Tuesday, November 25, 2014

U.S. Public Pensions on Solid Footing?

Business Wire reports, Public Pension Plans Report Solid Returns, Financial Strength, Increasing Confidence:
Confidence continues to rise among public pension plan administrators about the sustainability of their funds and their readiness to address future retirement issues, according to a new survey by the National Conference on Public Employee Retirement Systems (NCPERS).

The 2014 NCPERS Public Retirement Systems Study also shows continuing financial strength for public funds, with healthy long-term investment returns.

“Once again, our annual survey provides convincing evidence that the vast majority of public pension plans are financially sound, well-funded and sustainable for the long term,” said NCPERS Executive Director and Counsel Hank Kim, Esq. “It also demonstrates that defined benefit public pension plans are the least costly way to ensure retirement security for American workers.”

Partnering with Cobalt Community Research, NCPERS surveyed 187 state, local and provincial government pension funds with more than 11.8 million active and retired members and with assets exceeding $1.8 trillion. The majority – 81 percent – were local pension funds, while 19 percent were state pension funds. Of the responding funds, 61 percent are members of NCPERS. The data, collected in September and October 2014, represents the most up-to-date information available.

The major findings of the 2014 NCPERS Public Retirement System Study include:
Confidence continues to grow about readiness to address future retirement trends and issues. Respondents’ overall confidence rating measured 7.9 on a 10-point scale, up from 7.8 in 2013 and 7.4 in 2011.
  • Funds experienced an increase in average funded level – 71.5 percent, up from 70.5 percent in 2013. Two factors contributed to the change: average one-year investment returns of 15 percent and lower amortization periods.
  • Funds continue to experience healthy investment returns: 14.5 percent for one-year investments (compared to 8.8 percent in 2013); 10.3 percent for three-year investments (up from 10.0 percent last year); 9.8 percent for five-year investments (up from 2.7 percent last year); 7.8 percent for 10-year investments (up from 7.0 percent), and 8.1 percent for 20-year investments (virtually unchanged from last year’s 8.2 percent). Funds continue to work toward offsetting sharp losses from the Great Recession in 2008 and 2009 by strengthening investment discipline. Signs point to long-term improvement in public retirement systems’ funded status.
  • Public funds continue to be the most cost effective mechanism for retirement saving. The total average cost of administering funds and paying investment managers was 61 basis points. According to the Investment Company Institute’s 2014 Investment Company Fact Book, the expenses of most equity funds average 74 basis points and hybrid funds average 80 basis points.
“Because they have lower expenses, public retirement funds provide a higher level of benefits to members,” Kim said. “They also produce a higher positive economic impact for the communities those members live in than mutual funds and defined contribution plans like 401(k)s.”
  • Funds continue to tighten benefits, assumptions and governance practices. Examples include a continued trend toward increasing member contribution rates, lowering inflation assumptions, shortening amortization periods, holding actuarial assumed rates of return and lowering the number of retirees receiving health care benefits.
  • Income used to fund public pension programs came from member contributions (8 percent); employer (government) contributions (19 percent) and investment returns (73 percent).
“There is no question that public pension funds are continuing their strong recovery from the historic market downturn of 2008-2009,” Kim said. “The survey shows public pensions are strong and getting stronger, managing their assets efficiently and effectively, making plan design changes to ensure sustainability and are expressing strong and growing confidence about their readiness to address the challenges ahead.”

“The vast majority of public pension plans are thriving, more than adequately funded, inexpensive to operate and sustainable for the long-term. Policymakers, taxpayers and public employees can have confidence that public pension plans will be providing retirement security for covered workers – and thus making positive economic contributions to the communities they live in – well into the future.”


The National Conference on Public Employee Retirement Systems (NCPERS) is the largest trade association for public sector pension funds, representing more than 550 funds throughout the United States and Canada. It is a unique non-profit network of public trustees, administrators, public officials and investment professionals who collectively manage nearly $3 trillion in pension assets. Founded in 1941, NCPERS is the principal trade association working to promote and protect pensions by focusing on advocacy, research and education for the benefit of public sector pension stakeholders.

About Cobalt Community Research

Cobalt Community Research is a nonprofit research coalition created to help governments, schools and other nonprofit organizations measure, benchmark and manage their efforts through high quality and affordable surveys, focus groups and facilitated meetings. Cobalt is headquartered in Lansing, MI.
Let me go over some of my thoughts on this latest survey. First, there is no question that U.S. public pension funds are in much better shape now than right after the 2008 crisis. Public and private markets have rebounded solidly, no thanks to the Fed and other central banks pumping massive liquidity into the global financial system. This is why confidence is so high at U.S. and global funds.

