The Pension Investment Crystal Ball
By Hank Kim, Executive Director and Counsel, NCPERS
This article was originally featured in the June 2023 issue of The Monitor.
If I had a crystal ball, I would be a billionaire. Unfortunately, though, I cannot see into the future. But rather than beating myself up for not buying Apple stocks in the 90s, I choose to be happy that I diversified my investments to weather the many volatile periods that have already occurred in my lifetime.
Recent rhetoric around pension investments, however, suggests that some believe fund managers have the ability to see into the future. These pension critics have developed a formula: Strategically pick a time period where the S&P 500 had exceptionally strong performance and, if a pension fund underperformed that equities-heavy benchmark, point to a large number and claim mismanagement.
But those are dollars lost, right? Well, would you say ‘I lost hundreds of thousands of dollars' because you didn't invest in Apple back in the 90s?
Their perspective uses flawed logic that also demonstrates a fundamental lack of understanding of how pensions work. I don't blame them—pensions are complex entities, with varying governance structures. That is why NCPERS, and most pension funds, put such a strong emphasis on continuing education.
Sadly, though, public pension investment professionals cannot see into the future. So instead of holding out for the coveted skill, they choose to use diversification to manage investment risks. This strategic diversification means, however, that pension funds often do not realize the same highs or lows as the market at large. But as long-term investors, this is a deliberate strategy to mitigate risk. This slow-and steady (emphasis on the steady) approach to investing helps ensure that funds can deliver pensions to millions of retired public servants and beneficiaries each year while keeping employee and employer contributions stable.
Investment earnings continue to make up approximately two-thirds of public pensions' revenue, with average 10-year gross investment returns of 9.0 percent, according to NCPERS 2023 Public Retirement Systems Study. Comparatively, the stock market has averaged between 10 to 12 percent returns over the last ten years.
But isn't that underperformance?
Yes and no. Consider that the S&P 500 closed out 2022 deep in the red, at -19.64 percent. Meanwhile, public pensions reported positive returns averaging 11.4 percent for fiscal year 2022. So, while pensions might not see those extreme market highs, they also don't see those extreme lows. Those steady returns allow public pensions to maintain stable employee and employer contributions.
If fund managers did have a crystal ball, all that wouldn't matter of course. But for now, millions of retirees, plan participants, and taxpayers should be glad that pensions are mitigating risk through deliberate diversification and strong governance practices.