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US Public Pensions: Worst in the World?

Public pension funds in the U.S. are not only among the worst managed in the country—they are some of the worst-managed in the world. A recent paper found that U.S. public pension funds routinely take higher risks than pension funds in other countries or private-sector pension funds in America. And unlike their international and corporate peers, these funds have shown a tendency to double down on these risky investments when times get tough rather than adopting a more conservative investment strategy. AiCIO reports:

“We find that US public pension funds behave different from all other pension funds and not in line with economic theory,” authors Aleksandar Andonov, Rob Bauer, and Martijn Cremers assert. “In times of severe underfunding or political distress, the incentives are strong to not lower discount rates sufficiently in response to lower interest rates and a maturing client base, at the same time adopting (perhaps recklessly) risky asset allocation strategies and camouflaging the real costs of pension promises made to their beneficiaries and taxpayers.” […]

US public and corporate funds, on average, allocate 68.3% of their assets to “riskier investments” (defined as everything but cash and investment-grade fixed income), compared with 60.5% for Canadian funds, and 51.7% among European pensions. For every fund region and category except US publics, the study found that these allocations drop as funds become more mature (i.e. the ratio of retirees to working members rises).

This is depressing news to pensioners, but it shouldn’t come as a surprise. Over the past few years we’ve see pension funds in state after state clinging to ridiculously high estimates of investment returns, then turning to exotic Wall Street investments when they fail to meet them.

Fund managers are obviously at fault here, but timid politicians should shoulder much of the blame as well. Much of the pressure to earn high returns on investments stems from the unwillingness of politicians to fully fund their local pensions, forcing fund managers into an impossible situation where gambling on high-risk, high-reward investments is the only way to make up the shortfall.

This needs to change, but in the meantime, anyone relying on a public pension for retirement should start thinking about a Plan B.

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