(Bloomberg) - U.S. state and local governments have good reason to root for stocks to rebound from the crash.
The record-setting rally had muted warnings since the financial crisis by investment consultants, academics and public officials that government retirement plans couldn’t meet their targeted returns of seven to eight percent annually. The median public pension has exceeded those assumptions over the past five years, returning an annualized 9.1%, according to the Wilshire Trust Universe Comparison Service.
Last year, U.S. public pensions reported median gains of 15.2%, the best since 2013 and double the annual targets they count on to pay benefits, according to figures released by Wilshire Tuesday.
Global growth, strong corporate earnings and the prospect that the Republican tax cut will boost returns to shareholders powered stocks to record highs until late last month, when they began to retreat. International stocks got a boost from a weakening U.S. dollar, gaining 27%, compared to 21.8% for the S&P 500.
“For the past two or three years or maybe even longer, we’ve said don’t expect the returns you’ve experienced since the global financial crisis," Mike Manning, the managing partner of New England Pension Consultants, said in a Jan. 30 webinar to clients. “That clearly hasn’t come true."
Still, investors should expect that future returns will shrink, he said. This week that warning looked prescient: Stocks tumbled for a second day Monday, with the Dow Jones Industrial Average losing 1,175 points, or 4.6%, leaving the index down for the year. But prices rebounded slightly early Tuesday.
While the previously gains will help ease the fiscal strain on state and local governments who have had to pay more into the funds to make up for lost ground, they haven’t been enough to pull the retirement systems out of the hole.
U.S. public pensions had 71.8% of assets required to meet obligations to retirees as of the fiscal year that ended in June 2016, according to a report by the Center for Retirement Research at Boston College. Assuming they achieve annual expected returns of 7.6%, they will have funding ratio of about 73% by 2021, according to CRR.
That’s because the annual contributions made by governments to pensions are often inadequate to improve funding, while some fail to pay that amount in full, said Jean-Pierre Aubry, associate director of state and local research at CRR.
“While we’re seeing a kind of stagnant aggregate funding level, it really is a story of three different trajectories," he said: Pensions that are “falling off a cliff" such as Illinois, New Jersey and Kentucky, middling plans that need to state funding appropriately to “make it through" and plans like North Carolina, Florida and Georgia that pay their annual required contributions every year and aren’t in danger.
Illinois and New Jersey have a pension funding shortfall of a combined $310 billion, while Kentucky and Connecticut have deficits of $43.4 billion and $34.1 billion, respectively.
“For a lot of these places the trajectory is grim because they just can’t afford the cost of the system as it is today. They’ve fallen too far behind."
Both public pensions and college endowments, whose fiscal years typically begin on July 1, have started their years strong with a median return of 7.3% and 7%, respectively. Over the 20 year period, public pensions have a median return or 7%, according to Wilshire.
“They’re on target to have what I refer to boring, predictable target returns for the long term,” said Robert Waid, a managing director at Wilshire Associates Inc. in Santa Monica, California.