pension fund returns

Does Investment Return Affect Pension Costs?

Does Investment Return Affect Pension Costs? Larry Bader, who worked as an actuary for 20 years before moving to Wall Street, tackled that question in the latest issue of the Financial Analysts Journal.

An excerpt of his answer:

Answer: It doesn’t.

Yes, a higher return on plan assets reduces the funding requirements for the pension plan and the expense that the sponsor must report. But the plan’s true economic cost is independent of the investment performance of the plan assets.

To see why this is so, suppose that you establish a fund to pay for your child’s college education and I do the same for my child. We make equal contributions to our respective funds, and we both face the same tuition payments. But being a smarter, bolder, or luckier investor, you grow your college fund to twice the size of mine. Can we now say that your child’s education costs less than my child’s education? Surely not. Our tuition payments are the same; it’s just that you have a larger education fund available to help pay your child’s tuition.

Or think of it this way: Suppose that your college education fund performed miserably and a similar fund that you had set up to buy a small vacation home struck it rich. Would you now say that college tuition has become very expensive but vacation homes very cheap? Can you now afford to buy a vacation mansion — or private island — but not to send your child to college? Behavioral economics suggests that you might think along those lines, but common sense says, “Get over it.”

Similarly, a higher pension fund return does not lower the economic cost of the plan. The economic cost reflects solely the amount and timing of the pension payments, which are unaffected by the size or growth of the assets.

To read the full answer, click here.

Pension Policy: Taking Stock of Where Florida’s Candidates For Governor Stand

Pension policy has become an important issue in the race to be Florida’s governor, and the two major candidates (incumbent Rick Scott and challenger Charlie Crist) both have very different views on how the pension system should be altered, or not.

A rundown of their respective positions, from the Ocala Star Banner:

If Rick Scott is re-elected, you can expect a renewed push to move more public workers out of the traditional pension plan and into a 401(k)-type plan — which is currently an optional plan in the retirement system.

It was under Scott that public workers began making an annual 3 percent contribution to the state retirement fund in 2011. Scott’s criticism of the current system includes keeping a list of public workers who qualify for more than $100,000 in annual pension benefits on his state office website.

Under the changes, employees can choose whether their contributions and state contributions go into the traditional pension plan or into a 401(k)-type plan in which they can direct the investments.

If Charlie Crist wins, he is more likely to side with major labor unions that are supporting his campaign, including the Florida Education Association, which argue that Florida’s pension plan should not be changed.

The positive returns on the pension fund for the fiscal year that ended in June will bolster the argument that change is not needed.

Florida’s pension funds returned 17.4 percent in fiscal year 2013-14.

Photo by The 45th Space Wing via Flickr CC License

Contribution Rates Down In Wake of New York Pension Fund’s “Solid” Investment Returns

Employers who pay into the New York State and Local Retirement System will soon find their pension contribution bills to be significantly smaller. The System has lowered the contribution rates required of state and local government entities, as reported by the Associated Press:

Comptroller Thomas DiNapoli says the average rate will decrease from 20.1 percent of salary for most public workers to 18.2 percent. For police and firefighters the employer rate will drop from 27.6 percent of payroll to 24.7 percent.

The rate reduction announcement comes as the state’s pension system hit a record high of $180.7 billion. DiNapoli says the fund’s “solid investment performance” means local taxpayers won’t have to contribute as high a percentage toward their employees’ retirement costs.

DiNapoli says that with recent investment gains the state’s pension fund is now 92.2 percent funded. That’s an increase from 88.7 percent.

New York City’s pension funds combined returned around 17 percent last fiscal year. Decreasing employer contributions had been on the table since July, after the returns were announced.

CalPERS Rescinds $700 Million Investment With Private Equity Fund Headed By Doctor With No Private Equity Experience

You probably trust your doctor with your life. But with your money? Many people might balk at the notion of their doctor making their investment decisions for them.

But back in 2007, CalPERS made a big bet: a $705 million investment in a private equity fund, Health Evolution Partners Inc., specializing in health care companies.

The CEO of the fund, David Brailer, is a nationally renowned physician who had previously been the “health czar” under George W. Bush. But this was his first foray into the investment space, and he had no experience running an investment fund or making private equity investments.

Still, he reportedly promised the CalPERS board healthy returns in excess of 20 percent.

But through seven years, the fund has never managed to exceed single-digit returns. And portions of CalPERS’ investment have actually experienced negative returns.

That has led CalPERS to cut ties with the fund, according to Pensions & Investments:

CalPERS is ending its unique experiment as the sole limited partner of Health Evolution Partners Inc., a private equity firm that focuses on health-care companies.

…

CalPERS data show the HEP Growth Fund had an internal rate of return of 6.5% from its inception in mid-2009 through Dec. 31, 2013. By contrast, the $5.3 billion growth fund portion of CalPERS’ private equity portfolio returned 12.72% for the five years ended Dec. 31, the closest comparison that could be made with the data the pension fund made available.

