US state pension schemes certainly don’t lack for problems.

Many have nowhere near enough funds to cover growing payout liabilities (see first box below). And they struggle to shift their members from defined-benefit into defined-contribution schemes, which would sap their assets less quickly.

President Donald Trump

One solution would be to improve investment performance. Unfortunately, asset returns have been falling and market volatility rising, in part because of the geopolitical uncertainty and US-China trade tensions being fuelled by President Donald Trump’s administration.

The theatre around Trump’s trade war has raised tensions to the point that America’s public asset owners have begun to face explicit political opposition to making investments in Chinese assets (see box below, Opposing Chinese investments). It could also intensify the withering scrutiny that state pension funds are already suffering over how much they pay their in-house staff and external partners.

US PUBLIC PENSIONS’ FUNDING SHORTFALL

America’s states reported $2.9 trillion in assets in 2017, but they had a total liability of $4.1 trillion in pension obligations to workers and retirees, according to Pew Charitable Trusts, a Philadelphia-based think-tank. In other words, the schemes had a funding gap of $1.28 trillion, or only 69% of the assets they needed to fully fund their pension liabilities in 2017. 

This welter of difficulties has combined just at the point that US institutions look to invest more in emerging markets and particularly Asia, as part of a broader effort to diversify their portfolios and improve returns.

The current problems could serve to slow such plans. But a widespread view among senior US pension executives and industry experts is that these obstacles will ultimately be bumps in the road to building greater exposure to emerging markets, particularly China and wider Asia.

US state retirement funds are keen to move “toward a more focused China investment plan, but they’re thinking it may be best to wait till the current trade storm subsides”, said Jay Kloepfer, head of capital markets research at US investment consultancy Callan.

It’s still early days for most US state pensions when it comes to investing into Asia. They are well behind the likes of their Canadian counterparts, some of which are conduct regular direct investments via big, locally based teams.

“[US public funds] are not necessarily looking to overweight Asia,” said San Francisco-based Kloepfer, “but rather they’re asking at what point do they need to change how they implement their non-US portfolios.”

Asia is certainly becoming a bigger focus for some state pension players.

The chief investment officers of California State Teachers’ Retirement System, the Municipal Employees’ Retirement System of Michigan both say they have started spending more time on exploring regional investment possibilities. Similarly the Alaska Retirement Management Board has been looking into this are

Meanwhile the Teacher Retirement System of Texas is set to become the first large US public pension scheme to set up an Asian office – in Singapore.

OPPOSING CHINESE INVESTMENTS

President Donald Trump’s trade war and the tensions that come with it have led to recent unwelcome repercussions for large American pension funds.

On August 26 two US senators – Marco Rubio (a Republican) and Jeanne Shaheen (a Democrat) – wrote a letter to the Federal Retirement Thrift Investment Board, arguing that federal employees’ retirement savings should not be used to effectively fund Beijing’s espionage, military and security efforts.

Marco Rubio

The $590 billion state fund confirmed to AsianInvestor that it has been urged to reverse a decision to switch some $50 billion of government pension funds into stocks mirroring the MSCI All-Country World ex-US Investable Market Index. Chinese companies make up 7.6% of this benchmark and include state-owned enterprises (SOEs) such as China Mobile and AviChina Industry and Technology, an equipment and weapons systems maker.

The senators’ opposition is clearly politically motivated. FRTIB shifted assets to track the MSCI ACW ex-US IMI back in 2017, and only now has this opposition surfaced. What’s more, US state institutions have long used benchmarks that incorporate Chinese SOEs and made direct investments into various types of Chinese assets.

Since then Rubio has raised the stakes further. In late October he sent a letter to the press arguing that MSCI itself should be scrutinising Chinese companies more closely before including them in its indices. The index provider should be looking to ascertain their relationship with the Chinese Communist Party, the Chinese government’s military and intelligence services, or national security or human rights-related abuses.

Yet, as MSCI and others have pointed out, subjective analysis such as this has never been part of the index provider’s approach. Rather it focuses on standardised attributes such as company size and liquidity.

Look out for further articles on how American state pensions are playing Asia against this backdrop.

This article has been adapted from the feature 'US state pensions' Asia dilemma' in the latest (Autumn 2019) issue of AsianInvestor magazine.