Wednesday, April 16, 2014

Bridgewater's Dire Outlook For Pensions?

Lawrence Delevigne of CNBC reports, Outlook for pensions is pretty awful: Bridgewater:
Here's a scary retirement prediction: 85 percent of public pensions could fail in 30 years.

That's according to the largest hedge fund firm in the world, Bridgewater Associates, which runs $150 billion for pensions and other institutions like endowments and foundations.

Public pensions have just $3 trillion in assets to cover liabilities that will balloon to $10 trillion in future decades, Bridgewater said in a client note last week obtained by USA Today.

To make up the difference, the firm said pensions will need to earn about 9 percent per year on their investments. But Bridgewater estimates pension funds are more likely to make 4 percent. If that's true, the vast majority—85 percent—of retirement systems will run out of money because they will continue to pay out more than they take in.

The report comes as pensions wrestle with what rates of return to assume given their implications on future financial health.

The city of Detroit, for example, has reportedly agreed to increase its pensions' projected return to 6.75 percent on its pension funds, up from 6.25 percent and 6.5 percent, according to a separate USA Today report. The change is part of ongoing pension cut negotiations for the city to exit bankruptcy.

To test the broad financial health of public pensions, Bridgewater simulated the effect of various market environments on retirement system funding using 100 years of data on how stocks, bonds and other assets performed in the past, plus current projections of future long-term yields. Public pensions will run out of money in 20 years in 20 percent of those scenarios; they'll fail in 50 years in 80 percent of the situations.

A leading academic center for retirement and pension research criticized the report.

"These are inflammatory numbers which can create an enormous amount of anxiety," said Alicia Munnell, director of the Center for Retirement Research at Boston College. "The pension issue is not a game. Pensions represent the future security of today's public employees and those are real people."

Munnell, also the Peter F. Drucker professor of management sciences at BC's Carroll School of Management, believes Bridgewater's 4 percent return projection is far too low.

"If we live in a world where 4 percent nominal returns is the only returns people can get, it implies a really horrible economy with high unemployment, very slow growth and a big gap between potential and actual output," Munnell said.

"A cynic could say that these projections suggest that plans are going to earn only 4 percent unless they shift some of their investments to alternatives," Munnell added. She called on Bridgewater to release the full report.

The report was one of Bridgewater's daily notes to clients, called "Daily Observations." The communications are not public, but Bridgewater told CNBC.com it plans to release an explanation of the study in the future.

"Just as we stress test banks by running multiple scenarios through their future conditions to assess what might happen, we think it makes sense to stress test pension funds," Bob Prince, Bridgewater's co-chief investment officer, said in an interview.

"That's in contrast to the common approach, which is to determine sufficient funding by asserting a certain return and discounting that back to a present value and comparing that to your assets. We think that you can have a much more robust assessment by running stress tests based on multiple scenarios."

Bridgewater acknowledges that its 4 percent return projection—based on current asset prices like low bond yields and an already-elevated stock market—is just one potential outcome to consider and any long-term projection is inherently difficult.

Munnell said most public pensions assume long-term returns on their investments of about 7.75 percent annually. Her center regularly studies the impact of lower expectations, around 6 or 6.5 percent.

Bridgewater, founded in 1975 by now-billionaire Ray Dalio and based in Westport, Conn., has long attracted pensions and others with two types of products: "Pure Alpha" hedge funds that bet on broad macroeconomic themes, and a more conservative "All Weather" product that is designed to protect assets in any economic environment (also known as a "risk parity" strategy).

The firm's Pure Alpha II fund has gained 13.6 percent net of fees on average since inception in 1991. All Weather has produced average annual returns of 8.9 percent since inception in 1996.

Public retirement systems were 73 percent funded overall at the end of 2012, according to the latest data available from Boston College's retirement center. The numbers are based on the present liabilities value of $3.8 trillion, which uses a baseline projection of 7.75 percent stock market returns from 2013 to 2016.

"States and localities also continued to fall short on their annual required contribution payments," the report said. But it also noted that "the funded ratio is projected to gradually move above 80 percent, assuming a healthy stock market."
So, Bridgewater is now a leading expert on public pension deficits? Well, they regularly read my blog so let me commend them before I rip into them for being part of a much bigger problem.

First, Alicia Munnell doesn't have a clue of what she's talking about. Pension funds are more likely to see long-term returns of 4% than 7.5% or even 6.5%. This isn't scaremongering on Bridgewater's part, it's called being realistic and not hopelessly optimistic.

Go back to read an older comment on what if  8% is really 0% where I wrote:
Mr. Faber then asks a simple question:
Are funds prepared for a lengthy bear market in equities like when stocks declined nearly 90% in the 1930’s? Are funds prepared for both raging inflation of the 1970’s and 1980’s and sustained deflation like Japan from 1990 to the present? It is our opinion that most funds do not consider these outcomes as they are seen as extraordinary and beyond the scope of either feasible response or possibility.
He's absolutely right, the majority of pension funds are hoping -- nay, praying -- that we won't ever see another 2008 for another 100 years. The Fed is doing everything it can to reflate risks assets and introduce inflation into the global economic system. Pension funds are also pumping billions into risks assets, but as Leo de Bever said, this is sowing the seeds of the next financial crisis, and when the music stops, watch out below. Pensions will get decimated. That's why the Fed will keep pumping billions into the financial system. Let's pray it works or else the road to serfdom lies straight ahead. In fact, I think we're already there.
Now, Leo de Bever isn't the best market timer and I totally disagree with him on a bear market for bonds. I think all the bond panic of  last summer was way overblown and the real threat that lies ahead is a prolonged period of debt deflation which will expose a lot of naked swimmers.

