U.S. Retirement Funds, Heavy on Stocks, Brace for Losses

At the nation’s largest pension fund, the California Public Employees’ Retirement System, total reported holdings have fallen to $475 billion as of March 2 from $482 billion at the end of January. The S&P 500’s total return was minus 2.71% during the same period. Roughly half of the California worker fund is in stocks.

The situation highlights public retirement funds’ enduring dependence on the stock market and the potential impact on local government services and municipal-bond prices if losses continue. Smaller retirement systems tend to rely even more heavily on stocks than larger ones, which are more likely to seek returns from private-market assets like infrastructure and private equity.  

U.S. state and local government pension funds control more than $4 trillion in public-worker retirement savings but will need hundreds of billions of additional dollars to cover promised future benefits. Over the past 12 years, blockbuster stock performance has swelled pension coffers, bringing state and local governments closer to being able to cover those liabilities and taking some of the pressure off taxpayers already burdened by high pension costs. 

A downturn, however, could ultimately squeeze state and local budgets. That is because when pension-fund returns fall short, the workers and government employers that pay into them end up helping to make up the shortfall. Annual pension contributions are already a drag on the finances of some cities and states, leaving less money for operations and debt payments and leading to credit-rating downgrades.

Research firm Municipal Market Analytics views a sustained market correction as the biggest threat to state and local general-obligation-bond prices.

“State pensions often have an allocation to equities that is greater than the size of [the states’] annual budgets, so a correction in equity prices can ultimately have an outsize impact on the state,” said Municipal Market Analytics partner Matt Fabian.

States and cities cut services, laid off workers and rolled back benefits for new employees after the 2007-09 recession took a huge bite out of U.S. public-pension-fund holdings.

Government finances today are far from that type of austerity scenario. With the S&P 500 returning double-digit gains in nine of the past 12 calendar years, pension funds have built back their holdings. Over the past two years, federal Covid-19 aid and rising tax revenues from the stimulus-fueled economic boom have bolstered municipal budgets. 

Pension managers and trustees regularly pore over market projections in an attempt to distribute money in ways that will both insulate their funds against downturns and deliver ambitious long-term gains. 

Some pension funds missed out on gains by rolling back stock allocations in the years before the pandemic. Many reaped big returns from the stimulus-fueled economic boom that followed. Now many retirement systems are paring back equities targets in response to projections about dimming stock-market returns.

When Angela Miller-May took over as investment chief of the $57 billion Illinois Municipal Retirement Fund in August, U.S. stocks were 44% of the portfolio, above the fund’s 39% target. Her team worked to rebalance the portfolio, shifting funds into other asset classes, and trimming the holdings to approximately 42.4% by November. 

“Uncertainty and market volatility have impacted almost every fund and continue to be a concern along with expectations of muted returns moving forward,” Ms. Miller-May said.

Write to Heather Gillers at heather.gillers@wsj.com