Last week’s wild gyrations in global financial markets almost certainly exposed the vulnerability of U.S. state and local authority public pension funds, which have piled into riskier assets in recent years, actuaries and other pension experts tell Reuters.
Based on data from the Federal Reserve, the funds are sitting on nearly $4 trillion in assets that are more than 70% exposed to equities and other riskier assets, such as commodities and hedge funds. And some states with massive pension funding deficits, such as Louisiana, are likely most in danger of suffering big losses given their risk profiles.
Among states with pension funds having equity-type exposure of 80%, according to their 2014 annual reports, are those in Illinois, Louisiana, Michigan, and Alaska.
Since the financial crisis, many public pension funds have increased their exposure to hedge funds and other higher-risk assets to meet ambitious investment return targets. Most funds assume a rate of return of 7% to 8% percent a year, according to a May report by the National Association of State Retirement Administrators. Those assets can also take a big hit when equity and related markets plunge.
At the same time, they have cut back on safer assets, such as U.S. government debt and other lower-risk fixed income investments, which are not expected to provide big returns in the next few years.
Most major pension funds have also stopped short of employing other approaches to limiting losses in broad market sell-offs such as volatility management or dynamic asset allocation strategies that have attracted more attention in recent years, according to industry experts.
“A lot of them have just put their foot on the accelerator,” says John Vitucci, an actuary at accounting firm O’Connor Davies and a teacher at Columbia University’s actuarial science program. “They are very heavy in equities.”
