CalPERS Return Cut Would Be Small But Notable Step

CalPERS may be getting a bit more real. The $300 billion California public employees’ pension manager is considering cutting its investment-return assumption. The move would squeeze the budgets of public authorities and employees but secure funding for retirees. If the U.S. government-pension bellwether can do it, others will follow.

Public-pension funds in the United States have long relied on unrealistic investment assumptions, but the financial crisis and lackluster market performance have exposed that game. CalPERS took a baby step in 2012 by lowering its return assumption by 0.25 percentage point, to 7.5 percent, but the fund generated a return of just 0.61 percent in the 12 months ended June 30. Annualized returns were 5.1 percent over the past 10 years.

Chief Investment Officer Ted Eliopoulos has overhauled the fund’s portfolio since taking over two years ago, slashing the hedge-fund allocation and awarding fewer but bigger mandates to outside managers. Those moves aren’t sufficient to close the gap for a retirement system that has only 76 percent of the assets needed to ensure current retirement benefits to its members.

The CalPERS board will next week consider a plan to reduce the return assumption to as low as 7 percent, phasing the reduction over five years. State and local governments would see their pension contributions rise by as much as $2 billion a year in the fifth year. For employees, the hit could be another percentage point or more in payroll deductions.

That’s a political red flag, and the post-election stock-market surge might tempt some pension trustees to duck. But the Trump bump won’t solve their problem. Stocks could easily give up recent gains, and higher interest rates will hit bond returns in the short run. Consultant Wilshire forecasts that a classic 60-40 stock-bond portfolio will return less than 6 percent a year.

Private-sector defined-benefit pension plans typically use return assumptions of 4.25 percent at the moment, according to Milliman, another consultancy. The Netherlands’ well-funded pension system is even more demanding, assuming gains of less than 3.5 percent a year.

If CalPERS does bite the bullet now, that would improve its own position and send a useful signal. Many U.S. public pensions have worse funding situations and even more optimistic assumptions. It’s past time to stop pretending.

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