pension thread

[Skydaemon]

Place holder thread to put articles and related info on pension funds. It's no secret that they're invested heavily in both real estate and equity as well as fixed income.

Pension funds are largely hidden from view and do infrequent reporting at best. Nevertheless, facing boomer generation retirements in the not so distant future, and the collapse in all kinds of asset values it could well be a looming crisis for the retirement system.

Anyway, here's a starter article.

I'm not hugely knowledgable about pension funds, but from what I gather, the pbgc is a federal entity which takes over failed pension funds from companies. Sort of like what the fdic does for banks, except this is for pension funds. Anyway, I remember following this back early in the year when they announced they were going to plunge into equities to meet their funding shortfall. Yeah, that didn't work out so well.

pbgc talks about it's current year loss and funding deficit

[Grizzums]

Downturn Clobbers Public Pension Funds

"By Peter Whoriskey
Washington Post Staff Writer
Tuesday, October 28, 2008; D01



The market downturn is ravaging public pension funds across the United States, with many state and local governments seeing more than 20 percent of their retirement pools swept away in the turmoil.

Even before the financial crisis, many large pension funds already were considered to be inadequately funded, according to the Government Accountability Office. The losses could force some states and local governments to ask taxpayers to pay more into the funds or to demand more contributions from the police, teachers and other government employees whom the benefits cover.

Public pension funds dropped 14.8 percent in value for the year ended Sept. 30, according to Northern Trust, an investment company. The funds, which typically have most of their money in stocks, have probably dropped far more than that because the markets have dropped 20 percent more since then.

"We expect this is going to be the worst year we've seen since we've been tracking the funds," said William Frieske, of Northern Trust Investment Risk and Analytical Services, which began watching the funds 14 years ago. "It's got all the hallmarks of a bad -- really bad -- year."

Virginia's retirement fund, for example, has dropped about 20 percent since July 1, plummeting from $55 billion to $44 billion. Most of that fund was invested in stocks.

The California Public Employees' Retirement System has lost 20 percent of its portfolio since July 1.

The Maryland pension fund was down 17 percent for the year ended Sept. 30, and with about 58 percent of the fund invested in stocks, officials are expecting further significant drop-off when October's market plunges are calculated in.

"We have losses," said R. Dean Kenderdine, director of the Maryland retirement fund. "We anticipate that the market is going to return as it always has. How long that will be is uncertain.

"In the meantime, we will continue to meet our obligations to our beneficiaries," he said.

Public pension funds pay for more than 27 million people, according to federal statistics. The funds are supported through a combination of taxpayer money, investment returns and employee contributions.

From 2000 to 2006, an increasing number of those funds have been inadequately funded to support future payments to retirees, according to the GAO. Twenty-seven of 65 large pension funds were inadequately funded as of 2006, the GAO reported.

The shortfall stems from the market decline in 2001, an increase in pension benefits and a decrease in taxpayer contributions, pension administrators say.

But some critics have said one of the problems is that many public pension funds unwisely project that their investments will return 8 percent annually on average -- when in fact, returns could be far lower.

The market plunge played havoc on the careful calculations actuaries make to ensure there are enough savings to cover future retirees. Roughly 60 percent of public pension funds are invested in stocks, according to the National Association of State Retirement Administrators.

The impact of the recent market drop-off on state and local governments will probably be somewhat delayed, however.

Many public funds do not recalculate what is necessary to replenish their funds until June 30. By then, the market may have recovered some.

Moreover, many funds recognize gains and losses over a five-year period, not straight away, to avoid reflecting the volatility of the markets.

Earlier gains in Virginia's fund, for example, have helped balance some of the recent losses, officials said.

"Pension funds are long-term and designed to ride out short-term volatility," said Keith Brainard, research director for the National Association of State Retirement Administrators. "As with all investors, public pension funds have taken a hit. But they won't have to pay out all of their money next year, either.""

[Grizzums]

Insurers and pensions seen piling into long US swaps

"NEW YORK (Reuters) - Insurers and pension funds, haemorrhaging from the global stock sell-off, have piled into long-dated U.S. interest rate swaps as a way to match expected liability payouts, according to J.P. Morgan Securities.

The analysts estimated insurers and pension funds have scooped up $50 billion (32 billion pounds) in 20-year swap equivalents in October, as U.S. stocks ended at 5-1/2-year lows last week on recession worries and forced liquidation.

"As equities have sold off, there has been unusually heavy receiving in swaps in the long end this month from pension funds and insurance companies managing their asset-liability mismatches," they wrote in a research report published late Friday.

They attributed some of the initial money into long-dated swap contracts to pension funds replacing trades with Lehman Brothers after the U.S. investment bank filed for bankruptcy last month. However, the volume has exceeded "well beyond" these Lehman-related trades, they said.