But with bond yields at historic low levels and the threat of deflation looming large, this is most certainly not the time to be complacent because the environment is about to get a lot more challenging over the next decade.

As I recently stated, there is a reason why central banks are panicking, they fear that no matter what they do, they will lose the titanic battle over deflation. And with public pensions pension funds flocking to riskier investments and taking on too much illiquidity risk, if a severe bout of deflation does engulf the global economy, it will come back to haunt them.

This is why I cringe when I read this from the release above: "Signs point to long-term improvement in public retirement systems’ funded status." Unless they see rates coming back to 5-6% over the next ten years and stocks continuing to make record highs, I just don't see the signs of improvement they're talking about.

Moreover, far too many U.S. public pension funds are still holding on to the pension rate-of-return fantasy, believing fairy tales when it comes to discounting their future liabilities using rosy investment assumptions.

Second, it's important to remember there is a huge dispersion when it comes to the health of U.S. public pension plans. Last week, Bloomberg reported that Illinois will have to find a new way to fix the worst pension shortfall in the U.S. after a judge struck down a 2013 law that included raising the retirement age:
Yesterday’s ruling that the pension changes would have violated the state’s constitution undoes a signature achievement of outgoing Democratic Governor Pat Quinn and hands responsibility for tackling the state’s $111 billion pension deficit to Republican businessman Bruce Rauner, who defeated him in the Nov. 4 election.

State constitutions have been invoked elsewhere to try to prevent cuts to public pensions. In Rhode Island, unions settled with the state over pension cuts before their constitutional challenge could be put to the test. In municipal bankruptcy cases in Detroit and California, judges ruled that federal law overrode state bans on cutting pensions.

Illinois Attorney General Lisa Madigan, a Democrat, said she’ll appeal the ruling by Judge John Belz in Springfield and ask the state Supreme Court to fast-track the review.
And it's not just Illinois. At Kentucky, a  state panel will likely call on the General Assembly to find more money for Kentucky's struggling pension system, although it's unclear where the funding might come from:
The Public Pension Oversight Board advanced more than a dozen recommendations Monday to revamp polices at Kentucky Retirement Systems and help address concerns over the system's long-term financial health.

Key among the recommendations are:
  • The General Assembly should secure additional money to stave off any insolvency problems in KERS non-hazardous — the largest pension plan for state workers, which has only 21 percent of the money it needs to cover benefits.
  • The Kentucky Teachers' Retirement System, along with pension plans for lawmakers and judges, should be reviewed by the oversight board as part of its official duties.
  • KRS should better publicize its board meetings, particularly to employee, retiree and interest groups.
  • The General Assembly should enact legislation to regulate how agencies withdraw from the pension system — a concern that has emerged amid the bankruptcy of Seven Counties Services, the community mental health center for the Louisville area.
Other recommendations would modify how KRS handles its financial studies and how public employers pay for "spiking" — a situation in which employees use overtime and other strategies to boost their pension.

Lawmakers and state officials have spent the past year developing the recommendations, and officials plan to compile them into a report for final approval next month.
Third, and most critically, the governance at U.S. public pension plans needs to be drastically improved. Dan Fitzpatrick and Juliet Chung of the Wall Street Journal report, Strategy spurs rethink on San Diego pension’s oversight:
A large California pension fund is searching for a new investment chief amid concerns about an outside firm’s investment strategy, the latest clash between public retirement systems and external advisers.

The board of San Diego County Employees Retirement Association authorized the move in an 8-1 vote that requires the $10.5 billion fund to install an internal investment chief instead of relying on Houston-based Salient Partners LP for that role.

Directors stopped short of ending a contract with Salient, which suggested an investing strategy that uses derivatives to boost performance. Salient is paid $8 million annually to act as the system’s chief investment officer and manage retirement assets for county employees.

The strategy involves buying futures contracts tied to the performance of stocks, bonds and commodities. Salient recommended the approach, which would allow the pension fund potentially to receive bigger gains, and possibly suffer larger losses, than it would by owning the assets themselves.

Salient, which was first hired in 2009, said in a statement that a team led by Salient Chief Investment Officer Lee Partridge generated a 10.2% annualized return for the retirement system over the past five years, and it would continue to perform its duties “over the duration of whatever transition period the board establishes.”

“We are proud of our work,” the firm added.

Scrutiny of the relationships between pension funds and the outside firms that manage their money or provide investment advice is intensifying as public retirement systems wrestle with how to fulfill obligations to retirees. For external advisers, fees that can reach into the millions of dollars are at stake.

