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.

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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.

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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.

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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.

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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

Wrong Way CalPERS Increased Private Equity Allocation by Over 50% as Investors Are Dumping Holdings

Link: https://www.nakedcapitalism.com/2022/08/wrong-way-calpers-increased-private-equity-allocation-by-over-50-as-investors-are-dumping-holdings.html

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CalPERS is so reliably bad at market timing that the giant fund serves as a counter indicators. Last fall, CalPERS increased its allocation to private equity from 8% of its total portfolio to 13%, which is an increase of over 50%. This is after this humble blog, regularly citing top independent experts, pointed out that the investment raison d’etre for private equity had vanished in the 2006-2008 time frame, not once, but many many times as various studies kept confirming that finding. Not only did private equity no longer earn enough to compensate for its much higher risks (leverage and illiquidity) but it was no longer beating straight up large cap equities.

Now there is a way out of this conundrum: to bring private equity in house. Private equity fees and costs are so egregious (an estimated 7% per annum) that even a bit of underperformance relative to private equity indexes will be more than offset by greatly lower fees. A simpler option would be public market replication of private equity.

But the dogged way funds like CalPERS stick to private equity points to rank corruption, of the sort that landed CalPERS former CEO Fred Buenrostro in Federal prison for four and a half years.

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Another problem is cash flow management. Private equity funds do not take investor money at closing. Instead, investors get “capital calls” to pony up part of their commitment to the fund so the fund manager can buy a company. These capital calls require the dough to be sent as specified in the offering memorandum, usually in five to ten days. The consequences of missing a capital call are draconian. The fund manager can seize all the investments made so far and distribute them to the other limited partners.

In the financial crisis, CalPERS had too little cash on hand to meet private equity capital calls. It wound up dumping stocks at distressed prices to satisfy the private equity demands. So the risk outlined below is real.

Author(s): Yves Smith

Publication Date: 9 Aug 2022

Publication Site: naked capitalism

The Government Pension Reckoning Cometh

Link: https://www.wsj.com/articles/the-government-pension-reckoning-cometh-equable-institute-report-11660084312?st=j8a7o7efyyvjtdp&reflink=article_email_share&utm_source=Wirepoints+Newsletter&utm_campaign=24f39fc2e0-RSS_EMAIL_CAMPAIGN&utm_medium=email&utm_term=0_895ee9abf9-24f39fc2e0-30506353#new_tab

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The California Public Employees’ Retirement System reported a negative 6.1% return for the year, which includes a 21.3% positive return on private equity and 24.1% return on real estate as reported through the second quarter of 2022. What will happen if real-estate prices start to fall and some leveraged private-equity buyouts go south amid rising interest rates?

Collective-bargaining agreements limit how much workers must contribute to their pensions, so taxpayers are required to make up for investment losses. Employer retirement contributions—that is, taxpayers—make up 20% of government worker compensation. That amount has soared over the past decade as pension funds tried to make up for losses during the 2008-2009 financial panic.

A recent report by the Equable Institute found that state and local pension plans now are only 77.9% funded on average, which is about the same as in 2008. But some like Chicago’s are less than 40%. Advice to taxpayers in Illinois: Run.

Author(s): WSJ Editorial Board

Publication Date: 9 Aug 2022

Publication Site: WSJ

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

High Inflation Leads to Expensive Cost-of-Living Adjustments for CalPERS and Others

Link: https://www.ai-cio.com/news/high-inflation-leads-to-expensive-cost-of-living-adjustments-for-calpers-and-others/

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With big returns come big expenses. That’s what seems to be the case for pensions across the country, as they are forced to increase their payouts to beneficiaries due to inflation. While the past year has been a record breaker for pension fund returns, inflation will be claiming its fair share of the gains as well.

For CalPERS members, those who retired between 2006 and 2014 will receive the biggest increase at 4.7%. This will be the largest cost-of-living increase for beneficiaries in the past 32 years, dating to 1990.

While the Bureau of Labor Statistics has estimated the Consumer Price Index to have increased by 7% over  2021, CalPERS is not using the 7% to calculate its increased payments. Instead, it uses an average of each month’s numbers.

CalSTRS similarly also has built in inflation protection, thanks to a California law that requires public pensions to do so. However, CalSTRS’ method of calculating this payment is slightly different. The fund gives quarterly supplement payments to those whose annual benefit falls below 85% of their original benefit. This year’s inflation numbers will likely increase the number of supplemental payments that CalSTRS in forced to provide.

Author(s): Anna Gordon

Publication Date: 1 Mar 2022

Publication Site: ai-CIO

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%.  

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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

Wrong Way CalPERS: Dumping $6 Billion of Private Equity After Struggling to Put Money to Work and Then Increasing Target

Link: https://www.nakedcapitalism.com/2022/01/wrong-way-calpers-dumping-6-billion-of-private-equity-after-struggling-to-put-money-to-work-and-then-increasing-target.html

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When CalPERS does something as obviously nonsensical as planning to dump $6 billion of its private equity holdings, nearly 13% of its $47.7 billon portfolio, when it just committed to increasing its private equity book from 8% to 13%, it’s a hard call: Incompetent? Corrupt? Addled by the latest fads (a subset of incompetent)?

