Hawaii’s largest public pension fund was infected by the coronavirus during the first three months of 2020 and suffered its worst quarterly loss in more than 17 years.
The state Employees’ Retirement System investments tumbled 9.5% and the fund’s assets, which include contributions and distributions, shrank by nearly $1.8 billion, to $16.2 billion, according to a report presented virtually to ERS trustees Tuesday by investment adviser Meketa Investment Group.
It was the largest percentage drop for investments since the third quarter of 2002, when the fund lost 9.7%, and the fourth-largest decline since the third quarter of 1990, when it fell 7.6%.
Still, ERS Executive Director Thom Williams offered assurance that the pension fund’s nearly 126,000 benefit recipients need not worry about receiving money that they have earned.
“Our members and beneficiaries face absolutely no risks relative to our financial capacity to pay promised benefits or our operational ability to process payments and service our members,” he said. “Staff has selflessly stepped up to the challenges posed by COVID-19 to assure continuity of operations while balancing the need for personal and family safety.”
The steep quarterly drop was a short-term jolt to the pension fund, which provides retirement, disability and survivor benefits. The fund already had a $14.08 billion shortfall entering the fiscal year that began July 1, 2019, and its actuary, Gabriel Roeder Smith, projected in January that it would take until June 30, 2045, for it to become 100% funded. That forecast was predicated on the fund averaging a 7% annualized investment return and on legislation passed in 2017 to close funding shortfalls by having state and county employers increase their contribution percentage over a four-year period.
As of Dec. 31, the fund was up 5.3% and well ahead of its pace to reach its annualized 7% long-term return target. However, with just three months left in the fiscal year that ends June 30, the fund’s investment return had declined 4.6% to leave it no realistic chance of hitting its investment return objective.
Chief Investment Officer Elizabeth Burton said the fund’s diversification helped it avert what could have been a more disastrous quarter.
“The first quarter of the calendar year is a good example of why we diversify,” she said. “Global equities were down 22%, commodities down nearly 40% and no return from bonds. The ERS portfolio was down (about) 10%. While it is always disappointing to have a negative return, this is far better than peer funds who were down nearly 40% more. Our risk-focused, conservative approach has preserved capital as we planned.”
During the quarter, the fund’s broad-growth stocks, which made up 73.2% of the portfolio at the end of the quarter, fell 14.2%. However, the fund’s crisis risk offset asset class, which comprised 15.4% of the fund, rose 11.4%. The crisis risk offset class consists of long-maturity cash bonds and other defensive strategies that when combined are designed to preserve value in declining markets.
“The market has forgotten that market corrections (10%) and bear markets (20%) are actually common,” Burton said. “We have had them in 2018, 2016, 2011, 2010, 2002, 1999 and so on. Corrections are common in bull markets. Bear markets — our current situation — are less common but not uncommon. Prior to this quarter there were 25 S&P 500 bear markets since 1928 — almost the exact same number of bull markets (26).”
Burton emphasized that the ERS portfolio is designed for the long term.
”Bear markets and corrections are expected over time and we design the portfolio in anticipation of these events,” she said. “Therefore we do not drastically alter our portfolio composition when they occur. That said, we are always cautious and thoughtful and may tilt the portfolio slightly within our investment policy bandwidth towards those investments we expect to over(perform) or underperform in the medium term.”
With the pension fund only 55.2% funded heading into fiscal 2020, the Legislature sought to authorize the administration to issue “pension obligation bonds” that would allow the state government to borrow the money it needs to make annual pension payments on behalf of public workers. However, the state Department of Budget and Finance said during a Senate Ways and Means Committee hearing Thursday that it is opposed to the idea because of a potential adverse effect on the state’s bond rating.
The state is forecast to contribute $780 million to the ERS for the fiscal year ending June 30, 2021, to cover its pension obligations for state workers, and pension bonds would have allowed the state to borrow that money in the near term and repay it later.
“Pension obligation bond proceeds have been used in some instances to reduce a plan’s unfunded liabilities and in others to meet the current and future years contribution requirements,” Williams said. “Additionally, they might be used to provide valuable fiscal flexibility to the plan sponsor. Our board has not taken a position relative to their issuance by the state. Our board’s clear priority is that required contributions be made as legislatively mandated. We are less concerned as to the source of those contributions.”