Investing Novices Are Calling the Shots for $4 Trillion at US Pensions

Link: https://www.bloomberg.com/news/features/2023-01-04/us-public-pension-plans-run-by-investing-novices-are-on-the-edge-of-a-crisis?cmpid%3D=socialflow-twitter-economics&utm_campaign=socialflow-organic&utm_medium=social&utm_source=twitter&utm_content=economics

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In the US, a lineup of unpaid union-backed reps, retirees and political appointees are the vanguards of a $4 trillion slice of the economy that looks after the nation’s retired public servants. They’re proving to be no match for a system that’s exploded in size and complexity.

The disparity is dragging on state and local finances and — together with headwinds that include a growing ratio of retirees to workers and lenient accounting standards — gobbling up an increasing share of government budgets. Precisely how much it’s costing Americans is hard to say. But a Bloomberg News analysis of data from CEM Benchmarking, which tracks industry performance, indicates that the price tag over the past decade could run into the hundreds of billions of dollars.

….

The disconnect was on display at a 2021 investment committee meeting of the California Public Employees’ Retirement System, which provides benefits to more than 750,000 individuals. An external adviser warned board members that the boom in blank-check companies was a sign of froth in financial markets.

“I had never heard of those,” chairwoman Theresa Taylor told her fellow directors of the then-sizzling products known as SPACs, according to a transcript of the meeting.

….

Systems are underfunded partly because public officials face greater pressure to fulfill today’s demands than to fund obligations 20 or 30 years away. And because hikes in taxes and contributions are unpopular, there’s an incentive to downplay the problem.

Instead, plans are investing in higher risk assets, which make up about one-third of holdings, according to data from Preqin. That allocation has more than doubled since just before the 2008 financial crisis as plans have poured $1 trillion into alternatives.

….

Many pension advisers make smart recommendations: the guidance that CalPERS should stay away from SPACs, for one, was proven sound once regulators ramped up scrutiny of that market, which has all but ground to a halt. Yet it remains unclear how closely individual directors evaluate investments that get put in front of them.

“I served with one director for about 15 years and never saw him ask a question” about his system’s investments, said Herb Meiberger, a finance professor who sat on the board of the $36 billion San Francisco Employees’ Retirement System until 2017. A spokesman for the system said it takes governance and fiduciary duty very seriously, and that board members receive training to help them execute their duties.

Harvard finance professor Emil Siriwardane has researched why some US plans have put more money into alternatives. It wasn’t the worst-funded or those with the most aggressive performance targets. “By a factor of eight-to-ten,” the closest correlation is the investment consultants that pension plans hire, Siriwardane found.

….

Canada’s detour from the American-style model began in the late 1980s, when Ontario’s government and teacher federation decided to reboot a plan that was invested in non-marketable provincial bonds. They set up the Ontario Teachers’ Pension Plan in 1990, concluding the province could save $1.2 billion over a decade by operating more like a business.

Ontario Teachers’ first board chairman was a former Bank of Canada governor and its first finance chief was a corporate finance veteran. It soon began investing directly in private markets and infrastructure, opened offices in Europe and Asia and acquired a large real estate firm. The system pays its board members close to what corporate directors make, and manages 80% of its investments internally. Those practices have put it on a solid financial base: Ontario Teachers’ says it’s been fully funded for the past nine years, with a current funding ratio of 107%.

Until the 2008 financial crisis, boards in the Netherlands — where traditional public sector pensions are common — looked a lot like those in the US. Then the country’s central bank was given authority to assess candidates. It looked at directors’ combined risk management, actuarial and other expertise.

Many smaller Dutch funds didn’t make the cut. The regulatory hurdles helped set off a wave of mergers that, over the past decade, has reduced the number of plans by over two-thirds. The system has sprouted professional directors who serve more than one at a time. 

Few US boards are following suit. Only 19 of 113 funds studied made changes to their board composition from 1990 to 2012, a paper published in The Review of Financial Studies in 2017 found.

 “A lot of funds in the US like the idea of transforming, want to transform, but don’t have the political fortitude to do it,” said Brad Kelly of Global Governance Advisors, a Toronto-based firm that works with US and Canadian pension funds.

Author(s): Neil Weinberg

Publication Date: 3 Jan 2023

Publication Site: Bloomberg

NAHB Housing Sentiment and Present Conditions Crash to Covid-19 Lows

Link: https://mishtalk.com/economics/nahb-housing-sentiment-and-present-conditions-crash-to-covid-19-lows

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Please consider the NAHB/Wells Fargo Housing Market Index (HMI) for December 2022.

