Public Pension Returns Start to Roll In for Fiscal Year 2022

Gains from FY2021 likely wiped out

The results have not been looking good.

Remember that fiscal year 2022 ends for many (if not most) public pension plans on June 30.

Calpers: CalPERS Announces Preliminary Net Investment Return of -6.1% for the 2021-22 Fiscal Year

Tumultuous global markets played a role in CalPERS’ first loss since the global financial crisis of 2009, as the System today announced a preliminary -6.1% net return on investments for the 12-month period that ended June 30, 2022. Assets stood at $440 billion at the end of the fiscal year.

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Volatile global financial markets, geopolitical instability, domestic interest rate hikes, and inflation all have had an impact on public market returns. CalPERS’ investments in global public stocks returned -13.1%, while fixed income investments returned -14.5%. Public market investments make up roughly 79% of the CalPERS’ total fund. CalPERS’ private market investments fared much better, with private equity and real assets sectors returning 21.3% and 24.1%, respectively.

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With CalPERS’ discount rate of 6.8% and this year’s preliminary return of -6.1%, the estimated overall funded status stands at 72%.

Well, a week before Calpers did their own announcement, Reason Foundation unveiled their shiny new toy to project where pension funds were likely to land.

Reason projects short-term results of long-term promises

Reason: Unfunded public pension liabilities are forecast to rise to $1.3 trillion in 2022

According to forecasting by Reason Foundation’s Pension Integrity Project, when the fiscal year 2022 pension financial reports roll in, the unfunded liabilities of the 118 state public pension plans are expected to again exceed $1 trillion in 2022. After a record-breaking year of investment returns in 2021, which helped reduce a lot of longstanding pension debt, the experience of public pension assets has swung drastically in the other direction over the last 12 months. Early indicators point to investment returns averaging around -6% for the 2022 fiscal year, which ended on June 30, 2022, for many public pension systems.

Now, you may think it’s coincidence that Calpers and Reason landing in the same place was happenchance, but Calpers actually matches the overall “universe” of U.S. public pension funds for a variety of reasons.

I will give two:

1. Calpers is the largest of the funds, and when you weight all results by asset amounts, the largest funds will dominate all averages (not unique to pensions)
2. Calpers is very public in its investment moves, and many other funds adopt a “me too!” type of behavior. If Calpers is doing it, they think, we should also do it.

I have a comment about that in a future post, ready to go.

But let’s see what Reason’s app projected for Calpers.

CalPERS preliminary funded ratio: 72%
Reason projection: 73.6%

Close enough for government work.

Demo video

I decided to do a demo video for Reason’s app, in which I show examples of not only Calpers, but also plans from Illinois, Kentucky, and New York.

I also give some explanations about how the liabilities are measured, what the funded ratio means, and why I’m not happy to see the funded ratio move so much in both 2021 and 2022.

Other announcements

CalPERS isn’t the only pension fund that will be announcing less-than-happy results. It’s for obvious reasons.

They may be the first to announce as they have the resources to report their financials more quickly than others.

ai-CIO: Public Pensions Face Sharpest Funded Ratio Drop Since Great Recession

State and municipal retirement systems are on pace to lose nearly half of 2021’s bumper crop of investment gains, and the funded ratio of US public pensions is set for it’s biggest one-year decline since the Great Recession, according to a report from non-profit organization Equable Institute.
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The State of Pensions 2022 report said that record investment gains and economic growth last year helped push unfunded liabilities below $1 trillion and boost the funded ratio for state and local plans to 84.8%. However, based on preliminary 2022 investment losses of 10.4% on average for state and local plans, it said that all plans will miss their 6.9% assumed return and that the “net result is the largest single-year decline in assets since 2009” as the funded ratio for those plans have fallen to an estimated 77.9% as of June 30.

Of course, this follows the largest one-year gain in funded ratios as well. I will come back to this. Note that he estimated a different loss, but that’s because he’s looking at a bigger set of plans. The Reason Foundation set is state-only plans. Equable looked at some local plans as well. So I bet New York City is in this set, for example.

The findings of the report, which analyzed 228 of the largest statewide and municipal retirement systems in 50s states, include:

Asset allocations continue to shift toward alternative investments. The share of assets allocated to hedge fund managers and private equity strategies has grown to 14.9% from 8% in 2008.

This shift into alternatives is one of the thing that makes me queasy. I haven’t updated this graph, but I don’t think I need to:

My distribution is much more extreme than the statistics Equable mentions above. You can go to this post to try to figure out why.

Public retirees may be more exposed to inflation that many assume, given the limited cost-of-living adjustment provisions that are available across the country. For plans that do offer inflation protection, the average COLA is 1.58% in 2022, which is significantly less than the estimated 8.6% rate of inflation as of May.

I mentioned the COLAs (cost of living adjustment) in my video above.

A few points to consider: asset volatility and inflation

I mentioned both the COLAs and asset volatility in the demo video above.

For asset volatility, I want you to think about investments supporting these very-“guaranteed” liabilities.

These liabilities are promising a lot of things, usually. They promise lifetime income, usually based on some factor applied to a final average income, not even based on your whole income history (unlike Social Security). Sometimes there is some inflation protection in the form of a COLA. Sometimes there are all sorts of goodies baked in, like DROP programs, intended as a sweetener to get people to work longer… because many of these programs were set up to allow for too-young retirements.

Some of these pension promises are very valuable, even after a variety of reforms to cut down on certain behavior like spiking final pay.

Given these rather valuable promises that are “guaranteed”, backing them with extremely volatile, and in some cases rather illiquid, assets seems like a risky situation.

The thing that is left unsaid is that those running the systems don’t want to ask taxpayers (and definitely don’t want to ask the unionized public workers who are a powerful political force) to contribute more now to fund these pensions… but that if these risky bets go south, they assume the taxpayers will fill the hole. Or the bondholders will also suck it up when defaulted on.

Secondly, there will be retirees clamoring for better COLAs. It’s built into Social Security (and I will need to do a separate post on that), but that’s more complicated than you think.

While some retirees had been enjoying automatic 3% COLAs while inflation was low, that 3% doesn’t look so good anymore. They’ll want better. Of course, almost all such plans are poorly funded.

I recommended testing out the tool and seeing where you own state’s plan(s) fall. Remember that a one-year COLA boost also boosts all future payments, so it’s not merely a matter of making nice to retirees for one year.

It will likely get very contentious, and paying off retirees with higher pensions is a very old move by politicians (ask Roman emperors) that can lead to public financial insolvency.

Being “kind” in the short term can lead to very cruel results in the long term.