Despite risks, public pensions put faith
in long-term returns
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[February 07, 2017]
By Robin Respaut
SAN FRANCISCO (Reuters) - U.S. public
pension funds are cutting their expectations for investment returns over
the next 30 years or more, but some do not expect to meet even the new
targets over the coming decade.
After a long period of low interest rates, forecasts by investment
analysts show the next 10 years will probably bring slower market
growth, leading to reduced expectations for the $3.7 trillion of public
But public pensions are wary of lowering their expected return rates, or
the discount rate, too quickly because doing so would drastically
increase costs for state and local governments and their employees,
whose contributions form the funds.
Instead, the funds say they plan to make up for lower returns expected
in the coming decade over the next 30 years or more.
“Pension funds are in an extraordinarily difficult political situation,”
said Don Boyd, fiscal studies director at the Rockefeller Institute of
If they protect their portfolios by moving assets into safer,
lower-return investments, he said, “they will have to drastically
increase the cost for local governments. They are reluctant to do that.”
The California Public Employees' Retirement System, the largest U.S.
public pension fund, anticipates annual returns of 6.2 percent over the
However, CalPERS still expects its long-term return to align more
closely with a discount rate that it plans to reduce to 7 percent by
2020, because it anticipates returns will jump to 7.83 percent in the
decades to follow.
Such a forecast in the short term could spell declining fund conditions,
a rise in unfunded liabilities and increased costs for government
employers and workers.
CalPERS is not alone. The Ohio Public Employees Retirement System
expects an average 6.76 percent return over the next five to seven
years, short of its 7.5 percent discount rate. But the fund anticipates
returns will climb to 7.85 percent over a 30-year period.
Los Angeles Fire and Police Pensions expects compound returns of 6.33
percent over the next decade, considerably below its 7.5 percent
discount rate. The fund believes the compound return “will rise over the
long-term as interest rates move back up,” said General Manager Ray
PAST IS PROLOGUE
Private-sector and public plans in Canada and Europe lowered their
discount rates over the past two decades. But U.S. public pension funds
maintained higher return expectations and put more of their money in
risky assets to help achieve them, according to the Rockefeller
As a result, the potential impact of investment shortfalls, relative to
government tax revenue, is now more than three times as large as it was
in 1995, and about 10 times as large in 1985, the Rockefeller Institute
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As yields on risk-free Treasuries fell, private pension plans
lowered their investment return assumptions but public plans did
not. Instead, public pensions invested in risky assets.
CalPERS hopes to avoid another calamity like the one it experienced
during the 2008 recession, when its funding status dropped to 61
percent from 100 percent.
Like the vast majority of U.S. public pensions, the $307 billion
fund is now paying out more money to retirees than it is collecting
from current workers and employers.
“It’s a challenging market to operate in,” said CalPERS Chief
Investment Officer Ted Eliopoulos. “When you’re in that position,
you need to be asymmetrically concerned about downside risk as
CalPERS has reduced volatile stocks and private equity from its
portfolio. It made more than $9.2 billion in net equity sales in
September and October, according to fund documents. In December, the
board reduced the discount rate to reflect the new portfolio
The new expectations still did not reflect investment advisers’
short-term forecasts. Wilshire estimated only a 17 percent
probability that CalPERS would earn its new 7 percent discount rate
over the next decade.
At the time, CalPERS board member J.J. Jelincic proposed reducing
expectations further to align the discount rate more closely with
advisers’ forecasts. “6.25 is the reality,” Jelincic said at a
But the board worried that the costs of such a move would require
even higher contributions from California governments and workers.
Cities are already warning of the impending strain.
Scotts Valley, a small city outside of Santa Cruz, expects its
annual pension costs to jump by nearly 75 percent over three years
under CalPERS’ new discount rate. By 2021, the city’s annual pension
contributions will reach $2.8 million, about 16.3 percent of the
city’s total budget, up from $1.5 million, or 9.6 percent, today.
“Even though I personally would like to see a lower assumption,”
CalPERS board member Dana Hollinger said in December, "I realize it
would be too much of a strain on budgets."
(Reporting by Robin Respaut; Editing by Daniel Bases and Lisa Von
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