Public Pension Funds Taking Risks in Stocks, Report Warns

Citing the loss of $7.6 billion by California’s two largest public employee pension funds during the stock market crash a year ago, a legislative committee concluded Tuesday that the funds are taking unnecessary risks by investing heavily in stocks.

A report by the Assembly’s Public Employees, Retirement and Social Security Committee criticized the State Teachers Retirement System and Public Employees Retirement System for putting more than 40% of their money into the stock market instead of less volatile investments.

With stock prices now on the rebound, up 24% since the crash as of Tuesday, most of the money lost in the pension funds’ stock portfolios has been recouped.

But Assemblyman Dave Elder (D-Long Beach), whose staff prepared the report, said the committee is recommending that the pension funds put significantly more of their money into relatively safe investments, such as bonds, high-interest certificates of deposit and real estate.

“Given the high interest rates you can get from bonds, mortgages and other investments, it doesn’t make sense to play the stock market,” said Elder, who timed release of the report to the first anniversary of the market crash to draw attention to what he considers the highly risky nature of stock market investments.

The public employees pension fund has investments valued at $45.7 billion and serves 750,000 state and local government workers, about 200,000 of whom are retired. The teachers fund, serving 450,000 active and retired teachers, has $24 billion in investments.

Both pension funds generate cash from a combination of member contributions, taxpayer funds and investment profits. Taxpayers bear the ultimate responsibility for keeping the pension fund solvent.

During the six hours of frantic trading last Oct. 19 that resulted in the largest one-day stock market decline in Wall Street history, the two retirement systems lost money at the rate of $350,000 a second or $21 million a minute, the report said.

“This loss represented 22% of the market value of their total stock holdings and equaled approximately all their stock market gains in the previous 10 months,” the report added.

Measurement Period

Thomas E. Flanigan, chief investment officer of the teachers pension fund, disagreed with Elder, saying that a pension fund’s performance must be measured over a period of years.

“We are not short-term oriented. We intend to ride out the fluctuations in market cycles over the long term. Our time horizons generally are 40 or 50 years, not one year to the next,” he said.

The analysis of the pension fund investment practices by Elder’s committee began shortly after the crash.

The report said, “The October crash was much more precipitous than economists or portfolio managers previously thought possible. . . . Notions of ‘acceptable risk’ changed that day.”

Elder said that even though the value of the funds’ stock market investments have mostly recovered since last year’s crash, the two funds basically lost a year in which they could have earned rates as high as 14% from other investments.

Until 1984, pension funds were limited to investing only 25% of their money in stocks. But voters that year approved a ballot measure that allowed the funds to increase their holdings in stocks.

Percentage Breakdown

As of Tuesday, the teachers pension fund had 46% of its money in stocks, 42% in bonds, 7% in real estate and the rest in cash. The public employees’ pension fund has about 43% of its money invested in stocks.

Their percentage of investment in stocks has declined only slightly in the 12 months since the crash.

Over the last five years, the committee report said that the pension funds received about the same rate of return from real estate and bond investments that they did from stocks.

Given the relative safety of real estate, Elder believes that much more pension money should be invested in land and buildings.

“Everybody in the world is investing in California real estate,” Elder said. “Why aren’t we? No one argues that the downside on a real estate investment is as great as the downside on a stock market investment.”