Falling global stock and bond values slashed about $3 billion from the Pennsylvania State Employees Retirement System (SERS) in the second quarter, staff and consultants warned during the Thursday’s investment meeting.
The fund was worth $34.5 billion at mid-year, down from $38 billion three months earlier, after counting an 8.5% investment loss for the quarter, as well as payouts to 130,000 retirees and continued contributions from taxpayers and 100,000 public servants — legislators, judges, college staff, corrections officers, soldiers, social workers — who hope to one day retire with system pensions.
The fund fell as lawmakers pondered how to deal with pressure to increase pensions for more than 70,000 elderly state and public school retirees, including the latest increases to the “allowance cost of living” came into force in 2004. Their pension checks, unchanged since. time are losing their pricing power after food, fuel and other prices rose earlier this year at the fastest pace since the early 1980s.
US, foreign and “emerging markets” stocks on SERS all fell sharply in the three months to June 30 (by around 17%, 15% and 13%, respectively). System bonds, while long seen as a hedge that tends to rise in value when stocks are down, have instead lost almost 5%. And its commodities (whose value ironically reported by the SERS under the euphemism “inflation hedge”) were also down 7% for the quarter ended June 30.
Private equity investment fell a relatively modest 1%, while real estate rose almost 4%. But SERS staff and advisers, led by chief investment officer James Nolan, warned that these asset values, as noted, benefited from accounting practices that tend to lag actual value changes, and warned that they would likely lose value later this year.
Left unspoken: The threat that such losses could prevent SERS from meeting its annual return on investment target of 7%, potentially necessitating an increase in its annual “employer contribution” from taxpayers – currently at $2 billion – to keep its $19 billion asset-liability deficit from growing.
Nolan blamed the fall in investment values on “the Russian situation, which is only getting worse,” a reference to the invasion of Ukraine; in the same way inflation, which he attributed to high government spending during the peak years of the pandemic; and raising Federal Reserve interest rates, intended to curb price inflation.
The system deals with what amounts to a double whammy for stocks and bonds. Since stocks make up nearly half of SERS’ investments, “we generally rely on (bonds) to go in the opposite direction,” Nolan said. So the decline in value of existing bonds, while their low yields compare unfavorably to new debt at today’s higher interest rates, is an “unfortunate circumstance”, he said.
To be sure, higher bond yields will eventually boost returns as SERS managers buy more newer bonds, noted Thomas H. Shingler of Callan LLC, one of SERS’ investment advisers.
But mostly, “there haven’t been a lot of places to hide,” Shingler added.
Property yields are still “very strong” and private equity hasn’t lost as much value as public stocks – but “we expect them to cool down,” he said. Shingler said inflation is likely to drive up commodity prices, but cautioned against betting too much on these “highly volatile” assets.
What should SERS do with its available cash? Staff recommended two new investments, both managed by companies that already manage other funds for SERS.
One recommendation was for Ardian Secondaries Fund IX LP (and an associated Ardian Sidecar Co-Investment fund). Paris, France-based Ardian Group, which claims to invest around $80 billion, offers SERS “a different type of private equity fund, compared to our usual technology or industry focus,” said Glenn Becker, l suburban Philadelphia investor who runs SERS. ‘ investment committee.
This latest Ardian fund is a scavenger among private equity funds, at a time when many large investors are selling these investments in private companies, to raise funds.
The fund’s strategy, according to its founder, Dominique Senequier, is to buy non-public companies from buyout funds, at bargain prices, and hold them until they can be sold at a profit.
“We are the biggest buyer in the market,” Senequier added, “and we are focusing on the biggest deals,” in Europe and Asia, as well as the United States.
Compared to other private equity funds, Ardian “doesn’t have such high return expectations, but it is a ‘volatility absorber'” whose price is less likely to fluctuate with the latest market trends , added Becker.
If that sounds like lowered expectations for a tough market, that’s what the board was looking for: Directors voted unanimously, 11 to 0, to send $150 million to Ardian.
A second recommendation has been issued for Oak Street Capital Real Estate Capital Fund VI. Pittsburgh-based Oak Street Capital Group was recently acquired by Chicago-based Blue Owl Capital.
Acknowledging that “real estate may be going through tougher times”, Oak Street chief executive Gary Rozier assured directors that the company had “historically done well in times of disruption” and that it was the right time to invest fresh money in properties.
The team added few details on the impact on its investments of the change in the US real estate industry, from office and retail projects that generated big profits in the 2010s, to warehouses and service apartments. post-pandemic delivery companies, which have recently generated the highest earnings and greatest investor interest.
The two Republican lawmakers on the board, which is dominated by appointees and legislative allies of Governor Tom Wolf, a Democrat, said the presentation was not enough to win their support.
The directors voted 9 to 2 to invest $75 million in the new Oak Street fund. Schemel voted no on Oak Street, as did Sen. John DiSanto, R-Dauphin.
The directors will review these investments and ratify their decisions at the next regular meeting of the SERS Board of Directors on September 29.