Alarm bells about the impending pension crisis seem to have faded away. US corporate and public pension funds have achieved good returns in 2004. If assets returns continue to perform in line with historical norms, and interest rates return to more normal levels, the funding pressures should ease, according to the most optimistic pension funds’ managers.
In some states pension funds unfunded liabilities have reached “crisis proportions”, says Parry Young, a director at Standard & Poor’s. For example, Illinois and Wisconsin have both issued bonds to fill the gap, while other public funds are adopting more aggressive investing strategies in the hope of achieving superior returns.
An example is the California State Teachers’ Retirement System (CalTRS). In February 2004 its trustees agreed to expand investments in fast-growing foreign countries, targeting more than 700 firms in 27 emerging economies, from Chile to Sri Lanka. The state treasurer’s representative on the CalTRS board, Ted Eliopoulos, warned the move could be risky to the fund’s portfolio and reputation. He wanted CalTRS to adopt an “eligibility list” that ranks countries according to 20 categories, including the banking system, child labour laws and human rights policies.
The majority of trustees didn’t want to tie the hands of money managers and give up higher returns. The $120bn (e89.6bn) pension fund has placed about $2.3bn in emerging market investments through indexing, and plans to hire outside managers to actively trade in emerging market companies.
There is no foreseeable change either for the California Public Employees’ Retirement System (CalPERS). It has an expected return lower that most US corporate plans’ targets, which average 9.1% in 2005. CalPERS spokesman Brad Pacheco explained: “We reviewed our strategic asset allocation and assumptions last year and don’t expect to revise them this year. Our assumptions are derived from a consensus of our outside consultants [Wilshire, PCA, Bill Sharpe, Towers_Perrin] and staff. Using these assumptions a 10-year_forecast, our strategic mix is expected to return approximately 8%.”
Last year this target was exceeded by a good margin: CalPERS investments earned 13.5%, thanks to the fund’s increased attention to alpha generating strategies and to all ‘alternative’ strategies. The $183bn assets are 68% invested in equities, including 4.8% in AIM, 26.9% in global fixed income, 6.4% in real estate (negative 1.3% in cash). According to the CalPERS investment committee, in 2004 the most successful bets were investments in funds that use corporate governance strategies to turn around ailing companies (+28%); investments in real estate, which are largely office, retail, apartment and industrial assets (+18.9%) and in housing, timber and other specialised real estate assets (+24.6%); the alternative investment management program (AIM), which specialises in private equity holdings (+17.8%).
Having had three bad years, 2004 is the second successive year that CalPERS has earned double-digit returns (23.3% in 2003), so the five-year annual average is back in positive territory (by 3.3%). This should help CalPERS demonstrate its financial health and fight the California governor’s proposal to partially privatise the state pension system, and oppose President Bush’s social security reform.
One confident fund is the General Electric fund. “For our pension plan, the expected return on assets actuarial assumption has been 8.5% since 2002; it was 9.5% in 2000 and 2001. “We think it is an achievable target,” explains Michael Cosgrove, executive vice-president and chief commercial officer at GE Asset Management, which invests $47bn assets of the GE pension plan.
“We know that some experts forecast 7-8% annual returns for the American stock market, but we hope our active management will add some alpha to our investments,” says Cosgrove. “International equities offer higher yields than American ones, thanks to a better relative evaluation of foreign markets. Also we have 16% of GE assets in alternative investments (real estate, private equities and hedge funds) that allow us to achieve our target. We’d like to increase the allocation to alternative investments to 20%, but we are very selective about new opportunities.
“We don’t invest in hedge funds that have not been operating at least for three years, we avoid very leveraged funds and we almost don’t invest in funds of hedge funds.
In real estate the GE plan invests in equities not in new developments: “We look for existing buildings with good cash flows,” Cosgrove says. “And in private equity we invest directly in US deals, while abroad we invest in venture capital initiatives with local partners.” As a result of this strategy, the GE pension fund is overfunded by over $6bn.
The General Motors pension fund is overfunded by about $3bn, states GM spokesperson Jerry Dubrowsky. He claims it is not only the result of issuing a $17bn bond and making an extra contribution to the plan in 2003, but “because of good returns: 15% in 2004, 22% in 2003 and an average of 9% during the last 15 years.” The $90bn fund has a target of 9%. “We renew investment strategy once a year, but we don’t plan to change the current one, which is highly diversified in every asset class: stocks (50%), bonds (30%), real estate (10%), alternative products (private equity and hedge funds, 10%), and some commodity.”