The median return for six of the 10 largest U.S. public pension funds by assets was 6.36% in calendar year 2014, driven by strong returns in real estate, private equity and U.S. equities and fixed income.
That figure is 73 basis points below the 7.09% median return for public plans with more than $5 billion in the Wilshire Trust Universe Comparison Service.
Among the largest pension funds, the best return was by the $129.9 billion Texas Teacher Retirement System, Austin, with 8.51%. A performance report prepared by investment consultant Aon Hewitt Investment Consulting showed the strongest returns came from long Treasuries, “other absolute return” and private equity.
At the other end was the $89 billion Wisconsin State Retirement System Core Trust Fund, Madison, with 5.7%, matching its benchmark, data provided by spokeswoman Vicki Hearing showed.
Pension funds with higher allocations to U.S. stocks and bonds generally outperformed their peers in 2014, said Steve Charlton, partner and director of consulting services at NEPC LLC, Cambridge, Mass. The Russell 3000 returned 12.53% in 2014. While that result was positive, it was a significant drop from 2013's return of 33.6%.
Fixed income, on the other hand, posted higher returns in 2014 than 2013. The Barclays Capital U.S. Aggregate bond index was up 5.97% in 2014 compared with a -2.02% return in 2013.
And funds with heavy exposure to international equities might have suffered as well. The MSCI All-Country World index ex-U.S. returned -3.47% in 2014, down from 16.3% in 2013.
While the majority of pension funds reviewed met or exceeded their custom benchmark returns, there were exceptions.
The $301.7 billion California Public Employees' Retirement System, Sacramento, returned 6.5% in 2014, 31 basis points below its custom policy benchmark and 59 basis points below the TUCS median for public funds with more than $5 billion in assets.
A performance review prepared by CalPERS' investment staff cited an overallocation to public equities and an underallocation to private equity as reasons for the underperformance. Public equity, which made up about 53% of CalPERS' total portfolio as of Dec. 31, returned 4.6% in the year, two basis points below the pension fund's custom benchmark.
CalPERS has the highest international equity allocation among the pension funds reviewed, at 24.3%, vs. 28.7% for its public domestic equity holdings.
The $190.8 billion California State Teachers' Retirement System, West Sacramento, also underperformed its 8.78% benchmark. However, the pension fund's overall return of 8.1% surpassed its 7.5% assumed rate of return and the 7.09% median return for the large-fund Wilshire TUCS universe.
A document prepared for CalSTRS by Pension Consulting Alliance, its investment consultant, cited the “abnormal” return of its private equity benchmark as the reason the pension fund underperformed its overall benchmark. CalSTRS' private equity program, with a return of 13.83% was its second highest performing asset class, but trailed its benchmark by roughly five percentage points.
During the year the pension fund changed its private equity benchmark to a hybrid long-term/short-term model from one tied to public equity performance. With the strong equities market last year, that pushed the benchmark much higher than the actual portfolio, a spokesman said.
At CalPERS and Texas Teachers, active management contributed negatively to public equity returns, performance reports of the funds showed.
Active managers, particularly U.S. equity managers, have struggled to outperform passive management in recent years, said Tim Barron, president and CEO of investment consulting firm Segal Rogerscasey, Darien, Conn. A series of up years has “historically made it more difficult for active mangers to outperform,” Mr. Barron said. “There is less stock-to-stock volatility as everything tends to move more in lockstep.”
For CalSTRS and several other funds reviewed, the highest performing asset class was real estate, not U.S. equity.
Returns for privately held real estate were positive, but real estate investment trusts were “king,” said William Frieske, Chicago-based vice president and senior performance consultant for Northern Trust Corp.'s investment risk and analytical services group. Falling interest rates have been a tailwind for REITs, Mr. Frieske said. “If you were there, that was golden, that was a huge win,” he said.
The Wilshire REIT index was up 31.8% at the end of 2014.
Other alternative investments posted positive, but significantly lower returns.
“At the end of the day, hedge funds and private market assets did not help a lot, particularly investments that were long commodities or emerging markets, two asset classes that were hurt particularly by the sell-off in energy,” Mr. Charlton said. “That would have been pretty damaging for performance,” he said.
Double-digit negative returns in commodities were the norm for a number of the pension funds reviewed, including PennPSERS, CalSTRS and Texas Teachers.
While not in the top 10 by assets, the top performer for 2014 among public funds reporting calendar-year returns was the $51.7 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, which returned a net 8.83%, exceeding its policy benchmark by 217 basis points and the TUCS median return by 199 basis points.
The pension fund's three strongest returns came in real estate, 17.2%; master limited partnerships, 16.3%; and U.S. equities, 11.75%.
And while some pension funds' international equity returns were diminished by a rising U.S. dollar, PennPSERS' international equity portfolio was up 5.1%.
James H. Grossman Jr., chief investment officer, said in an interview that the pension fund's decision to hedge its non-developed markets U.S. currency exposure, starting in late 2013, “added a few $100 million to (PennPSERS') performance” in 2014.
Other strong performers were the $10.6 billion San Diego County Employees Retirement Association, with an estimated net return of 8.79% for the 12 months ended Dec. 31, compared with its 7.57% benchmark, and the $2.8 billion Nashville (Tenn.) Davidson & County Metropolitan Government Employee Trust Fund, which returned a net 8.3%, compared with its 6.16% benchmark. n
Reporter Randy Diamond contributed to this story.