Public Pension Quarterly 2Q 2024: A Little Leverage Can Go A Long Way
Quarterly Snapshot
Source: MSCI, Bloomberg, and Goldman Sachs Asset Management. As of June 30, 2024.
- In the second quarter, equity markets continued their move higher, driven by optimism surrounding potential interest rate cuts despite economic resilience.
- Additionally, many investors continued to show enthusiasm regarding the potential impacts of artificial intelligence (AI). Our colleagues in Global Investment Research highlighted continued momentum for the potential AI beneficiaries, although they also cautioned that some of the benefits of AI may be overstated.
- Interest rates modestly rose in the second quarter, though the labor market showed initial signs of cooling. Our colleagues in Global Investment Research forecast the US unemployment rate to end 2024 at 4.2%.
- Lastly, global elections have continued to be topical, potentially driving more volatility in the coming months.
Source: Boston College Center for Retirement Research and Goldman Sachs Asset Management. As of June 30, 2024. Funded status reflects estimated asset returns and liability growth.
- We estimate that investment returns for public pension plans were 1.2% in the past quarter, which contributed to our estimated aggregate funded status staying flat at 83%.
Source: MSCI, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management. As of June 30, 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document.
In The News
Pension Industry Updates
Equable Published Updated on State of Pensions 2024 Report
- In its recent publication, Equable Institute presented key statistics from its annual study of the US public pension system. Among others, the report highlights updates on contributions, plan funding, and investment returns.
- Preliminary 2024 investment returns for fiscal years ending June 30, 2024 were reported to be 7.4%, partly driven by strong market performance, allowing plans in the population to exceed their 6.9% average expected return on assets assumption. Equable projects the system’s average funded ratio to be 80.6% this year based on reported market assets, up from 75.8% in 2023.
- That said, it cites factors such as changes to actuarial assumptions, demographic turnover patterns, and stickier inflation that continued to place downward pressure on plans’ funded ratios. In part as a result, employer contributions were elevated in 2024, exceeding 30% of payroll on average for a third straight year.
Pension Plan Investment Returns Relative to 60 / 40 Index
- In June, the Boston College Center for Retirement Research (CRR) published a study comparing public pension plans' historical long-term investment returns with the return of a 60% US equity / 40% US aggregate bond index.3
- According to the CRR, public pension plans’ historical annualized net returns were 0.03% less than the 60 / 40 index returns from June 2000 through June 2023. This similar relative performance is despite the recent trend of pension plans increasing target allocations to alternative assets like private equity, real estate, and hedge funds.
- Given the study results and that trend, the CRR raises the question of whether the added complexity from alternative assets, which often times come with higher fees and monitoring requirements, is better for plans’ investment returns relative to traditional asset classes.
Notable Pension Asset Allocation Updates
- The five New York City Pension Plans (Teachers, Employees, Police, Fire, and Board of Education), which collectively manage over $274 billion in assets, announced FY 2024 returns.
- For the year ending June 30, 2024, the plans achieved an aggregate 10.0% return, net of fees. That marks the second consecutive year of outperformance relative to the 7.0% return target. The strongest performance was driven by the U.S. Equity allocation, while Private Real Estate was the only asset class area to realize negative returns in the year.
- During the year, the state of New York expanded the maximum potential allocation to non-traditional asset classes for the plans to 35% from 25%.
- In July, the California Public Employees’ Retirement System (CalPERS) reported preliminary investment returns for FY 2024. Over the 12 months ending June 30, 2024, CalPERS earned a net return of 9.3%, driving total assets to $502.9 billion. That return exceeded the plan’s return target of 6.8%. Interestingly, the private debt asset class, which was established in 2022, returned an estimated 17.0%.
- Also in July, the California State Teachers’ Retirement System (CalSTRS) announced an 8.4% net investment return for the same period. With that return, CalSTRS’ 1-, 5-, 10-, 20-, and 30-year historical returns are all in excess of its assumed 7.0% return target. The plan remains ahead of schedule in reaching its stated target of becoming fully funded by 2046. The next actuarial funded status estimate is expected to be released in May 2025 for FY 2024.
Portfolio updates highlighted here represent actions taken by large public plan sponsors that we believe would be of interest to readers.
CIO Corner: Craig Husting
We sat down with Craig Husting, CFA, Chief Investment Officer of the Public School and Education Employee Retirement Systems (PSRS/PEERS) of Missouri, to learn more about his views on the current market environment and what is most topical for the plan.
