Rhode Island’s State Investment Commission (SIC) and Rhode Island Treasury strive to deliver strong long-term returns and reduced risk for the state’s investments. Financial markets can be volatile, and it is normal for the performance of the state’s investments to fluctuate in the short-term. Long-term average performance is the best measure of a fund’s health and sustainability.
There are many ways to judge the investment performance of a fund. For Rhode Island, one important measure of performance is the pension system’s target annual rate of return, currently 7.0%. This is the number that is used to calculate the funded status of the pension system. Due to the volatility of the financial markets, the state does not expect investment performance to meet the 7.0% mark every year, but has set a goal of achieving an average annual performance of 7.0% over a long period of time.
More information about the fund's investments, including additional information on fund and individual investment performance are available in the monthly SIC books.
Another way to judge performance is a comparison with the fund’s policy benchmark, which compares Rhode Island’s performance to the hypothetical performance of an average fund with the same asset allocation as Rhode Island. Rhode Island’s performance relative to the policy benchmark is a measure of the quality of investment managers that the state is selecting.
The 60/40 is a hypothetical portfolio that consists of 60% US stocks and 40% US fixed income. 60/40 was a common asset allocation for pension systems in years past, but is rarely used today as more sophisticated investment strategies have become available.
Strong risk management is essential to ensuring that Rhode Island’s investments remain sound even in times of severe economic stress and volatility. Standard deviation is one way to measure how risky an investment portfolio is.
While there will always be some risk that comes with investing in the financial markets, a lower standard deviation generally means that the state’s investments are expected to have stronger protection during times of economic distress. This is important because more consistent returns improve the pension fund’s long-term performance, and ability to pay pension checks, through the impact of compounding (minimizing the risk penalty). Take a look at the example below:
|Time||high volatility||low volatility|
Both the high volatility and the low volatility scenarios have the same average return (0 percent) but in the low volatility scenario the pension system ends up with more money.
As part of the 2013 actuarial audit, an independent actuary showed the long-term impact of volatility. The firm compared two cases: a) one where the system earned 7.5 percent return every year (that is, no volatility) and b) one where returns averaged a higher 7.8 percent with volatility similar to the portfolio’s historic investment experience (+28.6 percent in the best year, -16.3 percent in the worst). Over 30 years, the level 7.5% return generated $3 billion more.