Public Pensions and the "soft" stock market

All images snipped from the Wilshire Report referenced below.

According to the Wilshire report, the public pension "industry" is about 72% funded.  One response to under-funding is to change the asset allocation into investments with more "pop" in the hope of catching up. 

Over the last ten years the percentage in "equities" has been constant but the mix shifted.  US equities decreased by 17% while Non-US equities grew by 7%, Private equity grew by 7% and Real Estate holdings grew by the balance.

There is no free lunch.  Changes that increase the upside nearly always increase the fund's downside potential.

Looking at two pensions that have been in the news:

CalPers has approximately $300B in assets and is funded at 77% of obligations.  About 63% of that is in equities and another 10% is in real estate.

Illinois State Pension is $138B in assets and is funded at about 43% of obligations.  The Illinois system is strange...it is a bit like the segments of an orange.  Rather than do a bunch of non-value added math to add them together I will just report on one of them, the Teachers Pensions.  They have about 52% of their assets invested in equities and 13% invested in real estate.

What next?

The mode for the Percent Funded is the 60%-to-70% funded bucket.  Fully one quarter of all funds examined fell into this bucket.

Regression of Funding Ratio and Equity Allocation

Those funds, on average, have 70% of their assets in equity type investments.

The rules of estimating funding and future return are a bit arcane.  They are allowed to average many year's performance to smooth things out.  But in my simple, back-of-envelop way of thinking, 70% exposure * 70% funding means that a 10% drop in the S&P500 (a broad based index of equities) means that their funding ratio dropped about five percent.

That may be one of the biggest reasons the Fed has been juicing up the economy in general and the Stock Markets in general.  It was seen as the only way to avoid Pension Armageddon. 

It does not look like they will be successful.