' trustees cut targets to four illiquid asset classes — private equity, venture capital, real estate and hedge funds - by 17.5 percentage points to 32% of plan assets and moved the assets to liquid public equities and fixed income, raising the combined target for both asset classes to 65% of the portfolio from 47.5%.
Other plans that also are making changes now to ensure being able to meet benefit payments well into the future are the $54.9 billion Minnesota State Board of Investment and the $4.2 billion Milwaukee Employes' Retirement System.
Indeed, sources said pension fund investment returns could make a huge difference in a pension fund's long-term ability to meet benefit payments.
Some plans already are paying out more in benefits than they are taking in through contributions.
“Month by month, quarter by quarter, year by year, demographically mature plans with chronic funding problems begin to experience an imbalance where benefit payments outstrip contributions. This won't create an immediate crisis, but rather, a slow death by 1,000 lashes, absent a change in investment returns or the contribution policy,” said a public fund investment consultant who asked not to be named.