An article in today’s Wall Street Journal illustrates yet another lie we’re being told. It seems that pension funds, despite plunging interest rates and negative returns in the stock market over the past decade, are still assuming an 8% annual return on their assets. This allows them to pretend to be more fully funded than they are. Here’s an excerpt:
Pension Gaps Loom Larger
Funds Stick to ‘Unrealistic’ Return Assumptions, Threatening Bigger ShortfallsMany of America’s largest pension funds are sticking to expectations of fat returns on their investments even after a decade of paltry gains, which could leave U.S. retirement plans facing an even deeper funding hole and taxpayers on the hook for huge additional contributions.
The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.
The country’s 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.
Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor’s 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst’s Accounting Observer, a research firm.
The rosy expectations persist despite the fact that the Dow Jones Industrial Average is back near the 10000 level it first breached in 1999. The 10-year Treasury note is yielding less than 3%, and inflation is running at only about 1%, making it tougher for plans to hit their return targets.
Return assumptions can affect the size of so-called funding gaps—the amounts by which future liabilities to retirees exceed current pension assets. That’s because government plans use the return rates to calculate how much money they need to meet their future obligations to retirees. When there are funding gaps, plans have to get more contributions from either employers or employees.
The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America’s government and corporate pension plans.
Pension funds at companies in the S&P 500 faced a $260 billion shortfall at the end of 2009, according to Standard & Poor’s. Estimates of the fund deficits faced by state and local governments range from $500 billion to $1 trillion.
Another article in today’s WSJ illustrates one possible future for underfunded pensions:
Japan Weighs More Risk in Pension
TOKYO—Japan’s public pension fund, the largest in the world with assets totaling 123 trillion yen ($1.433 trillion), is weighing the idea of investing in emerging-market economies in order to gain higher returns as it faces a wave of payout obligations over the next four to five years, the fund president said in an interview.
The Government Pension Investment Fund, which has roughly 67.5% of its assets tied up in low-yielding domestic bonds, is selling a record four trillion yen of assets by the end of March 2011 to free up funds for payouts to Japan’s aging population. By the year 2055, 40% of all Japanese are expected to be over 65.
Some U.S. public pension funds face similar issues. Burned by the financial crisis, some are rethinking their commitments to assets that tie up cash, such as real estate, while others are on the hunt for higher returns to make up lost ground and support swelling obligations to their pensioners.
Japan’s situation has its own distinguishing factors. Japan now has a record proportion of older people, with 21% over 65 years old, according to the Ministry of Internal Affairs and Communications. Within Japan, debate has been brewing over how the pension fund, also known by the acronym GPIF, allocates its assets in the near term, given the shrinking number of workers who pay pension contributions.
In addition to the roughly 67.5% of the fund’s assets in domestic bonds, including government and corporate bonds, 12% are in Japanese stocks, 10.8% in overseas shares, and 8.3% in foreign bonds.
Takahiro Mitani, president of the pension fund, said in an interview the fund could face a few years in which its payouts exceed its incoming contributions.
We “may face difficulty in the next four to five years…we currently have a hard time catching up with payouts since wages have been on a downtrend recently,” he said.
Mr. Mitani said the fund won’t sell just domestic bonds. “It could be [Japanese] stocks or foreign-currency-denominated securities or stocks,” depending on market conditions, he said.
Some thoughts:
- Because pensions are seen as politically untouchable, pension managers have no choice but to lie about their future returns and then try to make the lie a reality by investing in assets that are wildly unsuitable for this kind of institution.
- Both strategies will fail. The lies can’t continue for much longer in the face of low-single-digit returns — which are all but guaranteed by the rate on high-grade bonds which dominate most pension fund portfolios. And shifting to riskier assets will cause actual losses during the next bear market (coming soon), which will put underfunded pensions in an even deeper hole.
- Assuming we don’t slide directly in to a deflationary depression, interest rates in the US and Japan will rise as the major pension funds shift out of Treasuries and investment grade corporates and into emerging market securities and real estate. This will produce losses in the remaining “low-risk” part of pension fund portfolios, more than offsetting the returns (if there are any) from the riskier assets.
- Japanese stocks, the yen, and US long-term treasuries will be, for those who time it right, the short of a lifetime.
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{ 20 comments… read them below or add one }
After reading so many articles day after day that portend impending currency collapses, US and global depressions, inflation, deflation, collapsing credit, falsified balance sheets, negative GDP “growth”, political grid lock, political capitualtion, sovereign debt crises, market manipulations, unfunded liabilites, bubbles forming here, bubbles forming there, etc.- it’s refreshing to read that the pension managers just need to tweek their asset allocations a tad to meet their obligations.
Personally I’m looking forward to seeing the many “politically untouchable” topics becoming road kill – especially the public unions and pension systems. And, no, I don’t think tax payers will take up the slack. Besides there not being sufficent tax revenues to expropriate, people will (hopefully) finally insist that bad systems experience bad results, an ironic extension of the socialized loss concept.
He who lives by the government dies by the government.
P.S. I’m afraid to short bonds, especially government bonds. The bond market is so huge so aggressive monetary intervention seems inevitable and bound to create unpredictable volatility (unless you’ve got inside info.)
And lets not forget the government plan to protect us from loss by mandating treasuries in retirement portfolio’s.
I am unaware of any entity paying dividends even near 8%. Nor am I aware of asset class that is appreciating annually at 8%. So where does this number come from. It must be some sort of mark to model type of math .
