The COVID-19 recession has fueled volatility in the financial markets. Investment portfolios saw sharp drops in March and April but have rebounded recently as the economy opened up in some areas.
This volatility has negatively impacted public pension funds.
The Sacramento Bee reported last week that, “California’s pension fund for teachers missed its investment target for the last fiscal year, reflecting a global market turndown brought on by the coronavirus outbreak.” The California State Teachers Retirement System, or CalSTRS, reported a 3.9 percent return on investments for the 2019-20 fiscal year.
Earlier this month, the Sacramento Business Journal reported that the California Public Employees’ Retirement System (CalPERS) earned a preliminary net return on investments of 4.7% in its fiscal year ended June 30, dipping below the fund’s 7% target to be able to fulfill its pension obligations over time.
Taxpayers and retirees should be concerned for two reasons.
First, when CalSTRS and CalPERS underperform their investment projections, it increases the likelihood that they will be unable to meet their obligations to current and future retirees. Remember, it is taxpayers that have to make up the difference if the funds don’t generate sufficient investment income.
As PRI’s Dr. Wayne Winegarden calculated in a fall 2018 study, California’s unfunded public employee debt problem was nearly $1 trillion when taking a more honest look at the problem.
Former Gov. Jerry Brown’s took the first, modest steps to address the crisis. School districts are now paying a larger share of their employees’ pension costs, roughly 18 percent in 2019. But with the COVID-19 fueled recession slashing tax revenue and the budgets of public agencies, school districts begged Gov. Newsom for relief. Next year, school districts were projected to pay more than 19 percent of a teacher’s salary for pensions according to The Bee.
The 2020-21 state budget plan shifts this burden to state taxpayers instead, redirecting $2.3 billion from the 2019-20 budget to reduce CalSTRS teacher contribution rates to 16.15 percent in the 2020-21 fiscal year and 16.02 percent in 2021-22. This may give districts some short term budget breathing room, but it could worsen the state’s unfunded pension crisis long-term.
Winegarden has urged “tough but necessary action to reform the system,” saying that doing so “can still guarantee fair yet secure retirements for state workers without bankrupting the state.” He recommends bringing public employee pensions in line with California’s median household income, or median income in retiree-aged households, which could save up to $160.2 billion over 30 years.
The other concern is that public pension funds continue to make politically-driven environmental, social, and governance (ESG) investments. Earlier this year, Chief Investment Officer reported that CalSTRS “approved a new investment principle aimed at expanding its ESG investment policy.”
While ESG investments may achieve political goals, they may not be in the best financial interests of growing the fund.
Winegarden’s research has shown that ESG investments often fare worse than traditional investments. His 2019 study analyzed 18 ESG funds with a 10-year track record, concluding that a $10,000 ESG portfolio would be 43.9 percent smaller than a similar investment in a broader S&P 500 fund. Just one ESG fund beat the S&P 500 fund’s earnings over 5 years, and just two would beat it over 10 years.
ESG funds also traditionally have higher expense ratios that traditional funds – a typical sign that investment returns will be lower. It can also exclude investments in companies like Amazon.com, which have been big earners this year. Even though these firms aren’t energy companies, activists still criticize them for failing to adhere to environmental or social justice goals.
Now more than ever in these volatile economic times, public pension funds must remember their most important priority – ensuring their fiduciary responsibility to taxpayers and retirees.
Tim Anaya is the Pacific Research Institute’s senior director of communications and the Sacramento office.