Retirement fund lost $1.4 billion in two years
By John Duchemin
Advertiser Staff Writer
The state Employees' Retirement System, which pays for the pensions of thousands of government workers, rode the stock market to new heights in the late-'90s, but since mid-2000 its $8.4 billion portfolio has lost more than $1.4 billion, or 15 percent of its value, becoming one of the worst performers among 42 comparable pension funds nationwide.
Last year, the fund lost 5.2 percent, or about $400 million, and even with its strong investment returns from the late '90s has only managed to grow at a 6.8 percent annual rate over the last five years — well below its target of 8 percent.
The downward trend bodes ill for the pension fund, for taxpayers and for the state government, which will soon be faced with paying hundreds of millions more in annual pension contributions, in part because of the fund's poor returns.
ERS officials maintain that the fund is fundamentally sound, and that the recent poor performance is an anomaly produced by the global bear market. They point out that the same issues are afflicting dozens of the largest public employee pension funds nationwide: funds that blossomed with the bull market through the '90s are now losing billions in the new millennium and are being forced to ask their governments for extra money.
"These shortfalls are impacting all pension systems," said Dale Orr, chief financial officer for the Oregon Public Employees' Retirement System, which also saw the value of its portfolio drop and the need for government contributions rise last year. "You end up having to try to collect more money from some source, and often it's asking the employers (the various governments) to contribute more money."
Most funds — Hawai'i's included — already are performing better since equity markets bottomed after the Sept. 11 attacks. ERS has scraped out a 6.8 percent return since Sept. 30, and the fund plans only minor shifting of its investment strategy, such as moving about 2 percent of its portfolio out of poorly performing Asian stocks.
But the sharp downturn of 2000 and 2001 could hardly have come at a less than ideal time for ERS. Hawai'i government pensioners are increasing in number, living longer, and requiring ever greater monthly payments. Meanwhile, state and county governments have proven unwilling in the current political and economic climate to pay the optimal level of annual contributions to the pension fund.
That means future payments — and therefore the tax burden — will be much higher.
ERS' longtime investment advisor, Callan Associates Inc., predicts ERS will suck up more than $500 million per year in state and country contributions by 2009 — about one of every 10 dollars in state tax revenues. That's up from the $30 million total contributed in the past two fiscal years, and also higher than the $200 million contributed in an average year in the 1990s.
In Hawai'i, the need for ERS to grow its fund has become particularly urgent. For the past several years, employer contributions to the fund have dried up as state politicians decided to limit them and instead stake future growth on returns from investments in the stock and bond markets.
But as equity markets soured and the world economy slowed in 2000 and 2001, ERS' investment strategy has not performed as well as it had in the past. Under the advice of Callan Associates, the ERS portfolio for years has been globally diversified, with more than 22 percent invested in international equity and bond markets.
When the global markets outperform domestic stocks and bonds, this strategy can lead to higher-than-average returns — as when ERS added almost $4 billion, or about 70 percent, to its portfolio between 1996 and 2000.
But when international markets perform relatively poorly — as in recent years — globally diversified funds can come up short.
"Over the last two years, any fund with a substantial international exposure has had a very painful experience," said John Jenks, chief investment officer for the Alaska State Pension Investment Board, which oversees a public employees' pension fund about the same size as ERS that also lost hundreds of millions of dollars last year.
In 2001, the Hawai'i fund's international equity investments lost 19.5 percent of their value, or $285 million, and over the past five years ERS' international stock investments have averaged 1.6 percent growth, compared with 9 percent annual returns for its domestic stocks.
The recent international losses have knocked ERS down; over the three-year and five-year periods ending Dec. 31, 2001, ERS' portfolio ranked in the bottom 10 percent of comparable funds — 39th out of 42 public pension funds with more than $1 billion in assets, Callan Associates reported.
The best-performing funds made about 10.5 percent a year over five years, compared with ERS' 6.8 percent yearly growth.
To make matters more complicated, ERS for decades has put hundreds of millions of dollars — about 2 percent of the total portfolio — in Asian stocks. While this "Pacific Basin mandate" generated good returns when Asian economies were booming in the 1980s, the last 10 years have brought a Japanese recession, unrest in Southeast Asia and the late-1990s' economic crisis.
ERS' Pacific Basin investments have subsequently lost 5 percent a year, about $40 million total, over the last five years.
Recently the losses have driven ERS to abandon its Pacific Basin strategy. Last week, the fund's trustees voted to end ERS' relationship with Japanese investment firm Daiwa, moving all $150 million under that firm's management to global funds managed by Bank of Ireland and Schroder Capital that have more broadly diversified asset bases.
"Having a Pacific Basin mandate served us extremely well for a very long time, and made our performance better than our peers," said Toby Martyn, chairman of the ERS board of trustees. "But that hasn't been the case in the last 10 or so years. We've stuck it out for about as long as everyone could handle, hoping that certain changes Japan made to shore up their economy would bear fruit, but they simply have not done so."
Aside from that shift, ERS is sticking to its time-tested strategies, which have helped the fund grow from a few hundred million dollars in the 1970s to its current size.
Fund officials maintain that international diversity is an excellent long-term strategy that has worked extremely well for the system in better times. Many pension funds that failed to diversify globally didn't enjoy the stellar returns ERS and other forward-thinking funds racked up in the 1990s, said David Shimabukuro, ERS administrator.
Callan Associates says the pension fund's portfolio is actually very close to ideal if ERS wants to minimize risk, maximize return and keep up with the rising costs of employee benefits.
The fund is likely to earn an 8.4 percent annual return, on average, for the next several years, according to an actuarial report recently presented to ERS by Callan advisor Jay Kloepfer.
And Mainland pension fund officials said ERS' apparent patience in the face of losses is typical — and probably prudent. Most funds are avoiding radical change after a year of mild recessions, market corrections, accounting scandals and terrorist attacks.
"The majority of funds are long-term investors — they're not trying to time the market, but want to put money in, leave it there, and manage for the long term," said Brad Pacheco, spokesman for the California Public Employees' Retirement System, the nation's largest pension fund. "Our horizon is 20 or 30 years down the road."