And rest assured, the harder you look, the more it becomes apparent that this scheme is as hare-brained as it appears at the 30,000 foot level. But unlike another recent hare-brained private equity scheme, its “private equity new business model,” beneficiaries won’t have the good luck of having it collapse under its own contradictions. CalPERS has loudly announced that Jeffries & Co. will be handling these dispositions, so they will get done….at least in part. But the fact that CalPERS’ staff has gone ahead and merely informed the board, as opposed to getting its approval, is yet another proof of how the board has abdicated its oversight and control by granting unconscionably permissive “delegated authority” to staff.

The one bit of possible upside would not just be unintended, but the result of CalPERS acting in contradiction to its expressed objectives: that its allocation to private equity would undershoot its targets by an even bigger margin than otherwise.

Author(s): Yves Smith

Publication Date: 14 Jan 2022

Publication Site: naked capitalism

CalPERS Considering Selling Up to $6 Billion in Private Equity Stakes

Link: https://www.ai-cio.com/news/calpers-considering-selling-up-to-6-billion-in-private-equity-stakes/

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The California Public Employees’ Retirement System (CalPERS) has engaged financial services company Jefferies about the potential of selling up to $6 billion of its private equity stakes, according Buyouts magazine. This comes just after CalPERS announced it would be increasing the percentage of its portfolio allotted to private equity to 13% from 8% in November.  

CalPERS board member Margaret Brown told Secondaries Investor in November that the fund is considering investing in secondaries and divesting from some of its legacy private equity investments.

“We have some really old private equity that’s just sitting there and doing nothing,” she said.

Author(s): Anna Gordon

Publication Date: 13 Jan 2022

Publication Site: ai-CIO

Fossil Fuel Investments Are Burning California Pensioners

Link: https://www.dailyposter.com/fossil-fuel-investments-are-burning-california-pensioners/

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California’s two biggest pension funds have invested a staggering $43 billion in fossil fuel companies, and their opposition to divesting from the industry — including fighting legislation that would have stopped them investing in firms involved with the controversial Dakota Access Pipeline (DAPL) — has cost retirees and taxpayers billions, research shows.

The findings hammer home the fact that the divestment movement isn’t just about protecting the planet from the worst effects of climate change. With the oil, gas, and coal industries all on the decline, pension funds’ refusal to divest from fossil fuels is also endangering the retirement savings of teachers, government employees, and other rank-and-file public workers who have paid into these funds.

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While it is common knowledge that fossil fuel stocks have underperformed the broader stock market, large bank stocks have been lackluster as well — including the banks that helped finance DAPL.

If CalPERS and CalSTRS had not opposed the original DAPL divestment legislation, they could have instead put pressure on the companies involved not to move forward with the pipeline, and such efforts might have been enough to stop the project, given the pipeline project’s turbulent history.

Author(s): MATTHEW CUNNINGHAM-COOK, ANDREW PEREZ

Publication Date: 11 Jan 2022

Publication Site: The Daily Poster

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.

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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

City of Newport Beach Urges Greater Sustainability in State Pension Fund, Aims to Pay CalPERS Debt by 2030

Link:https://www.newportbeachindy.com/city-of-newport-beach-urges-greater-sustainability-in-state-pension-fund-aims-to-pay-calpers-debt-by-2030/

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Newport Beach City officials are advocating for policies aimed at increasing long-term sustainability in the state public employee pension fund, CalPERS, as Newport Beach continues to make significant progress in paying down its debt obligations to the system.

On November 16, the CalPERS Board of Administration decided to maintain the fund’s discount rate, or the expected rate of return of the pension fund investments, at the current 6.8 percent. The discount rate had been lowered from 7.0 percent to 6.8 percent in July through CalPERS’ Funding Risk Mitigation Policy, which automatically lowers the discount rate in years when investment returns are above the assumed rate of return. Prior to the recent discount rate change, Newport Beach had asked CalPERS to lower its discount rate to 6.5 percent or below, a more conservative number that could help further reduce future risk.

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Newport Beach expects to eliminate its unfunded liability by 2030, thanks to an aggressive payment schedule. Beginning in 2018, the City Council decided to increase annual payments to $35 million a year, $9 million more than required. This fiscal year, for the second year in a row, the City will contribute $5 million more as an additional, discretionary payment, bringing the total contribution to $40 million.

Publication Date: 29 Nov 2021

Publication Site: Newport Beach Independent

California public employees’ pension bill to go up after CalPERS lowers market expectations

Link:https://www.thecentersquare.com/california/california-public-employees-pension-bill-to-go-up-after-calpers-lowers-market-expectations/article_54d02942-47e4-11ec-940a-e3e851214b73.html

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The CalPERS board voted Monday to select a portfolio with a return of 6.8% and an expected volatility rate of 12.1%. This expected rate of return is two-tenths of a percentage point lower than last year’s target of 7%. The vote concluded a review of the pension fund’s assets, which occurs once every four years. 

This expected reduction in the rate of return means that some employees will have to contribute more to their pension funds because the fund expects to earn less from its investment portfolio.

For employees hired after the implementation of the Public Employees’ Pension Reform Act (PEPRA) in January 2013, CalPERS estimates they will contribute an average of 1.2% to 1.5% more toward their pensions. These changes will go into effect for school employees, excluding teachers, in July 2022 and will be enacted for most other local government employees in July 2023.

Author(s): Madison Hirneisen

Publication Date: 17 Nov 2021

Publication Site: The Center Square