Three recent news stories highlight the need to have clear definitions of what success looks like for public pension investment returns.

The news articles pointed out that three states — Hawaii, Arizona, and Nevada — were able to beat their “benchmark” returns for the fiscal year ending 2019. These pension funds measure their years from July 1 to June 30, so the “fiscal year” of 2019 just wrapped up this summer and the retirement systems can report how well they did on investments. However, it is important to remember that the “benchmark” for pensions funds is mostly irrelevant for long-term fiscal health.

A “benchmark” for large investment firms like pension funds is a selection of other, similar firms or measurements of the financial sector. For example, a state pension plan might measure itself against other institutions that manage a similar amount of assets, or it might use a stock market index as a benchmark for how well they are doing. Measuring the performance of investment returns of a pension plan against one’s peers is a helpful way to know whether the money is being managed as well as it could be. But ultimately, a peer group benchmark is just measuring where you stand among others.

It is far more important for pension funds to understand how their investment returns are influencing their funded status. Every public pension fund has an “assumed rate of return” on investments that they use to figure out how much money should be contributed each year into the pension fund. The money flowing into a pension fund is highly dependent on this investment return assumption. So measuring a pension plan’s investment performance each year to see if they met or exceeded their assumed rate of return should be the most important kind of benchmark.

The Employees’ Retirement System of Hawaii earned 5.8% during their last fiscal year. The investment managers for the statewide Hawaii pension plan say this was better than expected. “The $16.7 billion plan returned 5.83% in the period, 118 basis points above its 4.65% benchmark, confirmed Elizabeth Burton, Hawaii ERS’ chief investment officer.” However, it was less than the 7% assumed rate of return that the same Hawaii pension plan has used to set contribution rates.

Similarly, the Arizona State Retirement System (ASRS) earned 6.5% in the 2019 fiscal year, better than the 5.2% peer group benchmark. But since ASRS has a 7.5% assumed rate of return, this is well below what they should be measured against.

Meanwhile, the Nevada Public Employees’ Retirement System earned 8.5% during the last fiscal year. This beat their own benchmark of 8.3%, but more important for the funded status of the pension plan it exceeded the 7.5% assumed rate of return.

Hawaii and Arizona beat their benchmarks by a greater margin than Nevada, but Nevada improved their funded status (all else equal) by exceeding the assumed rate of return whereas Hawaii’s funded status dipped down and Arizona’s is likely to do the same.

The goal for pension plans cannot simply be the peer-based benchmarks that the investment managers set for themselves. The goal has to be meeting or exceeding the assumed rate of return.

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This article quotes selections from “Hawaii ERS Blasts Past Its Benchmarks,” published August 16, 2019 in Chief Investment Officer, “Arizona State Retirement System returns 6.5%, well above benchmark, published August 7, 2019 in PI Online, and “Nevada Public Pension Beats Benchmark with 8.5% Return in 2019,” published August 14, 2019 in Chief Investment Officer.