Tuesday, March 27, 2012

Question Authority

State Pensions Missed the Boat
Earlier this month I wrote a couple of pieces on Random Glenings criticizing the investment allocation decisions of the state pension boards of California and Massachusetts.

Specifically, I focused on the fact that the boards had been constantly reducing their exposure to the US stock market over the past few years in favor of either fixed income or alternative investments. This despite the fact that equity valuations versus bonds haven't been this attractive in 40 years.

Not surprisingly, both states now face significant pension shortfalls, as recent returns have not kept up with actuarial assumptions. 

So imagine my reaction when I read in this morning's New York Times that there is a serious proposal afloat to have state pension boards run retirement assets for workers:

As growing numbers of baby boomers face retirement with inadequate savings, some state officials are considering a novel proposal to rebuild America’s ailing retirement system — having state pension funds run retirement plans for companies. 

Fortunately, some other observers have pointed out that:

 Not everybody sees it that way. The big public pension systems have been criticized in recent years for, among other things, underestimating the cost of providing conventional pensions and failing to anticipate market crashes that have left local taxpayers to bail out investment failures. Participating cities and taxpayers are rebelling in some places but have no legal way to drop out of state-run plans.  


Back to my thoughts on the boards.

Here's what I wrote on March 15:

Here's a report from CNBC last September, right before the market started to rally:

The California Public Employees Retirement System is as worried as any investor about the uncertainty in the U.S. and Europe.
That's why Calpers, as it is known, is a "longterm trader" that is playing down equities, Chief Investment Officer Joe Dear told CNBC Wednesday. He indicated the Calpers portfolio is "underweight" equities by about 4 percent from its typical allocation
When you go to the CalPERS website, you see that just 48% of their portfolio is invested in public equities.

Meanwhile, 22% of the fund is invested in either "income" or "liquidity", both of which are essentially yielding less than 2%.

You would think that CalPERS would have investments with a very long term time horizon.  Most of the beneficiaries of the plan will be drawing their benefits for many years, but the yearly outflows are only a small fraction of the overall fund size.

But instead the group is investing with their eyes fixed firmly in the rear view mirror.  They have investments that will guard against inflation - with virtually no signs of inflation on the horizon.  They have huge investments in real estate and private equity, whose eventual returns are totally unknown.  They have hedge funds which, as a group, are probably barely earning their fees.

But common stocks - boring, large cap stocks trading at the most attractive level of valuation to bonds in more than 40 years - are getting a cold shoulder from the group, since they have been disappointing performers in the past decade.

This decision is not only likely to hurt returns, but also will cost the taxpayers of California. At a time when public services are being cut in many towns around the state, California municipalities are being forced to pony up more funds to keep the public pension plans funded.
This cautious investment stance is consistent with the state of Massachusetts, by the way, and probably most other states as well.

The decision to place money with the so-called "smart investors" who run hedge funds and private equity pools never seems to be questioned, despite a paucity of evidence that would warrant continued allocations to alternatives.

If nothing else, the fact that nearly $2 trillion has been placed with non-traditional asset managers almost certainly means that returns will be subpar for most of the group, especially after the enormous fees these funds charge.

And are these managers truly superior investors compared to, say, index funds?

Well, here's a piece from yesterday's Bloomberg that would suggest that once again the so-called smart money has found itself on the wrong side of the market action:
Hedge funds trailing the Standard & Poor’s 500 (SPX) Index for the last five months are giving up on bearish bets and buying stocks at the fastest rate in two years. 

A gauge of hedge-fund bullishness measuring the proportion of bets that shares will rise climbed to 48.6 last week from 42 at the end of November 2011, the biggest increase since April 2010, according to data compiled by the International Strategy & Investment Group. The Bloomberg aggregate hedge fund index gained 1.4 percent last month, lagging behind the Standard & Poor’s 500 Index by 2.65 percentage points.