The NAHB/Wells Fargo Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.

Bloomberg Econoday Consensus Outlook

Spiraling downward, the housing market index has missed Econoday’s consensus every month this year. November’s 33 was 3 points short of the consensus. December’s consensus is 34.

December’s 31 was also 3 points lower than consensus and 1 point lower than the entire consensus range of 32-35.

Well done! Perfection for 12 months is very difficult. 

Author(s): Mike Shedlock

Publication Date: 19 Dec 2022

Publication Site: Mish Talk

People Will Pay for Illiquidity

Link: https://www.bloomberg.com/opinion/articles/2022-11-01/people-will-pay-for-illiquidity

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Adding liquidity is, conventionally, desirable. It reduces risk: If you can sell a thing easily, that makes it less risky to buy it, so you are more likely to commit capital to the thing. It increases demand: If only a few rich people can buy a thing with great difficulty, it will probably have a lower price than if everyone can buy a share of it easily. It improves transparency and makes prices more efficient. Also, financial innovation tends to be done by banks and other financial intermediaries, and their goal is pretty much to do more intermediation. More liquidity means more trading, which means more profits for banks.

Another, funnier sort of financial innovation is about subtracting liquidity. If you can buy and sell something whenever you want at a clearly observable market price, that is efficient, sure, but it can also be annoying.

….

Or we have talked about a fun post from Cliff Asness titled “ The Illiquidity Discount,” in which he argues that private equity is essentially in the business of selling illiquidity. If you are a big institution and you buy stocks in public companies, the stocks might go down, and you will be sad for various reasons. You might be tempted to sell at the wrong time. You will have to report your results to your stakeholders, and if the stocks went down those results will be bad and you will get yelled at or fired. Whereas if you put your money in a private equity fund, it will buy whole public companies and take them private, and then you won’t know what the stock price is and won’t be able to sell. The private equity fund will send you periodic reports about the values of your investments, but those values won’t necessarily move that much with public-market stock prices: The fund will base its valuations on its estimates of long-term cash flows, and those will not change from day to day. By being illiquid, the private equity fund can look less volatile. Getting similar returns with less volatility is good; getting similar returns and feeling like you have less volatility also might be good.[4] Asness writes:

If people get that PE is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? “Ignore” in this case equals “stick with through harrowing times when you might sell if you had to face up to the full losses.” What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if it’s simply not shoved in their face every day (or multi-year period!)? 

One objection to this sort of financial product — illiquidity provision — is that it does not generate a lot of transactions. If you work at a bank and you think of a product that will cause customers to trade bonds or houses or diamonds more often, then it is pretty easy to figure out how to make money from that product. 

Author(s): Matt Levine

Publication Date: 1 Nov 2022

Publication Site: Bloomberg

As Pension Goes Broke, Bankruptcy Haunts City Near Philadelphia

Link: https://news.bloomberglaw.com/bankruptcy-law/as-pension-goes-broke-bankruptcy-haunts-city-near-philadelphia

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Decade after decade, Chester, Pennsylvania, has fallen deeper and deeper into a downward financial spiral.

As the city’s population dwindled to half its mid-century peak, shuttered factories near the banks of the Delaware River were replaced by a prison and one of the nation’s largest trash incinerators. A Major League Soccer stadium and casino did little to turn around the predominantly Black city just outside Philadelphia, where 30% of its 33,000 residents live below the poverty line. Debt piled up. The government struggled to balance the books.

Now, with its police pension set to run out of cash in months, a state-appointed receiver is considering a last resort that cities rarely take: filing for bankruptcy.

…..

In the years after the housing-market crash, three California cities, Detroit and Puerto Rico all went bankrupt, in large part because of retirement-fund debts. Such pensions are now being tested again, with the S&P 500 Index tumbling over 20% this year and bonds pummeled by the worst losses in decades.

….

Michael Doweary, who was appointed receiver of the city in 2020, is exploring options such as eliminating retiree health care, cutting the city’s costs for active employees’ medical benefits and reducing the city’s pension and debt-service costs. 

But that’s virtually certain to draw resistance from employees, who would need to approve such changes. In February, Pennsylvania’s Department of Community and Economic Development gave Doweary the power to seek bankruptcy protection for Chester if such steps fall through. 

