State and local pension funds have been increasing their allocations to riskier assets since 2001 but the higher risk has not translated into higher returns, according to a report from Fitch Ratings.
According to the report, the combined asset allocation to equities and alternatives among U.S. state, county and municipal pension plans rose to 77% in 2017 from 67% in 2001, while the average median return for the period from 2008 to 2017 is 6.2%, falling behind the average median return of 6.4% for 2001 to 2017.
The report also said that with historically low interest rates in recent years, "pension portfolios have shifted into broader ranges of equity and alternative assets with the intention of preserving long-term returns. However, this is often at the cost of higher exposure to short-term volatility and the risk that plan sponsors and participating governments will have to absorb the consequences of heightened risk."
The state with the highest combined allocation to equities and alternatives is Arizona with 86%, the report noted. It is one of seven states, including Connecticut, Hawaii, Maryland, New Hampshire, New Jersey and Rhode Island, that showed average underperformance of 2% or higher.
The report also noted that every state from 2001 to 2017 underperformed its expected rate of return, except South Dakota, which has a combined allocation to equities and alternatives of 66%.
"Persistent shortfalls in investment performance eventually necessitate future increases in employer contributions, which could be especially problematic for states with already elevated pension liabilities," said Olu Sonola, Fitch Ratings analyst and co-author, in the report.
Total unfunded pension liabilities increased to $1.2 trillion at the end of 2017 from $33 billion at the end of 2001, according to the report, reflecting lower than expected investment returns, contribution shortfalls and increases in projected future benefits.
