The New York City inspector is the latest government official to try to change laws aimed at limiting the risk in retirement investments as U.S. state and local pension funds try to close deficits in a low-yield environment.
Inspector Brad Lander, who oversees about $ 260 billion in pension money for city police, firefighters, teachers and other government workers, is asking New York lawmakers for more flexibility to invest in private markets, high-yield debt and foreign stocks. The State Comptroller’s Office, which oversees an additional $ 280 billion in pension assets, welcomes the idea, with a representative saying such flexibility “is key in times of market volatility.”
Pension funds, like household investors, face a relatively gloomy environment for equities and bonds, which are bread and butter in a traditional pension portfolio. In light of historical inflation and the Federal Reserve’s efforts to curb it, these funds are finding that they can no longer rely on bonds rising when stocks fall and vice versa. In the first quarter of the year, the S&P 500 returned minus 4.6%, while the Bloomberg US Aggregate bond index returned minus 5.93%.
“The two things together are what’s scary: the prospect of both falling at the same time,” said Steve Foresti, chief investment officer at Wilshire Associates, which advises large public pension funds. Retirement portfolio managers, he said, ask “in that environment, do I have anything that is actually rising?”
Fourteen states have laws on the books that limit how public workers’ pension money can be invested. Restrictions include imposing a maximum on what percentage of pension assets can be parked in the stock market, how much can be invested outside the U.S., or how much can be allocated to alternatives, according to research from the National Association of State Retirement Administrators.
Such laws typically aim to limit risk, as equities can crash in a downturn and illiquid private market investments can be difficult to pay out if pension funds need the money to pay benefits. However, many public pension systems are increasingly increasing the risk in an attempt to close significant funding gaps and meet investment return targets of around 7%.
‘Investment advisers and managers must [pension] boards and says there is no way you are going to meet the return assumption if you wear these handcuffs, ”said Kevin Leonard, partner at NEPC, which advises public pension funds.
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The Texas Legislature in 2019 decided to make a permanent 2011 decision to temporarily increase to 10% from 5% of the amount the State Teacher Pension Fund can invest in hedge funds. The Georgia Teacher Pension Fund began investing in private markets for the first time in fiscal year 2021 following the adoption of a bill allowing the fund to diversify beyond equities and bonds.
“I just felt it was not a sensible investment strategy to be so ultra-conservative,” said one of the sponsors, retired Sen. Ellis Black of Georgia. More than a third of legislators were against the measure. “When people promise greater returns, it’s obviously associated with greater risk,” said retired Senator Steve Henson.
In New York, more risky assets such as high-yield debt, private equity, hedge funds and private loans can account for no more than 25% of a pension fund’s assets. The law also limits non-US shares to 10%; any additional foreign shares count towards the 25% limit. Lander wants to increase this limit to 35% or raise the ceiling for foreign shares that do not count towards the limit of 30%.
The current law, last amended in 2006, “does not reflect the realities of the modern investment world,” Lander, a Democrat, told lawmakers in February, according to a copy of his remarks. Gov. Kathy Hochul, also a Democrat, “will evaluate this request along with the Legislature,” a representative said.
Lander, who was elected in November, struck a somewhat different tone when campaigning, saying in his strategic plan that he would consider reducing the city’s pension funds’ allocation to private equity and hedge funds, citing the high fees that these investments often carry.
An investigation conducted for the control office by Rocaton Investment Advisors showed that under Mr. Lander’s proposal allowed pension assets to be modified to increase returns by as much as eight tenths of a percent without increasing volatility, a representative said.
New York City’s pension funds, which serve police, city workers and teachers, report that they have just over three-quarters of the assets needed to pay future benefits, around the national average. This is to be compared with 94% at the city fund, which serves other school workers, and 63% at the firefighters’ fund. These actuarial calculations are based on 2019 holdings and do not reflect significant gains in the financial year 2021.
The funds’ annualized private equity returns for the five years ending in 2021 range from 18.8% to 19.7%. This is slightly higher than their domestic stock returns, which ranged from 17.1% to 18.2%. Wilshire and other consultants expect private equity returns to exceed equities by several percentage points over the next decade.
Public pension funds get their money from three sources: government employees, the state and local authorities that hire them, and return on investment. Adding investments with higher return expectations typically helps avoid or limit cost increases for these employers and employees.
But if investment eventually underperforms, governments and workers could end up stuck with an even higher bill. At a panel on inflation risks for the state and cities on Thursday, Les Richmond, an actuary for the municipal bond insurance company Build America Mutual, worried loudly that state and local pension schemes would push further into risky assets to increase returns.
“We would consider that negative,” Mr. Richmond.
Write to Heather Gillers at email@example.com
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