Buoyed by U.S. equities, public pension funds see double-digit returns this year

U.S. public pension funds chalked up a second straight year of positive returns for the fiscal year ended June 30, with half posting double-digit numbers despite a somewhat muted bond market and continuing challenges in private markets.

While experts said this was all good news, the dominance of U.S. equities has left them having to convince some public pension fund board members that diversification is still important.

The median return was 9.9% among the 64 pension funds with more than $1 billion in assets whose results had been tracked by Pensions & Investments as of Sept. 16. The median return among plans tracked by P&I the previous fiscal year was 7.6%.

For the most recent fiscal year, every tracked pension fund reported positive returns — with a range of 5.9% to 14.5% — and those with greater exposure to public equities and lesser exposure to private markets posted the most impressive numbers, continuing a trend from the prior fiscal year.

It was even a more impressive year than fiscal year 2023 when pension funds recovered strongly from an anemic fiscal year 2022 that saw negative returns across the board. Returns for the fiscal year ended June 30, 2023, ranged from 2.2% to 11.9%.

“Public markets, particularly U.S. equities, were far and away the standout performer,” said Thomas Toth, managing director at Wilshire Advisors. “For a relatively diversified portfolio it was up well north of 20%. Other areas of the portfolios lagged meaningfully, even though they were also up quite well.”

For the year ended June 30, the Russell 3000 index returned 23.1%, above even its impressive return of 19% for the year ended June 30, 2023.

Toth said other asset classes also performed well, often above 10%, and those included international equity and high-yield fixed income. For the year ended June 30, the MSCI EAFE returned 11.5% and the Bloomberg U.S. Corporate High Yield Index returned 10.4%

Private equity and real estate indexes lag by one quarter. For the year ended March 31, the Cambridge Associates US Private Equity index returned 8.3%, and the NCREIF Fund Index – Open-end Diversified Core Equity returned -12%.

Private equity, which for many public pension funds in the prior fiscal year experienced negative returns as a result of the drawdowns from fiscal year 2022, in general did perform positively in the low single digits, said Toth.

Because of the dominance of the public markets, however, Toth said smaller pension funds in general performed better this past fiscal year.

“Smaller plans tend to be a bit more middle-of-the-fairway in terms of a very strong focus on public markets (that) did tend to outperform the larger plans, which have more sophisticated, complicated asset allocations incorporating private assets and could be incorporated portfolio construction techniques like leverage in the portfolio,” he said.

Those “additional nuances” have created a drag on the portfolios of larger pension funds, Toth said.

Georgia on top

Two larger pension funds that are outliers with nearly all their assets in the public markets are the $109.5 billion Georgia Teachers’ Retirement System and $17.9 billion Georgia Employees’ Retirement System, both based in Atlanta. The two pension funds posted the highest recorded returns for the period at 14.5% and 14.1%, respectively.

Jim Potvin, executive director of the Georgia Employees’ Retirement System, said in an interview it’s “all about the allocation.”

“Our (state) statutes are somewhat restrictive in terms of what we can invest,” Potvin said. “It starts with a maximum 75% exposure to equities and then to a max to alternatives — which we’ve gone into private equity — of 5%. It’s pretty much 75% stocks, 25% bonds and then 3% or 4% of private equity and that’s the way it’s been for the last couple of decades.”

Potvin added that ERS and TRS use the same investment managers and have similar asset allocations, which accounts for the closeness of the two pension funds’ investment returns.

As of June 30, TRS and ERS had actual allocations of only 0.7% and 3.1%, respectively, to alternatives.

Posting the third-highest return at a net 14% was the $15.1 billion Louisiana State Employees’ Retirement System, Baton Rouge. Unlike the Georgia pension funds, LASERS has a significant allocation to private markets totaling 21.7% as of June 30, although that is considerably lower than the allocation for the largest public pension funds.

Bobby Beale, chief investment officer, said in an Aug. 27 news release the outperformance “underscores our commitment to strategic asset allocation and prudent risk management. The plan benefited from favorable equity markets, as well as our allocation to global multisector/opportunistic investments, which makes up the majority of our fixed-income portfolio.” Beale later referred questions to the news release.

LASERS’ total equity portfolio returned a gross 18.9% for the fiscal year ended June 30, while global multisector/opportunistic investments returned 14.3% (which includes a mix of gross and net returns), and the alternatives asset class returned a net 6.2%.

The pension fund had posted the second-highest return in the P&I universe for the fiscal year ended June 30, 2023, at 11.7%.

The fourth-highest return for the most recent fiscal year was posted by the $12.2 billion Oklahoma Public Employees’ Retirement System, Oklahoma City, which returned a net 12.7%. The prior year, OPERS had the second-highest return with a net 10.9%.

Joe Fox, OPERS’ executive director, said while the pension fund benefited from an overweight position to U.S. and non-U.S. equity markets, fixed income also contributed positively to the pension fund’s overall results.

