The amount of risk public pension plans take is often overlooked, with much of the focus being on metrics like funded status and target returns. With lower return expectations, funds are embracing riskier assets.
Mind the gap: With Treasury yields falling faster than expected returns, the risk premium is growing. The spreads improved in 2017 as 10-year Treasury yields rose, but plans still need to add more risk relative to pre-crisis years.
Seeking alternatives: Alternatives have been put to work to combat low yields with plans investing more in hedge funds, private equity and real estate. Public plans have doubled their alternative allocations since 2007.
Volatility changes: Low volatility in 2016 and 2017 improved the risk/return profile of a model portfolio relative to the years prior. The contrast of portfolio efficiency when looked at through a seven-year and 10-year window shows the impact the financial crisis has on historical models. Low volatility and Treasury rates in 2016 and 2017 boosted Sharpe ratios when 2008 and 2009 are removed.
Sources: The National Association of State Retirement Administrators; P&I Research Center; Bloomberg LP; thanks to The University of Minnesota’s Heller-Hurwicz Economics Institute