"These pension funds operate over very long time frames but at the same time they can't ignore what's happening in the near term," said Keith Brainard, research director for the National Association of Retirement Administrators.

WASHINGTON – Disappointing public pension investment fund returns released recently by Virginia and Maryland may be indicative of a more nationwide trend, pension experts warned.

The two mid-Atlantic states had public pension plan returns of more than five percentage points less than their assumed levels for fiscal 2016, which ended on June 30. Pension experts attributed those less-than-expected levels to low interest rates and lower inflation than in past years. Still, the returns exceeded long-term estimates.

The Maryland State Retirement and Pension System's (MSRPS') $45.5 billion investment portfolio had a 1.16% return after fees, well short of its 7.55% assumed rate of return. Across the Potomac, the Virginia Retirement System's (VRS') $68.1 billion investment portfolio earned a 1.9% return after fees, also short of its 7% assumed rate of return.

Keith Brainard, research director for the National Association of State Retirement Administrators, said that the return figures reported by Maryland and Virginia are consistent with what other public pension funds experienced during the same period.

"Interest rates are lower, inflation is lower and a lot of people are predicting that returns on equities and capital markets in general will be lower," Brainard said. "Nobody expected rates to stay this low for so long. A lot of investors, not just public pension funds, are reevaluating their expectations and projections."

VRS chief investment officer Ronald Schmitz called the past fiscal year's market "volatile," but stressed that VRS is a long-term investor and still exceeded its one-year, three-year, five-year and ten-year benchmarks for the period ending June 30.

"We know market environments vary from year to year, and we will see returns above and below the 7 percent assumed rate of return level," he said.

Similarly, Maryland State Treasurer and chair of the MSRPS' Board of Trustees Nancy Kopp also pointed to the long-term implications.

"While this is a very disappointing one-year return, it's important to remember that we are long-term investors, meaning we should not be distracted by a single-year's performance, whether the earnings are high or low," she said. "Over the last 30 years, including both good years and bad, the fund has earned an average return of eight percent."

Brainard was a bit more tempered, saying, "These pension funds operate over very long time frames but at the same time they can't ignore what's happening in the near term."

He declined to comment on whether states should lower assumed rates of return to better align with most recent figures.

But a July paper from the Center for Retirement Research at Boston College forecasted "considerably" lower equity returns, and suggested muni officials adopt a 6% rate of return as a baseline assumption. Most rates of return are between 7.5% and 8%, according to the center and NASRA.

Alicia Munnell, director of the Center for Retirement Research, told The Bond Buyer on Friday that the consensus among industry officials is that returns will continue to be lower in the future due to a number of factors, including low bond rates and the stock market being at an all-time high.

"We don't fundamentally criticize their approach, but we think expected return assumptions are too high," Munnell said.

The political ramification of lowering the return assumptions would mean increased normal costs and increased unfunded liabilities, she added.

"It's a hard thing to do, biting the bullet," Munnell said. "To be fair, you wouldn't do anything after one year."

According to a March report by Wilshire Consulting, the investment consulting unit of Wilshire Associates, the funding ratio of 131 state benefit plans fell three percentage points to roughly 74% in fiscal 2015. As of September 2015, state and local government retirement systems had assets of $3.56 trillion, according to the Federal Reserve.

A February report published by NASRA acknowledged that current low interest rates and volatile investment markets could require public pension funds to take on excessive investment risk to reach their assumptions, but stressed that the median annualized investment return for the 25-year period ending in 2015 exceeded the average assumed return of 7.62%.

Investment return assumptions set too low could overstate liabilities and costs, which could cause current taxpayers to be overcharged and future taxpayers undercharged, according to NASRA. A rate set too high could understate liabilities, which could undercharge current taxpayers and adversely affect future taxpayers, the group added.

"An assumption that is significantly wrong in either direction will cause a misallocation of resources and unfairly distribute costs among generations of taxpayers," NASRA officials wrote in the February report.

"Changes in economic and financial conditions are causing many public plans to reconsider their investment return assumption," they added. "Such a consideration must include a range of financial and economic factors while remaining consistent with the long timeframe under which plans operate."

VRS officials said the state's investment portfolio for fiscal 2016 included $26.6 billion in public equity, $12.5 billion in credit strategies, $12 billion in fixed income, $8.8 billion in real assets, $5.2 billion in private equity and $1.1 billion in "strategic opportunities portfolio."

The real assets program for fiscal 2016 saw the highest return of all investments at 11.6%, while the public equity program had the lowest at -3.2%.

The MSRPS' pension investment returns, on the other hand, were highest for private equity, at 9.94%. Like VRS, the MSRPS' lowest returns were for public equity, at -4.31%. About 37.4% of assets were allocated to public equity.

Even in fiscal 2015, which ended on June 30, 2015, the MSRPA had a 2.68% return on a $45.8 billion investment portfolio, more than five percentage points less than its 7.65% actuarial return target for the year. Still, it was 1.82 percentage points higher than the plan's policy benchmark of .86%, which is a weighted average of the overall market performance of the underlying asset class indices.

"Unlike FY 2015 where asset returns were broadly low, FY 2016 had returns that were low on average but displayed much larger variability among assets classes," MSRA chief investment officer Andrew Palmer said. "MSRA's balanced asset allocation helped us earn modest positive returns."

With 677,000 members, VRS is the 22nd largest public or private pension fund in the U.S. and 49th largest in the world, according to the system. MSRPS administers retirement and pension allowances to more than 148,000 retirees and future benefits to 246,000 active and former members of the system.

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