Public Pension Funds Are Adding Risk to Raise Returns

[Cees Binkhorst]

REPLY TO: D66 at nic.surfnet.nl

Ze zullen hartelijk worden verwelkomd door GS & Co.
Nieuwe melkkoeien voor HF-trading ;).

Groet / Cees

PS. 130+ dagen per jaar > $100M winst per dag op VaR-investeringen van
gemiddeld $218M (maakt toch maar even 50% PER DAG) en max. 19 dagen <
$10M verlies.

Public Pension Funds Are Adding Risk to Raise Returns
http://www.nytimes.com/2010/03/09/business/09pension.html
By MARY WILLIAMS WALSH

States and companies have started investing very differently when it
comes to the billions of dollars they are safeguarding for workers’
retirement.

Companies are quietly and gradually moving their pension funds out of
stocks. They want to reduce their investment risk and are buying more
long-term bonds.

But states and other bodies of government are seeking higher returns for
their pension funds, to make up for ground lost in the last couple of
years and to pay all the benefits promised to present and future
retirees. Higher returns come with more risk.

“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a
Dallas investor and the former chairman of the Texas Pension Review
Board, which oversees public plans in that state. “Double up to catch up.”

Though they generally say that their strategies are aimed at
diversification and are not riskier, public pension funds are trying a
wide range of investments: commodity futures, junk bonds, foreign
stocks, deeply discounted mortgage-backed securities and margin
investing. And some states that previously shunned hedge funds are
trying them now.

The Texas teachers’ pension fund recently paid Chicago to receive a
stream of payments from the money going into the city’s parking meters
in the coming years. The deal gave Chicago an upfront payment that it
could use to help balance its budget. Alas, Chicago did not have enough
money to contribute to its own pension fund, which has been stung by
real estate deals that fizzled when the city lost out in the bidding for
the 2016 Olympics.

A spokeswoman for the Texas teachers’ fund said plan administrators
believed that such alternative investments were the likeliest way to
earn 8 percent average annual returns over time.

Pension funds rarely trumpet their intentions, partly to keep other big
investors from trading against them. But some big corporations are
unloading the stocks that have dominated pension portfolios for decades.
General Motors, Hewlett-Packard, J. C. Penney, Boeing, Federal Express
and Ashland are among those that have been shifting significant amounts
of pension money out of stocks.

Other companies say they plan to follow suit, though more slowly. A poll
of pension funds conducted by Pyramis Global Advisors last November
found that more than half of corporate funds were reducing the portion
they invested in United States equities.

Laggards tend to be companies with big shortfalls in their pension
funds. Those moving the fastest are often mature companies with large
pension funds, and who fear a big bear market could decimate the funds
and the companies’ own finances.

“The larger the pension plan, the lower-risk strategy you would like to
employ,” said Andrew T. Ward, the chief investment officer of Boeing,
which shifted a big block of pension money out of stocks in 2007. That
helped cushion Boeing’s pension fund against the big losses of 2008.

Shedding stocks gave Boeing “material protection right when we needed it
most,” Mr. Ward said. By the time the markets had bottomed out last
March, Boeing’s pension fund had lost 14 percent of its value, while
those of its equity-laden peers had lost 25 to 30 percent, he said.

“We estimated that the strategy saved our company in the short term
right around $4 or $5 billion of funded status,” he said.

Boeing and other companies seeking to reduce their investment risk are
moving into fixed-income instruments, like bonds — but not just any
bonds. They are buying and holding bonds scheduled to pay many years in
the future, when their retirees expect their money.

The value of the bonds may fall in the meantime, just like the value of
stocks. But declining bond prices are not such a worry, because the
companies plan to hold the bonds for the accompanying interest payments
that will in turn go to retirees, not sell them in the interim.

Towers Watson, a big benefits consulting firm, surveyed senior financial
executives last year and found that two-thirds planned to decrease the
stock portion of their companies’ pension funds by the end of 2010. They
typically said their stock allocations would shrink by 10 percentage points.

“That’s 10 times the shift we might see in any given year,” said Carl
Hess, head of Towers Watson’s investment consulting business. Economists
have speculated that a truly seismic shift in pension investing away
from stocks could be a drag on the market, but they say it would not be
long-lasting.

Corporate America’s change of heart is notable all on its own, after
decades of resistance to anything other than returns like those of the
stock markets. But it’s even more startling when compared with
governments’ continued loyalty to stocks. When governments scale back on
the domestic stocks in their pension portfolios these days, it is often
just to make way for more foreign stocks or private equities, which are
not publicly traded.

Government pension plans cannot beef up their bonds that mature many,
many years from now without dashing their business models. They use
long-range estimates that presume high investment returns will cover
most of the cost of the benefits they must pay. And that, they say,
allows them to make smaller contributions along the way.

Most have been assuming their investments will pay 8 percent a year on
average, over the long term. This is based on an assumption that stocks
will pay 9.5 percent on average, and bonds will pay about 5.75 percent,
in roughly a 60-40 mix.