With the Standard & Poor's 500 index .SPX falling 40 percent this year and prospects of cuts in short-term interest rates from central banks worldwide, a number of pension funds and insurers rushed to replace their depleted stock exposure with long-dated fixed-income assets.

Such a move should ensure they generate enough income to pay for future payouts, J.P. Morgan analysts said.

They added insurers and pensions have preferred swaps and futures over cash bonds because they do not require an outlay of cash."

(Reporting by Richard Leong; Editing by Tom Hals)

[Grizzums]

Pension fund gap hits $100bn

By Deborah Brewster in New York

Published: October 30 2008 02:00 | Last updated: October 30 2008 02:00

US companies will need to inject more than $100bn into their pension funds to cover market losses, putting them in a cash squeeze at a time when it is difficult to raise money.

The cash payment, estimated by several pension industry executives, would be spread over this financial year and next year.

Companies' pension fund losses - running at an estimated 20 per cent in the year to date - also are expected to alter earnings this year, partly because of accounting changes.

The 700 largest corporate plans were more than 100 per cent funded at the end of last year, but as of last week that had fallen to about 83 per cent, according to estimates by Mercer, a pension consultant.

John Erhardt, a principal at Milliman, a consulting firm, said: "To bring company funds back to 100 per cent funding, companies would need to put in about $50bn this year and that again next year, for the top 100 funds. You could add another 30 per cent to 40 per cent to that for the rest of the funds."

"Earnings will be impacted significantly. The 2008 year-end balance sheet will reflect that."

Mr Erhardt said there were about $300bn in fund losses to the end of this month.

After the introduction of the Pension Protection Act this year, that would go "straight on to the company balance sheet".

A report by Credit Suisse estimated that at the end of September there were 136 companies that would need to lift contributions to their pension plans by half or more.

It said 76 companies had seen a drop in funded levels for their schemes that was greater than 5 per cent of their corporate book value.

These included seven companies where the drop was more than 25 per cent of book value: Unisys, Qwest, Embarq, Ford, Western Union, Dean Foods and Pactiv Corp.

David Zion, who wrote the report, estimated that apart from the cash payout, there were 65 companies whose earnings could be cut by 10 per cent because of an increase in pension costs.

The change to earnings is separate from the cash infusion necessary to shore up the funds.

The American Benefits Council, which represents corporate pension plans, is lobbying for the federal government to suspend some of the PPA rules, which require mandatory contributions if funds fall below a certain level.

[Grizzums]

I was reading David Merkel's post on who's to blame from this fiasco the other day and I found his point on diversification an interesting one.

"16) Academics who encouraged a naive view of diversification, and their followers who believe in uncorrelated returns. In a bad economy, everything is correlated, and your statistics from a good economy don’t matter."

He added in a follow up post:

"One final note on my point 16, diversification, from the prior post: many quants did us wrong by focusing on correlations stemming from only boom periods. There are many problems with correlation statistics in finance, but the big problem is that correlations are not stable even during boom times, much less between booms and busts. In a bust, all risky assets become highly correlated with each other, invalidating ideas of risk control through diversification.

My view of diversification is holding safe assets and risky assets. High quality short-term debt does wonders to reduce the volatility of results. Other hedges are less certain. Nothing beats cash, even when money market funds are open to question."

Today I read the following article in The Economist

[Grizzums]

All bets are off


Oct 30th 2008
From The Economist print edition


Spreading the risk has spread the losses


THERE is such a thing as a free lunch. That, at least, is what pension funds have been told in recent years. Diversify into new asset classes and your portfolio can improve the trade-off between risk and return because you will be making uncorrelated bets.

Boy, did pension funds diversify. They bought emerging-market equities, corporate bonds, commodities and property, while giving money to hedge funds and private-equity managers with their complex strategies and high fees.

The idea was to “be like Yale”, the university endowment fund run by David Swensen, a celebrated investor, which started to diversify into hedge funds and private equity in the 1980s. Compared with other institutional investors over the past 20 years, Yale had very little exposure to conventional equities. It also produced remarkably strong returns.

But those who thought Yale had found the key to success have been disappointed. Every one of those diversified bets has turned sour this year. In retrospect, it looks like the strategy had two problems. The first was that all risky assets were boosted by the same factors: low interest rates and healthy global growth. That encouraged investors to use leverage, or borrowed money, to enhance returns. The result was what Jeremy Grantham of GMO, a fund-management group, describes as “the first truly global bubble”. As confidence has unravelled, investors have been forced to sell all those asset classes simultaneously, driving down prices across the board.

The second, and related, problem is that some of the asset classes were quite small. Initially, this illiquidity was attractive since it seemed to offer more alluring returns. And as more investors became involved, their liquidity duly improved. But they still suffer from the “rowing boat” factor. When everyone tries to exit the asset class at once, the vessel capsizes.

