America’s Pension Funds Fell Short in 2019
Public plans with more than $1 billion in assets earned a median return of 6.79% for the year ended June 30, the lowest since 2016, according to Wilshire Trust Universe Comparison Service data released Tuesday. Public pension plans project a median long-term return of 7.25%, according to data collected by Wilshire Associates in 2018.In May, I wrote all about the coming US public pension crisis, stating the following:
Each year, pension funds must make this estimate on how much they expect to earn on investments. The projection determines the amount the government that is affiliated with the pension fund must pay into it.
Robust returns reduce the need for government support. When returns fall short, however, the amount the government must contribute increases, potentially diverting money from other public services.
“I think a lot of plans fell a little bit short,” said Becky Sielman, principal and consulting actuary at Milliman. “Bonds generally did well, but there are other asset classes that didn’t do as well.”
Overall, a decadelong bull market in stocks has been good for pensions. Large public plans had five years of double-digit returns and a 10-year annualized return of 9.7% for the year ended June 30, according to Wilshire.
But those returns still haven’t brought pension funding levels close to what is needed to pay for future benefits. State and local pension plans have about $4.4 trillion in assets according to the Federal Reserve, $4.2 trillion less than they need to pay for promised future benefits. Contributing factors include increasing lifespans, overoptimistic return assumptions, and government decisions to skimp on pension payments. Record losses in 2009, when pension funds fell by a median 19.19% according to Wilshire, also played a role.
In hopes of reducing their unfunded liabilities, pensions have pushed further into riskier, less traditional investments over the past decade. Large public pension plans had a median 11.47% of their assets in alternative investments such as private equity for the year ended June 30 and a median 4.45% of their investments in real estate.
Even so, some of the best-performing investments in the year ended 2019 were plain domestic stocks and bonds.
The roughly $2 billion Tampa Fire and Police Fund, which steers clear of alternatives, returned 8.7% for the year ended June 30, said Jay Bowen, president and CEO of Bowen, Hanes & Co.
“For a public defined-benefit plan, we just feel like if you can focus on high-quality stocks and bonds and take a long-term approach, you’ll be better off, especially after fees,” said Mr. Bowen, whose firm has been the pension fund’s sole manager for 45 years.
Wilshire calculated that a portfolio of 60% domestic stocks and 40% domestic bonds would have returned 9.13% for the year ended June 30.
“Global equities worked against you, alternatives or private equity probably worked against you, cash worked against you, and anything where you didn’t stay the course worked against you,” said Robert J. Waid, managing director at Wilshire Associates. For example, he said, a pension fund that sold equities or switched to lower-risk equities at the end of last year as stock prices fell missed first-quarter gains.
The nation’s two largest pension funds, which serve California public workers and California teachers, earned 6.7% and 6.8%, respectively. Both funds project long-term returns of 7%.
“It was a roller-coaster year and a very challenging environment in which to generate returns,” said Christopher Ailman, investment chief for the teacher fund, known as Calstrs.
The discount rate US public pensions are using is still too high but states are reluctant to lower it for the simple reason that to do so would require increasing the contribution rate and possibly other politically unpalatable measures.Today, the yield on the 10-year US Treasury note fell below 1.6%, hit 1.59% before settling at 1.68%.
In Canada, large public pensions are using much lower discount rates and even though many are fully funded, they're still lowering their discount rate further to build a reserve cushion (eg., CAAT Pension Plan, OMERS, OPTrust, OTPP, and HOOPP).
There are other structural flaws impeding many US public pensions which Canada's large public pensions have addressed by adopting good governance and a shared risk model.
Good governance means pensions can pay their employees very competitively to manage more assets internally, lowering the overall fees while delivering strong long-term returns. Shared risk means the cost of the plan is shared more equitably among employers and employees so in the case of a deficit, they can increase contributions, lower benefits (typically through conditional inflation protection), or both until the plan's fully funded status is restored.
The problem is most US public pensions haven't adopted either of these measures which explains why they're in such a dire situation. The ones that have, like Wisconsin, are doing well and will survive the coming pension crisis.
Unfortunately, when the next crisis rolls around, many chronically underfunded US public pensions will be hit so hard that politicians will be forced to take very difficult decisions to keep these plans afloat.
Why am I bringing this up? Because pension analysts always forget pensions are all about managing assets and liabilities. And when long bond yields drop precipitously, as they have done, pension liabilities soar and deficits widen.
Remember, the duration of pension liabilities is a lot bigger than the duration of pension assets. Liabilities go out 75, 100 or more years. So when rates drop, it has a disproportionately negative effect on pension deficits even if assets rise.
