Recession and State Government and Economy and Finances and Public Pensions and Government & Economic Development and Government

Billions lost in state pension-fund fallout

November 24, 2008

Think your portfolio's been hit hard by the economic downturn? Consider Indiana's public pensions. Together, they lost $5 billion in the 12 months ending Sept. 30. And that doesn't include October, when markets suffered their sharpest declines.

Indiana's Public Employees' Retirement Fund, which is responsible for the pensions of 167,000 Hoosier police officers, firefighters and civil servants, had assets of $16.7 billion at the end of October 2007. Over the next 11 months, PERF confirmed, it lost $3.4 billion. The pension fund says it's still finalizing October figures, but called IBJ's loss estimate of $1.9 billion for the month "in the ballpark."

The bottom line: One year of losses has erased the previous three years' investment gains. PERF's total assets are now worth $12 billion. That's 28 percent less than they were a year ago and about where they stood when Gov. Mitch Daniels took office in 2005.

Shawn Wischmeier, PERF's chief investment officer, said the fund's diversification protected it from even steeper losses. He blamed the decline on the entire market's collapse.

"Despite October being an ugly month, we're happy with our relative position," Wischmeier said. "There was no place to hide. It didn't matter where you were."

The Indiana State Teachers' Retirement Fund, which is responsible for more than 140,000 teacher pensions, saw its assets fall from $9.4 billion at the end of October to $7.8 billion at the end of September — a 17-percent tumble.

TRF said it was unable to provide October figures. The fund declined requests for an interview and did not respond to written questions by IBJ's deadline. Unlike PERF, the fund has investment discretion over only part of its assets; teachers are able to make some of their own decisions.

Pension experts say public retirement plans around the country find themselves in similarly painful circumstances. But a local economist says the well-compensated investment managers hired by Indiana's funds should have fared better.

"I won't second-guess anybody's investment decisions," said Bill Styring, president of locally based Styring and Associates and former senior fellow at the conservative Hudson Institute. "But I do have a cat by the name of Trixie who could probably have done as well," he said. "Trixie and I figured out, over a year ago, where this thing was going."

He added: "The problem is, how much money are we paying these geniuses to lose my money, your money? I'll work for $1 and my cat needs a can of cat food now and then."

While PERF's managers and board oversee investments, they dole out day-to-day decision-making to 130 private money managers around the world. Each manager focuses on a different part of the market. PERF said in its 2007 annual report that investment expenses topped $57.6 million that year.

Pension benchmarks

PERF Executive Director Terren Magid stressed that the pension remains sound, despite the evaporation of billions of dollars in value. He said the money it owes retirees will be dispersed over decades, giving the plan plenty of time to make up lost ground.

"No matter what's going on in the market right now, I can assure our members that they will get paid in full and on time," Magid said. "We see no reason for that to change."

"The health of this fund is not going to be dictated by this year," he added. "The health of a fund is determined in our industry by our actuarial values. One year is not going to materially change the health of our fund."

Other public pension experts echoed Magid.

U.S. pension funds are "in the market, and their fortunes tend to go up and down with it over time," said Keith Brainard, research director for the Washington D.C.-based National Association of State Retirement Administrators. "Their focus is measured in terms of decades, not in days, weeks or months."

Almost every pension plan has shed at least 10 percent of its value, said Elizabeth Karier, managing editor of Pensions and Investments, a trade publication. And most have bled 15 percent to 20 percent. So PERF and TRF are far from the exception.

"Every report we're getting is down, down, down," Karier said. "It's horrible. It looks awful; it is awful. But they're pretty much in the same boat as everybody else right now."

Wischmeier notes that PERF's losses actually compare favorably to those of the S&P 500, a broad index often used as proxy for the overall stock market. As of Sept. 30, PERF's one-year return was minus 18.6 percent, compared with the S&P 500's 22-percent decline. And PERF's 5.6-percent five-year return is slightly better than the S&P 500's 5.2-percent return for the period.

The PERF returns factor out the day-to-day inflows and outflows of money that occur as new contributions are added to the fund, and retirees draw their pensions. In fiscal 2007, PERF took in $651 million in contributions and paid out $751 million.

