Tuesday, September 27, 2011

Another Reason to Worry

Over at the AEI, Andrew Biggs asks an important question:
Public pensions report that over the 25-year period from 1985 through 2011 they have achieved a median investment return of 8.8 percent, exceeding the 8 percent returns they project for the future, and have earned these returns without taking undue risks. Given this, they say, why shouldn’t we assume they can keep on doing so into the future?

The answer, of course, is that that period had a reduction in rates from 10% to 3%. The raised the sample return to an average bond portfolio by about 3% annually. If long term interest rates went to zero, the benefit would only be about 2.1% annually. Most likely, rates will rise, because that is what the Fed wants them to do! Thus, instead of a 3% tailwind, there will be something like a 1-2% wind in our faces over the next 25 years.

I hope there are lots of Doug Edwards's out their, eager to pay more taxes.


Anonymous said...

Mr. Falkenstein,

Truly enjoy your blog. Your insight is consistently enlightening. Thanks for writing.


P.S. You have a typo in your last sentence.

Anonymous said...

What is even more depressing is that a simple strategy of of buying the on the run 30 year Treasury, holding it for a year, and then rolling into the new 30 year bond a year later, is a strategy that has compounded wealth at a 10.1% annual rate over the exact same period. Thus, the army of pension investment staffs and outside advisors, along with their faith in the equity risk premium, has destroyed value to the tune of 2% per year for almost 3 decades versus the simple strategy of buying, holding, and rolling the long bond on a yearly basis. What is even more hilarious is that a 100% allocation to long duration Treasuries would have outperformed a 100% allocation to stocks over the period, and would have more effectively hedged the long duration liabilities of pension funds. It's too bad these guys are finally learning that equities have zero or negative empirical duration when the long bond is trading below 3%. Still think "rates are too low" and its a bad idea to "lock in a loss" boys?