Author: Ted Ballantine

Institutional investors aren’t racing each other; even still, it’s interesting to see how they stack up against one another.

Corporate ERISA plans posted a higher median return in the second quarter of 2016 than any other plan type, according to Northern Trust data; public pensions came in second, with endowments trailing.

The ranking holds when the timeline is expanded to the last 5 years.

More from PlanSponsor:

In the second quarter of 2016, the corporate Employee Retirement Income Security Act (ERISA) plans category fared best among all plan types with a median return of 3%, Northern Trust finds. Public funds were close behind with 1.7% in gains, while foundations/endowments netted 1.5% in the second quarter.

“Differing returns across plan types were driven largely by the duration of their fixed-income investments,” explains Bill Frieske, senior investment performance consultant, Northern Trust Investment Risk and Analytical Services. “In an effort to de-risk their defined benefit pension plans, corporate ERISA plan sponsors have been lengthening the duration of their fixed-income programs. Interest rates declined in the second quarter, which increased returns for long duration bonds and helped boost corporate ERISA plan returns.”

[…]

For public funds, returns were dampened by a larger allocation to international equities (15% at the median), which produced the lowest median return of the major asset classes. For foundations and endowments, returns were muted by weak performance from a significant 11% allocation to private equity, “the second lowest returning major asset class at 0.2%.”

Long-term data reported with the quarterly results shows corporate ERISA plans have enjoyed 5-year trailing returns of 7.5%, while public funds earned 6.9% and foundations/endowments netted 5.7%.

U.S. public pension funds take a more aggressive approach to risk than their private — or foreign — peers.

Why? A recent paper examined the regulatory incentives that make U.S. public pensions different than their counterparts in the private sector and in other countries.

From the Economist:

As a recent paper* by Aleksandar Andonov, Rob Bauer and Martijn Cremers shows, that different approach is driven by a regulatory incentive—the rules that determine how pension funds calculate how much they must put aside to meet the cost of paying retirement benefits. Usually, the bulk of a pension fund’s liabilities occur well into the future, as workers retire. So that future cost has to be discounted at some rate to work out how much needs to be put aside today.

Private-sector pension funds in America and elsewhere (and Canadian public funds) regard a pension promise as a kind of debt. So they use corporate-bond yields to discount future liabilities. As bond yields have fallen, so the cost of paying pensions has risen sharply. At the end of 2007, American corporate pension funds had a small surplus; by the end of last year, they had a $404 billion deficit.

American public pension funds are allowed (under rules from the Government Accounting Standards Board) to discount their liabilities by the expected return on their assets. The higher the expected return, the higher the discount rate. That means, in turn, that liabilities are lower and the amount of money which the employer has to put aside today is smaller.

Investing in riskier assets is thus an attractive option for a public-sector employer, which can tap only two sources of funding. It can ask its workers to contribute more, but since they are well-unionised that can lead to friction (after all, higher pension contributions amount to a pay cut). Or the employer can take the money from the public purse—either by cutting other services or by raising taxes. Neither option is politically popular.

Unsurprisingly, therefore, the academics found that American public pension funds choose a riskier approach.

The Illinois Teachers’ Retirement System will consider revising its assumed rate of return downward as part of an upcoming asset allocation study, according to a report by Bloomberg.

Return targets have been in the news lately, as the country’s largest pension funds have announced investment results that underperform assumptions. Bill Gross went on Bloomberg TV last week and called for pension funds to revise return targets downward to 4 percent.

More from Bloomberg:

Illinois’s largest state pension, the $43.8 billion Teachers’ Retirement System, plans to take another look at how much it assumes it will make in the coming year as part of an asset allocation study, said Richard Ingram, executive director. Currently it assumes 7.5 percent, lowered from 8 percent in June 2014.

“Anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality,” Ingram, whose pension is 41.5 percent funded, said in a phone interview. The fund has yet to report its June 30 return.

[…]

Public pensions over 30-year-or-so horizons traditionally could hit targets for returns of 7 percent to 8 percent. But that was in an era before the Fed began holding down interest rates to stimulate the economy and returns in the stock market were not high enough to offset lower fixed-income investments.