Furthermore, some of these asset classes were always likely to be driven by the same factors as stockmarkets. Private-equity funds, for example, give investors exposure to the same kinds of risks as quoted companies, only with added leverage.

So was the whole idea of diversification a write-off from the start? The strategy’s defenders say no. They argue that pension funds (and other institutional investors) had made too big a bet on equities in the 1990s. When the bet went wrong with the bursting of the dotcom bubble, funds went into deficit.

They accept that, in a crisis, correlations head towards one; in other words, all asset classes (except government bonds) tend to fall together. But the diversifiers have three counter-arguments. The first is that any correlation less than one is still worth having. Hedge funds may have performed badly this year but their losses have been far lower than those of equity markets.

Second, there is a difference between short-term correlations and long-term ones. If you take a five- or ten-year view, it still looks as if property, commodities and the rest offer some diversification benefits. They did so during the equity bear market of 2000-02, for example.

Third, consultants like Colin Robertson of Hewitt Associates argue that diversification does work when it is applied in a sophisticated way. There is no point in diversifying if the investment does not offer a genuinely different source of return (much of private equity falls into this category) or if the asset is already overvalued.

Yet even allowing for this, diversification has surely not offered the benefits most pension funds expected. Indeed, it may have had perverse results. In the old days, with equities trading at below-average valuations, funds would now be on a buying spree. They could afford to ignore the short-term risks because of the long-term nature of their liabilities. Pension funds thus acted as an automatic stabiliser for the market.

This time round, that does not seem to be happening. One reason may be accounting changes which make pension-fund managers more focused on the short term. Another, however, may be the strategic drive to diversification. The Wall Street Journal has reported that CalPERS, America’s largest public-pension fund, has been selling shares to meet commitments to put more money into private-equity firms.

The final problem with diversification has been the cost. Investing in quoted shares via an index fund is very cheap—a fraction of a percentage point. But diversified asset classes cost more to trade and involve higher management fees, expenses that eat into pension-fund returns.

So perhaps diversification has been a free lunch after all. Not for the pension funds, but for the fund managers.

[TNTrader]

Asset class based diversification has long been a point of contention amongst managers and economists. The theory of the decades long hold tactic is a mathematical illusion dreamt up by narrow azzed dipsticks. Academia lives and dies by the cleaned up math that long term observation allows. In the real world, averaging 7 1/2% across a forty year hold period only pays when that forty year hold begins as a lump sum. And the holds are managed in an active fashion, which does not happen,despite the shiny prospectuses.

When inflation and tax rates are factored in across that time frame such long term holds lose their luster. In 1968 a half million bucks was a set for life retirement fund. The average lifespan is now 10 years longer and a half million has the purchasing power in 2008 of about 185,000 in 1968.

The average up/down cycle in the markets prior to 1973 was about 10% with a cycle of around 8 years. A cycle with this rythm and such a moderate swing in the pendulum of capital value would benefit from the tactic of hold at all costs. That changed with the over 40% drop in the 73-74 bear. Such a precipitous drop actually would have brought a late 60's account far into the red, well past just losing gains and including a capital loss of around 10-12% into principal. The cycle between 74 and 87 spent 10 of those years range bound. In late 83 when the bull run began that 60's account would have recouped its principal losses and gained about 45% across the 4 year span of the bull run. When the bear of 87 hit, the losses were not so dramatic. This was a major correction but still only took 22% off the top. Our 68 account is still up by 23% or so.

Across a twenty year span.

Are we beginning to see a problem with the math?

Now lets bring the real world into our 1968 account with a vengence.

Inflation has averaged over 4 1/2% per year since 1974. Thats a loss of over 58% in purchasing power in exchange for 23% in long term gains based on a lump sum investment. The loss of purchasing power does not just contain the gains. It also applies to the principal. Our 1968 account now has 23% more value,but far less purchasing power. In exchange for that 23% gain, we have lost the equivelent of 35% of our original investment plus all of the gains. But we still must pay the taxes as if we had actually made money. So take off another (insert capital gains rate here).

If you want, I will be glad to continue, but you get the point. The rest is just detail. The end result is that extremes do not work, either in length of hold or brevity. True daytraders are nearly extinct, that extreme proved even less efficient than the hold forever theory.

Good Luck

[Skydaemon]

Originally Posted by TNTrader

The theory of the decades long hold tactic is a mathematical illusion dreamt up by narrow azzed dipsticks. Academia lives and dies by the cleaned up math that long term observation allows.

Amen to both notions. Sheltered academic economists have far too much clout in our policy-making and do far too much damage.

I view economists basically as nothing more than historians, incapable of predictions or analysis, only scribing what has occurred in sufficient high level as to remove the contextual decision points from the record.

Would you ask a historian how to execute your next war just because they write about them all the time? Hell no. So why do you ask an economist how to create policy or deal with a financial crisis.