U.S. equities, fixed income give boost to public plans

Domestic equities and fixed income served large public pension plans well in the fiscal year ended June 30, with many U.S. defined benefit systems seeing returns in line with expectations.

"A heavier concentration in U.S. equities was definitely a tailwind for plans," said Steven J. Foresti, chief investment officer at Wilshire Consulting. "Fixed income also did fine, (while) commodities had a difficult return period."

The median one-year return as of June 30 of the 22 plans tracked by Pensions & Investments through Aug. 14 was 6.66%. Public defined benefit plans in the Wilshire Trust Universe Comparison Service posted a similar median return of 6.62% for the year ended June 30. For large plans (those with more than $5 billion in assets), the median return was 6.69%.

Although the median return for large public plans was the lowest it's been in three years — the median return was 8.94% for fiscal year 2018 and 12.4% for FY17, per P&I data — Mr. Foresti said the average returns for many large public plans hewed pretty close to their expected targeted returns.

Of the 21 tracked plans that provided benchmark data, 13 exceeded their policy benchmark returns. And several of those that lagged did so by only 50 basis points or less. For example, the $101.1 billion Minnesota State Board of Investment, St. Paul, returned a net 7.3%, vs. 7.6% for its benchmark. The $74.8 billion Massachusetts Pension Reserves Investment Management Board, Boston, returned 6.1% gross of fees, below its benchmark of 6.6%. And the $76.3 billion Ohio State Teachers' Retirement System, Columbus, returned 7.13%, 17 basis points below its benchmark.

None of the plans that P&I tracked posted double-digit or negative returns in the most recent year.

Longer term, the plans' annualized returns ranged from 7.5% to 11.26% for the three-year period and 4.2% to 8.5% for five years. Median annualized returns for the respective periods were 9.63% and 6.69%. For the 10 and 20 years ended June 30, P&I's return tracker showed median annualized returns of 9.53% and 6.09%, respectively.

The $44.1 billion pension Nevada Public Employees' Retirement System returned a net 8.5%, the highest return that P&I tracked. The pension fund exceeded its policy benchmark of 8.3% for the fiscal year.

Stephen J. Edmundson, investment officer for the Carson City-based pension fund, attributed the high return to being overweight to equities. "U.S. equities carried the day for us," Mr. Edmundson said in a phone interview.

Nevada's state plan had an actual allocation of 46.1% to domestic equities and 18.4% to international equities as of June 30. The pension fund's domestic and international equity portfolios are all invested in index funds.

In December, Nevada PERS rebalanced nearly $1 billion back into U.S. equities. "The timing of that event ended up working out pretty good for us," Mr. Edmundson said.

The plan with the lowest reported annual return was the $1.7 billion Louisiana Firefighters' Retirement System, which returned a net 3.9% in the fiscal year ended June 30, below its policy benchmark return of 6.1% for the year. Michael Becker, chief investment officer for the Baton Rouge-based retirement plan, did not respond to a request for an interview.

Although no plan is identical, performance of the two largest state plans — the California Public Employees' Retirement System and the California State Teachers' Retirement System — wound up representing several performance and return trends among public plans overall, according to Thomas Aaron, a vice president and senior analyst at Moody's Investors Service.

"Thus far, we have seen one of the biggest systems in the country, CalPERS fall a bit shy of its return target," Mr. Aaron said in a phone interview.

The $376 billion CalPERS, Sacramento, reported a 6.7% net return for its fiscal year ended June 30, underperforming its 7.1% benchmark. The $236.9 billion CalSTRS, West Sacramento, returned a net 6.8%, surpassing its 6.5% benchmark.

"If you look at where the first half of the fiscal year was, this represents a rebound," Mr. Aaron added. "The outlook as of Dec. 31 for returns was a bit worse than where they ended up. Q1 and Q2 (of 2019) were quite strong."

He noted that private equity served CalPERS and CalSTRS well during the fiscal year, returning 7.7% for CalPERS and 10.5% for CalSTRS. Fixed income was another big driver for CalPERS, returning a net 9.6% for the year.

Looking forward, Mr. Aaron said that because returns for large public plans were "pretty close to expectations, contributions (for fiscal 2020) may be a bit higher" than expected, "but not by a lot."

"That said, volatility risk is quite high," Mr. Aaron added. "If we see a recession combined with significant pension investment losses, that could do greater credit damage to state and local governments than the last recession."

Wilshire's Mr. Foresti said there are concerns of a potential global slowdown, driven by trade wars between the U.S. and China and an inversion in the yields on the 2-year and 10-year U.S. Treasuries for the first time since 2007.

"There are lots of clouds ahead," Mr. Foresti said. "But these are institutions that take a long-term view, so I wouldn't expect a radical shift in asset allocations. They're just facing some challenging times."