Public pensions have been reducing assumed rates of returns, cutting from a median of 8 percent six years ago to 7.5 percent currently, said Keith Brainard, who tracks pensions for the National Association of State Retirement Administrators. Now “more than a handful” are below 7 percent, he said.

[…]

Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, [Bill] Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV.

The deadline is closely approaching for the New Jersey Senate to approve a ballot measure that would ask voters whether the state’s constitution should be amended to require full pension contributions be made on a quarterly basis.

The deadline is Monday, and even the bill’s sponsor – top Democrat Steve Sweeney – says the bill might not get to a vote.

From Bloomberg:

Lawmakers face a Monday deadline to authorize a ballot measure, which if approved by voters in November would require the state to pay what it owes to pension plans that have less than half of what’s needed to cover obligations. Senate President Steve Sweeney, a Democrat and union official who sponsored the bill, said Thursday he won’t put it up for a vote until he wins an agreement on transportation funding. He accused two unions of trying to illegally coerce the vote.

The constitutional amendment would put the state on track to make full actuarially required contributions by 2022 and cut the unfunded liability by $4.9 billion over three decades. The quarterly payments would strain the state’s cash flow, Moody’s Investors Service and S&P Global Ratings said. Republican Governor Chris Christie, whose signature isn’t required, has called the measure a “road to ruin” that would mandate massive tax increases.

“Getting the funding up is going to be painful,” said Tamara Lowin, director of research at Rye Brook, New York-based Belle Haven Investments, which oversees $5.3 billion of municipal debt. “Making it a forced, fixed expense and making it senior to appropriation debt is a credit weakness, despite the fact that it will eventually bring the state to fiscal stability.”

Though sources confirmed Rahm Emanuel’s proposal earlier this week, the Chicago mayor on Wednesday officially unveiled his proposal to raise utility taxes to generate revenue for pension contributions to the city’s largest funds.

The tax will hit water and sewer bills, and is expected to raise in the neighborhood of $230 million annually.

From NBC Chicago:

In a speech to investors Wednesday, Emanuel suggested applying a tax on the city water and sewer bills under a plan that would increase the utilities by close to 30 percent over the course of four years.

By the end of the four-year phase, the average homeowner would pay an additional $226 per year, the Tribune reports, or close to $38 on each bill.

Emanuel believes the new tax will help stabilize the city’s pension fund. With the new revenue source, the city could raise close to $239 million a year to help reduce the multi-billion dollar municipal workers fund that the city of Chicago owes.

The mayor says he will seek a City Council vote on the water and sewer tax in September.

The New Jersey Investment Council, the body that sets investment policy for the state’s pension systems, unanimously voted to cut its strategic allocation for hedge funds from 12.5% to 6%, as well as to prioritize low-fee managers.

Union officials had been putting pressure on the Council to make such a move; but ultimately, the Council decided it couldn’t stomach the fees it was paying for a hedge fund portfolio that returned -3 percent last fiscal year.

From Bloomberg:

“It sends a message to the hedge fund community that the world has changed,” New Jersey council Chairman Tom Byrne said Wednesday in the meeting in Trenton. “Public funds aren’t going to just pay whatever fees they are charging.”

The pension’s investments in hedge funds, which typically charge a 2 percent management fee and 20 percent of profits, lost about 3 percent this year through May. The entire pension fund has gained 1.6 percent in 2016.

As part of the plan, the state is targeting to pay only a 1 percent management fee and 10 percent of profits.

The state’s investment division has made almost $1 billion in redemption requests from hedge funds this year, including Brevan Howard Asset Management and Farallon Capital Management. The plan calls for withdrawing an additional $300 million from hedge funds and reducing the number of firms it invests in to below 25 by the end of 2016, according to the documents.

New Jersey will eliminate its exposure to long-short equity and event-driven hedge funds next year, the plan says, and reduce its allocation to credit and distressed debt hedge funds to 1 percent from 3.75. Its target allocation to market-neutral and global macro funds will remain at 5 percent.

