Sunday, January 29, 2012

What if Returns Don't Reach 7%?

A review in the WSJ on the book The Hedge Fund Mirage by Simon Lack notes:
The return-on-investment targets of 7% to 8% that are structured into pension plans are beyond reach in today's artificial environment. To redeem their promises to retiring teachers, firemen and the like, managers are risking more money with hedge funds in hope of yields higher than those on safer investments.

And so it is, as I read subsequently that:
Just five years ago, it was illegal for South Carolina's public pension plan to invest in hedge funds, private equity and other complicated bets.

Now, nearly half its assets are in such investments. That is way too much for the state treasurer, who is charged with squeezing the most out of the $26 billion pension fund.

Unfortunately, hedge funds are doing worse than ever:
The "Global Macro" trading strategy, one of seven tracked by the Dow Jones Credit Suisse "Core Hedge Fund Index," finished last year down over 10%, worse than the entire index, which fell 7.4%.

This isn't going to end well. The risk premium of 5% that everyone expects is not going to happen, and this failure will act as positive feedback in the upcoming fiscal disaster; when the pension funds all under perform and need more money, it will be the nail in the coffin. I think the tinder will be inflation, which the central banks seem to think is the cure for their GDP ills (and those of underperforming pensions), so they will push until it comes back.


Mercury said...

...then private wealth will be seized to make up the difference. Please make a note of it.

And if (when!) inflation hits hard existing COLA adjustments (which are based on metrics that aren't exactly written in stone anyway) or some new scheme will insure that public sector retirees get paid out pretty much what they are scheduled for.

JWO said...

IMHO USA Governments (Fed, State and Local) really need a combination of mild inflation 3%/year and an end to COLA/CPI indexed raises. Fixing the CPI which seems to me to over estimate inflation would help, but is not enough alone. So the question is how can the politicians pull this off and if they cannot what should a wise person do, other than trying to work as long as possible and keep good relationships with their children. Maybe buy real-estate?

It might be instructive to think what would a smart and ruthless politician do in this situation? Put some pressure on the Bureau of Labor Statistics to under estimate inflation by a couple of percent? That is what I would do if I was a ruthless politician that and squeeze the medical establishment.

JWO said...

I just thought of another thing that they could do, that is to lower the pay of any new employees and of course not offer defined benefit to new employees. Many people love working for the Gov., so hey can easily get by paying much less than they pay now.

Dave Pinsen said...

It would be nice to see a president lay out the fiscal situation and propose a 1% cut in all federal pensions, transfer payments, Medicare reimbursements, salaries, etc., followed by a 3 year freeze on increases. If everyone's ox is gored a tiny bit, and if the fiscal case is made convincingly enough, maybe there would be a shot.

I think a key point would be to ask for an actual cut. The typical move is to propose a cut in the rate of growth, but most Americans probably aren't numerate enough to grok the difference, and it gets demagogued by the opposition as an actual cut anyway. So propose an actual cut. Who couldn't scrape together enough cost savings to make up for a 1% cut in their federal pension check or Social Security check? What physician couldn't afford to perform a procedure for 99% of what he charged the government last year?

As for the state pensions, let them promise their retirees whatever they want, but jack up the PBGC premiums accordingly, and remind employees and pensioners that the max PBGC payout may be a lot less than they are expecting, so the states collectively pay for the cleanup when it blows up.

farm land investment said...

Agree with JD up there. ONE key is to move put new employees on 401k plans. Second, they should contribute a lot more to their benefits, just like private sector workers.