How should a public sector pension plan invest its assets? A trend since the 2007 financial crisis is public pension funds making up for losses by seeking higher returns in riskier portfolios. Michael Corkery at The Wall Street Journal takes a look at the Texas Teachers’ Retirement Fund which is placing more of its assets in private equity in an attempt to “hit its target” of 8 percent annual returns. Therein lies the problem.
Due to how public pension liabilities (i.e. the benefits owed to retirees) are valued (based on the expected return on plan assets), there is pressure to invest plan assets to achieve a targeted return that is linked to how the liability is valued. This approach is deeply flawed and been criticized often. Instead, plan assets should be invested in a way that hedges the risks inherent in the liability. These risks include changes in wages and interest rates since the value of the retiree’s benefits is affected by changes to wages and are usually indexed to inflation.
Source: Mercatus Center. Read full article. (link)