Hawaii’s largest public pension fund, coming off its best performance in its 95-year history, continued its momentum by starting the new fiscal year on a positive note.

The state Employees’ Retirement System, which provides benefits to more than 148,000 members and beneficiaries, achieved a 2.1% return on its investments in its fiscal first quarter as the fund’s assets rose to a record $21.8 billion, according to a new quarterly report presented to ERS trustees by investment adviser Meketa Investment Group.

In the fiscal year that ended June 30, the ERS fund posted a record 26.2% investment return.

“I am very pleased with this quarter’s continuation of the strong performance posted by our investment team over the past year and earlier,” ERS Executive Director Thom Williams said in an email. “Although the recent results represent only a single quarter, it infers we are on track to achieve our long-term investment target of 7% annually. Attaining, or exceeding our investment objective serves to reduce the long-term cost of the plan to the state, counties and taxpayers. Improving the plan’s sustainability and affordability is our goal.”

The portfolio’s 2.1% gain in the July-September period topped its benchmark of 1.5%. The benchmark is a composite of various market-sector returns that are meant to emulate the investments in the ERS portfolio. ERS also beat the 0% return of the median public funds that have assets greater than $1 billion.

“We achieved our primary goals — we beat our public benchmark and exceeded our target return on an annualized basis,” ERS Chief Investment Officer Elizabeth Burton said in an email. “There was quite a bit of uncertainty in the markets over the quarter.”

Burton said achieving a 26.2% return in the fiscal year that recently ended was not an easy feat, particularly in a volatile market with lots of uncertainty.

“We continue to be proud of adding billions in return to the portfolio in FY 2021 and beating our benchmark handily last year,” she said. “However, not all time periods are created equal. This summer/fall had quite a bit of volatility around China, unemployment, supply chains, resurgence in covid, and inflation fears.

“We do not expect to achieve double digit returns across every time period, but we do aim to beat our benchmarks in the most responsible, risk-adjusted way. We do believe this quarter — and the prior quarters — demonstrate the value an in-house investment staff adds over passive beta strategies (such as buying an index fund).”

ERS has structured its risk-focused portfolio so that it outperforms its peer funds during market sell-offs and underperforms them in bull markets.

The fund’s private growth category, which purchases higher-returning investments that rely on the private markets, jumped 12.5% in the fiscal first quarter to lead all segments in its portfolio.

“Our portfolio is largely constructed to achieve performance targets over longer time periods like three, five and ten years or more,” Williams said. “For that time frame, we’re positioned quite well. We can however make modest tactical adjustments in response to near-term expectations, like rising inflation for example. Our goal is to take advantage of the best the market has to offer regardless as to where we are in the economic cycle.”

Williams said virtually every component and strategy within the ERS portfolio performed well during the recent period.

“The fund’s outperformance relative to our benchmarks and peers is due almost entirely to manager selection and portfolio construction,” he said. “Superior performance is not easily achieved and especially so for a plan such as ours which is defensively oriented.”

The ERS pension fund, which is trying to close a gaping shortfall, is not expected to be 100% funded until June 30, 2046, if all assumptions are met regarding contributions, an average annualized investment return of 7% and mortality expectations, according to the annual report for fiscal 2020 by independent auditor Gabriel Roeder Smith that was released at the beginning of this year.

The annual report for fiscal year 2021 is not expected to be finalized until January.

As of June 30, 2020, the portfolio’s funded ratio was 55.3%, meaning it had just more than half the funds needed to pay future beneficiaries.

But the state has taken steps to shore up that shortfall, with lawmakers passing legislation in 2017 to close the funding deficit that was created partly due to existing unfunded liabilities, retirees living longer and lower projected investment returns.

Those pension reforms included increased contributions from state and county employers, namely taxpayers, that are based on a percentage of an employee’s pay. Those contributions were phased in over a four-year period for general workers and police and fire employees. The employees’ contributions remained constant.

The new, higher employer rates were intended to remain constant once established. The higher payments will cut into the shortfall in future years.

Williams previously said after the blockbuster return in fiscal 2021 that the number of years it will take for the fund to become 100% funded likely will decline by between two and three years with the funding level expected to increase from 55.3% to between 57% and 58% once the actuary finalizes its report for the fiscal year that just ended.

“It is unrealistic for us, or any long-term investor, to expect a repeat of the returns we realized last year,” Williams said. “That said, we’re happy to accept them.”