The state Employees’ Retirement System pension fund posted a 6.2 percent return on its investments last quarter to boost its assets above $11 billion for the first time since 2007.

The ERS fund provides retirement, disability and survivor benefits to more than 111,000 active, retired and inactive vested state and county employees.

ERS Administrator Wes Machida said the investment gain will help with the pension’s unfunded liability, which stood at $7.14 billion at the end of June.

The fund’s portfolio increased in value by $596.3 million last quarter to $11.2 billion. Over the last 12 months, the fund’s assets increased by $971.4 million.

"The fund grew by about a billion dollars," said Neil Rue, managing director of Portland, Ore.-based Pension Consulting Alliance Inc., which advises the ERS trustees on investments. "Any time you add a billion dollars to a $10 billion fund, that’s a pretty good year."

But Machida cautioned that the ERS still has $1.5 billion in deferred investment losses. The portfolio lost 18.7 percent in 2009 and 3.4 percent in 2008. In addition, the ERS is projecting benefit payouts of close to $1 billion in the fiscal year ending June 30, after paying out $925 million in benefits the year before that.

"As long as we offset the $1.5 billion in deferred losses and we meet the actuarial assumptions, such as payroll growth, age and mortality, and investment returns, then the unfunded liability should go down," Machida said.

Rue said the ERS trustees aren’t going to be chasing returns to make up for the unfunded liability.

"We’re trying to get as high and as prudent a return as possible," Rue said. "But there has not been any knee-jerk response to try to increase the return because of the funded status."

Beginning on April 1, the ERS will be shifting out of some bonds and domestic stocks and into more international stocks, according to the ERS quarterly report. It is lowering its domestic equity target allocation to 35 percent from 41 percent, increasing its international equity allocation to 21 percent from 17 percent and lowering its total fixed income allocation, which includes both domestic and international bonds, to 24 percent from 28 percent. In other areas, real estate is being reduced to 7 percent from 9 percent, private equity is increasing to 5 percent from 2.5 percent, real return (returns linked to inflation such as energy, oil and other commodities) is rising to 5 percent from 2.5 percent and covered option calls (equities with downside protection) will represent 3 percent of the portfolio as opposed to no representation now.

"It’s going to become a more diversified portfolio going forward," Rue said. "If they were going to chase returns, they’d put more in public equity, but public equity is being reduced. They’re further diversifying in other classes that will prove helpful to provide a potentially more stable long-term return."

There has been more pressure placed on the state and counties to close the shortfall with higher contributions as the ERS unfunded liability — what is needed to meet its total obligations — worsens.

A leading bond rating agency, Moody’s Investors Service, rated Hawaii’s state-issued debt "Aa1," one notch below its top rating of "Aaa." Moody’s also has a negative outlook on Hawaii’s rating, which means it could be subject to downgrades in the future.

Last quarter, the ERS fund beat its benchmark by 0.2 percentage points. The fund’s domestic equity holdings led the way with an 11.7 percent return, followed by a gain of 7.4 percent by international equity. Real estate, which is reported on a one-quarter lag, rose 5.3 percent. However, total fixed income slipped 1 percent. Through the first six months of the current fiscal year, the fund is up 15 percent.

"I think the performance for the fourth quarter of 2010 was very good," ERS chief investment officer Rod June said. "I think the trustees are very pleased with the performance that came in the last year despite the volatility of the markets."

The fund ended the 2010 calendar year up 11.6 percent. By comparison, the Standard & Poor’s 500 index’s total return was up 15.1 percent in 2010 and up 10.8 percent in the last three months of the year.