PA pension fund most 'risky' in US?

(More on this story, including SERS' response, in Thursday's Philadelphia Inquirer here)

The Pennsylvania State Employees' Retirement System (PennSERS) tops a list of the most "risky" state employee pension funds, National Public Radio claims in reports here and here, citing data from Pensions & Investments magazine and a formula attributed to Joshua Rauh, a tenured associate finance professor at Northwestern University.

NPR applies a simple analysis that ranks bonds and cash as the safest investments. The more a state fund keeps in other kinds of investments - stocks, private investments, hedge funds, real estate - the more "risky".

As the Inquirer and P&I have reported, Pennsylvania leads the nation in the total proportion of "alternative" private equity, hedge fund, real estate and other illiquid investments managed by high-fee private money managers, some of whom are contributors to Gov. Rendell and other politicians who control the funds.

But do these investments really make the funds "risky," as NPR claims? I asked Rauh, and he wrote back: "SERS and Washington State are the two state public pension funds with the largest allocation to private equity. This is really what sets SERS apart and what pushes them up the list in terms of aggressiveness of their investments.

"Is it a good or bad idea for public pension funds to invest in private equity? The jury is still out. On the one hand, public funds should be doing more asset-liability management than they are, using bonds to match the benefit payments they have promised to employees.

"However, if their size and patience allows them to reap higher returns from illiquid investments than other investors could, there is also a role for them as private equity investors."

The tough choices will come a few years down the road, Rauh said, "if the pension funds start getting really low on assets and have to liquidate some assets to pay benefits. I did some calculations suggesting that under baseline investment return assumptions and without pension reform, Pennsylvania will run out of pension fund assets completely in 2023. The horizon of state pension funds may not be as long as people think" NJ is already trimming benefits.

Rauh has ranked state pension funds based on when they are likely to run out of money. According to his newly-published paper, "The Day of Reckoning", here, Pennsylvania ranks near the middle of the pack. New Jersey is in greater danger: it could run dry by 2018, five years sooner than PA, under current investment assumptions.

NPR's "risky" claim as regards PennSERS's asset mix is goofy. Dollar for dollar, Pennsylvania's pension system isn't the most "risky". But years of political over-promising and underfunding have made it risky enough, and things are as bad or worse in other big states.