But David Bennett, executive director of the Community Foundation of Greater Fort Wayne, isn't impressed that PERF outperformed the S&P 500. He said that index is a dubious yardstick, since the pension fund invests in a wide range of asset types — including bonds and alternative investments such as hedge funds.

This month, the nonpartisan Indiana Fiscal Policy Institute released a paper Bennett co-authored warning how a deepening recession will affect Indiana's finances, including its pensions. Its title: "Economic Hurricane Coming — Is Indiana Ready?"

"It's hard to tell if 18.6 percent down is good or not until we know what a good benchmark is," Bennett said. "But I don't think S&P 500 is a good benchmark, because it's all stocks."

New asset allocation

Last month, PERF adopted a new asset-allocation plan that will move the pension largely out of domestic stocks. Magid said the change stemmed from a regularly scheduled two-year review cycle, not a response to the market's downturn.

Under the previous allocation, PERF earmarked 65 percent of its assets for equities, while 20 percent went to fixed-income investments such as bonds, and 15 percent went to alternative assets, such as venture capital, real estate investment trusts and hedge funds.

Under the new asset allocation, PERF will hold only 40 percent of its assets in equities. It will simultaneously increase fixed-income and alternative investments to 30 percent each. That's a major policy shift for a pension that, until 12 years ago, had never invested in anything riskier than bonds. And before August 2006, PERF held only 5 percent of its assets in alternatives.

It also means PERF expects domestic stocks won't provide the gains it needs in the days to come. Under the old asset allocation, 45 percent of PERF's assets were in U.S. equities. Under the new plan, just 20 percent will be.

"Was it in reaction to the markets? I can safely say, no, it wasn't," Magid said. "The whole reason was to assure the right returns over the long term and further reduce risk and volatility. That's what we did and would have done, regardless of the markets. That was part of the normal course. It's only a month old, but we're positive about that strategy."

Not everyone agrees with PERF's new approach.

Ken Skarbeck, president of locally based investment-management firm Aldebaran Capital LLC, said PERF is moving along with the rest of the pension herd toward the "Yale and Harvard model" that emphasizes heavy investment in alternatives. Skarbeck is skeptical of it, despite the great gains it has created for Ivy League endowments.

"I think that the alternative-investment area is a very, very big minefield. If you're able to pick out the right areas, you could do very well. But you could also lose a heck of a lot of money, and people have found that out over the last year or so," said Skarbeck, who writes an investing column for IBJ.

"Look at CalPERS [the California Public Employees' Retirement System]. They've made some horrendous mistakes in the last few years. Everybody thought these are some of the smartest guys around. But they were piling money into commercial real estate and land."

Skarbeck questioned PERF's heavy reliance on consultants, who he said use "rearview mirror" methods to steer investment decisions.

"They look at what has worked in the past and extrapolate it into the future. For example, at the top of the late 1990s bubble, consultants were advising to pour money into the large-cap growth stocks, because that was the asset class turning in the best returns," he said. "Of course, large-cap growth stocks were peaking by the time they got on board."

Some financial experts worry that PERF will miss out on the stock market's upside when the U.S. economy recovers.

Don Woodley, co-founder of locally based Woodley Farra Manion Portfolio Management Inc., said he thinks established public companies like IBM, McDonalds, Wal-Mart and Exxon will do well when markets eventually begin a sustained rally.

And right now, Woodley said, their shares are cheaper than they've been for 45 years.

"Large-cap companies, if you take out the financial companies, are in really good condition," said Woodley, whose firm manages $12.5 million in large-cap domestic stocks for PERF.

"Most have strong balance sheets, strong cash flows. While their earnings may be down from peaks of 2006 and 2007, they're still making money. ... I think large U.S. stocks are some of the best values in the world."

Wischmeier said he's working 80-hour weeks to take advantage of those very opportunities while reducing PERF's risk for further losses.

But even if PERF does suffer further declines, retirees who draw from it have nothing to fear, PERF officials said.

They note the fund is a defined benefit plan, which means Indiana taxpayers are obligated to pick up the pension tab if investment losses erode too many of its assets.

Magid considers that scenario unlikely.

"Now if markets continue like this for two or three years, those impacts could be larger," he said.

"But I would argue that if markets continue like this for two or three years, I think our economy's going to be facing a lot more serious issues than just retirement security."

 

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