Public pension fund assumed rates of return are coming down — and it's about time — but the lower assumptions might not be low enough.
As reported in the Sept. 30 issue of Pensions & Investments, only three of 129 public plans tracked by the National Association of State Retirement Administrators now have assumed rates of return of 8%, compared with 59 in 2010 and another 30 that had rates higher than 8%. The median rate of return in 2010 was 8%. In fiscal 2019, the median assumed rate of return in the NASRA survey is 7.25%.
Are the new returns low enough? Some projections for the next 10 to 15 years are bleak and suggest funds may have to aim lower.
Morningstar Investment Management LLC, J.P. Morgan Asset Management, BlackRock Investment Institute and Vanguard Group Inc. predict nominal returns (returns before inflation) of 1.8% to 7% for equities and 2.5% to 4.5% for fixed income.
Given that U.S. equities are near the record high, even these projections are too optimistic.
Thus, even a 100% U.S. equity portfolio will likely return less than the median 7.25% return assumed by public employee pension funds. Throw in some bonds and the return will be significantly lower than the 7.25%.
Alternative investments such as venture capital, private equity and real estate will not return enough to make up the difference.
This suggests that public funds will have to further reduce assumptions. But many public plans are significantly underfunded, and lower assumptions would require increased contributions to maintain funding levels.
This makes reducing the return assumption difficult for public fund officials because it involves politicians approving contribution increases. Employees also might have to contribute more or accept reduced benefits.
Nevertheless, additional return assumption reductions, and increased contributions likely will be necessary in the not too distant future.