State pension fund pops in final quarter to end year in the black

It was a get-well quarter for the state’s largest public pension fund as it overcame the effects of COVID-19 to post a 6.2% investment return and edge into positive territory for fiscal year 2020.

The state Employees’ Retirement System investments finished the fiscal year that ended June 30 with a 1.3% return, according to a report presented to ERS trustees Monday by investment adviser Meketa Investment Group. But the fund, which provides retirement, disability and survivor benefits for about 126,000 recipients, still fell far short of its 7% annualized investment target that it needs over the long term to meet the financial needs of ERS members. It also was the worst fiscal-year performance by the fund since logging a negative 0.9% return in fiscal 2016.

The fund’s assets, which include contributions and distributions, rose about $950 million in the quarter to $17.2 billion.

“COVID-19 has impacted all institutional portfolios in different ways,” ERS Chief Investment Officer Elizabeth Burton said in an email. “We have not changed our investing philosophy which is based on decades of financial and economic data and research. We are long-term, conservative investors who believe a diversified, risk-aware portfolio provides our plan with the best opportunity to achieve our long-term return targets.”

The fund’s performance in the April-June period salvaged what could have been a dismal fiscal year after the fund’s investments nose-dived 9.5% in the January- March time frame for its its worst quarterly loss in more than 17 years. In this most recent quarter, the fund easily beat the 4.2% gain of its policy benchmark, which is a composite of various market-sector returns that are meant to emulate the investments in the ERS portfolio. The ERS fund, however, significantly trailed the 10.4% gain of its peer funds with greater than $1 billion in assets

“We trailed peers in the (fiscal) fourth quarter but outperformed peers in the third quarter — which is to be expected,” Burton said. “Our portfolio is more conservatively positioned than peers which means we do not move in tandem with equity markets as much as some peer funds. So we protected capital in the third quarter and outperformed peers 300-400 basis points. Peer funds had a wide gap of losses to recoup in the fourth quarter. We were able to recoup losses with less risk. In general, we have less exposure to U.S. equities as we have a globally-oriented portfolio. Peer funds with high exposures to U.S. equities, and tech specifically, had higher returns in the fourth quarter.”

The pension fund had a $14.08 billion shortfall entering the 2020 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. At the start of the fiscal year, the portfolio was only 55.2% funded.

ERS Executive Director Thom Williams repeatedly has said that the pension fund’s recipients “face absolutely no risks relative to (ERS’) financial capacity to pay promised benefits.”

During the fiscal fourth quarter, the fund’s traditional growth stocks jumped 21.2% to lead all categories. Its private growth investments fell 8.1% but far exceeded the category’s benchmark, which declined 21.7%.

“We never like to lose money — but if we had invested the assets in the benchmark — which would be the alternative if our team was not allocating to private equity funds — we would have lost 21.7%,” Burton said. “So, the market lost 21.7% while our team preserved capital. Private growth is mostly private equity and noncore real estate — two sectors that one would expect to be negative in a COVID-type of environment.”

The ERS fund matched the peer funds’ 1.3% return in the fiscal year but has been exceeding its peers over longer stretches of time. The ERS fund is up an annualized 5% over the last three years (vs. 4.9% for peer funds), 5.5% over the last five years (vs. 5.4% for peers) and 8.1% over the last 10 years (vs. 7.9% for peers).

“Given the extremely challenging second half of fiscal year 2020 we are pleased that our strategy protected portfolio capital and ended the fiscal year positive,” Burton said. “Unlike some peers, because we maintained portfolio value we were not forced sellers of assets — we had ample liquidity to capitalize on new investments.”

Burton acknowledged, though, that the impact of COVID-19 is not far from the minds of ERS trustees.

“In the interim and at the margin, we are evaluating what the go-forward impacts to financial markets may be due to COVID — for example, how does this change the outlook for real estate (office space, suburban housing, retail, et cetera) or certain equity sectors (tech, health care, et cetera),” she said.