“The positive total return to fixed-income markets for the fiscal year were a welcome development, as the Federal Reserve took its foot off the brake during the fiscal year,” Fox said. “That asset class had been an anchor dragging overall fund performance for three out of the last four fiscal years.”

“Overall, there were few areas of the financial markets that did not produce positive total returns, and active risk-taking in certain pockets of the market was particularly well-rewarded for the period,” he said.

As of June 30, OPERS' actual allocation was 41.1% U.S. equity, 30.1% U.S. fixed income, 28.4% international equity, 0.3% cash and 0.1% real estate.

While every public pension fund posted positive returns for the fiscal year ended June 30, some inevitably regretted a lack of exposure to domestic equities during a period in which stocks dominated so strongly.

“For our clients, how are they acting upon this?” asked Jay Kloepfer, executive vice president and director of Callan’s capital markets research group. “Interestingly they are eager and keen to be invested in the U.S. equity market.”

However, he said that many board members are not financial experts, primarily serving by virtue of government positions or elected by plan participants.

While many board members are required to have some financial background, Kloepfer said not all do and can respond to market movements emotionally. They're human, he said.

The result is some board members have looked upon their investments in asset classes like emerging markets equities and international small-cap equities as missed opportunities.

“We try so hard to keep our clients invested in the non-U.S. markets when they’re 40% of the global market," Kloepfer said, “and the premise — which has not been fulfilled — is emerging markets is going to be a place where growth happens, and that growth will translate to stock-market share. But as a U.S. investor, you have been penalized for that belief for five, 10, 15 years.”

For the five and 10 years ended June 30, the Russell 3000 index returned an annualized 14.1% and 11.9%, respectively, while the MSCI EAFE index has returned an annualized 6.5% and 4.3%, respectively.

Long-term returns

Among the 46 U.S. public pension funds for which P&I has 10-year annualized returns, only 20 plans returned at or above 7%, which is the median for public pension plan assumed rates of return, for the 10 years ended June 30.

The two top public pension funds for the 10-year period were the $64.1 billion Nevada Public Employees’ Retirement System, Carson City, and the $95.3 billion Ohio State Teachers’ Retirement System, Columbus, which posted annualized net returns of 8.4% and 8.1%, respectively, for the period. Notably, the latter system is currently embroiled in controversy due to a group of reform trustees claiming their investment returns are poor and the system should move to all or nearly all index funds, citing the success of the Nevada system, which is more than 80% passive.

For the longer term, larger pension funds with higher allocations to private markets performed better against the median than they did for the fiscal year ended June 30.

Those whose most recent fiscal-year returns fell below the median return of 9.9% in the P&I universe but finished well above the median return of 6.8% for the 10 years ended June 30 include the $344.9 billion California State Teachers’ Retirement System, West Sacramento (which returned 8.4% for one year and 7.7% for 10 years) and the $94.5 billion Oregon Public Employees Retirement System (6% for one year and 7.3% for 10 years).

For the five years ended June 30, 39 U.S. public pension plans posted annualized returns at or above 7% of the 52 public pension plans for which P&I had current data.

Cutting emerging markets

In the past year, at least a half dozen public pension funds have reduced or eliminated their emerging markets equity exposure due sometimes to geopolitical concerns but also because of the strength of U.S. equities.

In June, the Pennsylvania State Employees’ Retirement System, Harrisburg, cut the target to emerging markets equities for its $36.4 billion defined benefit plan to 2% from 5% and raised the target to domestic equities to 37% from 34%.

PennSERS spokeswoman Pamela Hile said at the time that "emerging markets' long-term underperformance relative to U.S. equity was one factor in the decision and part of a long-term strategic change."

Another issue is the level to which the U.S. dominates in technology, with the Magnificent stocks including NVIDIA and Apple.

“You have companies that actually make things,” he said. “They’re not ephemeral. NVIDIA is a real company that makes things, although I would hesitate that NVIDIA is more valuable than Apple.”

Kloepfer said the skyrocketing stock prices of technology companies represent existing companies and it isn’t like the dot-com recession in which people were buying on a promise of future production, and trying to convince boards that they should continue to invest in non-U.S. equities has led to “frustrating conversations.”

Margaret Belmondo, partner and public fund team leader at investment consultant NEPC, echoed that it has been frustrating for the firm to see such a narrow market outperforming when they want to create a diversified all-weather portfolio, but signs are the market is broadening again since the beginning of fiscal year 2025.

“We’re seeing a broader market in value names, and we’re also seeing it in small caps, which is great,” Belmondo said. “It’s so hard because our clients are diversified across all asset classes … so we want to create an all-weather portfolios. It does get frustrating when you just see this narrow market outperforming, but we do see ourselves coming out of it.”

“I also think with the Fed going to begin to cut rates in September, that should be a tailwind. But there’s still a lot of uncertainty,” she said.