Uncertainty requires financial conservatism. That is why I worry when Calpers and LACERS use assumed rates of returns in the 7% to 8% range.
By contrast the 30-year Treasury Bond yield is 4.71% and the 20-year Corporate Bond composite yield is 5.23%. Both of these benchmark yields are indicators of the future. Bond yields are influenced by anticipated long-term inflation and market risks. In theory, the difference between the yields of equity investments and the long-term Treasury Bond is considered the risk premium. That is the additional return required for an investment over and above what you would receive from virtually risk free government backed bonds.
So, think about it. If you assume Calpers and LACERS are betting that their portfolios will yield 8%, that is the same as saying the risk premium is 3.29% (8% minus 4.71%). That is 70% higher than the risk free benchmark. Sounds like the state and city pension plans have a pretty aggressive portfolio strategy in mind.
Is that wise in a very volatile and unpredictable economic climate?
If the United States were the predominant economic engine in this world, one could support an aggressive investment strategy. Unfortunately, future conditions may have more to do with what happens in China.
Is China’s economy a paper tiger or is there real substance behind it? Since information does not flow freely in the PRC, the situation is difficult to gauge, according to this article published in the New York Times.
I also have a concern. China and the United Sates are in a symbiotic relationship. China keeps its currency artificially undervalued. That hurts our exports. However, China has been willing to finance our debt at very low rates. That is a huge benefit to our country.
The two countries, therefore, are joined at the hip. Unless there is very careful surgery to separate us, both patients could die.
The basic question for any portfolio, private or pension, is how aggressive a rate of return assumption to use?
Personally, I do not feel the least bit comfortable with an 8% long-term yield assumption in this day and age. Here’s the rub – if Calpers and LACERS lowers it, it will drive up the unfunded pension liability, which is already in the stratosphere. Of course, that will be politically unacceptable to Sacramento and City Hall. Our leaders will bury their heads in the sand and we will all pay in the long run because they lack the courage to decrease the size and cost of government in a responsible fashion.
Paul Hatfield
Suzanne Lauer
[...] ball and cannot project the market. However, I am well aware of the uncertainties ahead and the need for conservatism when projecting returns in a volatile international economy. Major corrections can be [...]
[...] rate assumption of 8% sustainable? If it is not, then the unfunded liability is higher. I have written about this before. No one knows for sure, but in a world filled with both economic and social uncertainties and [...]
[...] rate assumption of 8% sustainable? If it is not, then the unfunded liability is higher. I have written about this before. No one knows for sure, but in a world filled with both economic and social uncertainties and [...]
[...] Aggressive rate of return assumptions have no place in an economy ripe with uncertainty. McClain fails to recognize that the world is no longer operating under the forces of our fathers’ economy. We have all been slow in recognizing the signs of change over the last few decades. That’s why governments are in the mess they are today. The largely predictable trends of the past provided a false sense of security regarding investment returns in many sectors – from the stock market to housing – and led to unsustainable government spending . Downturns were always considered merely bumps in the road from which the markets would recover rather quickly. [...]
[...] “Aggressive rate of return assumptions have no place in an economy rife with uncertainty. McClain fails to recognize that the world is no longer operating under the forces of our fathers’ economy. We have all been slow in recognizing the signs of change over the last few decades. That’s why governments are in the mess they are today. The largely predictable trends of the past provided a false sense of security regarding investment returns in many sectors – from the stock market to housing – and led to unsustainable government spending. Downturns were always considered merely bumps in the road from which the markets would recover rather quickly.” [...]
Congrats you’ve earned my respect