“The answer is not to go to people and say we promised you if you work here for 25 years we’re going to give you post-retirement medical benefits, and then take it back,” said Les Neri, a former president of the Pennsylvania Fraternal Order of Police who is currently working with Chester’s officers. “At least current officers can make a decision to accept it and stay, or reject it and leave.”

Author(s): Hadriana Lowenkron

Publication Date: 17 Oct 2022

Publication Site: Bloomberg Law

The Economic Cost of Gun Violence

Link: https://everytownresearch.org/report/the-economic-cost-of-gun-violence/

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  • Taxpayers, survivors, families, and employers pay an average of $7.79 million daily in health care costs, including immediate and long-term medical and mental health care, plus patient transportation/ambulance costs related to gun violence, and lose an estimated $147.32 million per day related to work missed due to injury or death. 
  • American taxpayers pay $30.16 million every day in police and criminal justice costs for investigation, prosecution, and incarceration. 
  • Employers lose an average of $1.47 million on a daily basis in productivity, revenue, and costs required to recruit and train replacements for victims of gun violence.
  • Society loses $1.34 billion daily in quality-of-life costs from the suffering and lost well-being of gun violence victims and their families.

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Publication Date: 19 July 2022

Publication Site: Everytown Research

Young Versus Old Will Define Fight Over Public Pensions

Link:https://www.washingtonpost.com/business/young-versus-old-will-define-fight-over-public-pensions/2022/10/06/d4fae69a-4566-11ed-be17-89cbe6b8c0a5_story.html

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Younger workers are mostly excluded from those benefits, and few believe pension funds will be around to pay them at retirement time anyway. So younger workers want salary increases rather than promises. Also, portable, employee-directed accounts like 401(k)s rather than large and ever-increasing contributions to black-hole public pension systems. The fight in 2023 may be more between younger and older public employees than between united public employees and taxpayers.I think young employees will score their first victory after many years of getting pushed down. It will be short-term inflation then that applies lethal pressure in a tight labor market, not stock prices, interest rates or even longer-term expectations of price increases. Wages will have to be raised for public employees, who will refuse burdens from past underfunding or benefit cuts that apply only to them. The alternative is unacceptable declines in public services as the best employees quit, job openings go unfilled and qualifications for new hires are lowered.The most heavily indebted states, with the worst credit ratings and biggest pension funding shortfalls, may not be able to pay these increases. While 2022 should be a good revenue year for a majority of state and local governments, heavily indebted states with big pension-funding gaps need to brace for some serious headwinds. Illinois already spends 11% of its revenue to service debt. Increased yields on its bonds could double that to 22% as debt is refinanced, even if the state runs balanced budgets.

The temptation to cut benefits for retirees may be overwhelming. While these people can (and will) yell and scream, that’s easier to accept than a teachers’ strike or a police slowdown. Current employees can be offered generous wage increases and portable pensions. Reducing actuarial pension liabilities will please creditors and rating agencies. Taxpayers will appreciate being spared. In many states, cutting benefits will require a constitutional amendment or other legal heavy lifting, but with enough incentive, that can be done.

I expect something like Social Security reforms. A cap will cut benefits for people receiving the highest pensions, and states will put tax surcharges on benefits for high-income people even if they have moved out-of-state. Copays and deductibles will be increased for health coverage.

The first state to try this will face strong legal challenges, a nationwide union counteroffensive and significant in-state political resistance. But with enough fiscal pressure it may happen. If state administrations can keep current public employees on the sidelines, via wage increases and benefit restructuring, it might succeed.

Author(s): Aaron Brown, Bloomberg

Publication Date: 6 Oct 2022

Publication Site: Washington Post

UK Pensions Got Margin Calls

Link: https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pensions-got-margin-calls

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I said above that pension funds are unusually insensitive to short-term market moves: Nobody in the pension can ask for their money back for 30 years, so if the pension fund has a bad year it won’t face withdrawals and have to dump assets. Still, pension managers are sensitive to accounting. If your job is to manage a pension, you want to go to your bosses at the end of the year and say “this pension is now 5% less underfunded than it was last year.” And if you have to instead say “this pension is now 5% more underfunded than it was last year,” you are sad and maybe fired; if the pension gets too underfunded your regulator will step in. You want to avoid that.

And so the way you will approach your job is something like:

  1. You will try to beat your benchmark, buying stocks and higher-yielding bonds to try to grow the value of your assets.
  2. You will hedge the risk of rates going down. If rates go down, your liabilities will rise (faster than your assets); you are short gilts. You want to do something to minimize this risk.