(Corporate plans do their calculations differently, and for them,
investment returns are a less important factor.)

The problem now is that bond rates have been low for years, and stocks
have been prone to such wild swings that a 60-40 mixture of stocks and
bonds is not paying 8 percent. Many public pension funds have been
averaging a little more than 3 percent a year for the last decade, so
they have fallen behind where their planning models say they should be.

A growing number of experts say that governments need to lower the
assumptions they make about rates of return, to reflect today’s market
conditions.

But plan officials say they cannot.

“Nobody wants to adjust the rate, because liabilities would explode,”
said Trent May, chief investment officer of Wyoming’s state pension fund.

The $30 billion Colorado state pension fund is one of a tiny number of
government plans to disclose how much difference even a slight change in
its projected rate of return could make. Colorado has been assuming its
investments will earn 8.5 percent annually, on average, and on that
basis it reported a $17.9 billion shortfall in its most recent annual
report.

But the state also disclosed what would happen if it lowered its
investment assumption just half a percentage point, to 8 percent. Though
it might be more likely to achieve that return, Colorado would earn less
over time on its investments. So at 8 percent, the plan’s shortfall
would actually jump to $21.4 billion. Contributions would need to
increase to keep pace.

Colorado cannot afford the contributions it owes, even at the current
estimated rate of return. It has fallen behind by several billion
dollars on its yearly contributions, and after a bruising battle the
legislature recently passed a bill reducing retirees’ cost-of-living
adjustment, to 2 percent, from 3.5 percent. Public employees’ unions are
threatening to sue to have the law repealed.

If Colorado could somehow get 9 percent annual returns from its
investments, though, its pension shortfall would shrink to a less
daunting $15 billion, according to its annual report.

That explains why plan officials are looking everywhere for
high-yielding investments.

Mr. May, in Wyoming, said many governments were “moving away from the
perceived safety and liquidity of the investment-grade market” and
investing money offshore, but he said he was aware of the risks.
“There’s a history of emerging markets kind of hitting the wall,” he said.

Last year, the North Carolina Legislature enacted a measure to let the
state pension fund invest 5 percent of its assets in “credit
opportunities,” like junk bonds and asset-backed securities from the
Federal Reserve’s Term Asset-Backed Securities Loan Facility, an
emergency program created to thaw the frozen markets for such securities.

The law also lets North Carolina put 5 percent of its pension portfolio
into commodities, real estate and other assets that the state sees as
hedges against inflation. A summary of the bill issued by the state’s
treasurer and sole pension trustee, Janet Cowell, said it would provide
“flexibility and the tools to increase portfolio return and better
manage risk.”

But some think they see new risks.

“It doesn’t pass the smell test,” said Edward Macheski, a retired money
manager living in North Carolina. “North Carolina’s assumption is 7.25
percent, and they haven’t matched it in 10 years.” He went to a recent
meeting of the state treasurer’s advisory board, armed with a list of
questions about the investment policy. But the board voted not to permit
any public discussion.

Wisconsin, meanwhile, has become one of the first states to adopt an
investment strategy called “risk parity,” which involves borrowing extra
money for the pension portfolio and investing it in a type of Treasury
bond that will pay higher interest if inflation rises.

Officials of the State of Wisconsin Investment Board declined to be
interviewed but provided written descriptions of risk parity. The
records show that Wisconsin wanted to reduce its exposure to the stock
market, and shifting money into the inflation-proof Treasury bonds would
do that. But Wisconsin also wanted to keep its assumed rate of return at
7.8 percent, and the Treasury bonds would not pay that much.

Wisconsin decided it could lower its equities but preserve its
assumption if it also added a significant amount of leverage to its
pension fund, by using a variety of derivative instruments, like swaps,
futures or repurchase agreements.

It decided to start with a small amount of leverage and gradually
increase it over time, but word of even a baby step into derivatives
elicited howls of protest from around the state.

The big California pension fund, known as Calpers, was already under
fire for losing billions of dollars on private equities and real estate
in the last few years. So far it has stayed with those asset classes,
while negotiating lower fees and writing off some of the most troubled
real estate investments.

It announced in February that it had started looking into whether it
should lower its expected rate of investment return, now 7.75 percent a
year. It has embarked on a study, but a spokesman said that process
would not be done until December, safely after the coming election.

**********
Dit bericht is verzonden via de informele D66 discussielijst (D66 at nic.surfnet.nl).
Aanmelden: stuur een email naar LISTSERV at nic.surfnet.nl met in het tekstveld alleen: SUBSCRIBE D66 uwvoornaam uwachternaam
Afmelden: stuur een email naar LISTSERV at nic.surfnet.nl met in het tekstveld alleen: SIGNOFF D66
Het on-line archief is te vinden op: http://listserv.surfnet.nl/archives/d66.html
**********