The Relationship Between Public Pension Investments and Declining Bond Yields

In the last two decades, public pension systems have steadily shifted plan assets away from fixed-income investments, like government and corporate bonds. This outcome is not surprising, given the declining rate of return on these investments. But, in search of higher yields, and under pressure to maintain unrealistic investment return assumptions, public pension plan managers are now allocating a greater share of assets to riskier investments like private equity.

In 2001, fixed-income investments made up 31.5 percent of US public pension plan investments. Less than 20 years later, in 2019, these investments made up 23.2 percent of plan assets. The decline in interest rates was even larger over that time period. At the start of 2001, the interest rate on a 10-year Treasury note was above 5 percent. At the end of 2019, before the COVID-19 pandemic, it fell below 2 percent.

Furthermore, in 2001, 91 percent of all public pension plan assets were invested in public equities, fixed income, or cash. The latest data shows that these investments now make up only 72 percent of the public pension system investment pie. This decline again shows the steady movement away from fixed-income assets in the last two decades.

The data visualization below shows the relationship between declining interest rates and public pension asset allocations. As corporate and treasury bond rates have fallen, public pension plans have invested their funds differently.

The visualizations display how private equity investments have grown in popularity. Private equity allocations are now the third-largest asset class for public pension plans, growing from 3.62 of nationwide plan portfolios in 2001 to 9.15 percent in 2019.

Portfolio managers should be free to pursue whatever investment philosophies they believe are in the best long-run interests of their plan members. However, policymakers, pension plan members, and taxpayers should be aware of these trends and the risks that come with them. Pension systems and lawmakers need to address the growing risk of volatility in ways that maintain a plan’s resiliency to unpredictable market factors. Also, plan stakeholders should be wary of a situation where the tail wags the dog—with pension systems swapping safety for risk and volatility as they chase outdated and overly optimistic investment return assumptions.