U.S. public pension plans invest more in riskier assets than private plans, a report issued by the Center for Retirement Research at Boston College said.
In addition, for any given asset allocation, public plan return assumptions are on the optimistic end compared to those of investment professionals in the industry at large.
The report, "Impact of Public Sector Assumed Returns on Investment Choices," reveals that public pension plans have a riskier portfolio relative to private plans, which don't calculate the assumed return in the same way.
The report shows that from 2001 to 2008, the average allocation to fixed income, equities and alternative asset classes was roughly the same for public and private plans. But from 2009 to 2015, those allocations diverged, with public plans allocating significantly more to risky assets than private plans. Specifically, public plans had 72% in risky assets (50% in equities and 22% in alternatives), while private plans had 62% (44% in equities and 18% in alternatives).
CRR's analysis suggests that the main difference in allocation "is related to unobservable differences between the two sectors, including the public sector's use of the assumed return," the report says.
In an interview, Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College and co-author of the report said that the difference between how public and private plans allocate their assets "can't really be explained."
"Even when establishing controls, comparing plans that look the same, have the same size, the same maturity, you'd expect they'd have the same allocation," he said. "But they don't."
Mr. Aubry suggested that one reason why public plans may have riskier allocations than private plans is that public plans benefit from a higher assumed rate of return than private plans.
"So, to achieve that, their portfolios need to look riskier," he explained.
In addition, the assumed returns of public-sector plans are on the optimistic end of the assumptions of investment experts in the industry.
Even given the riskier asset allocation of public-sector plans, many investment experts contend that public plans' assumed returns are too high. And because public plans use the assumed return to set funding policies, optimistic return expectations could undercut their financial stability through inadequate contributions, the report said
The report compares the public sector's assumed return to an assumed return based on published expectations from BlackRock (BLK). The report shows that the average assumed return for a public plan is 7.4%, which equals the optimistic expectations constructed from the BlackRock data (its pessimistic return is 5.8%).
"Given their allocations, public plans' assumed returns aren't out of whack compared to what asset managers are projecting," Mr. Aubry added.
The report suggests that the situation is worth monitoring because optimistic return expectations "could yield required contributions that are ultimately inadequate to meet benefit obligations and, thus, threaten the financial stability of public plans."