I've been worried about deflation for a very long time. I even went head to head with the great Ray Dalio back in 2004 in front of PSP's president and CEO, Gordon Fyfe, and pushed Ray on this until he finally blurted out: "son, what's your track record?!?"

Well Ray, thanks for asking because my track record has been pretty lousy on some stock picks but right on the money when it comes to calling the big picture. I warned Gordon Fyfe and PSP's senior managers of the collapse of the U.S. housing market and the credit crisis back in the summer of 2006 when I was researching CDO, CDO-squared and CDO-cubed issuance and was petrified. I got promoted in September 2006 and then abruptly fired a month later for "being too negative" (a euphemism for you're not towing the line so we will fire your ass). PSP lost billions in 2008 selling CDS and buying ABCP (and they weren't the only ones "investing" in structured crap in their portfolios). 

The analysts at Goldman Sachs I was talking with tried to reassure me that all is well but I never trusted those hypocrites and knew they were taking the opposite side of the trade, betting against their Muppets. Sure enough, Goldman made a killing off the financial crisis. Ray Dalio and Bridgewater also performed well as they understood the dangerous dynamics of deleveraging but they overstayed their welcome on that trade and underestimated the resolve of politicians and central banks to deal with the European and global debt crisis. 

Things haven't been great for macro funds since the financial crisis. Central banks have effectively clipped their wings and many are not bringing home the bacon they once used to. Apart from Abenomics, which spurred a global macro lovefest and cemented George Soros as the ultimate king of hedge fund managers, there hasn't been much going on in terms of returns in the global macro world. Maybe that's why Soros is pleading with Japan's PM to get their giant pension fund to crank up the risk. He sees the future and it ain't pretty (I threw a bone at global macro funds back in December when I recommended shorting Canada and its loonie...still waiting for a small cut of their management and performance fee). 

But rest assured the Ray Dalios of this world are doing just fine, charging 2 & 20 to their large institutional clients, many of whom are more than happy being raped on fees even if the performance of these large hedge funds has been lackluster as assets under management mushroom. 

Now, before I get a bunch of angry emails telling me how great Ray Dalio and Bridgewater are, save it, I was among the first to invest in them in Canada when I was working at the Caisse as a senior portfolio analyst in Mario Therrien's team covering directional hedge funds. I have nothing against Ray Dalio and Bridgewater, but I think they've become large lazy asset gatherers like many others and their alpha has shrunk since their assets under management have mushroomed to $150 billion.

My beef with all hedge fund gurus managing multi billions is why are they charging any management fee? To be more blunt, why are dumb institutions paying billions in management fees to Ray Dalio or anyone else managing multi billions? Management fees are fine for hedge funds ramping up operations or for those that have strict and small capacity limits but make no sense whatsoever when you're dealing with the larger hedge funds all the useless investment consultants blindly recommend. 

And Alicia Munnell is right on one front, why doesn't Bridgewater publicly release this study? In fact, there are other studies from Bridgewater that magically disappeared from public record, like hedge funds charging alpha fees for disguised beta (I used to have a link on my blog to that study, which was excellent). Another good point Munnell raises is that alternatives funds love talking up their game but public pension funds praying for an alternatives miracle that will never happen are only enriching Wall Street

Go back to read Ron Mock's comments on OTPP's 2013 results as well as Jim Keohane's comments on HOOPP's 2013 results. Ron and Jim both attended HOOPP's conference on DB pensions and they know the next ten or twenty years will look nothing like the last twenty years. They understand why it's important to closely match assets with liabilities and how important it is to manage downside and liquidity risk. The Oracle of Ontario uses one of the lowest discount rates in the world, something which they think reflects reality. 

And Bridgewater is right, the outlook for U.S. pensions is awful. They're not the only ones sounding the alarm. The Oracle of Omaha recently warned that U.S. public pensions are in deep trouble. I'm concerned too but as I wrote in the New York Times, my chief concern remains on the lousy governance model that plagues most U.S. public pensions. Pension reforms have thus far been cosmetic. Until they reform governance, nothing will change. 

Finally, it is worth remembering that even though pensions aren't perfect, they're way better than 401 (k) plans, RRSPs or PRPPs. A new study finds that the typical 401(k) fees — adding up to a modest-sounding 1% a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring. When it comes to retirement, most people need a reality check on pensions.

On that note, I welcome all comments by Bridgewater and anyone else who has something intelligent to contribute to the outlook for pensions. Feel free to email me your thoughts at LKolivakis@gmail.com.

Below, once again, a 2009 report which explains America's 401(k) nightmare. As the default retirement plan of the United States, the 401(k) falls short, argues CBS MoneyWatch.com editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work. The same thing is happening in Canada, which is why now is the time to act to bolster defined-benefit plans for many Canadians that are staring at a retirement crisis.