Private equity buoys pension fund returns
22nd Mar 12
By Bronwyn Bailey, vice president of research at the Private Equity Growth Capital Council, Washington
The California Public Employees’ Retirement System decision on March 19 to reduce its assumed rate of return by a quarter point — to 7.5% from 7.75% — has rippled across the pension community.The downward revision can be seen as a bellwether for pension funds around the country, bringing into focus the factors challenging public pension plans’ ability to meet their obligations to retirees, including rising and unfunded liabilities, tighter state and municipal finances, and volatile capital markets.But the most glaring problem is the simplest to understand: Pension plans are not able to consistently generate adequate returns from public markets to meet their needed return targets.
When pension investments yield lower returns, employers — in this case the State of California and participating municipalities — must pay higher pension contributions to ensure the fund has the needed resources to pay retirement obligations. A target reduction of a mere one quarter of 1% is expected to cost California more than $300 million per year as well as increasing obligations of local municipalities and school districts. This could put even more pressure on cash-strapped state and municipal budgets and force taxpayers to ultimately foot the bill. The results could mean fewer schools, police officers and firefighters in California communities. But this is not an issue for California alone. Pensions & Investments data show that four of the nine largest public pension funds maintain assumed rates of return of more than 7.5%.
With U.S. public markets underperforming over the past decade, large pension funds have increasingly turned to alternative asset classes, including private equity, for their proven track record of generating superior investment returns. Given the challenges facing pension funds, this would seem like an easy decision.