Virginia Will Lower Assume Rate of Return for Its Retirement Fund

The Virginia Retirement System is lowering its assumed rate of return to 6.75% from 7% following a Thursday board meeting. The change is in effect retroactively as of July 1, 2019. The $82 billion system, based in Richmond, reportedly made the change based on the recommendation of Verus, a consulting firm.

The system is also making modifications to asset allocation and will revise several benchmarks to be less reliant on public funds. The notable new long-term targets are 34% public equity, 15% fixed income, and 14% credit strategies. These new benchmarks will go into effect Jan. 1, 2020.

For public equity, Virginia is turning to a new MSCI ACWI IMI index, leaving behind a 50% hedged index for one that is not hedged and a peer universe index for hedge funds. For credit strategies, the state will use a benchmark of 60% S&P/LSTA Performing Loan index, 30% ICE BofAML BB/B US High Yield Constrained index, and 10% Bloomberg Barclays US Aggregate Bond index.

In fiscal year 2019, the system received a 6.7% return on its portfolio. The private equity program returned 14% and fixed income 8.3%. Other high-performing major asset classes were real assets and credit strategies.

The Center for Retirement at Boston College found that public plans invest a larger share in risky assets than private plans. From 2009-2015, public plans had 72% in risky assets, with 50% in equities and 22% in alternatives. Private plans had 62% in risky assets, with 44% in equities and 18% in alternatives.

There are reasons for the disparity in the share of risky assets. Risk tolerance tends to be lower for more mature plans. Other reasons include the health of a plan—risk may be reduced to lower the potential for default. Smaller plans may be more able to cushion risky investments. The higher a return, the less likely a plan may turn to risky assets. Other factors include the health and debt obligations of plan sponsor.

There is a reckoning occurring over overly rosy expectations. The University of California Board of Regents recently dropped its expected rate of return. Lower inflation projections and a looming recession are also triggering the decline. When inflation falls, the level of benefits also falls and plans make downward adjustments.

In March, a Virginia Retirement System report found that the state’s pension fund is less prepared today for a market crash than it was before the financial crisis, when its funding status fell nearly 25%. The state’s pension plan would see an increase in unfunded liability of about $6.9 billion.