How Asset Allocations of Public Pension Plans Have Shifted

As there has become more of an incentive for public pension funds to invest in private markets, asset allocations for these pension funds have shifted dramatically over the years, according to a panel of experts who spoke at the Council of Institutional Investors’ 2024 Fall Conference in Brooklyn, New York, on Tuesday.

Tyler Bond, research director at the National Institute on Retirement Security, explained that in 2007, before the global financial crisis of 2008 and 2009, public equities made up about 60% of asset allocations for public pension plans. By 2021, public equities had dropped to less than half of asset allocations.

Allocations to fixed income also dropped significantly in these years, and Bond noted significant growth in allocations to private equity, private credit, real estate and other alternative assets.

Across state and local pension plans in the U.S., over the past 30 years, NIRS found that 61.4% of pension revenue came from investment earnings.

“It matters how public pension plans are investing because they rely on their investment returns to generate such a substantial portion of revenue,” Bond said. “If [the plan] is not getting the revenue [it] needs from investment earnings, either the members or the taxpayers—or both—have future revenue to make up for.”

Different Challenges, Similar Strategies

Andrew Roth, CEO and executive director of the Colorado Public Employees’ Retirement Association, said the $61.5 billion pension fund that he oversees has allocated more to private equity over time. However, he said Colorado PERA, as well as the Teacher Retirement System of Texas and the California State Teachers’ Retirement System—where he served as the deputy executive director and chief benefits officer respectively—have dealt with funding level challenges, as none of them are currently at 100% funded status.

“In terms of how we can invest to continue to [pay benefits to] as well as grow the fund and pay down the unfunded liability—that’s forced us to consider higher returns,” Roth said. “With bonds and fixed income generating lower returns over the past 20 years, all three of the [pension] funds … have invested in private equity.”

Leola Ross, deputy CIO and head of ESG at Seattle City Employees Retirement System, said SCERS has invested more diversely in private markets over the years—moving from a focus on U.S. markets to more of a global portfolio. She said the pension fund expanded from investing in U.S. core real estate to non-core real estate in Asia and Europe, as well as in infrastructure. More recently, Ross said SCERS has allocated funds to private credit and venture capital.

Besides investing in alternatives, with interest rates rising, Ross said SCERS has been able to lower its portfolio volatility and funding level volatility by going more into long-term bonds.

Funded Status

While public pension assets have more than doubled since 2010, and employers have been contributing more to plans, Bond said overall funded status has remained relatively flat in recent years, with an average funding level of about 75%.

Bond said a primary factor in stagnant funded status is plans making changes to their actuarial assumptions, with the average discount rate moving down to 7% from 8% and more plans adopting generational mortality.

“Plans have invested a lot in buying more conservative assumptions, and going forward, that should be to the benefit of the plan and various stakeholders,” Bond said. “But that comes at a cost, and the cost is that budget ratios have been pretty flat over this time period.”

Ross said SCERS’ funded status has increased in recent years and is currently around 75% or 80%, depending on what actuarial measure is used.

“The notion of fundedness doesn’t get talked about enough,” Ross said. “We actually now measure fundedness volatility as part of our asset allocation strategy.”

In order to lower fund volatility and improve funded status, Ross said SCERS increased its allocations to both private credit and infrastructure, while adding long bonds to the portfolio and diversifying away from some of the core bond allocations. She noted that SCERS has been in the top quartile for pension funds in terms of returns.

Roth added that Colorado PERA currently has a funded status of about 69.6%. He said the tightening of actuarial assumptions has been a “real hit” to the plan’s funded status, and the plan is currently working on “playing catch-up.”

He explained that the pension plan uses an auto-adjust provision, a complex mechanism that automatically causes employer contributions to increase and retiree cost-of-living-adjustments to decrease when investment returns fall below a certain point. While stakeholders rarely define shrinking COLAs and increased employer contributions as a “measure of success,” Roth said this provision is helping the plan reach fully funded status.

“We’re really engaged in education,” Roth said. “Educating members and stakeholders about complicated actuarial concepts is difficult but worthwhile. Whether it’s 10 years from now or 20 years from now, when we’ve gotten to a much better place, COLAs for retirees can go up, [and] contributions from employers can go down.”