State pension funds earn median 6.8% over 10 years, analysis finds

U.S. state pension funds earned an annualized 6.8% median return for the 10-year period ended June 30, 2015, compared with 7.3% the prior year, showed new data analysis from Cliffwater LLC, Marina del Rey, Calif.

The $13.8 billion Oklahoma Teachers' Retirement System was the best-performing state pension for the period, with an 8.3% return, followed by the 8.1% return produced by the South Dakota Investment Council for the $10.8 billion South Dakota Retirement System, and Minnesota State Board of Investment's 7.9% return for the $65 billion of retirement plan assets it manages, Cliffwater's recently released report showed. (All returns cited are annualized figures.)

The alternative investment consultant's yearly report — “An Examination of State Pension Performance: 2006 to 2015” — analyzed 10-year returns of the 64 U.S. state pension plans with June 30 fiscal-year ends. The 28 U.S. state pension funds with different fiscal-year ends were excluded from Cliffwater's analysis.

The 6.8% median return for 2015 fell within a wide range of individual pension fund returns — between 8.4% and 4.8%, a phenomenon Cliffwater researchers said in the report was “mostly … attributable to implementation rather than differences in asset allocation. We find that fund/manager selection by state pensions, in aggregate, has been accretive to return over the (10-year) study period.”

Two-thirds of state pension funds in Cliffwater's report exceeded the 6.5% return of a passive 65% equity/35% bonds portfolio over the same 10-year time period. However, in aggregate, U.S. state pension funds underperformed the 8% assumed rate of return for the decade ended June 30, 2015.

The good news, according to the Cliffwater report, is that “most state pensions were able to earn higher returns through diversification into alternatives and other forms of active management.”

“Most pension boards and staffs are fully aware of the investment challenges ahead,” the report noted and stressed “the increased use of alternative investments, including private equity, real estate, private real estate, hedge funds and real assets, has been the most pronounced change” by state funds in the last 10 years.

The aggregate asset allocation of the pension funds as of June 30, 2015, remained the same as the prior year, the report found, averaging 50% to public equity, 26% to fixed income and cash, and 24% to alternatives.

But the move by state pension systems into alternatives has stalled, leveling off between 24% and 25% of total plan assets since 2012, Cliffwater's analysis showed.

The breakdown of the aggregate $722 billion invested in alternatives by Cliffwater's state pension plan universe as of June 30, 2015, was: private equity assets, $273 billion; real estate investments, $194 billion; hedge funds, $124 billion; real assets, $103 billion; and other alternatives, $29 billion.

Median annualized returns of alternative investments for the 10 years ended June 30, 2015, were 11.9% for private equity; real estate, 6.6%; and hedge funds, 4.6%.

Topping Cliffwater's private equity annualized performance ranking for the decade ended June 30, 2015, was the $60.6 billion Massachusetts Pension Reserves Investment Management Board, which returned 16.9%, followed by the 15.4% return of the $128.2 billion Teacher Retirement System of the State of Texas, and the $22 billion Iowa Public Employees' Retirement System, with 15%.

The best-performing state funds in real estate over the 10-year period were the $69.9 billion Ohio State Teachers' Retirement System, with an annualized 10.9% return; the 9.9% return of the $14 billion Hawaii Employees' Retirement System; and the $106.5 billion New York State Teachers' Retirement System, which produced a 9% return.

By way of conclusion, Cliffwater's report authors said “the role of investment in helping (to) solve pension underfunding will largely be determined by the future of the capital markets, particularly for equity securities.”

“States overall have been successful stewards of pension assets over our 10-year study period, achieving returns that captured the opportunities presented by global markets and then some,” the report said, recommending that going forward, state plan fiduciaries continue to help investment staff maximize return potential “paying particular attention to differences in how state pensions implement within asset classes.”

The Cliffwater report is available here.