Archive for March, 2009

CalPERS’ lost decade: From boom to bust

March 20, 2009

A new CalPERS staff report shows a remarkable reversal of fortune for the giant public employee pension system.

The pension fund had a huge surplus in 2000 during a high-tech driven stock market boom, 138 percent of the funding needed for future obligations. After the stock market crash last fall, the funding level dropped to 66 percent in December.

That’s well below the 80 percent funding level regarded by some as a minimum for pension funds.

The pension system that covers half of all non-federal government workers in California warned last fall that employer contribution rates are likely to go up, beginning in July 2010 for the state and July 2011 for 1,500 local governments.

Meanwhile, the California Public Employees Retirement System plans to adjust its investment policies, making minor changes as soon as June before a regular three-year overhaul of asset allocations next year.

The CalPERS investment portfolio has had an historic drop in value, going from a peak of $250 billion in the fall of 2007 to $167 billion last Tuesday — a loss of about a third.

The staff report to the investment committee this week shows that CalPERS still has a healthy cash flow and does not have to sell off parts of its bleeding investment portfolio to make current pension payments.

CalPERS received $10 billion in contributions from government agencies and their employees last year, while paying $10.84 billion in benefits. The gap was filled with investment income from stock dividends, bonds and real estate totaling $1.89 billion.

A CalPERS senior investment officer, Farouki Majeed, told the committee that investment income, averaging about $5 billion in previous years, was down last year because of a drop in real estate revenue but is expected to bounce back this year.

The investment policy that the CalPERS board is adjusting has not been a top performer.

The CalPERS investment portfolio loss of 27 percent last year ranked near the bottom third, according to a comparison with other public pension systems with more than $10 billion in assets done by a board consultant, Wilshire.

“Real estate and fixed income were two of the big contributors to the underperformance for the year,” Andrew Junkin of Wilshire told the committee.

The CalPERS portfolio ranking is better over a longer period. Wilshire said a loss of 2.32 percent during the last three years ranked in the top third. A gain of 3.22 percent during the last five years ranked in the top 28 percent.

The market storm has driven some CalPERS investments off course from their targets.

Stocks were intended to be 56 percent of the portfolio, but were only about 40 percent by the end of last December. Fixed income such as bonds, expected to be 19 percent, was 23 percent. Cash, allotted zero, was 8.8 percent.

“There are some pretty big differences obviously between you and the average plan,” Michael Schlachter of Wilshire told the committee.

For example, he said, CalPERS has a larger allocation for real estate and private equity and has done away with the “hometown bias” that earmarks part of the portfolio for U.S. stocks, going instead with global equity.

Schlachter touched off a clash with the CalPERS chief actuary, Ron Seeling, when he showed a chart illustrating that most state pension systems have investment plans unlikely to achieve their average goal of an 8 percent annual investment return.

Wilshire told the CalPERS board in December, Schlachter said, that most state and local governments were spending more than their tax revenue. He said increased pension contributions would add to their problems.

“This chart would indicate that apparently the average state plan isn’t exactly going to earn their way back out of this hole because their asset allocation is actually targeting a return south of that 8 percent actuarial growth rate,” he said.

Schlachter said he thinks there is likely to be pressure on pension systems to make riskier investments, with the goal of getting greater returns, or to cut benefits if state and local governments cannot afford to increase pension contributions.

Seeling said CalPERS has recently been criticized for projecting annual earnings of 7.75 percent in the future, while earning only 3.32 percent during the decade ending in December. (See Calpensions post March 9: “Pension funds: A double whammy?”)

“So I’m quite nervous that this graph, this slide could cause further potential misunderstanding,” Seeling said of Schlachter’s chart.

If you look at the 10-year period ending last June 30, instead of the 10-year period ending Dec. 31, the average annual return is 9 percent instead of 3.32 percent, Seeling said.

In addition, he said, Wilshire assumes that the 8 percent annual earnings target is made up of the real return plus 1.5 percent inflation, about half of the average inflation rate during the last decade.

Seeling said if you assume that inflation will average 3 percent, then the real return only has to be 5 percent to reach the target of 8 percent assumed by many pension plans.

“Inflation drives the liabilities — the pay raises, the cost-of-living adjustments for retirees,” Seeling said in an interview. “So all of those things drive multiple moving parts within the system.”

In the same way that President Obama reportedly values advisers with conflicting views, the CalPERS board hires consultants such as Wilshire and Allan Emkin’s Pension Consulting Alliance to give them second and third opinions.

The investment committee chairman, George Diehr, said the CalPERS board plans to meet with the consultants, without CalPERS staff present, on April 20, one of four such meetings held during the year.

The new CalPERS chief investment officer, Joseph Dear, summed up five issues raised during the committee meeting this week for consideration during the next meeting in May:

A specific allocation for cash, allocation target ranges, opportunistic investments during the current market turmoil, high-yield bonds advocated by Wilshire, and the status of hedge fund investments.

During public comment, a retired state worker, Robert Thacker, told the committee that CalPERS risk models missed the high-tech bubble a decade ago and the recent real estate bubble.

“How much more wrong can we afford to be?” said Thacker. “I’m really scared what’s going to happen when your sponsors, the employers, are presented with the increases that they may have to come up with. They are having shortfalls, too.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 20 Mar 09


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