The way to do that hedging is basically to get really long gilts in a leveraged way. If you have £29 of assets, you might invest them like this:

  1. £24 in gilts,
  2. £5 in stocks, and
  3. borrow another £24 and put that in gilts too.[5] [5] No science to this number, and you’d probably do a bit less if your stocks are correlated with rates.

That way, if rates go down, the value of your portfolio goes up to match the increasing value of your liabilities. So you are hedged. You were short gilts, as an accounting matter, and you’ve solved that by borrowing money to buy more gilts. In practice, the way you have borrowed this money is probably not by actually getting a loan and buying gilts but by doing some sort of derivative (interest-rate swap, etc.) with a bank, where the bank pays you if rates go down and you pay the bank if rates go up. And you have posted some collateral with the bank, and as interest rates move up or down you post more or less collateral. 

This all makes total sense, in its way. But notice that you now have borrowed short-term money to buy volatile financial assets. The thing that was so good about pension funds — their structural long-termism, the fact that you can’t have a run on a pension fund: You’ve ruined that! Now, if interest rates go up (gilts go down), your bank will call you up and say “you used our money to buy assets, and the assets went down, so you need to give us some money back.” And then you have to sell a bunch of your assets — the gilts and stocks that you own — to pay off those margin calls. Through the magic of derivatives you have transformed your safe boring long-term pension fund into a risky leveraged vehicle that could get blown up by market moves.

I know this is bad but I find something aesthetically beautiful about it. If you have a pot of money that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That is an emergent property of modern finance. No one sits down and says “let’s make pension funds vulnerable to bank runs!” Finance, as an abstract entity, just sort of does that on its own.

Anyway, as I said above, 30-year UK gilt rates were about 2.5% this summer. They got to nearly 5% this week, and were at about 3.9% at 9 a.m. New York time today. You can fill in the rest.

Author(s): Matt Levine

Publication Date: 29 Sept 2022

Publication Site: Bloomberg

CalPERS Cooks the Books While Taking an Unnecessary Loss to Exit $6 Billion of Private Equity Positions

Link: https://www.nakedcapitalism.com/2022/07/calpers-cooks-the-books-while-taking-an-unnecessary-loss-to-exit-6-billion-of-private-equity-positions.html

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CalPERS is up to its old crooked, value-destroying ways. Its sale of $6 billion in private equity positions, at a big discount….because CalPERS was in a hurry despite no basis for urgency, shows yet again the sort of thing the giant fund routinely does that puts it at the very bottom of financial returns for major public pension funds.

Oh, and on top of that, CalPERS admitted to Bloomberg that it is lying in its financial reports for the fiscal year just ended this June 30 by not writing down these private equity assets. As former board member Margaret Brown stated:

In Dawm Lim’s Bloomberg story, Calpers Unloads Record $6 Billion of Private Equity at Discount, CalPERS admits to cooking the books. Not recognizing the sale (the loss in value) in the same fiscal year can only be to play shenanigans with the rate of return. So if, or more likely when, CalPERS again does badly in comparison to CalSTRS and similar funds, remember it would be even worse if CalPERS was accounting honestly.

Author(s): Yves Smith

Publication Date: 8 July 2022

Publication Site: naked capitalism

DOJ Antitrust Chief Warns S&P Global Over Insurer Ratings Tweak

Link: https://www.yahoo.com/now/doj-antitrust-chief-warns-p-152645646.html

Excerpt:

S&P Global Inc. should “carefully consider” a proposed tweak to how it assesses the creditworthiness of bonds owned by insurance companies, the Justice Department said, warning that such a change “could raise significant concerns” under U.S. antitrust law.

The Justice Department’s antitrust division said in a letter dated last Friday that a proposed methodology change by S&P — the world’s largest credit ratings company — could raise barriers for its rivals. The changes could end up hurting the credit grades of insurance companies that invest in bonds that aren’t rated by S&P.

The firm should “carefully consider whether penalizing insurers that purchase securities rated by S&P’s competitors has the potential to raise barriers to entry and expansion by competitors, insulate S&P from competition, or otherwise suppress competition from rival rating agencies,” said antitrust chief Jonathan Kanter in the letter. “Such actions could raise significant concerns that the Sherman Act has been — or will be — violated and warrant additional scrutiny.”

