State Pensions’ Struggles to Meet Obligations Mount

The struggle by state-sponsored defined benefit retirement systems to meet their pension obligations became even more intense in fiscal 2016, according to a new study by Wilshire Consulting.

The estimated funded ratio for 131 retirement systems sponsored by 50 states and the District of Columbia fell to 69% from 73% the prior year.

The drop marks the first time the funding ratio has dipped below 70% since 2010, when the US economy was recovering from a severe recession, and the second year in a row it has dropped by 4%, said Ned McGuire, vice president and a member of the Pension Risk Solutions Group of Wilshire Consulting. Funding levels totaled 77% in 2014 and 73% in 2015.

A weak US stock market and strong dollar over the period of the study, which ended June 30, 2016, weighed on assets. Poor domestic equity performance combined with weaker overseas returns due to currency fluctuations saw assets shrink.

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However, a growth in liabilities as assets struggle to keep up has resulted in the significant drop over the past three years.

The study also found that state pension portfolios have, on average, a 64.8% allocation to equities, including real estate and private equity, a 24.7% allocation to fixed income, and a 10.5% allocation to other non-equity assets. The 64.8% allocation is lower than the 68.6% equity allocation from 10 years prior in 2006.

During the decade ending in 2016, the average allocation to US equity and fixed income declined significantly, from 42.3% to 27.4% and 27.2% to 22.3%, respectively. Flows from US equity and fixed income have moved primarily to real estate, private equity, and other assets, including cash, cash equivalents, commodities, hedge funds, and other absolute return strategies.

The study lists possible drivers as rotation out of the relatively efficient US stock and bond markets into less-efficient asset spaces, reducing the home-market bias in fund holdings, increasing asset diversification in an attempt to de-risk the Total Fund, and increasing exposure to more leveraged strategies, such as private market equity, in an effort to meet return targets.

Tags: Data, Pensions, State Pensions, Wilshire Consulting

After adding China to its emerging market index this year, MSCI is now watching Saudi Arabia for possible inclusion to this index in 2018, based on the progress of various stock market reforms the country has implemented.

If the Middle Eastern country is added to the MSCI emerging market index, it would attract more investor interest. As growth in emerging markets rises, with the International Monetary Fund projecting a 4.5% growth rate for 2017, according to Tadawul, the Saudi Arabia stock exchange, more investors are likely to benchmark against emerging markets indices. And with Saudi Arabia garnering a potential 2.4% weight in the MSCI emerging markets index if this proposal goes through, more investors would need to have exposure to the country’s stock market.

“Saudi Arabia’s addition to the MSCI Watch List is an important milestone for Tadawul, and reflects the Kingdom’s significant progress in capital market reform in support of Vision 2030,” said Sarah Al Suhaimi, chairperson of Tadawul. “Potential inclusion in MSCI’s Emerging Market Index signals to international investors that the country’s capital market has attained greater maturity in terms of efficiency, governance, and regulatory framework.”

Saudi Arabia opened up its equity markets to direct foreign investment in 2015, and has been making market reforms since 2016. The improvements that MSCI sees in the Saudi Arabia stock market include:

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The raising of the cap for qualified foreign investor ownership from 20% to 49%
Lowering of the assets under management criterion to be considered a qualified foreign investor from $5 billion to $1 billion
The recognition of additional institutional investors such as sovereign wealth funds and university endowments as qualified foreign investors
Simplifying the registration process for qualified foreign investors
Changes to the exchange’s clearing and settlement process
Accommodation of securities lending and short selling

To consider Saudi Arabia’s inclusion to its emerging market index, MSCI will weigh aspects such as:

Whether the country’s opening up of its equity market to foreign investors is adequate to consider the change
Should investors have more time to absorb the changes before the country’s addition to the index
Are there any residual concerns about market accessibility
The experiences of qualified foreign investors.

Tags: China, MSCI, Saudi Arabia, Stock Market

Will Saudi Arabia Be Next on MSCI Emerging Market Index?