Tuesday, June 19, 2012

The Pathetic State of State Pension Funds?

Lisa Lambert and Hilary Russ of Reuters report, US public retiree benefits gap grows to $1.38 trillion:

The funding gap for U.S. state public employee retirement benefits climbed by $120 billion to $1.38 trillion in fiscal 2010, according to a report released on Monday.

The report comes at a time when many voters and politicians already claim that compensation for public employees is bloated.

The Pew Center on the States said that public pension systems in 34 states were funded at less than the 80 percent level that is considered the threshold for a healthy pension. That's in stark contrast to 2000, when more than half of the states' pension plans were 100 percent funded.

"The larger (the shortfalls) are, the higher the cost for taxpayers today and for many years to come," said David Draine, a Pew senior researcher, who compared many states to credit card holders who hadn't paid their bills in full but kept racking up charges.

Since 2009, the dire lack of funding has led at least 43 states to enact some reforms, many of which may not go far enough. Reforms passed after 2010 were too recent to be reflected in the new study, the Pew Center said.

The 2010 pension data was the most current that Pew said it could gather from all 50 states. For most states, the fiscal 2010 year ended on June 30, 2010.

The study comes as members of AFSCME, the largest public employees union, elect a new president to chart the union's course during the current rocky times. One candidate, Danny Donohue, said he has never seen such skepticism toward public employees in the 30 years he has been in the American Federation of State, County and Municipal Employees.

For years, many states and local governments underfunded pensions and other benefits for retirees, particularly healthcare. During the 2007-09 recession some cut contributions further to deal with shrinking revenue.

New Jersey, for example, failed to consistently make full required payments to its pension plan in previous years, Draine said. Now its annual required contribution to close the gap for its pension fund is at least $2 billion more than neighboring New York, even though New York's pension plan is larger.

"Back when the market was going like blazes, people didn't put money into pensions," said Donohue, who also heads the union's New York branch. "Just like anything, there was a day of reckoning."


Pension systems could see further strains. The Baby Boom generation could swell the ranks of retirees drawing benefits, at the same time that public employees, who provide about 10 percent of pension fund revenue, are losing their jobs.

In fiscal year 2010, the gap in public pension funding rose by nearly $100 billion to $757 billion, with the shortfall in retiree healthcare benefits increasing by more than $20 billion to $627 billion, Pew found.

The Pew Center provides the most widely cited estimate of the gap between how much money public pension and retiree healthcare funds have and how much they must pay in future benefits.

Investment earnings provide about $6 out of every $10 in pension funds. In fiscal 2008, at the depth of the recession, those investments lost 25 percent, Pew found.

Recently, investments have rebounded, but those gains may not be enough. According to the U.S. Census, pensions' cash and security holdings rose to $2.61 trillion in the fourth quarter of 2011, still below their end-of-2010 levels.

Healthcare costs have also soared over the last few years, but 17 states have set aside no funds for these additional benefits. According to Pew, states currently have only 5 percent of what is needed for these non-pension benefits.

Despite strict legal protections that make pension reforms difficult to enact, many states have begun doing just that.

Rhode Island - which has one of the worst-funded pension systems along with Connecticut, Illinois and Kentucky - has enacted the "most far-reaching and comprehensive reforms we've seen," Pew's Draine said.

Last year, Rhode Island suspended cost-of-living adjustments, raised the retirement age, and moved employees onto a hybrid pension benefit plan, among other changes expected to cut its unfunded liability by $3 billion.

In 2010, Illinois limited retirement benefits for new employees, but pressure is mounting for a bigger solution to a problem that Moody's Investors Service describes as "staggering."

Wisconsin Governor Scott Walker and the state's legislature in 2011 slashed pension benefits and curbed public employee unions' rights to organize. The moves were so controversial that they triggered a recall vote for Walker, which he survived earlier this month.

Wisconsin's pension was 100 percent funded in 2010, making it the best funded state pension in the nation.

You can read the update on the widening gap from the Pew Center on the States here. US public pension funds aren't in good shape and while the media loves demonizing public unions, the truth is there is plenty of blame to go around.

Importantly, we didn't just end up in this situation. Years of neglect and poor governance have now come home to roost, forcing state legislators to enact difficult pension reforms.

While I agree with some reforms like raising the retirement age and cutting cost of living adjustments, I'm dead set against anything that cuts defined-benefit pension plans to new or existing public sector employees.

This is what I call 'soft austerity' in the United States as opposed to 'hard austerity' in the peripheral economies of Europe but the end result is the same, more pension poverty and higher social welfare costs which will be borne by the rest of society. It's plain stupid, dangerous thinking based on a convoluted ideology that is wreaking hell on many hard working citizens.

