The Texas Teacher Retirement System recently announced that it would make its first investment in a special purpose acquisition company (SPAC) totaling $200 million. Pension funds across the nations have spent the last decade seeking out higher investment yields from alternative investments like private equity in response to stagnating returns from more traditional investments. Recently a few funds have started to experiment with even more non-traditional vehicles such as cryptocurrencies and NFTs to improve investment results. Texas’ SPAC investment signals pension funds’ continued interest in these alternative assets.
SPACs are a perfect example of a high-risk, high-reward investment. Risk and transparency issues associated with this type of investment have even motivated the creation of SPAC insurance. Companies like HubInternational sell this insurance to investors for each stage of the SPAC process, ensuring they come out whole. Public pension funds like Texas TRS could theoretically buy this type of insurance on their SPAC investments, thus reducing the risk of the investment. The problem is the cost of SPAC insurance is rising fast, and the return adjusted for these costs is dwindling.
The risks associated with SPACs should make public pension funds very weary. Rather than continuing to take on riskier strategies to achieve lofty investment return goals, policymakers and those managing the retirement investments of public workers should lower assumed rates of investment returns and make other funding reforms that secure the long-term stability of retirement systems.
The latest analysis by the Pension Integrity Project at Reason Foundation, updated this month (February 2021), shows that deviations from the plan’s investment return assumptions have been the largest contributor to the unfunded liability, adding $897 million since 2002. The analysis also shows that failing to meet investment targets will likely be a problem for TRS going forward, as projections reveal the pension plan has roughly a 50 percent chance of meeting their 7.5 percent assumed rate of investment return in both the short and long term.
In recent years TRS has also made necessary adjustments to various actuarial assumptions, exposing over $400 million in previously unrecognized unfunded liabilities. The overall growth in unfunded liabilities has driven Montana’s pension benefit costs higher while crowding out other education spending priorities in the state, like classroom programming and teacher pay raises.
In the United States, public pension funds, which have an average investment return target of 7.25 percent, will likely struggle to meet those investment targets and could be severely impacted by plummeting interest rates. Without changes to pension plans’ assumed rates of return, many public pension systems will see an increase in debt.
Unfortunately, many public pension plan managers are not interested in adjusting their investment return targets to realistic levels at this time. Instead, they are seeking riskier, potentially higher-yielding investments in an effort to make up for depressed interest rates and hit their targets.