In a fiscal year fraught with geopolitical unrest, supply-chain issues, rising inflation and a bearish stock market, the state’s largest public pension fund capitalized on its risk-averse strategy to finish in positive territory.
The Hawaii Employees’ Retirement System pension fund posted an investment return of 3.7% for the year that ended June 30 to boost its total assets to a near-record $22 billion, according to a report presented Monday to ERS trustees by investment adviser Meketa Investment Group.
ERS’s performance follows on the heels of a 26.9% return in fiscal 2021 that was the best gain in the portfolio’s 96-year history. The
asset level is the fund’s second-highest ever behind the $22.5 billion reached
Dec. 31, 2021.
“Our ‘risk averse strategy’ has served us extremely well,” ERS Executive Director Thom Williams said via email. “In fact, recent markets and our resulting return have served as a proof statement to the wisdom of our design. While the average public pension fund is down this year somewhere between a negative 6% and negative 8%, our fund experienced a positive 3.7%
return.
“We can’t incur the same level of risk as a more well-funded plan. So, we try to win two ways. One, we capture as much of the upside as we can during bull markets (the good times), and second, by not losing as much when markets decline (the bad times).”
The end of the fiscal year also marked the departure of Chief Investment Officer Elizabeth Burton after nearly four years at the helm. She resigned her position, effective June 30, for personal and family reasons, Williams said.
“She has elected to spend more time with her family on the mainland,” Williams said. “I am unaware as to where she will land but I’m quite sure that she will find an appropriate opportunity, perhaps with another pension fund, an investment management firm or an
investment bank.”
ERS recently hired Honolulu-based Kumabe HR to lead an external outreach for a new chief investment officer. Howard Hodel, who is serving as acting CIO, has decided not to apply for the job. Hodel, who also is ERS’s chief risk officer, had been serving as deputy CIO. Anthony Goo, ERS’s investment officer of public markets,
is now serving as acting
deputy CIO.
“We’ve been experiencing significant interest in the role and are confident in our ability to attract appropriate talent,” Williams said. “Our current plan is to make a selection sometime later in the fall. The final decision will be made by the Board of Trustees with input from me and others.”
The ERS pension plan provides retirement allowances and other benefits to more than 149,000 retirees, beneficiaries, inactive vested members and active public employees working for the state and its counties.
“We have enjoyed an
extraordinarily good year, especially considering the volatility of the markets during 2022,” Williams said.
Irving, Texas-based actuary Gabriel, Roeder, Smith &Co. said in a report released in January that the unfunded liability in the ERS pension fund decreased to $14.2 billion, from $14.6 billion, in the 2021 fiscal year. It was the first decline in the plan’s unfunded liability, or shortfall, since 2007.
The actuary’s annual valuation report is generally published in late December for approval and for acceptance by the ERS board of trustees in January.
Williams said the actuary already is estimating that the ERS pension fund in fiscal 2022 improved its funding ratio, or the percentage of the fund needed to reach 100%, to 61.2% from 58.3% in fiscal 2021. The actuary also expects the fund’s unfunded liability to have declined
by about $500 million to $13.7 billion as of June 30, 2022.
Gabriel, Roeder, Smith now expects the ERS portfolio to be fully funded by June 30, 2044, rather than June 30, 2045, as it had forecast last year.
“That could represent over $1.3 billion of savings in today’s dollars,” Williams said of the shorter time frame to be fully funded.
Even though the pension fund’s 3.7% return in fiscal 2022 was below the fund’s 7% annual average target, or assumed investment return, the shortfall in the pension fund improved because of ERS’s four-year smoothing strategy — an actuarial strategy generally employed by public pension funds that use either a three-year or four-year smoothing method to dampen the volatility in funding requirements year to year, either up or down.
“In fiscal year 2021 we experienced a 26.9% investment return which generated in excess of $2 billion in deferred, or unrecognized investment gains,” Williams said. “A portion of those gains are being recognized this year and will be over the next two years. Investment losses are treated the same way. Those deferred gains help to make up for our shortfall this year.”
Williams said despite last year’s record 26.9% investment return, the smaller fiscal 2022 investment return was “perhaps our most important.”
“Why? Because it validates our strategic portfolio decision-making and keeps us on pace to full funding,” Williams said. “Our return places us amongst the top 10% of all public plans in the nation. We have made a conscious decision to limit downside risk. By design, our plan participates in up markets, but not to the same degree as funds not employing downside protection. In the alternative, when markets are down, we are structured to not fall as much.”
Williams said the ERS constructs its fund to be risk averse because its subpar funded ratio leaves it at greater risk to market downturns than more well-funded plans.
“Deep and protracted losses could pose risks to our long-term sustainability,” he said.
Williams said during the budget process this year that the Legislature appropriated an additional $300 million to the ERS pension trust. That infusion follows previous legislative pension reforms that increased contributions from state and county employers, namely taxpayers, based on a percentage of an employee’s pay. Those contributions were phased in over a four-year period for police and fire employees as well as all other employees. The employees’ contributions remained constant during that period.
The employer contribution rate for police and fire employees is now 41%, and the employer contribution rate for all other employees is 24%. These contribution rates are scheduled to remain in effect until the ERS is fully funded.