U.S. public pensions are looking to the future by planning for the possible impact of further economic and market shocks, according to a report from Ortec Finance.

Although public pensions have been bruised, many are preparing for the future viability of the retirement funds, Ortec found in research published this month.  

“The degree of uncertainty is extremely high for U.S. public sector pension plan sponsors, but there is genuine optimism that lower inflation will become well-established, with very few managers expecting it to be as high as it currently is within a year or two,” states Marnix Engels, managing director for pension strategy at Ortec Finance, based in Rotterdam, Netherlands.

Analysts at the nonprofit Equable Institute say that despite the investing and economic challenges of 2022, U.S. public pension funds are currently in better shape than before the COVID-19 pandemic, according to data cited by Ortec in the report.

The Ortec study examined a range of issues to grasp the attitudes of public pension managers on risk management, inflation hedging and stress testing and what U.S. public pension managers believe will happen to inflation.

US Pension Plan Takeaways

Public sector pension plan managers are generally feeling confident that they have addressed inflation with hedging strategies, but not complacent that the risk has passed entirely, Ortec found. Of those interviewed, most relied on commodities to help hedge against inflation over the past year.

“Some 70% of those interviewed said their plans had increased their allocation to commodities to help with hedging compared with 52% who had increased allocations to infrastructure and 40% who put more into gold,” the report stated. “Just 42% said they had increased allocations to inflation-linked bonds.”  

U.S. pension fund managers remain “active in changing asset allocations to hedge against inflation.”

Some 66% told researchers they “think they will increase allocations to commodities to help with [inflation], while 50% will boost allocation to infrastructure investing. Some 32% will increase allocations to inflation-linked bonds and 38% will increase allocations to gold to hedge against inflation.”

In addition to concerns about inflation, some of the managers interviewed said they still fear stagflation. Ortec reported that all those surveyed “expect to see a change in actuarial assumptions on the expected inflation or discount rate.”

The current economic climate and investment uncertainty remains high for U.S. public sector pension plan sponsors, meaning that, “on a basic level this has decreased the likelihood of U.S. public pension plans meeting their liabilities and being able to pay pensioners,” the report stated. “It is undoubtedly the case that the sector is facing a tough period, and the past three years have increased uncertainty and the pressure on pension plan managers.”

The recent fall in U.S. inflation to 4.9% from 6% was unsurprising to pension plan managers, because U.S. public sector pension plan managers are “largely convinced that inflation as a major issue is fading away, with the U.S. economy firmly on the path to inflation moderation,” Ortec researchers wrote.

Ninety percent of managers surveyed say they are confident inflation is declining: 52% expect inflation could be 3.3% or lower within a year, while only 10% of public sector pension professionals interviewed said the rate will be more than 6% within a year, the report finds.

Changing Risk Profiles

U.S. public pension fund managers continue to address market, economic and political stresses on their funded ratios by making changes to their risk profiles, as 94% of public pension plan respondents said the risk profile of their plan increased last year, and 16% said it increased significantly, Ortec research found.

Of pension fund managers surveyed, 81% expected the increase in their risk profiles to continue in the next year, and nearly 32% expected a dramatic increase, the report finds.

“The biggest driver of pension fund risk identified by the study is interest rate movements, with managers questioned saying this is the biggest concern for their fund followed by cash flow requirements and liquidity,” Ortec researchers wrote. “The volatility of investment markets was rated as the third most concerning risk, ahead of inflation, which was rated fourth. Cybersecurity was rated as the fifth most concerning risk.”

U.S. public pension funds weathered a “torrid year of investment volatility and increasing interest rates,” according to the Ortec report, U.S. Public Pensions Are Building for the Long Term.

Ortec is a technology solutions provider of tools for measuring risk and return. The firm’s principal business is to model and map uncertainties to help pension funds monitor their goals and decisions.

Ortec commissioned independent research company Pureprofile to interview 50 U.S. public sector pension fund managers responsible for a collective $1.315 trillion assets under management. The survey was conducted in April 2023.