Public pensions across the U.S. have a big problem: The gap between their assets and liabilities is growing while the outlook for investment returns is worsening.

“For the next 10 years, our expected returns are 6.1%, not 7%,” Chief Investment Officer Ben Meng told the board of the California Public Employees’ Retirement System last week. Calpers, the country’s largest pension at about $366 billion, lowered its long-term investing return target to 7% in late 2016.

Here’s a look at what has happened and what pensions are doing about it:

The Funding Gap Is Widening

Even a record bull stock market hasn’t been enough of a boost, as the average U.S. plan had only 72.5% of its future long-term obligations in 2018, compared with more than 100% in 2001. Recessions, insufficient government contributions and generous benefit guarantees have caused the imbalance to grow, according to the Center for Retirement Research at Boston College, and investing decisions often hurt too. […]

Simpler Has Been Better

Pensions that bet aggressively on stocks, especially U.S. companies, outperformed funds that poured into so-called alternative investment vehicles like hedge funds or private equity. “Sometimes diversification, while it’s the right strategy, makes you look dumb,” said Andrew Junkin, president of Wilshire Consulting. […]

Alternatives Are in Vogue

Public pensions increased private equity allocations to 10.2% on average in 2018 from 5.6% in 2008, a trend likely to continue in the hunt for yield. Mega plans are hiring more staff to internally manage private equity and other alternative assets, which they expect to beat stocks in the future. […]

Assumptions Are Getting Scaled Back

About 85% of 129 U.S. public pensions have cut return assumptions since 2014, including recently the Pennsylvania State Employees’ Retirement System. Pensions started scaling back after the last recession. The average target will probably go lower, according to Keith Brainard, research director at the National Association of State Retirement Administrators. “Each month and each quarter that goes by with low inflation and interest rates remaining low provides more ammunition to justify lower investment returns,” Brainard said. […]

There Aren’t Any Easy Answers

While easier targets are prudent from a risk perspective, they’re not always politically palatable. A dollar drop in investment projections can mean a dollar out of the pockets of taxpayers. The Kentucky Retirement Systems’ plan for 123,000 employees in non-emergency jobs has $2 billion in assets for $15.6 billion in liabilities. It has only a 35% allocation to equities and has stopped new investments in private equity because it can’t spare cash on volatile or locked-up holdings. The pension burden is leading to government service cuts, pay freezes and a falling headcount feeding on itself.

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This article quotes selections from “Pension Crisis Deepens in U.S. as Strategies Shift, Outlooks Dim” by Alexandra Stratton and John Gittelsohn, in Bloomberg, June 28, 2019.