Posts Tagged Pensions
Last week, the Wall Street Journal reported that pensions are moving more money back into hedge funds:
Also, pension officials are using the historically strong returns of hedge funds to justify a rosier future outlook for their investment returns. By generating more gains from their investments, pension funds can avoid the politically unpalatable position of having to raise more money via higher taxes or bigger contributions from employees or reducing benefits for the current or future retirees.
The Fire & Police Pension Association of Colorado, which manages roughly $3.5 billion, now has 11% of its portfolio allocated to hedge funds after having no cash invested in these funds at the start of the year.
While pensions have been investing in private equity and what are called alternative investments for many years, hedge funds have represented a smaller part of their portfolio. The average hedge-fund allocation among public pensions has increased to 6.8% this year, from 6.5% for 2010 and 3.6% in 2007, according to data-tracker Preqin. (Emphasis added.)
PERA’s own investments in hedge funds are unclear from the latest data, but if the “Other of Other” category is representative, it could be about 10% of their holdings.
This may be good in the short run. There’s no doubt that some of these funds have done well, being able to hedge some of their risk away and focus on capturing industry or sector returns. But there are some serious dangers here, and they are complicated by the problems already noted with pension accounting.
First, there’s no such thing as risk-free alpha. Remember, the market tries to match risk with return. If someone is selling an investment with 10% return and the risk associated with equities, beware. Because if that were possible over the long run, enough people would pull money from equities and pile it into this mythical investment, so the returns would match. Either that, or there’s hidden risk in there that justifies the extra return.
Either way, in the long run, the funds are taking on more risk, or will have the additional return arbitraged away as more people invest in these strategies. Also, if many of the funds are using the same strategy, it may be difficult for them to execute trades that actually allow them to limit risk, as they may all be trying to sell overperformers, or buy hedges, at the same time.
Another threat to pension funds is in the bolded sentence above. Managers are not only using these returns to justify higher projected returns. What goes unstated is that they’ll also use them to justify the higher discount rates, that make their pensions look better-funded than they are. It’s a perfect example of the perverse accounting incentives built into fund management.
Last, these strategies are not necessarily transparent, making it difficult for independent auditors to even assess the risk that these pensions are taking on.
I’m all for finding ways to hedge away risk, and there’s no reason that pension funds can’t participate in some of those techniques. I’m skeptical that, in the absence of fixing the underlying problems, this approach is going to do any more than paper over problems, yet again.
In this morning’s Denver Post editorial, explaining why government employees should only temporarily be asked to take more partial responsibility for their own retirement, comes this remarkable claim:
But it shouldn’t be a long-term fix. Shifting the makeup of the pension funds could adversely affect the financial soundness of PERA.
That’s because employee and employer contributions are treated differently. The money that employees put in the system goes with them if they leave the system. If the fund mix gets too out of whack, it could be a financial problem.
This is a classic example of thinking inside the fiscal box they’ve put the rest of us in. These pensions – the ones in question – are defined benefit plans. As has been pointed out in a number of places this morning, Colorado is uncommonly generous with the percentage of an employee’s income it tries to replace in pensions.
At a minimum, shouldn’t that obligation be either contingent on the employee leaving his money with the plan? If not, if they have the right to take that money with them, then ought not the pension plan’s obligation be reduced, proportional to the amount funded by the employee? If it’s the employee’s money, then, well, it’s the employee’s money, and if they want to be responsible for investing half of their retirement money on their own, then they should live with the consequences of that. It certainly doesn’t make any sense for the plan to have to shoulder more of the burden for an employee who leaves before retirement.
The real problem here is that it’s a defined obligation plan in the first place, and that it’s less than fully-funded. If the plan were fully-funded, if every dollar of future obligation were already invested for, then this wouldn’t be a problem. It’s complicated by the fact that none of these plans is fully-funded, so all of them rely on current contributions to pay current obligations, rather than socking that money away under the account for the individual.
It’s a result of lousy accounting having had a meet cute with lousy political incentives starting about 10 years ago. It’s no longer sustainable, and eventually we’re going to have to convert all of these plans over to defined benefit plans. If we can’t do that in one fell swoop, we can at least start by having public employees permanently assume a greater responsibility for their own retirement.
In track and field, when a runner has the wind at his back, and records he sets don’t count. Of course, in track, the win is still fair, because all the runners run under the same conditions. With the press, it’s always uphill and against the wind for Republicans and Tea Parties, downhill and wind-assisted for Democrats and unions.
In a previous post, I put up a little retrospective of some of the more troubling behavior by Wisconsin public servants, aided and abetted by college students, Organizing for America, and the DNC. I doubt whether even Mike Littwin would be able to claim this as a “win” if most of the country had seen these events as they were happening. The national media, which goes out of its way, if necessary, to make up stuff about Tea Partiers, was rigorously careful not to expose the American public to these scenes.
What are perceived as heavy-handed tactics often have a way of backfiring. (In Pennsylvania during the Constitutional ratification convention, for instance, dissenting members of the convention fled the scene to deny the convention a quorum, and two of them had to be hauled back bodily to Independence Hall to get the 2/3 necessary for business. This, along with the refusal of the press to publish speeches critical of the Constitution and the refusal of the convention’s official journal to record all the speeches, forced the Federalists to tread much more carefully in succeeding states, particularly Massachusetts, New York, and Virginia.)
But they don’t usually backfire when the targets are unsympathetic louts.
Just to pick on Mike a little, the last lines in his column suggest that the DC Democrats might find the inspiration and spine to make bold entitlement reform proposals from the events in Wisconsin. This makes no sense. In Wisconsin, the Democrats were defending the insupportable and unsustainable status quo. Failing to deal with entitlements, as the President has failed to do, would be more in keeping with that strategy.
While it remains to be seen if the public sector unions in Wisconsin can (re)build a political movement based on coercion and extortion, it’s worth remembering that they’d have no chance of doing so without help from their friend in the working press. Let’s a take a little trip down memory lane, so close it almost seems like yesterday:
Attack FreedomWorks’ Tabitha Hale
Protesters re-take the Wisconsin Capitol
Wisconsin GOP Senator Glenn Grothman chased, trapped by hecklers, saved by Dem. Rep. Brett Hulsey
Wisconsin Union Wisconsin Republican senators leave through secret tunnel after march 9th vote
Chances are, unless you were reading Ann Alhouse’s blog or Instapundit you didn’t know about much of this. That, combined with the national media blackout on the death threats against Wisconsin Republicans, and the protestors who’ve taken to taking down license plate numbers of their political opponents, constitutes the sort of propaganda that money literally can’t buy.