State pension fund declines 1.1 percent

Hawaii’s largest public pension fund couldn’t overcome weakness in the domestic and international markets in the July-to-September period as it had its first losing quarter in more than two years.

The state Employees’ Retirement System’s portfolio recorded a 1.1 percent investment loss in the quarter ended Sept. 30 and saw its assets decrease in value by $200 million to $13.9 billion, according to a report presented to ERS trustees Monday by Portland, Ore.-based Pension Consulting Alliance Inc., which advises the ERS trustees on investments.

It was the first losing quarter for the ERS since the fund fell 1.9 percent during the April-June quarter of 2012 and ended a streak of eight straight positive quarters.

"That’s a long time to go without a negative quarter," said Neil Rue, managing director of PCA. "You’d expect negative quarters to occur a little bit more."

The fund, which provides retirement, disability and survivor benefits to 118,466 active, retired and inactive state and county employees, targets an annual 7.75 percent fiscal-year return to help fulfill its pension obligations. It was a slow start to the fiscal year, which began July 1, after the ERS fund posted double-digit percentage gains — 17.4 percent and 12 percent — during the fiscal years that ended on June 30 in 2014 and 2013, respectively.

"Even though we want to make 7 3/4 percent, that doesn’t mean we add more risk to the portfolio," said ERS chief investment officer Vijoy "Paul" Chattergy. "We are long-term investors, and we need to make that on average over the long term. The portfolio is structured to produce that type of annual return so if we underperform for a quarter or two, we should be OK as long as we’re in the ballpark of where the policy benchmark is."

Last quarter, the ERS pension fund’s 1.1 percent negative return matched the return of 68 median public funds with assets greater than $1 billion. The ERS’s benchmark fund, which comprises indexes invested in a similar way to ERS’ portfolio managers, was down only 0.8 percent.

Despite the down quarter, the ERS portfolio has outperformed its peer funds over the last one- and three-year periods. The ERS fund beat the median public fund, 10.8 percent to 10.2 percent, over the last year and had an annualized 13.8 percent return over the last three years, compared with 12.8 percent for the median fund.

"A lot of the fund sponsors were down the same as Hawaii (last quarter)," Rue said. "It’s just the market environment. Over the last three years, the Hawaii fund has outperformed the median fund by 1 percent a year."

The ERS fund is in the early stages of playing catch-up with its future pension obligations after being only 60 percent funded — a shortfall of $8.49 billion — as of June 30, 2013. The unfunded liability for the fiscal year that just ended will not be released until early December, but ERS Administrator Wes Machida said the strong results from the fiscal year that ended June 30 should lower the unfunded liability.

Pension reforms — including cutting benefits for new employees and increasing contributions — were implemented in the past three years to bring down the unfunded liability.

If investment returns hit their targets and mortality rates are in line with expectations, the pension is expected to be 100 percent funded by 2041, according to the most recent actuary report, issued in December.

Total fixed income, which includes domestic and international holdings, topped the ERS holdings last quarter with a 0.6 percent gain.

Domestic equities eked out a 0.1 percent gain while international equities fell 5.3 percent.

"Overall in the market you have increased volatility due to uncertainty from some geopolitical risk," Chattergy said. "You’ve got what’s going on in Russia with (Rus­sian President Vladi­mir) Putin and in the Middle East, and there’s concern with the economic slowdown in Europe and in China. That’s finally come to weigh in on the market. The first half of the year was a very strong performance, and since July we’ve had increased volatility and uncertainty. I think the markets are sort of catching up a little bit with these risks."

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