Underwater Pension Funds and What that Means for California
The California Public Employees’ Retirement System (CalPERS) has announced its worst performance in seven years. Its meager rate of return for the fiscal year ending June 30 just managed to squeak by .6%, not even beating our current minimal rate of inflation.
After two successive years of tepid returns, long-term fund averages have sunk far below the critical 7.5% benchmark. It’s bad news for California taxpayers, because if returns don’t soon show a long-term average of 7.5%, they’ll be the ones who will have to make up the difference. Ted Eliopoulos, the fund’s chief investment officer, admits the massive pension fund’s long-term returns are well below anticipated levels, telling the Los Angeles Times, “We’re moving into a much more challenging, low-return environment.”
Yeah. Average returns are now barely over seven percent for a twenty-year period, and returns over ten and fifteen years now average less than six percent.
These changes are not just a blip on the investment horizon, as we assume bond yields and stock dividends will improve. According to the Milliman pension consulting firm, many public pension funds have had to adjust their expectations to accommodate lower returns overall. CalPERS needs to adjust its own expectations accordingly, even though doing so would drive up costs for state and local government agencies covered by the big pension firm.
“We quite clearly have a lower return expectation than we had just two years ago,” Eliopoulos said. “That will be reflected in our next cycle. We are cognizant that this is a challenging environment for institutional investors.”
Thus, while the Times reports this dismal turn of events as a new development, it’s apparent Eliopoulos and CalPERS have been struggling for a while. What’s more, financial observers have been voicing concerns about pension fund depletion for at least as long as bond yields and stock dividends have been anemic.
Last November, an article in The Economist warned, “Pension funds and endowment funds are too optimistic,” adding:
When final-salary pension schemes, which are still prevalent among America’s public-sector employees, decide how much to put aside to pay pensions, they have to make an assumption about what returns they will earn. The higher their estimate, the less employers have to contribute today.
Sound familiar? And that from a financial magazine observing our public-employee pension funds from far across the pond!
But who knows? Maybe pension funds and endowments haven’t been all that optimistic. Maybe they’ve simply been hesitant, until now, to own up to an iceberg two miles in front of the ship.
The bad news is: If you’re a California public employee, you’re going to take a hit. But even if you’re not a public employee, but merely a California taxpayer, you’ll also take a hit. In addition, while private employee pension funds don’t pose the same financial risk to non-participants, their members run a similar risk; after all, they’re toiling in the same universe of stocks and bonds.
According to a 2014 article written by David Stockman and posted on his blog, the former Director of the Office of Management and Budget under President Reagan says eighty-five percent of pensions will fail if their returns average just four percent. CalPERS is reaping less than one.
As potential retirees concerned about the value of our nest eggs, we should view The Economist and Stockman analyses as handwriting on the wall. We must stop relying on external entities like pensions and Social Security as resources that will certainly be there for you the day you retire.
The uncertainties that are constricting growth in bond yields and dividends – and therefore in the pension funds that invest in them – are the very same uncertainties currently driving the bull market in physical gold. Don’t abandon your pension fund or employer plan by any means. But in the long run it may work out better if you’re at least as conscientious, if not more so, about setting aside a monthly amount for your safe haven precious metals.