August 2012
Every five years the Teachers’ Retirement System Board reconsiders its assumed annual rate of return, and we will do that again this Thursday, August 23. As you may know, our annual target for many years has been 8.5%. How have we done? Our thirty-year annual rate of return has been over 9%, twenty-five years just over 8.5%, twenty year just under 8%, ten year about 6.5%, and five years at 2.5%. Last year’s 23+% gain was not repeated, and I expect when we get the numbers for this last fiscal year on Wednesday, it will show a growth of just a couple of percentage points.
Our 8.5% assumption has become an outlier. IMRF uses 7.5%; SURS and SERS dropped their target last year from 8.5% to 7.5% and CalSTRS, the largest teachers’ pension fund in the nation, went from 7.75% to 7.5% at the start of 2012. What this all adds up to is there is an expectation that we will lower our assumed rate of return on our investments and, when we do, there will be headlines. This is a fiduciary decision, one that is made by the pension board with the advice of staff and consultants. We need to make a realistic and sound decision in arriving at a number. It cannot be a political decision, but it is going to have a huge political impact.
Since by law the goal of the State of Illinois and the State’s five pension funds is to be 90% funded by 2045, how much we think the fund will grow year over year through investing has a significant and direct effect on how much money the State will be required to contribute to our fund to achieve that distant goal. Lowering the assumed rate of return would correspondingly increase the amount that the State would have to contribute to make up for less money coming in from investments. For every quarter of a percent we lower our expected investment returns, we increase the pension benefit obligation of the State of Illinois by several billion dollars, and those dollars show up on the unfunded side of the equation. This will allow those who have been arguing that the Illinois pension problem is worse than we have been told, and they will scream: “We told you so!” It will certainly increase the pressure on legislators “to do something.”
Since the results of this decision are potentially dire, wouldn’t it be better to leave the number where it is? The answer is "No." If we consistently fail to achieve an overly-optimistic target, and no additional funds are coming in from the State, our unfunded obligation not only grows, but so does the demand to do something even if it is not constitutional. TRS has to accept that the long-held expected rates of return for equities, bonds, real estate, and every other kind of assets are being seriously questioned. A number of those who predict what will happen next in investing are talking about the “new normal”: an economic future of slower growth, greater market swings, and overall lowered expectations on returns. There are those that are saying TRS needs to pick a realistic number like 7% or something even lower. I do not agree because I do not believe that is a realistic number. It is too low. On Thursday, we will pick a number that we rationally believe we can achieve going forward.
As Yogi Berra put it, “Making predictions is hard, especially about the future.” The past thirty years saw the invention of the personal computer and the Internet. Could the next thirty years see that same kind of technological revolution repeated? Will the growth of a new middle class in China, India and Brazil spur economic growth for the world? We hope so. We cannot invest our way out of our funding problem, but we count on our investments to move us in the right direction.
--Bob Lyons, TRS Trustee
Every five years the Teachers’ Retirement System Board reconsiders its assumed annual rate of return, and we will do that again this Thursday, August 23. As you may know, our annual target for many years has been 8.5%. How have we done? Our thirty-year annual rate of return has been over 9%, twenty-five years just over 8.5%, twenty year just under 8%, ten year about 6.5%, and five years at 2.5%. Last year’s 23+% gain was not repeated, and I expect when we get the numbers for this last fiscal year on Wednesday, it will show a growth of just a couple of percentage points.
Our 8.5% assumption has become an outlier. IMRF uses 7.5%; SURS and SERS dropped their target last year from 8.5% to 7.5% and CalSTRS, the largest teachers’ pension fund in the nation, went from 7.75% to 7.5% at the start of 2012. What this all adds up to is there is an expectation that we will lower our assumed rate of return on our investments and, when we do, there will be headlines. This is a fiduciary decision, one that is made by the pension board with the advice of staff and consultants. We need to make a realistic and sound decision in arriving at a number. It cannot be a political decision, but it is going to have a huge political impact.
Since by law the goal of the State of Illinois and the State’s five pension funds is to be 90% funded by 2045, how much we think the fund will grow year over year through investing has a significant and direct effect on how much money the State will be required to contribute to our fund to achieve that distant goal. Lowering the assumed rate of return would correspondingly increase the amount that the State would have to contribute to make up for less money coming in from investments. For every quarter of a percent we lower our expected investment returns, we increase the pension benefit obligation of the State of Illinois by several billion dollars, and those dollars show up on the unfunded side of the equation. This will allow those who have been arguing that the Illinois pension problem is worse than we have been told, and they will scream: “We told you so!” It will certainly increase the pressure on legislators “to do something.”
Since the results of this decision are potentially dire, wouldn’t it be better to leave the number where it is? The answer is "No." If we consistently fail to achieve an overly-optimistic target, and no additional funds are coming in from the State, our unfunded obligation not only grows, but so does the demand to do something even if it is not constitutional. TRS has to accept that the long-held expected rates of return for equities, bonds, real estate, and every other kind of assets are being seriously questioned. A number of those who predict what will happen next in investing are talking about the “new normal”: an economic future of slower growth, greater market swings, and overall lowered expectations on returns. There are those that are saying TRS needs to pick a realistic number like 7% or something even lower. I do not agree because I do not believe that is a realistic number. It is too low. On Thursday, we will pick a number that we rationally believe we can achieve going forward.
As Yogi Berra put it, “Making predictions is hard, especially about the future.” The past thirty years saw the invention of the personal computer and the Internet. Could the next thirty years see that same kind of technological revolution repeated? Will the growth of a new middle class in China, India and Brazil spur economic growth for the world? We hope so. We cannot invest our way out of our funding problem, but we count on our investments to move us in the right direction.
--Bob Lyons, TRS Trustee
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