Mission impossible for US municipal pensions

Carl Hess, global head of investment consulting, Watson Wyatt, said the current funding practice by nearly all municipalities was to assume the current investment mix was static, and that continued investment in risky assets would produce positive returns in the future.
But he warned: "This combination represents a bet taken using the wallet of future generations of taxpayers.

"Despite continued diversification into alternative asset classes, where the ability of skilled managers to add value would be arguably higher, an alpha expectation of nearly 1.5% by these funds certainly could be characterised as optimistic, at best."

Greenwich Associates said municipalities relying on this type of performance to fund pension plan liabilities should look closely at historic investment results and consider whether other, non-investment actions would be required to meet future obligations.

The average solvency ratio of public pension funds in the US increased modestly to 87% in 2007 from 86% in 2006, according to the results from Greenwich. However, those gains were attributed to advances made by state funds, which saw average solvency ratios increase to 85% from 79% year-over-year.

Municipal fund solvency ratios declined to 87% from 89% over the same period. In addition, more than 30% of municipal pensions have solvency ratios of 79% or less.

Steven J. Foresti, managing director and head of the investment research group at Wilshire Consulting, said while some plans would certainly achieve this type of relative outperformance, it was unrealistic to expect such results to come to fruition across a broad swathe of plans.

Kris Wulteputte, managing director, DEPFA Bank, added it was impossible to generate this type of return consistently, without incurring risks.

He said: "The volatility necessarily associated with this targeted level of outperformance is often underestimated."

And Jeff Schutes, who leads investment consulting at Mercer in the US, echoed this view, warning sponsors would need to have managers with a huge tracking error and a very aggressive investment style to get the high total alpha return in the portfolios.

"If you have to invest aggressively to get high returns, you will pay higher fees," said Schutes.

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