Public pension funds should avoid local economically targeted investments

Some politicians continue to insert their interests and agendas into the complex process of managing public pension fund investments. After some pension plans recently made decisions focused on leveraging investment behavior to achieve environmental goals or to pursue geopolitical ends in China, a few lawmakers are now pushing local economically targeted investments into the limelight. These proposed investments are another deviation from pension plans’ fiduciary responsibilities to their members and taxpayers, who serve as the ultimate backstop to paying for the pension benefits promised to public workers. Economically targeted investments introduce unnecessary risks for public pension funds that should be avoided.

Incorporating non-fiduciary objectives into public pension investment decisions is not a novel concept; the recent push for economically targeted investments (ETIs) represents another example of politically driven intervention putting alternative priorities above responsible considerations like retirement security and the affordability of taxpayer-backed benefits.

This issue has come to the forefront recently in Philadelphia and Jacksonville, where policymakers have intervened in pension fund investment strategies, advocating for allocations toward local projects and businesses.

In Philadelphia, the Philadelphia Public Banking Coalition proposed that the city’s pension fund allocate $168 million—equating to 2% of its portfolio—toward local economically targeted investments, including affordable housing, renewable energy projects, and cooperative development initiatives. Proponents of this plan believe these investments would match but potentially exceed the investment returns of current asset classes, posing less risk compared to the public pension fund’s ventures into derivatives.

In Jacksonville, the office of Mayor Donna Deegan has suggested using pension funds to bankroll significant renovations planned for the city’s municipal stadium. The renovation of the stadium and the development of a surrounding “sports district” are projected to reach up to $2 billion, and the city is considering novel financing strategies. Among these is the proposal to borrow from the Police and Fire Pension Fund and other city employees’ pension funds—all of which collectively hold $5 billion in assets. The idea is to provide a loan that would fulfill the pension funds’ investment return objectives while saving the city from conventional financing costs. 

However, the assumption that pension funds can meet their investment return targets while contributing to the local economy through ETIs is questionable at best, and there have been notable examples of recent ETI losses.

For example, in Pennsylvania, an investment in a local automobile plant resulted in a combined $40 million loss for the state and teacher pension funds. The Kansas Public Employees Retirement System incurred a $73 million loss due to investments in a steel mill and a savings and loan association, both of which later failed. The Connecticut Retirement and Trust Funds also faced a $20 million loss after buying a significant stake in Colt, a firearm manufacturer that declared bankruptcy three years after the purchase.

Economically targeted investments were more common in the 1980s and 1990s before more data and better investment professionals began populating more public pension boards. A 1995 report from the CFA Institute stated that public pension portfolios that engaged in ETIs and other socially focused investments typically underperformed by 43 to 246 basis points annually. Further substantiation from a 1998 study by Marquette University Professor of Finance John R. Nofsinger shows that pension plans investing in ETIs experience notably lower abnormal returns compared to those that avoid such investments. 

Achieving the lofty investment return rates set by public pension plans is already a significant challenge, particularly when viewed against the backdrop of diminishing funded ratios. As of March 2024, the average assumed investment return rate has decreased to 6.91%, a drop from the 7.95% observed in 2007.

In Jacksonville, the pension plan’s investment return assumption has been adjusted downward from 6.625% to 6.5% in 2022, coinciding with the plan’s funded ratio of just 56.93%.

Similarly, Philadelphia has encountered a decline in its pension system’s funded ratio, falling from 60.9% funded to 55.5% within a year. Philadelphia also reduced its assumed investment return, which was adjusted from 7.95% in 2012 to 7.4% by 2022.

These figures highlight pension funds’ growing difficulty in reaching their financial targets, compounding the stress on their long-term sustainability and ability to pay for promised liabilities.

While some politicians may be tempted by calls for public pensions to invest in local economies, a pension board’s duty is to maximize investment returns to fully fund plan members’ benefits and minimize taxpayers’ expenses. Public pension managers must prioritize this duty to earn solid investment returns so they do not compromise workers’ retirement security or overburden taxpayers with debt and rising costs.

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