Recently the Oregon Public Employees Retirement System (PERS) board voted to affirm the current 7.2% assumed rate of return on the fund’s investment earnings for the next two years (the 2021-2023 budget cycle). This assumption is extremely important to PERS, because investment earnings on the $77 billion fund pay for about 75% of the money the system sends out to retirees. The assumed rate of return was 8% from 1989 to 2012. It was reduced to 7.75% in 2013, 7.5% in 2015 and then 7.2% in 2017.

The asset allocation – or mix of investments – for the PERS fund was 36.7% in public equity (i.e. stocks that can be traded on a public exchange), 19.7% in private equity (i.e. non-publicly traded companies), 18.9% in debt securities (bonds), 10.1% in real estate, 7.3% in alternative equity, 5.2% in cash and 2.1% in the “opportunity portfolio”.

So, the fund’s mix of investments is fairly aggressive, and far riskier than the portfolios held by the vast majority of our clients. Because of the aggressive asset allocation, we would expect the fund’s returns to be fairly volatile. The returns for the 10-year period from 2009-18 ranged from -22.3% to +22.3%. So, the fund’s performance was indeed quite volatile. The average annual return was 7.47%.

Why is the assumed rate of return important? The assumed rate of return determines the amount of contributions government agencies must contribute to the fund to pay retiree pensions. The lower the rate, the more governments must deposit into the fund. The opposite also holds. PERS is facing (as of the end of 2017) a $22.3 billion unfunded pension liability. This is a measure of the shortfall in assets expected to be needed to fund retiree pensions. That liability will grow to the extent that returns realized in the PERS fund do not meet projected returns.

You might be asking why this is of interest. If you are receiving PERS benefits, as many of our clients are, you want to know that PERS is well-funded and able to make its payments to you and other PERS beneficiaries. If you are a taxpayer in Oregon, you are probably concerned about the massive unfunded liability facing the state. At some point, this huge gap between obligations and actual funds will need to be closed. Taxpayers will undoubtedly be required to help.

We would also point out that return assumptions matter more broadly. For example, if your retirement plan depends on your portfolio earning 7%, then your actual future average annual returns need to track accordingly. If your actual returns fall below your projected returns, a gap will develop between the resources your plan assumes are available and the resources actually at your disposal. That will require either saving more (if you are still working) and/or reducing future spending. Putting this in the context of PERS, it means the state will either need to make larger contributions (from taxpayers) or reduce future benefits.