In wake of the stock-market drop off early this year due to COVID-19, state and local investment funds lost an estimated $1 trillion dollars in assets, even as it’s hidden from beneficiaries due to a lack of transparency in reporting earnings. As states have continued to fall behind on their pension obligations since the recessions of the 2000s, they have steadily increased their proportion of investments in risky asset classes to make up for years of consistent underperformance. Additionally, with the decrease in business activity caused by the virus, states have lost significant tax revenue to help cover the expanding shortfall.
Changes in US monetary policy are effecting how institutional investors look at removing risk in their portfolios. The Federal reserve announced its intention to maintain low interest rates, even if inflation rises above its traditional benchmark of 2%, through at least 2024. The potential for higher inflation than interest rates removes some of the appeal of traditional fixed income bonds and treasury notes. To protect against this inflation risk, pension funds are now looking increasingly at gold and precious metals as an asset class.
Responding to these trends, the Ohio Police & Fire Pension decided to shift 5% of its allocation into gold by increasing its leverage to try to protect its beneficiaries against a downturn in the bond market. They join Texas Teacher Retirement Systems as the only two state or local pension systems to hold precious metal investments. Wyoming had a contentious public debate earlier this year between a newly elected state treasurer and his career deputy over the possibility of investing in gold, after the state lost $300 million investing in third world debt.
Ultimately, the decision to invest in bonds remains hotly debated within the investment space. However, many of the factors that might deter retail investors, including storage issues and higher capital gains rates, do not apply to pension funds. For gold to provide a better counterweight to equities, it requires a downturn in the bond market. Thus, a pension fund diversifying its low-risk assets by adding gold alongside traditional fixed income could further hedge risk against a downturn in the bond market. However, given the consistency with which their active management strategies fail to keep pace with general market recovery, an increased allocation into low-risk assets, including gold, could help pension managers protect assets.