PORTLAND – Oregon’s public pension managers have voted to undertake a major shift in the way they invest members’ money, turning to age-based investment funds for beneficiaries’ individual accounts.
For Treasury staff and the Oregon Investment Council, the citizens’ panel that oversees the investment of the pension assets, it’s a no-brainer, Investment 101 decision they’ve been discussing for years. They say they’re replacing a one-size-fits-all investment approach with one that will insulate older workers from market volatility as they near retirement, while giving younger workers a more aggressive, growth-oriented investment mix.
“This is the right thing to do and a common sense change,” said Oregon Treasurer Tobias Read, a member of the council.
For the Public Employees Retirement System Board, or at least its chair, however, it’s a misguided and unnecessary change that will require significant member education. It also will require complicated and potentially costly technology upgrades to track and report investment returns that will now vary across the membership pool.
John Thomas, a Eugene businessman who chairs the PERS board, said his colleagues have not had a detailed discussion of the change, which is being presented as a fait accompli that they will be responsible for administering. He believes the board’s focus needs to remain on how to manage the crippling costs associated with the pension fund’s existing $24 billion unfunded liability, not adding another wrinkle to an already complicated system that will increase costs and may not deliver much value to members.
“This plan is already one of the most complicated in the country, and the benefits are among the highest if not the highest in the country,” he said. “We can’t control what the OIC does, but I think it’s very misguided.”
As is usually the case when the pension system is involved, there are complicated politics in the background. The move puts a spotlight on the $8.2 billion pool of assets funded by member contributions, which are the central part of ongoing and controversial pension reform discussions in the Legislature. It’s unclear whether the investment shift, or simply the increased attention it brings, will complicate that discussion.
At the treasurer’s request, the council also took the unusual step Wednesday of interrupting its meeting to allow the president of the Service Employees International Union 503 to comment on the change. The situation was made more awkward because Steve Demarest had also just been confirmed for the PERS Board, and he was taking an advocacy position on an issue he hasn’t discussed with the board.
“Members want it,” he told the investment council. “They want to be able to choose how investments are directed. SEIU will be advocating in the future for member choice.”
To be clear, investment managers are not changing the way they invest pension assets. The shift deals with members’ individual accounts, which were created in 2004 when the legislature redirected member contributions – 6 percent of pay – out of the pension system to slow the runaway growth of pension liabilities under the system’s lucrative money match formula.
Those individual accounts now provide a supplemental benefit to the regular pension. They belong to the employees, and like a 401(k), earn market returns. Unlike a typical 401(k), however, members have had no choice in the investment of those funds, which have been invested alongside the pension assets with no differentiation based on age.
Changes come jan. 1
That will change as of Jan. 1. Members still won’t be able to choose their own investment mix. But their individual accounts will be transferred into one of 10 target-date funds, based on their birth year. The pension fund will remain the primary asset in each of the age cohorts, but older workers will have 50 percent of their money invested in more conservative bond index funds, while younger workers will have 25 percent invested in equity index funds, giving them a more aggressive, growth-oriented allocation.
The general approach is common in private sector 401(k) plans. According to Treasury’s chief investment officer, John Skjervem, the cleanest way to accomplish that typically would be to hire a low-cost provider of such funds – such as Vanguard – give them the entire $8.2 billion currently in the individual accounts, and have them administer the program.
In this case, he said, that’s not feasible. Liquidating the current investment pool would incur substantial transaction costs, and a large chunk of it is tied up in illiquid private equity and real estate funds. Hence the decision to leave most of members’ money pooled and invested alongside the pension assets – which have performed well – and overlay that with a mix of stock and bond index funds.
Skjervem says the change has an ancillary benefit. By protecting older retirees from big swings in the market, it reduces the likelihood of a major rush to retirement in a down market, with the corresponding need for investment managers to liquidate investments in a bear market. That problem is manageable now, but becomes a bigger risk as the individual accounts become a larger share of the investment pool under management.
Not done in haste
Treasury estimates it will only have to transfer $1.6 billion to $2 billion into the new index funds to establish the target-based funds. That’s about 2 percent of the assets under management, and can be accomplished without creating any major imbalances in the existing portfolio, Skjervem said.
The investment council on Wednesday approved Treasury staff’s recommendation to hire Alliance Bernstein to design and provide ongoing analysis of the new accounts, and State Street Global Advisors to manage the assets in a series of stock and bond index funds.
Rukaiyah Adams, the chair of the investment council, described the age-based approach as a strategic shift that should provide a better risk/reward profile for members.
“This is us moving forward and getting better,” she said. “We’re not doing anything in haste here. This isn’t in response to any market condition or dislocation.”
Challenges for PERS
PERS Executive Director Steve Rodeman briefly discussed the challenges of the decision during Wednesday’s meeting. PERS has been paying an outside firm to help administer the individual account program, and is in the midst of a five-year effort to bring that work back in-house to save money. It already has spent nearly $5 million on that project, and the target-based funds will change the scope, involving revisions to completed work and new capabilities. That could involve significant delays and budget changes. In the meantime, it will continue to work with the outside vendor.
“We have to pause and think about how we most productively move forward,” Rodeman said.
Rodeman said PERS also has a team working on the member education piece, and will be coordinating with Treasury to make sure the message is consistent.
The new target date funds will be a topic of discussion at Friday’s meeting of the PERS Board, the first where Demarest will take his seat as a board member.
Thomas, the board chair, said that the emphasis of the panel needs to be on long-term funding solutions, not spending time on changes within individual accounts.
He points out that one of the only legally viable pension reforms remaining for lawmakers to address the current deficit is to redirect some or all of members’ retirement contributions to support the pension fund. Those contributions currently go into the member accounts, making Oregon one of the only public pension systems requiring no member cost sharing.
A bill was proposed earlier this year to redirect as much as a third of those contributions to support the pension fund, but Democratic leaders declined to move forward after failing to reach consensus on new corporate taxes.
“This is really the only viable way left to deal with some of the long-term costs,” said Thomas, whose term on the PERS Board expires in March. “I’m not sure the governor or legislative groups truly understand this.”
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