State pension fund off 0.7% but on track for 1-year mark

Hawaii’s largest public pension fund rode out the recent stock market correction with a 0.7 percent loss in its fiscal third quarter to remain on track to hit its 7 percent investment target for the fiscal year.

The state Employees’ Retirement System provides retirement, disability and survivor benefits to more than 135,000 active, retired and vested state, city and county employees. The fund was up 6.94 percent through March 31, according to a report presented to ERS trustees Tuesday by Portland, Ore.-based Pension Consulting Alliance LLC. The 7 percent assumed rate of return is what the ERS now targets annually to help cover its financial obligations to current and former employees.

Assets in the fund declined by $357.6 million, to $16.58 billion, after factoring in contributions, distributions and the quarter’s investment loss.

“The portfolio responded just like we expected it to respond in the quarter,” said acting Chief Investment Officer Howard Hodel, who was promoted from investment officer — risk management after Vijoy Chattergy resigned in mid-February for undisclosed reasons.

“We’re very pleased with where we are with allocations in the portfolio, and we’re on track to achieve our 7 percent return for the fiscal year (ending June 30),” added Hodel by phone from Hong Kong, where he is attending a global leadership meeting as president of Charter Financial Analyst Society Hawaii. “What we’ve really tried to do in the portfolio in the last 3-1/2 years when we started down this path of risk allocation is we wanted to increase income to reduce volatility and diversify the return sources that we have in the portfolio. We want to improve the probability that we’ll reach our funding goal to become fully funded.”

The ERS had a $12.93 billion shortfall as of June 30 and a funded ratio — what is needed to meet future obligations — of 54.9 percent. But steps have been taken in the Legislature to close the funding shortfall by increasing the required contributions by employers, whose money comes from taxpayers.

Actuary Gabriel Roeder Smith projects it will take 26 years, or until June 30, 2043, for the pension fund to become whole because employers began increasing their percentage of contributions of an employee’s pay starting July 1.

The stock market correction, which represented a drop of at least 10 percent for the Dow Jones industrial average and the Standard &Poor’s 500 index, began after the market peak on Jan. 26 and continued to its low point on Feb. 8.

ERS’ 0.7 percent investment loss in the quarter trailed the positive 0.1 percent return of its policy benchmark (a combination of different indexes that correspond with the ERS investments) and the 0.0 percent return of the median public fund with assets greater than $1 billion.

“We don’t get too worried at all about quarters,” Hodel said. “What we’re looking at is where we end up in the fiscal year, and longer than that because we have a 30-year horizon to achieving fully funded status because we’re long-term investors. The market changed in the first quarter (of the calendar year) back to a more normal regime in the capital markets. We’ve had unusually low volatility for the last two years.”

As part of its investment strategy, the ERS has $2.9 billion, or 17 percent of its portfolio, invested in options.

“We need to take enough risk to achieve our 7 percent return, but what we want to do is diversify from equity risk and harvest the volatility premium by writing the options,” Hodel said. “Diversifying the portfolio is a very good buffer in a market correction. It’s an equity replacement, diversity and risk mitigation all in one. It’s a definite strategy in the stabilized growth part of the portfolio.”