The HEP fund of funds has had more serious performance problems. Its IRR from inception in 2007 through Dec. 31, 2013 was -5.2%, show CalPERS statistics. CalPERS also wants out of that investment, but sources say a complicated fund-of-fund structure may make that difficult.

Mr. Desrochers would not comment on HEP, telling a Pensions & Investments reporter the matter was too sensitive to discuss.

CalPERS spokesman Joe DeAnda, in an e-mail, said, “We continue to evaluate all options relating to Health Evolution Partners.”

Mr. Brailer did not return several phone calls.

CalPERS paid the fund over $18 million in fees in the fiscal year 2011-12, according to the System’s financial report.

Meanwhile, CalPERS is gearing up for another large investment partnership, to the tune of $500 million, that will focus on infrastructure investments. FTSE Global Markets reports:

The California Public Employees’ Retirement System (CalPERS) today announced a new $500m global infrastructure partnership with UBS Global Asset Management.

CalPERS, the largest public pension fund in the US, will contribute $485m to the newly formed company, while UBS will contribute $15m and act as managing member.

The partnership will operate as Golden State Matterhorn, LLC and is set to pursue infrastructure investment opportunities in the US and global developed markets.

“UBS brings extensive experience and a proven track record in global infrastructure investing that makes them a great fit for this partnership,” says Ted Eliopoulos, CalPERS Interim Chief Investment Officer. “We’re excited to work with them as we identify and acquire core assets that will provide the best risk-adjusted returns for our portfolio.”

The CalPERS Infrastructure Program seeks to provide stable, risk-adjusted returns to the total fund by investing in public and private infrastructure, primarily within the transportation, power, energy, and water sectors.

Infrastructure investments returned 22.8% during the 2013-14 fiscal year and 23.3% over the past five years, outperforming the benchmark by 17.23 and 16.6 percentage points, respectively.

CalPERS holds about $1.8 billion in infrastructure assets.

Photo by hobvias sudoneighm via Flickr CC License

Philadelphia Funds Return 15 Percent As New Investment Strategies Play Out

The Philadelphia Board of Pensions, the entity that handles investments for the city’s pension funds, released its annual return data this week. The fund returned just over 15 percent for the fiscal year. From the Philadelphia Enquirer:

The total fund ended the fiscal year up 15.6 percent, outperforming its benchmarks by 1.96 percent. A more narrow portfolio, managed internally, did well, too, showing an 11.97 percent return, about 3.5 percent higher than similar benchmark funds.

The city’s pension system is severely unfunded, with only about half the money it needs to pay its $5 billion in obligations to current and future retirees.

The fund altered its investment strategy in recent years, in large part to the hiring of Chief Investment Officer Sumit Handa. From the Inquirer:

The board’s investment strategy has been revamped with the arrival three years ago of Handa and executive director Francis X. Bielli.

Investments were tweaked, Handa said, particularly the pension board’s fixed-income portfolio.

While investment firms handle the bulk of funds, the pension board staff manages a portfolio of about $260 million, or 5.3 percent of the pension fund. Known as the Independence Fund, it is designed as a “tactical” fund, Handa said, to be used to rapidly respond to opportunities the staff might see.

It strives for high returns at low risk. Since it was established in early 2012, it has been an overachiever by those standards. Outperforming its benchmark, it has shown only a third of the risk associated with investing in the S&P 500, while achieving 60 percent of the rate of return.

This marks the third consecutive year the fund has outperformed its benchmark. Previous to that, the fund has underperformed its benchmarks over the past five and ten-year periods.

The S&P 500 returned 21 percent over the period (July 1- June 30) that the Board of Pensions reported their annual return.

New York City Funds Lag Behind on Private Equity Performance

The private equity analytics firm Bison just came out with a list ranking the private equity performance of 50 public pension funds. New York City’s pension funds have been particularly active in PE funds, and are looking to invest even more in the area in coming years. So, how did the city fare?

You have to pay to see the full rankings, but the New York Post kindly outlined the results. And the news wasn’t good for New York City’s four largest pension funds. From the NY Post:

The worst performers — the New York City Employees’ Retirement System and the New York City Teachers’ Retirement System — tied for 45th place. The police pension fund, in 42nd place, and the firefighters fund, 37th, didn’t fare much better when it came to picking private equity firms, according to the analysis by Bison, a Boston analytics firm focused on the private markets.

“They have scores that put them closer to the bottom of that list than to the top,” Bison research manager Michael Roth said. “Fund selection could be better.”

New York funds’ reliance on private equity is part of a broader strategy to produce big returns. Across the city’s five funds, about 11.5 percent of assets ($18 billion) were committed to private equity fund.

