While many factors affect the funded level of pension plans, portfolio performance is the main one, accounting for 62 percent of state and local pension sources of revenue from 1988 through 2017, according to Ivan Gulich, senior vice president at Loop Capital. The median market return for 66 state pension plans with total liabilities of more than $5 billion (with a June 30 fiscal end), which account for 77 percent of aggregate state pension liabilities reported so far, was 9.2 percent in fiscal 2018--versus 12.5 percent in fiscal 2017.
Plans in the top quartile of returns have funded ratios that are an average of 15 percentage points higher than plans in the bottom quartile, Loop Capital found. Well-funded plans (in the top quartile of asset sufficiency) returned 140 basis points more, on average, than plans in the bottom quartile.
Pension funds have been diversifying across alternative asset classes in an effort to boost returns while limiting overall portfolio risk. The total share of alternative assets has increased by about 1.5 percent per year since fiscal 2004. In fiscal 2018, pension plans boosted holdings of commodities, trimmed exposure to hedge funds, and kept real estate holdings the same. About half of aggregate pension plan assets have been invested in equities, while fixed income assets keep shrinking due to low yields/returns.
Loop Capital looked at diversification across many asset classes to see if it boosted portfolio returns and reduced their volatility. They found that public pension portfolio aggregate performance from fiscal 2001 to 2018 was about the same as for a generic portfolio consisting of 60 percent stocks and 40 percent corporate bonds issued by the S&P 500 companies (compound annual growth rate of 5.8 percent net of fees). The benefit of diversification across many asset classes is not evident, as pension plans often underperformed benchmarks in down years (e.g., 2009) and outperformed in fiscal years when asset returns were positive, suggesting they have a higher beta (a measure of the risk arising from exposure to general market movements as opposed to idiosyncratic factors) than the benchmark.
Many pension funds may benefit by switching from active investment management across numerous asset classes to passive investment in market indexes, using ETFs or similar instruments, according to Gulich. This would minimize fees, costs involved in selecting and monitoring investment managers, and other expenses...