Missouri PSRS/PEERS has a 40% allocation to private risk assets. What goes into this portfolio and how do you think about allocating across private markets?
We think about private assets as serving three main purposes in the portfolio: enhancing returns, broadening the investable universe, and providing diversification. Over the last 10 years, we have observed significant outperformance in our private market allocations relative to their public market counterparts. For example, private equity outperformed public equity by 500 bps, and private credit outperformed high yield by 400 bps. Additionally, we seek to capitalize on the trend of more companies staying private for longer and more loans being sourced privately. Within our privates portfolio, we believe non-core real estate, such as data centers and cold storage, is a particularly attractive area given the fall in valuations over the last two years.
The Board of Trustees approved the use of leverage in the plan a couple of years ago. How do you use leverage in the portfolio?
We use leverage in two ways: a structured alpha overlay program as well as direct leverage at the total plan level. For over a decade, our alpha overlay program has been in place to gain equity market exposure through swaps and various hedge fund strategies. More recently, our board approved direct use of leverage at the plan level, with the primary purpose for rebalancing. Through this application, we are able to adjust exposure in different market conditions without having to impact our liquidity. As an example, in both March 2020 and May 2022, we were able to increase equity market exposure as markets had sold off. However, we aim to use it opportunistically, as we believe other parts of our portfolio are well-positioned to achieve our expected return target.
What risk are you most concerned about for the rest of 2024?
Left tail events, or the types of things we cannot predict, remain top of mind for us. The most recent example being COVID-19, or some type of geopolitical shock going forward. We believe we are well-prepared for the more predictable sources of market risk. Generally, we lean on Treasuries and different hedge fund strategies to mitigate equity market risk in the portfolio.
Additionally, inflation continues to be a focus, as CPI ties into our cost-of-living adjustment that impacts benefit payments and ultimately required contributions.
Looking longer-term, what trend are you most excited about and how do you see this as an investing opportunity?
We are most excited about a couple of areas, particularly in alternatives. Firstly, although some pension plans have decreased their hedge fund allocations, we think the strategies may make sense both now and more strategically. Secondly, we see attractive opportunities in private credit, especially directly lending to private companies while staying at the top of the capital structure. Lastly, private equity co-investing, in addition to our direct lending strategy, has been a major source of fee savings for our portfolio, with $300+ million in collective savings for us historically, and the potential for around $750 million over 10 years.
There are a hundred things we could ask you. What should we be that we have not or what doesn’t get enough airtime?
By far, the two most important items are governance and building a long-term, sustainable structure. The two go hand in hand. We believe in creating a positive cycle between all of the different components, from staff training and compensation to communication with other stakeholders. All of this is aimed to drive long-term investment performance. I have worked through two 50% equity market drawdowns, which prove the importance of a long-term structure. To give one example on the governance side, we recently opened an office in St. Louis as we continue to seek ways to attract top talent. Through all of this, flexibility is key.
Source: Public School and Education Employee Retirement Systems of Missouri and Goldman Sachs Asset Management. As of August 2024. For discussion purposes only. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Please see additional disclosures at the end of this document. Diversification does not protect an investor from market risk and does not ensure a profit. There is no guarantee that objectives will be met. Past performance does not predict future returns and does not guarantee future results, which may vary.
Strategy In Focus: Use of Leverage
We are seeing different public pensions consider using leverage to help achieve different portfolio objectives, ranging from potentially enhancing returns to diversifying risks or some combination of both.
Source: Goldman Sachs Asset Management as of August 2024. Note: The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. De-risking strategies should not be construed as providing any assurance or guarantee that as a result of applying the strategy an investor will reduce and/or eliminate risk, as there are many factors that may impact end results such as interest rates, credit risk and other market risks. For Illustrative Purposes Only. There is no guarantee that these objectives will be met. Diversification does not protect an investor from market risk and does not ensure a profit.
Asset Class Views
Source: Goldman Sachs Asset Management Multi-Asset Solutions. As of August 2024. Views typically reflect a six to twelve month forward investing time horizon. Views expressed are for informational purposes only and do not constitute a recommendation to buy, sell, or hold any security. Views and opinions are current as of the date of this document and may be subject to change, they should not be construed as investment advice. The economic and market forecasts presented herein have been generated for informational purposes as of the date of this document. They are based on proprietary models and there can be no assurance that the forecasts will be achieved. Please see additional disclosures. 1. Views on Global Equity are absolute whereas regional / country-specific views are relative to Global Equity.
