News that public state pension funds are $1 trillion short in funding expected retiree benefits should be rattling everyone and come as no surprise. As they increased real estate allocation targets to 10% or more of their total asset portfolios, many state funds invested with wild abandon in real estate opportunity funds and private equity accounts in vain attempts to boost returns and fill burgeoning gaps-only exacerbating their liability problem in the ongoing crash.
In raising real estate allocations, public plan sponsors and their consultants rationally had talked up the benefits of investing in real estate for income plus returns, which matched nicely with future retiree payouts. But instead of concentrating in core real estate, they ramped up investments in riskier value-add, opportunistic, and global funds with a keen eye on bigger paybacks. And these higher risk strategies were largely based on using more leverage to boost returns, not part of the traditional plan sponsor conservative playbook.
Of course, real estate is just a small part of the public pension fund crisis. Essentially, the system is untenable. Public employees can´t work for just 20 or 25 years and retire in their 40s on full pensions without eventually bankrupting state and local governments. Well eventually has arrived.
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