The real pension storm is when rates drop precipitously and assets get slaughtered, as they did in 2008. That is a huge problem for most US pensions which are chronically underfunded (the starting point matters, even fully funded Canadian public pensions will get hit but they’re managed a lot better and have more levers like conditional inflation protection to address any shortfall).
Return expectations in the United States are still too high. Also, they need a huge governance overhaul to get governments out of public pensions.
I wrote an op-ed for the New York Times back in 2013 explaining the need for independent, qualified investment boards at US public pensions but there are too many hands in the cookie jar milking US pensions dry so they will never adopt the Canada model, or if they ever do, it will be too late.
Next, the article above spreads disinformation on alternative investments like private equity, real estate, infrastructure and hedge funds. There's nothing wrong with alternatives, as rates hit record lows, US public pensions need them but its the approach that matters a lot.
They need to hire professionals who can do more co-investments and they need to reduce fees and get better alignment of interests, just like Japan's giant pension is doing right now with its new fee structure.
Also, I am sick and tired of hearing about that Tampa Bay Fire and Police Fund. As I have written before, there is something very shady going on there and I would conduct a thorough operational, investment and risk management due diligence on that fund (as well as hire forensic accountants to audit their books).
There is another myth I have addressed recently, namely, indexing might have beaten US public pension returns over the last ten years but it would be highly irresponsible to invest billions in pension assets only in US stocks and bonds.
What if we get a market where US stocks and bonds return paltry returns for an extended period? What about the volatility in public markets which increases in an ultra-low rate environment?
It's just stupid to think US public pensions can index all their investments and not worry about huge volatility which will impact the volatility of their contribution rate. And when stocks and bonds get whacked, a lot of pensions that avoided alternatives altogether are going to be in big trouble.
When it comes to large pensions, it's not just about returns, it's about risk-adjusted returns over the long run.
Institutional Investor recently reported that the Florida State Board of Administration (SBA) did something unusual this spring: It committed $150 million to a fund-of-hedge funds, on top of the $300 million it already invested.
I'll let you read the article but here is the gist:
SBA does have PhDs and quants on staff, Webster added, and has transitioned from funds of funds to direct for certain categories.I used to allocate to CTAs, global macros, and L/S Equity funds. Some CTAs (like Fort) are better than others but there are great new funds out there.
In late 2014, for example, the team made its initial $300 million Elan Fund commitment, hiring JPMAM to build it a portfolio of managed futures and quantitative strategies, SBA documents show. Since then, “We’ve told our funds of funds to go out and find the more specialized managers. At CTAs” — commodity-trading advisors — “the fee structures are changing such that it’s becoming economic to do it directly. We’re starting to allocate to the commoditized strategies, and letting the fund of funds focus on the more specialized areas.”
CTAs and managed futures have had several years of rocky performance. The Elan Fund delivered somewhat better returns than average — 4.3 percent annualized as of the end of 2018, according to an SBA report. “For us, it’s been OK,” Webster said.
The often-complex products make sense for an equity-diversification mandate, explained Frans Harts, a partner at CTA shop KeyQuant. The French firm runs $430 million in assets, about half of them for U.S. clients. “Managed futures don’t have a bias towards an asset class. They trade currencies, equities, bonds, currencies — and within those different markets, they can be long or short.”
“If you’re concerned about having a strategy that will potentially do well in a medium to long-term reversal in equities or bonds, CTAs are a good fit,” Harts said Friday by phone from France. “If there’s a reversal that’s unexpected — such as in January and February of 2018 — you’re going to feel that pain.”
If I had to put my pension money into SBA or the Tampa Fire and Police Fund, I'd choose SBA hands down.
Below, it was another wild day on Wall Street. The market was down nearly 600 points at its low before a huge comeback. With CNBC's Melissa Lee and the Fast Money traders, Pete Najarian, Tim Seymour, Karen Finerman and Guy Adami.
Second, the trade war between the US and China could be creating a recession -- at least that's what the Treasury yield curve is indicating. Jim Bianco, President and macro strategist at Bianco Research, explains how we are nearing an all-time low for the 30-year bond.
Lastly, Joachim Fels, managing director and global economic adviser at Pimco, discusses the outlook for US Treasury yields with Bloomberg's Joe Weisenthal, Romaine Bostick and Caroline stating negative interest rates are eventually coming to the US. I predicted deflation is headed to the US and the world is going negative years ago.
Nonetheless, negative yields in the US aren't around the corner. I think the recent drop in long bond yields was overdone but lower yields and more volatility in stocks do not portend well for pensions, and if we get another crisis, many chronically underfunded US public pensions will be in big trouble.
Comments
Post a Comment