More and more experts are criticizing CalPERS and other public pension funds for sticking with outdated, unrealistic return assumptions in the light of the “new normal” of post-crisis super-low and even negative policy interest rates. The latest to weigh in is bond maven Bill Gross. Gross’ perspective is particularly important because at Pimco and presumably now at Janus, Gross is in the circle of bond heavyweights which means that he interacts on a regular basis with Fed officials and thus has a perspective that CalPERS and its advisers lack. From Bloomberg:
Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV. Public pensions, including the California Public Employees’ Retirement System, the largest in the U.S., are reporting gains of less than 1 percent for the fiscal year ended June 30…
Public pensions have been hurt by the Fed’s zero-rate policy that Gross says has led to “erosion at the margins of business models” such as the ones used for funding public pensions, which depend on assumptions about returns over time horizons of 30 years or more.
“Pensions have to adjust,” said Gross. “They have to have more contributions and they have to reduce benefit payments.”
If you look at the short clip in the Bloomberg article, Gross has taken a very risk averse posture, and is at zero duration which is tantamount to being in cash. Gross’ view, like that of Jeff Gundlach of Doubleline, is based on seeing a dearth of sensibly priced investments at these risk levels. He called bonds “a liability, not an asset” as current levels and sees stocks as equally unattractive given weak fundamentals and the exposure to large losses if interest rates increase. Other experts see embracing risk and leverage as CalPERS has, in its desperation to achieve unrealistic return levels, as dangerous for other reasons: that political instability in advanced economies can produce major dislocations, and risky assets are the worst place to be. As David Llewellyn-Smith of MacroBusiness pointed out:
Markets did not react at all to the French atrocity. They can’t. They do not know how to discount political risk, have virtually no way to hedge it, and they either won’t or can’t countenance asymmetric risk (that is “Black Swans). Rather quaintly, they believe central banks will protect them. It is not that markets are a good judge of these things, they are not, and you should not believe that no movement in equity or other prices is a guide to the events of Europe being marginal. They are not.
The first point to make about asset allocations in this emerging environment is that it is as much higher risk of asymmetric shocks than the decades that preceded it. Thus the strategic narrative for allocations should reflect that risk. In general terms that will mean:
- avoid leveraged and illiquid assets;
- safe haven assets will trade at a premium, and
- cash and cash-like instruments should occupy a much larger percentage allocation than in the past.
Bloomberg also points out that contrary to CalPERS, which has a adopted a plan to reduce its return goals that is so attenuated as to be tantamount to not lowering it, Illinois is taking a hard look at revising its return targets downward:
Illinois’s largest state pension, the $43.8 billion Teachers’ Retirement System, plans to take another look at how much it assumes it will make in the coming year as part of an asset allocation study, said Richard Ingram, executive director. Currently it assumes 7.5 percent, lowered from 8 percent in June 2014….
“Anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality,” Ingram, whose pension is 41.5 percent funded, said in a phone interview.
Mind you, the Illinois plan is deeply underfunded even as currently measured, but that is not preventing state officials of getting a grip on where it really stands.
It is also critical to understand that all investors are facing the same underlying problem. Even though institutional investors are having a difficult time, going to the Wall-Street-enriching solution of fobbing the problem off on retail investors, is barmy. They would see what little in the way of returns they earn chewed up in fees, and that’s before factoring in that retail investors are more easily snookered than professionals, and typically dent their returns by overtrading. As we wrote:
With its head-in-the-sand response, CalPERS is making it difficult even for those who believe in pension funds to defend them. The best solution societally for retirement savings is to have them funded federally, since the US is a sovereign currency issuer, and needs to deficit spend on an ongoing basis due to the fact that businesses chronically underinvest. Moreover, having the federal government provide for an adequate level of retirement income would align incentives much better, since officials would correctly come to regard retirement payments as coming out of the productive capacity of the real economy, as opposed to the confused focus on financial asset values (remember, a financial asset is always and every someone else’s financial liability, and will have the value you hope it will have only if the party on the liability side performs well over time). But if we are in a second-best world of inadequate Federal retirement payments, professionally managed programs are clearly preferable to individual plans. Cathy O’Neil gives one reason:
It’s actually, mathematically speaking, extremely dumb to have 401K’s instead of a larger pool of retirement money like pensions or Social Security.
Why do I say that? Simple. Imagine everyone was doing a great job saving for retirement. This would mean that everyone “had enough” for the best-case scenario, which is to say living to 105 and dying an expensive, long-winded death. That’s a shit ton of money they’d need to be saving.
But most people, statistically speaking, won’t live until 105, and their end-of-life care costs might not always be extremely high. So for everyone to prepare for the worst is total overkill. Extremely inefficient to the point of hoarding, in fact.
Instead, we should think about how much more efficient it is to pool retirement savings. Then lots of people die young and are relatively “cheap” for the pool, and some people live really long but since it’s all pooled, things even out. It’s a better and more efficient system.
Another reason, as any fan of John Bogle will tell you, is that institutional investors pay vastly less in fees and costs than retail investors do, and those savings make a huge difference in total returns over a 20 to 40 year time horizon. And that’s before you get to the fact that 401 (k)s have all sorts of nasty hidden fees.
But instead of calling attention to the real problem, such as the destructive impact of central bank policies on savers of all sorts, as well as the damaging impact of bank-favoring post-crisis policies on growth, CalPERS is trying to snooker its beneficiaries on the fantasy that the old normal is coming back. 25 years of post-crisis malaise in Japan, near deflation in Europe, and nearly a decade-long weak recovery in the US, with no reason to expect better on any front, should disabuse them of that notion.
CalPERS’ tactic of resorting to aggressive denials when the fact are against them is only going to further weaken its already damaged reputation and make it hard even for natural allies to defend them. Their refusal to acknowledge how difficult a fix they are in is making a case against, not for, public pensions. If you want to help your enemies, this is precisely the way to do it.