Try master limited partnerships (mlp’s) in the US or Canadian income trusts. Both invest in energy infrastucture (pipelines, storage, gas and oil processing) and pay no federal taxes. By holding these in a regular or roth IRA you will earn 10+% returns over the long haul. Just on dividend payments alone, KMR and EEQ have paid 8.5% since 2002. Timber biological growth of 6% is also the main driver of timber REIT returns of 8%. Try RYN, PCH, PCL. They also exempt from federal tax on timber income if the payout at least 90% of timber income.
Hi JB,
You may have forgotten gold as an asset class!
Hasn’t gold had annualized returns of some 15% since 2000?
Regards,
-james
They should have invested in gold.
The people who run these pension funds all went to the same school. All had the same text books and had the same economic models taught to them. Not likely any of them could have or will ever imagine an event that falls outside of the realm of their background. So things will disintegrate around them. They will be paid until the last dollar is used up and then they will move on and pass the blame on to some one else . Do incompetent Generals and politicians ever accept blame? Do incompetent money managers ever admit incompetence? Maybe, but none that I am aware of.
When the politicians/bureaucrats delay budget #s until after a forthcoming election – now happening in both Calif. and US – you know TS is about to HTF. I am just hoping the pyramid of Ponzis that makes up our entire political economy doesn’t collapse for another year or two; I simply have not laid in enough .30-.30 yet.
You waited to long to prep.
Looks like the Amish & the Pennsylvannian Dutch are in a better position than the rest of the US. They’ll be wearing wry smiles, they deserve it, they’ve stuck to their ideology for centuries while all around them everyone chased ‘Success’. They’ll still be baking bread, eating meat & scooting around on horse and cart while the rest of us fight over the inflated scraps left on the empty supermarket shelves.
I believe I read somewhere that Warren Buffet had been investing in farming stock??? Maybe he’s going to grow a beard and buy a wide-brim hat?
The US economic situation is akin to a 747 full of soon-to-retire auto-workers on a short vacation to the beach to spend some credit on R&R. But there’s a problem. It’s running on only one spluttering engine. It’s been circling around ‘Depression airfield’ for some time now, shunting fuel from one engine tank to the other just to stay airborne, but now it’s last fuel tank is starting to run dry and it’s heading towards the runway. Alarmingly it has less than half it’s landing gear extended. It’s going to crash, like it or not. Everyone on board knows it but they’re trying not to think about it, they just want to retire and relax. However, the Captain, Co-pilot and Flight engineer keep telling the cabin crew to keep up the illusion & to tell all the other passengers that all is well. Even going as far as to lie to the passengers and tell them the worst is over and that although the ground looks closer the aircraft is, infact, gaining altitude. But the airfield know’s better, the ground staff are busy preparing for the worst. Moving their parked valuable assets from around the projected crash site, putting on their protective firefighting equipment and filling the firetrucks with damper-foam. They can see the stricken plane coming in on the radar and the flight pattern is erratic. It’s going to get messy and lots are people aren’t going to make it. The airfield will no doubt get damaged along with several other aircraft, but it’ll get repaired after time, and at least the rest of the ground crew and airfield staff would manage to get to safety….
….One of the new guy’s, an Asian guy that’s just started work in the Control Tower, suddenly points out of the window while shouting – “Get ready, here it comes…”
I’ll be flying with Gold & Silver Airways in the meantime….
If you don’t by Gold and Silver today, you will only be another day older when you do!! Mark Libertycpm.com
I heard about this guy named Bernie who had a fund which paid out 12% year in and year out! The only problem is you had to know the “right” people to be allowed to invest in his fund!
The bond market is so huge? Who is buying bonds? Who has the kind of money? Is this a real market? Who is managing the market? Will some professor do some study into bond and derivative markets????
Don’t forget the politically untouchable mother of all the bank boys who pulled off the biggest heist in the history of man, okay to point the finger at the unions etal but never forget that when the money boys get in trouble it is the working people who suffer and do without so that the money boys don’t have to.
@jb
“Nor am I aware of asset class that is appreciating annually at 8%”.
I am about 30% up on gold bullion this year.
I also buy silver. That too is now starting to lift off and I am already 20% up this year on silver as well.
Google “FOFOA gold” if you are in doubt about gold!!
The desire to earn 8% on paper money investments is the result of a weak work ethic characterized by the love of “making money” with little or no work.
The only asset class which will produce returns of 8% in the future are healthy and well educated children who believe in a strong work ethic.
To raise such children is unfortunately, highly uneconomical in the existing fiat monetary system with its associated taxing policies.
The ultimate problem is a problem of ethics and social justice. That’s where the fundamental decisions are being made.
Reply to 8% Returns Mythology
Translation ‘Magic of Compound Failures’ Wailing Wall Street to big to fail replaced by cadres of to big to Fails. Underachievers, whiners, wimps, complainers and criminals confiscating $900,000 per hour of citizenry labor, property, assets, and wealth.
$900K per hr not a typo.
Private pensions are an entirely different animal from public pensions. Private corporations merely waltz into BK court, discharge their pension obligations, pass out some 7 figure bonuses to the fatcats who got it done and move on.
Some people call that freedom.
Those of you that followed the dot com bubble of 2007 to 2000 might recall that during the last stage of the bubble, in January and February of 2000, it was the infrustructure penny stocks that outperformed.
During the next leg up for the gold bull (already underway) you are going to see explosive breakouts in microcap gold exploration companies. A good proxy for the sector is the Canadian Venture Exchange composite, stockcharts.com symbol $cdnx. These penny gold stocks have deposits that are starting to become economic over $1300/oz gold. Imagine the % increase in share prices when gold takes out $1500/oz, later this year.
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