Outside firms are hired by cities, states, corporations and others to provide guidance to retirement plans. A number of those firms also offer to help manage pension assets, an assignment that typically means higher fees. More than 75% of pension-consulting firms registered with the Securities and Exchange Commission act as both investment managers and outside consultants for clients, according to reports filed on the SEC website.

A top Labor Department official recently said in a private letter that consultants recommending themselves as money managers for pensions could be violating federal law, according to a document reviewed by The Wall Street Journal. The letter came in response to a request from a senior Democratic congressman that the department examine potential conflicts of interest within the industry.

Salient said it isn’t a consultant to the San Diego County pension. The county has a separate outside consultant that offers advice to the system, while Salient as the external CIO makes decisions on strategy and investments.

In some parts of the U.S., disputes between outside firms and their pension-fund clients are spilling into court. Providence, R.I., sued an actuarial firm over estimates of how much the city would save by making a change to its pension system. In Houston, the city is wrangling with an outside consultant over a series of calculations in 2000 that the city views as “the root cause of the pension funding crisis now facing the city of Houston,” according to a lawsuit filed in August.

Even consultants that have a long-standing relationship with a pension fund are encountering questions about their conduct. Last month, the chairman of the San Francisco Employees’ Retirement System delayed a vote on whether to invest in hedge funds for the first time because he said he wasn’t aware the system’s adviser operated its own fund. Angeles Investment Advisors has provided advice to the system for the past two decades.

During the meeting, Angeles principal Leslie Kautz said the existence of the fund, which invests in other hedge funds, had been communicated in a 2010 letter to the system and that her firm wouldn’t recommend it as an investment for San Francisco. Angeles principal Michael Rosen said in an interview Monday that Angeles doesn’t charge clients a fee to participate in the fund.

“We believe disclosure has been made and there is no conflict with regard to our advice,” Ms. Kautz said in October.

In San Diego County, several retirement-system board members have argued for Salient’s ouster amid a debate over the company’s new investment strategy.

The board approved the plan at an April meeting, and one estimate floated at the time was the bet could involve an amount equal to as much as 95% of the fund’s $10.5 billion in assets. Salient eventually increased the fund’s market exposure to $16 billion, according to the firm.

But some board members said they were surprised total exposure had become that large and set a limit of $12 billion.

“It was a surprise, and board members should never be surprised,” said Dianne Jacob, one of the board members, in an interview. In October, a proposal to terminate the consultant’s contract failed in a 5-4 vote.

The decision on Friday to restore an in-house chief investment officer and have that person report to the chief executive doesn’t mean the board decided to end Salient’s contract, a spokesman for the retirement system said.
I've long argued that there should be more transparency on useless investment consultants and advisers, scrutinizing the fees and services they charge. The same goes with all the fees being doled out to brokers, vendors peddling risk, front and back office software, and alternative investment managers charging 2 & 20 for lousy performance.

In fact, never mind buyout bullies, we need a lot more transparency on all costs at the operational level. This can be done in a way that does not jeopardize the best interests of the plan's stakeholders.

My final thoughts on this survey is that it clearly demonstrates the cost effectiveness of public defined-benefit plans. Go back to read my comment on the brutal truth on DC plans. As stated above, most of the income used at U.S. public pension programs (73%) comes from investment gains and the rest from employee (8%) and employer contributions (19%). The 73% seems high but is consistent with the typical investment gains DB plans report (66%).

I happen to think that employees and employers need to share the risk equally at public pension plans but there is no doubt that these plans are cost effective and a potential solution to America's looming retirement crisis. Moreover, as more plans follow Wisconsin and CalSTRS and start managing assets internally, the cost of these plans will fall further.

Below, Charlie Bilello, director of research at Pension Partners, and Bloomberg’s Mia Saini examine whether or not Federal Reserve policy is creating a market bubble. They speak in "On The Markets" on "In The Loop.”

Also, Dan Morris, global investment strategist for TIAA-CREF, which holds $840 billion in assets under management, discusses why even though the S&P 500 and the Dow Jones industrial average both at all-time highs, it's all about to get rocky for stocks when interest rates start rising (see the clip here).

As I stated in my last comment on the Caisse souring on debt, I'm not concerned about rising rates. Moreover, the Fed will never raise rates as long as global deflationary pressures remain intense. As Sober Look rightly notes, the Fed is concerned about importing disinflation.

So enjoy the liquidity party while it lasts but choose your stocks and sectors carefully because when deflation eventually hits America, the hangover will last for decades.

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