Public Pensions Up 12% Get Most in 2 Years as Stocks Soar

Firefighters protest outside the Theodore Levin United States Courthouse in Detroit, on July 24, 2013. Detroit's bankruptcy is hitting a courtroom for the first time as a judge considers what to do with challenges from retirees who claim their pensions are protected by the Michigan Constitution.

U.S. state and local-government pension investments gained the most in two years in fiscal 2013, overshadowed by intensifying scrutiny of underfunded municipal-retirement plans following Detroit’s record bankruptcy.

Public pensions booked a median gain of 12.4 percent for the 12 months through June, powered by a surge in U.S. stock prices to a record, Wilshire Associates said today in a report. The funds chalked up an annualized three-year median return of 11.4 percent while their assets surpassed a pre-recession peak to reach $2.9 trillion, according to U.S. Census Bureau figures.

“I’d be happy,” said Bob Waid, a managing director at Santa Monica, California-based Wilshire. “We’ve had a pretty good three-year run.”

Detroit, a former auto-manufacturing powerhouse that has lost more than 60 percent of its population since 1950, sought bankruptcy-court protection on July 18 with about $18 billion in liabilities. That included an estimated pension deficit of as much as $3.5 billion and $5.7 billion in uncovered retiree health benefits. The filing prompted U.S. governors to call for more local-finance oversight in a meeting that ended yesterday.

The Federal Reserve’s policy of keeping short-term interest rates near zero, robust corporate earnings and an improving economy helped drive U.S. shares to records since January. The S&P 500 Index surpassed its pre-recession intraday peak of 1,576.09, set in October 2007, for the first time in April.

Photographer: Paul Sancya/AP Photo

Firefighters protest outside the Theodore Levin United States Courthouse in Detroit, on July 24, 2013. Detroit's bankruptcy is hitting a courtroom for the first time as a judge considers what to do with challenges from retirees who claim their pensions are protected by the Michigan Constitution. Close

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Photographer: Paul Sancya/AP Photo

Firefighters protest outside the Theodore Levin United States Courthouse in Detroit, on July 24, 2013. Detroit's bankruptcy is hitting a courtroom for the first time as a judge considers what to do with challenges from retirees who claim their pensions are protected by the Michigan Constitution.

Equity Weighted

The median public pension placed almost 45 percent of its portfolio in U.S. equities at the end of the second quarter, according to Wilshire.

Larger allocations for U.S. and international stocks gave public pensions better returns than corporate retirement plans, which hold more bonds, according to Wilshire.

The Wilshire 5000, an equity index of more than 6,700 publicly traded U.S. companies, returned more than 20 percent for the 12 months through June. The Fed’s easy-money policy has hurt bond investors -- the Barclays U.S. Aggregate index lost 0.7 percent in the same period.

Corporate pensions had a median return of 10.1 percent for fiscal 2013, while for foundations and endowments, the gain was 11.3 percent, according to Wilshire.

The report covers more than 1,700 institutional investment funds with combined assets of more than $3.46 trillion and was compiled by Wilshire’s Trust Universe Comparison Service. The survey includes 275 public pensions.

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General Motors Co. headquarters is seen in the distance past a run down building in Detroit, Michigan, on April 1, 2013. Close

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General Motors Co. headquarters is seen in the distance past a run down building in Detroit, Michigan, on April 1, 2013.

Wider Deficits

State public pensions in the U.S. had unfunded liabilities of $833 billion as of fiscal 2011, a 10 percent wider gap than in the previous year, as the plans continued phasing in 2008 and 2009 losses, according to a July report from Standard & Poor’s. S&P also cited increased longevity for beneficiaries and previously granted retirement sweeteners.

The average funded ratio, or the value of projected assets divided by estimated long-term liabilities, fell about 1 percentage point to 72.9 percent in 2011. The drop was 1.6 percentage points in 2010 and 7 percentage points in 2009, according to the S&P report.

“U.S. state pensions are showing some signs of stabilization, but significant improvement in funded levels will take many more years,” S&P analysts led by John Sugden in New York said in the report.

Calpers Gains

On July 15, the California Public Employees’ Retirement System, the biggest U.S. pension with $267.8 billion in assets as of Aug. 2, reported a preliminary 2013 return of 12.5 percent. The pension listed its funded ratio as 73.6 percent at the end of last week.

New York City’s $137 billion pension system reported a 12.3 percent preliminary gain for fiscal 2013 on July 18, while Maryland’s retirement plans on July 16 posted a 10.6 percent net return after management fees.

Corporate pensions had a median return of 10.1 percent for fiscal 2013, while for foundations and endowments, the gain was 11.3 percent, according to Wilshire.

New York City’s five pensions benefited by increasing their stock holdings to 70 percent of total assets, the most allowed by policy, from 64 percent, said Larry Schloss, the city’s chief investment officer. The pensions reduced bond allocations to 30 percent from 36 percent.

“Those were the right calls to make,” Schloss said by telephone. “This was the year to be in U.S. equities.”

Above Target

The city’s retirement system, which had a funded ratio of 60 percent in June 2010, has an estimated annualized 10-year return of 7.5 percent, a half-percentage point more than the 7 percent target.

The median 10-year return for public pensions was 6.9 percent, according to Wilshire.

“Over time you should be able to get to 7 percent,” said Schloss.

Maryland’s $40.3 billion pension returned 10.6 percent for fiscal 2013, trailing the median for all state and local plans. The Free State allocated about 42 percent of its portfolio to stocks and plans to lower that ratio to 35 percent, said Robert Burd, deputy chief investment officer.

The state is reducing the potential for bigger returns in order to minimize wide swings in the value of its assets.

“We saw what happens when you have a reliance on public equity,” said Burd, referring to market losses following the financial crisis. “Public equity is the most volatile asset class.”

Past Gains

The median public-pension gain was 1.4 percent in fiscal 2012 after a 21 percent surge in 2011 and a 12 percent increase in 2010, Wilshire figures show. The median loss was almost 17 percent in 2009.

To make up for losses stemming from the financial crisis and the recession it spurred, municipal officials devoted more revenue to retirement funds, straining budgets and leaving less money available for services.

States have also increased employee contributions, eliminated cost-of-living adjustments and changed age requirements and benefit levels for future employees.

Between 2009 and 2013, 48 states and Puerto Rico enacted pension-financing or benefit changes, said S&P, citing the National Conference of State Legislatures.

Retirement systems in 10 states, including Illinois, Kentucky and Connecticut, had 60 percent or less of what they need to cover promised benefits, according to S&P. Pensions should have a strategy to achieve or maintain 100 percent funding over a reasonable period of time, according to the American Academy of Actuaries.

Weakening Effect

“We do not view pension liabilities as immediately jeopardizing state governments’ capacity to fund their debt-service obligations, but we believe they can weaken a state’s relative credit profile if left unmanaged,” the S&P analysts said in the report.

Detroit may have a deficit of as much as $3.5 billion, in part because of unrealistic assumptions of 8 percent annual investment returns, according to Kevyn Orr, the city’s emergency manager. Pension overseers say the gap is about $700 million.

The failure of elected officials to make annually required pension contributions rather than poor investment returns is the biggest reason for funding gaps, said Wilshire’s Waid.

“When tax revenues are up, they don’t make contributions,” he said. “When tax revenues go down, they don’t have the money.”

To contact the reporter on this story: Martin Z. Braun in New York at mbraun6@bloomberg.net

To contact the editor responsible for this story: William Glasgall at wglasgall@bloomberg.net

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