Author(s): Leah Nylen

Publication Date: 4 May 2022

Publication Site: Yahoo (Bloomberg)

Why Retirement Isn’t Necessarily the Same as Not Working

Link: https://www.thinkadvisor.com/2022/03/07/why-retirement-isnt-necessarily-the-same-as-not-working/

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If you claim Social Security at age 70 instead of 62 the sum total of your accrued benefits will be 17% higher if you make it to age 82 (which is the male life expectancy at 62). And remember that’s low risk, inflation-indexed income; there’s no better deal on the market.

Of course, delaying benefits means fewer years collecting them, but if you end up living to your early 80s you’ll come out ahead. The figure below plots how much you’ll get from Social Security (inflation-adjusted and discounted using today’s TIPS curve) at each age depending on when you retire.

And if you already claimed Social Security you can still change your mind and get higher benefits.

But if you are already retired (or resolved on it this year) and the market is down, it may seem like delaying Social Security isn’t an option. After all, you still need to eat.

Author(s): Allison Schrager

Publication Date: 7 Mar 2022

Publication Site: Think Advisor

California Public Pensions Are Major Fossil Fuel Investors

Link:https://www.rigzone.com/news/wire/california_public_pensions_are_major_fossil_fuel_investors-09-dec-2021-167254-article/

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California’s climate-conscious policies aren’t matched by the investment choices of its largest public pension funds, according to a report from two environmental groups. 

Of the 14 top U.S. pension funds analyzed by Stand.earth and Climate Safe Pensions Network, California Public Employees’ Retirement System, known as Calpers, and California State Teachers’ Retirement System, known as CalSTRS, were the largest investors in fossil fuel companies, with $27.1 billion and $15.7 billion, respectively, according to findings published Wednesday. 

The two combined hold about half the fossil fuel assets for the entire group, according to the study. Calpers also came first in fossil fuel holdings as a proportion of its total assets under management, at 6.9%.  

….

The New York State Teachers’ Retirement System had the second-largest share of its portfolio invested in fossil fuels, at 6.6%. 

Author(s): Robert Tuttle

Publication Date: 9 Dec 2021

Publication Site: Rigzone

Bloomberg, Other Publications Criticize CalPERS’ Leverage on Leverage Plan to Boost Returns While Missing Additional Types of Borrowing

Link:https://www.nakedcapitalism.com/2021/12/bloomberg-other-publications-criticize-calpers-leverage-on-leverage-plan-to-boost-returns-while-missing-additional-types-of-borrowing.html

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The financial press has gone into a round of hand-wringing over CalPERS’ efforts to chase higher returns in a systematically low-return market, now by planning to borrow at the CalPERS level on top of the leverage employed in many of its investment strategies, in particular private equity and real estate.

These normally deferential publications are correct to be worried. Not only is this sort of leverage on leverage dangerous because it can generate meltdowns and fire sales, amplifying damage and potentially creating systemic stresses, but the debt picture at CalPERS is even worse than these accounts they depicted. They failed to factor in yet another layer of borrowing at private equity funds and some real estate funds called subscription line financing, which we’ll describe shortly.

…..

CalPERS tells other less obvious fibs, such as trying to depict private equity as so critical to success that it need to put more money on that number on the roulette wheel. Remember, the name of the game in investment-land isn’t absolute performance but risk adjusted performance. Not only has private equity not generated the additional returns to compensate for its extra risk at least as long as we’ve been kicking those tires (since 2012), academic experts such as Ludovic Phalippou, Richard Ennis and Eileen Appelbaum have concluded private equity has not even beaten stocks since the financial crisis.

Let us stress that unlike German investors, who have a pretty good handle on all the leverage bets in their investment portfolios and thus can make a solid estimate of how much risk they are adding via borrowing across all their investments, CalPERS is flying blind with respect to private equity. It does not have access to the balance sheets of the portfolio companies in its various private equity funds.

And while having balance sheet would be a considerable improvement over what is has now, it doesn’t give the whole picture. CalPERS would also need to factor in operating leverage. When I was a kid at Goldman, whenever we analyzed leverage (as in all the time), we had to dig into the footnotes of financial statements, find out the amount of operating lease payments, and capitalize them, as in gross up the annual lease payments to an equivalent amount of borrowing so we could look at different companies on a more comparable basis.

Author(s): Yves Smith

Publication Date: 10 Dec 2021

Publication Site: naked capitalism