But the truth is most US state pension funds aren't in good shape and they're underperforming on all fronts. Amanda White at Top 1000 Funds, one of the best reporters covering global pensions, wrote an excellent comment, US public pension funds underperform:

US public-pension funds significantly underperform their global peers in real-estate portfolios due to a propensity to manage the assets externally, according to a new ICPM-sponsored research paper by three Maastricht University academics.

Value added from funds management in private markets: an examination of pension fund investments in real estate looks at real-estate investing among the 880 pension funds on the CEM database from 1990 to 2009. On average the allocation to real estate was 5.5 per cent, but fluctuates over time.

The paper by Aleksandar Andonov, Nils Kik and Piet Eichholtz examined the funds’ approach to investing in the asset class, costs and performance.

The paper found that US funds, both small and large, underperformed their self-reported benchmark by a whopping 127 basis points per year. Furthermore, their costs were twice as high as their global peers.

“I would be asking how it is possible that you do this and you keep on doing this,” Eichholtz says.

“This paper found that a fund’s approach, size and geography determine the cost and performance in real estate. You can’t choose to be a US or non-US fund, but you can learn from your peers.”

The paper found that while large pension funds overall are more likely to invest in real estate, they invest internally and have lower costs. They also have some exposure through real-estate-investment trusts (REITs) and few fund-of-fund investments.

Smaller funds are less likely to invest in real estate and more likely to invest in funds of funds.

Eichholtz said with regard to costs, the biggest driver is the approach decision, how a fund invests from internal management to funds of funds.

He said geographically there were some interesting results: US funds were more likely to invest externally, regardless of their size, and pay higher fees.

“It’s as if the real-estate-investment management industry in the US is able to charge higher fees,” he says. “The costs don’t lie in the pension funds but in the service industry, and in the US it is tens of basis points more. US funds pay far more for external managers and are more likely to retain managers. It’s double crazy.”

Eichholtz describes funds of funds as “way beyond expensive” and believes smaller funds would be better off getting real-estate exposure through REITs than funds of funds.

Another finding of the paper was that the more expensive the strategy, the worse the performance.

Internal management was the best performer across the board, both before and after fees. At the same time, Eichholtz says, funds of funds “destroy value in two ways” through costs and picking the wrong investments.

He has some practical advice stemming from the results of the paper: if a fund is big enough, it pays to manage real estate internally.

“There is a lot of low-hanging fruit, funds that are big enough and could go internal, especially in the US.”

If you’re small, he says, avoid funds of funds and invest in REITs, and if you don’t want listed exposure then he proposes investing in a syndicate.

An example of this is in The Netherlands, where there are three large real-estate funds established by pension funds, Amvest, Aldera and Vesteta, the latter started by ABP and now open to a large group of investors.

They key, Eichholtz says, is that the management organisation is owned by the shareholders of the fund (that is, the pension funds) so there is no conflict of interest.

“The owner pays the salaries. There is a 30-basis-point fee, no bonuses or incentives.”

You can access the study here. The findings of this study don't surprise me. US public pension funds are poorly governed, paying monkey salaries and getting monkey results. They're getting raped on fees by funds and funds of funds. It's all part of a culture of secrecy/ cover-your-ass politics which literally ensures mediocre results relative to their global peers who have gotten the governance right.

Last week, I wrote about Fast Times in Pensionland, exposing some questionable investment practices that took place in South Carolina. I spoke to South Carolina's state treasurer, Curtis Loftis Jr., after writing that comment and we agreed that this is happening all over the US where most state treasurers "have never bothered reading the fine print in private placement memorandums" (see interview below).

Yesterday, someone sent me this article stating that despite staggering pension pension fund shortfalls, trustees overseeing the largest public retirement systems in the Bay Area have spent over $60,000 to attend conferences just miles from their home.

Sure, when it's not your money, just bill your grossly underfunded public pension plan and stick the bill to workers and pensioners. And as far as pension conferences, the majority of them are a frigging joke.

In an era of austerity, every public corporation, especially public pension funds, should publicly disclose all expenses related to travel for everyone of their senior managers, investment/ finance analysts and on their board of directors.

Admittedly, traveling isn't fun when working and it's necessary when performing due diligence, but these costs have to be carefully scrutinized (trust me, some abuse their travel budget).

Below, CBS News reports on U.S. public pension plans face $1 trillion shortfall. Also, watch several Fox Business reports covering state pension woes. The first discusses a 'confidential' J.P. Morgan study putting pension liabilities closer to $4 trillion (ignore this exaggerated figure). The second is an interview with South Carolina's state treasurer, Curtis Loftis Jr., discussing the state's $14.4 billion pension fund deficit. And the third report discusses rising pension costs at Illinois, one of the worst pension basket cases in the United States.

You can read all about Illinois' pension reform here. I also embedded Illinois representative Mike Bost's entire outburst below. Nothing like pension reform to make one lose his mind!

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