With another property tax increase as unpalatable as ever, Chicago Mayor Rahm Emanuel is considering levying a larger tax on utilities as a mechanism for raising funds to help stabilize the city’s underfunded pension systems, according to sources who talked to the Chicago Sun-Times.

Emanuel was coy on the subject when speaking this week, however.

From the Chicago Sun-Times:

Unwilling to hit property owners for the third time in one year, Mayor Rahm Emanuel plans to raise the city’s utility taxes to save the largest of Chicago’s four city employee pension funds, City Hall sources said Monday.

Chief Financial Officer Carole Brown acknowledged that the city needs “in the ballpark” of $250 million to $300 million in new annual revenue to shore up a Municipal Employees Pension fund with 71,000 members and $18.6 billion in unfunded liabilities.

After a luncheon address to the City Club of Chicago on Monday aimed at touting the progress made to right the financial ship, Budget Director Alex Holt refused to say where Emanuel would find the massive sum needed to save the Municipal Employees pension fund.

“Everything’s on the table and we’ll hopefully be in the position of announcing both the benefit reforms and the funding plan in the coming weeks,” Holt said.

“We’ve got to look at every possible source,” she said. “This is about solving a long-term problem and making sure that we’ve got funding sufficient to do that.”

Brown read from the same script. “Everything is on the table and we’ll be telling you our solution shortly,” she said. “We’re looking at every option. The mayor is committed to putting forth a solution for the Municipal Fund. Right now, we’re publicly considering everything.”

A Democratic Party official confirmed this week that the union representing teachers in New Jersey will not make any cash donations to the party until the Senate votes for a proposed constitutional amendment requiring the state to make full, quarterly payments to its public pension fund.

According to NJ.com:

County Democratic Party leaders won’t be able to count on New Jersey’s largest teachers union for political contributions this year because state lawmakers haven’t acted to put a constitutional amendment on state pension payments on the fall ballot.

Three county chairman told NJ Advance Media they received calls from a New Jersey Education Association lobbyist informing them the powerful union would be withholding campaign contributions until next spring out of frustration with stalled legislative action on the proposed public pension constitutional amendment.

[…]

The constitutional amendment would require the state increase payments into the government worker pension fund. It must be approved by the voters in a public referendum. But Senate President Stephen Sweeney (D-Gloucester) has so far declined to hold a vote on the referendum for a vote in the upper chamber until lawmakers resolve a transportation funding impasse.

The potentially steep price tag of a deal to fund the Transportation Trust Fund could jeopardize funding for the pension amendment, Sweeney has said. He was booed by public workers Monday when he adjourned a Senate session without holding a vote on the referendum.

The Assembly has already passed the measure.

Affluent retiree households — despite having similar median incomes as “traditional” retiree households — rely more on financial accounts for retirement income than sources like Social Security and pension benefits, according to a recent Vanguard study.

In an article on Benefits Pro, the specifics of the study were discussed:

The study divided households into two segments: the “traditional retirement” group, made up of households whose wealth holdings consist largely of guaranteed income sources like Social Security and pension income, and the “new retirement” group, which has predominant wealth holdings from financial accounts, including tax-deferred retirement accounts, a variety of taxable investment and insurance accounts, as well as bank checking and savings, money market, and similar accounts.

Among the study’s findings was where the two groups’ incomes originated. For both groups, the median total household income was about $69,500. The two groups of retirees, traditional and new retirement, showed very similar median incomes, the study said, and overall, a quarter of retirement income for wealthier households comes from financial account withdrawals.

But when it came to those financial account withdrawals, the new retirement group’s withdrawals made up an average of 39 percent of their retirement income; that’s more than twice as much as such withdrawals contributed to traditional retirement households.

In addition, withdrawals from retirement accounts are often made more to comply with required minimum distribution rules and their attendant tax penalties, and less because those households use the money.

In fact, nearly a third of such withdrawals are saved and reinvested in other accounts—while those households spend less than they withdraw.