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June 03, 2014 01:00 AM

Pew: Public funds at risk because of rise in equity, alts investments

Rob Kozlowski
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    U.S. public pension plans have significantly shifted their allocations to equities and alternatives from fixed income during the past 30 years to boost returns, putting their long-term sustainability at risk, according to a report from the Pew Charitable Trusts and the Laura and John Arnold Foundation.

    The report, “State Public Pension Investments Shift Over Past 30 Years,” says that while investment returns have been mostly strong since the early 1980s when public plans began to invest in equities and alternatives, more information is needed on plan performance because of greater fees and greater risk.

    The move came as state governments relaxed restrictions that also had been used to regulate insurance and savings banks that did not allow for a significant allocation to equities and alternatives.

    According to data from the Federal Reserve, almost 80% of U.S. public plan assets were in fixed income in 1982, compared to less than 25% in 2012.

    The report cited pension funds maintaining high assumed rates of return to keep contribution rates low as a significant reason for betting on a much higher risk premium.

    From 1992 to 2012, the report said, the median assumed rate of return for U.S. public plans had dropped only 25 basis points to 7.75% from 8%, while the expected return of U.S. Treasury bonds dropped to 2.92% from 7.67%, necessitating investing in riskier assets such as equities and alternatives.

    In the period between 2006 and 2012, meanwhile, plans' total allocations to alternative investments more than doubled, to 23% from 11%.

    Gregory Mennis, director, states public sector retirement systems project, at Pew, said that while higher risk has led to higher investment returns, the level of volatility in these plans means more governments should provide “additional information on pension performance, strategies and fees.”

    “Approximately $3 trillion of public pension plan assets currently are invested approximately three-quarters in stocks and alternatives investments, and in recent years we have seen significant increases in the use of alternatives in public pension plan portfolios, as well as management fees,” Mr. Mennis said.

    The report is available on Pew's website .

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