Still, the strategy isn’t working as well for New York as it is for others. From the New York Post:

New York City Comptroller Scott Stringer has tasked his new chief investment officer, Scott Evans, who started this week, with figuring out how to boost the pension funds’ private equity portfolio.

“While we are concerned about long-term return in private equity, we have reason to be encouraged by the relative returns of our private equity portfolio in recent years,” a spokesman for the comptroller’s office said.

For the Massachusetts state pension, which ranks 6th, every $100 invested in private equity 10 years ago generated a 17.7 percent annual return and is now worth $512. The same investment in the five NYC pensions, which combined generated a 12.4 percent return, is worth $322.

Industry sources blame the city’s byzantine system under former New York City Comptroller Bill Thompson, who oversaw many of the pensions’ private equity investments from 2002 to 2009.

“The city was a hard place for private equity firms to navigate,” a placement agent said, adding that firms with the best records didn’t bother dealing with the city.

As of 2012, NYCERS was only 66 percent funded. The teacher’s fund was only 58 percent funded, the police fund was 64 percent funded, and the firefighters fund was a mere 52 percent funded.

Photo by Chris Chan via Flickr CC

CalPERS and CalSTRS Rake in Big Returns, But Much Work Left To Be Done

The 2013-14 fiscal year ended June 30, which means we’ve entered a new year for public pension funds, at least in fiscal terms. It also means that the latest investment performance data is being released, and that data has some funds smiling.

California is one state that has to be happy with what it sees: big investment returns for both of the state’s major pension funds, CalPERS and CalSTRS. From SWFI:

The California Public Employees’ Retirement System (CalPERS) returned 18.42% for the fiscal year that ended on June 30th. CalPERS defeated its custom benchmark of 17.98% and surpassed last fiscal year’s return of 13.2%. The private equity portfolio of CalPERS generated 19.99% returns, just 3.31% shy of the benchmark. The asset classes of real estate and fixed income beat their respective benchmarks.

And CalSTRS saw similar success, says SWFI:

Looking toward the other Sacramento pension giant, CalSTRS posted 18.66% for the fiscal year that ended on June 30th.

The CalSTRS global equity portfolio posted 24.73% in returns. CalSTRS private equity posted 19.61% in returns.

But just because you can see the light doesn’t mean you’re out of the tunnel. CalPERS still has a lot on its plate. From the Sacramento Bee:

Happy days are hardly here again for the California Public Employees’ Retirement System, or for taxpayers who must make good on government pensions.

“There’s much, much work to be done,” said Ted Eliopoulos, CalPERS’ interim chief investment officer. “We’re ever vigilant; we try not to get too excited in good years or bad years about one-year results.”

Eliopoulos knows better than most that CalPERS remains in a deep hole.

Even with the 18.4 percent return, CalPERS estimates that it is only 76 percent funded, a remnant of overpromises made by the Legislature in 1999 and the finanical crash of 2007 and 2008. CalPERS would need to make 18 percent on top of 18 percent for several years running, and no one should expect that to occur.

CalPERS was also in the news last week when its former chief executive, Fred Buenrostro, pleaded guilty in a sordid federal criminal case in which he admitted to taking bribes of $200,000 in cash, some of it delivered in a shoebox, no less, as detailed by The Sacramento Bee’s Dale Kasler.

The case against Buenrostro and Villalobos is salacious, but it’s also a sideshow. No matter how corrupt they might have been, they would not have affected the giant pension fund in any significant way.

The far bigger problem is CalPERS’ unfunded liability. That will take years to fix.

In fact, although both funds have come a long way since 2008, neither one is out of this mess. From the Sacremento Bee:

On the surface, CalPERS and CalSTRS have recovered from the crippling multibillion-dollar losses they suffered when the housing bubble burst and the stock market crashed in 2008. CalSTRS’ portfolio, for example, has risen to $189.1 billion in market value, well above the pre-crash watermark of roughly $160 billion. Similarly, the CalPERS portfolio has soared 83 percent since bottoming out at $164 billion in 2009, putting it at $299 billion.

Despite the comeback, the funds spent several years after the crash with a much smaller pool of money to invest. That limited the amount of money they could earn. Even as they made gains, they’ve been unable to keep pace with their pension obligations, which have continued to rise as government workers accumulate years of service.

As a result, CalPERS is 76 percent funded. CalSTRS is 67 percent funded. They have more than enough money to pay pension benefits for now and the foreseeable future, but don’t have enough for the long term. Experts say 100 percent funding is ideal, although a funding level as low as 80 percent is acceptable.

To be fair, California isn’t in denial about the funding status of its two largest funds. And it isn’t letting big returns blind them to the issue, either.

Both funds are increasing contributions rates for members and employers, and the state has increased its own 2014 contribution to both funds. The changes will bring in billions more dollars annually to the system.