US - The California Public Employees' Retirement System (CalPERS) has rejected recommendations to lower its discount rate and voted to keep it at 7.75%.
The Benefits and Program Administration Committee's recommendation to maintain the current rate, which represents what the fund believes it can realistically earn from its investments on an annual basis when averaged over the course of 20 years or more, will go to the pension fund's full Board tomorrow.
Actuaries for $226bn scheme last week recommending trustees cut the discount rate by 25 basis points to 7.5%, arguing the new rate better reflected lower expected returns going forward. They also said it took into account the new asset allocation adopted in December which divides assets into so-called risk buckets - inflation, growth, income, real returns and liquidity. (Global Pensions: 9 March 2011)
"There appears to be a consensus that returns are expected to be lower than historical returns over the next 10 years and the expected returns that were presented to the Board reflected that," the actuaries' memo to the Board said.
Although CalPERS chief actuary Alan Milligan recommended the fund adopt the lower discount rate, he told the committee keeping the rate unchanged was prudent. He said: "As pension fund administrators, we want to make sure CalPERS remains financially sound over the long term.The discount rate adopted is reasonable and achievable, and appropriate for funding the promised benefits."
Rob Feckner, CalPERS Board President and vice chair of the Board's Benefits and Program Administration Committee added: "Given the current economic environment, we believe keeping our discount rate unchanged is in the best interest of our members, employers, and taxpayers."
Over the past 20 years, CalPERS has earned an average annual 7.9% rate of return before deducting administrative and investment expenses. For the fiscal year that ended June 30, 2010, CalPERS earned a 13.3% return.
CalPERS' investment portfolio has an allocation target of 49% publicly traded stock, 16% bonds, 14% private equity, 13% real assets - real estate, infrastructure, and forestland - and the remaining 8% in smaller allocations in asset classes designed to minimize volatility and liquidity risk.
As a part of its analysis, CalPERS staff, using the revised asset allocation, generated 10,000 investment performance scenarios covering the next 60 years. The analysis concluded that expected returns will average 7.38 % in the first 10 years and 8.50% in years 11 and beyond, which resulted in a 7.95% average annual return over 20 years or more.
Based on the historical performance of the different asset classes and sophisticated computer analysis, the updated asset allocation is expected to produce an average annual return of 7.95% over the next 20 years or more, with a 50-50 chance that returns will be either higher or lower, the Board said. With historical administrative expenses of 0.15%, the expected net return rate is 7.80%.
CalPERS reviews its asset allocation and assumed rate of return every two to three years. The fund last adjusted its discount rate in 2004, when it was lowered from 8.25% to 7.75%.