Public plans miss targets, eke out single-digit returns

Despite stocks plummeting in March when the COVID-19 pandemic was accelerating, most large public plans with heavy exposures to U.S. equities experienced single-digit returns for the fiscal year ended June 30, thanks to markets rebounding in April.

"It looked like we were on pace for double-digit losses. For many public pension systems, given their underfunded statuses and negative cash flow, those double-digit losses would have been severe," said Thomas Aaron, a vice president and senior analyst at Moody's Investors Service Inc., New York. "So, a market rebound was very welcome."

Still, returns were largely below assumed rates of return for public plans.

The median one-year return as of June 30 of the 36 plans tracked by Pensions & Investments through Sept. 2 was 3.14%. Public defined benefit plans in the Wilshire Trust Universe Comparison Service posted a median return of 3.2% for the year ended June 30. For large plans with more than $1 billion in assets, the median return was 2.37%.

Only two plans tracked posted assumed rates of return in the typical 6% to 7.5% range for these funds: the $46.6 billion Nevada Public Employees' Retirement System, Carson City, which returned 7.2% for the fiscal year; and the $916 million Merced County (Calif.) Employees' Retirement Association, 6.8%.

Although the median return for large public plans was lower than the previous two years — the median return was 6.5% for fiscal year 2019 and 8.9% the year before, according to P&I data — Mr. Aaron said it could have been far worse had markets not bounced back and stabilized.

"It was a very volatile fiscal year," Mr. Aaron added. "Most systems scored returns in the low single digits, which is still quite positive, and welcome compared to where we were at end of March."

According to a report from Moody's published March 24, U.S. public plans were on pace for an average investment loss of about 21% for the fiscal year ended June 30.

On March 23, the S&P 500 was down 30.43% from the end of 2019. But stocks have since bounced back, as the S&P 500 rebounded 39.31% through June 30 from March 23.

Longer term, the plans' annualized returns ranged from 3.4% to 8.1% for the three-year period and 4.4% to 7.7% for five years. Median annualized returns for the respective periods were 6.1% and 6%. For the 10 years ended June 30, P&I's return tracker showed a median annualized return of 8.3%.

Nevada PERS not only posted the highest one-year return that P&I reported, but also the highest three- and five-year annualized returns, at 8.1% and 7.7%, respectively, and the second-highest 10-year return at 9.6%.

Stephen Edmundson, investment officer for the pension fund, said in an email that its "portfolio benefited from our emphasis on high-quality liquid assets. Specifically, our allocation to large-cap U.S. stocks and Treasuries were the primary driver of our fiscal year return."

Mr. Edmundson added that the portfolio's "high degree of liquidity" enabled the plan "to implement a disciplined rebalancing program."

Even Mr. Aaron from Moody's cited Nevada's strong performance, noting that the plan benefited from "very good market timing moving out of equities before the downturn and sitting on proceeds in Treasuries, which let them go back in" when prices were low.

After being overweight public equities in 2019, Nevada PERS sold $2 billion in U.S. stocks at the end of December and rebalanced those assets into Treasuries. Then, equities sold off sharply in the first quarter of 2020 and Treasuries rallied as interest rates fell.

The Nevada plan then rebalanced $2.6 billion back into equities during the last two weeks of March "and risk assets subsequently rallied through the end of the fiscal year," Mr. Edmundson said.

Another advantage that Nevada PERS had is that the bulk of its portfolio (88%) is invested in passive strategies, with the remaining 12% split evenly between private real estate and private equity.

For the fiscal year, plans that were more diversified tended to see lower returns, according to David Lindberg, a Pittsburgh-based managing director at Wilshire Associates Inc. Larger plans with higher allocations to alternatives underperformed compared with the smaller plans that adhered more closely to a traditional 60% equities/40% bonds allocation, Mr. Lindberg said.

This is because plans with higher allocations to alternatives and private equity didn't rebound as quickly, since many alternatives assets weren't marked to market.

In addition, Mr. Lindberg added that larger plans are in general more diversified than smaller plans, so even in the public market, larger plans might have had less in U.S. equities than their smaller counterparts.

"The classic 60/40 portfolio was a dominant return provider over the one-year period," he added.

Of the four plans tracked that posted net losses for the fiscal year ended June 30, San Bernardino County (Calif.) Employees' Retirement Association reported the biggest loss, returning -3.1%.

"SBCERA has a long-term investment strategy and we've built an investment portfolio designed to generate positive returns over decades — rather than days, weeks, or months," said Olivia Applegate, spokeswoman for the $10.1 billion pension fund, in an email. "We have a meaningful allocation to credit and while we've seen a recovery from March lows, it has not been as dramatic as the stock market recovery."

SBCERA, which reported a 10-year annualized return of 7.4%, had an actual allocation of 14.8% to U.S. fixed income and 14.5% to global fixed income as of June 30.

Ms. Applegate added that "while pricing has not recovered to its prior levels, the defaults on our portfolio are well below expectations. As a result, we expect to recover significant value as our bonds mature or are refinanced."

The three other plans that posted negative returns were the $14.3 billion New Mexico Public Employees Retirement Association, Santa Fe, which returned -1.5% for the fiscal year ended June 30; the $12.8 billion New Mexico Educational Retirement Board, Santa Fe, -0.97%; and the $3.2 billion Santa Barbara County (Calif.) Employees' Retirement System, -0.12%.

In terms of prospects for the current fiscal year, Messrs. Lindberg and Aaron said they don't see plans shifting away from equities and alternatives anytime soon.

"There's always a lot of talk about it as retirement system boards have allocation meetings and consider their return targets and risk appetites, but I don't think that's translated to an observable shift at this time," Mr. Aaron said. "Most plans have return targets of 7%, so in a persistent low-interest-rate environment, they're forced to reach for yield in equities and alternatives. I don't think that's going to shift."

Meanwhile, Wilshire's Mr. Lindberg said the challenge he sees is that, with interest rates near zero, it will be difficult for investment-grade fixed income to provide the balance needed against riskier assets such as U.S. equities and alternatives if and when there are periods of market sell-offs.