From the “Here We Go Again” files:
Yet another big pension fund has decided, despite the overwhelming evidence to the contrary, to engage in higher-risk, higher-cost investing. One day, this might end well, but history is replete with an almost-unbroken string of examples where it hasn’t.
You might have missed the Wall Street Journal article during the Labor Day bustle reporting how the California State Teachers’ Retirement System (often referred to as Calstrs), the nation’s second-largest pension fund with $191 billion in assets, was considering an aggressive move into both market timing and alternative investments:
Top investment officers of the California State Teachers’ Retirement System have discussed moving as much as 12% of the fund’s portfolio—or more than $20 billion—into U.S. Treasurys, hedge funds and other complex investments that they hope will perform well if markets tumble, according to public documents and people close to the fund. Its holdings of U.S. stocks and other bonds would likely decline to make room for the new investments.
We can’t help but be astonished by this development, given all we know about almost every chief investment officer’s ability to time markets or the typical investment committee’s ability to select hedge funds or other alternatives.
My wife is a teacher, and she and her colleagues often ask me questions about their self-directed 403(b) retirement accounts. Perhaps I can be of some assistance to those educators on the other side of the country who might be curious about how their retirement funds are being managed.
So here are questions those California teachers should feel free to ask the managers running the Calstrs fund managers about their new investments:
1) You are considering moving a substantial amount of assets into U.S. Treasuries at a time that rates are near record lows, and the Federal Reserve is considering raising interest rates for the first time in more than nine years. Does this move mean you believe rates are going lower? Second, if you believe rates are going higher, won’t that have a negative impact on the value of these holdings?
2) If you are moving into Treasuries as a defensive measure against a decline in equities, what basis do you have for believing you can A) get back into stocks at the correct time once they have reached bottom, and B) what makes you think you will have the requisite discipline to buy into equities and sell bonds when things will be looking especially gloomy? Do you have any history or a track record of this sort of market timing?
3) You seem to be implying that future returns are going to be lower than they have been. If that is the case, does it really make sense to move toward more expensive, higher-fee asset classes? If you expect returns to be lower, why aren’t you moving toward lower-cost investments?
4) Are you familiar with any index of alternative investments (hedge funds, private equity and venture capital) that offers an objective measure of returns? Do you know of any indexes that include mandatory performance reporting? Aren’t the industry-wide performance indexes you cite filled with survivorship bias, and composed of self-reported managers who don’t disclose quarters or years when they underperform?
5) Calstrs CIO Christopher Ailman was quoted in the WSJ article as saying “The recent market volatility has been painful.” In what way has the volatility been painful? What is it about a 15 percent decline following a 206 percent, six-year rally that is either unusual or a source of discomfort?
6) Speaking of which: How unusual are 10 percent to 20 percent corrections? Is this something truly aberrational or is it just the markets going up and down as they so often do?
7) The New York Times recently reported that hedge funds have failed to beat a 60/40 mix of stocks and bonds every single year since 2002, and they’re on track to fall short again this year. They have underperformed their benchmarks for one, three, five, 10 and 20 years. And Bloomberg Businessweek noted that “Hedge Funds Are for Suckers.” Given this, why do you want to move a substantial percentage of our assets into hedge funds?
8) The Wall Street Journal also reported that Calstrs CIO Ailman “hopes a move away from certain stocks and bonds could help stub out heavy losses during future gyrations. This could include moving out of some U.S. stocks as well as investment-grade bonds.” What did the fund do in the 2000 crash? Or 2008 crash? Mr. Ailman, what did you learn from these experiences?
9) Here’s a related question, thanks to Larry Swedroe of BAM Alliance:Do hedge funds really hedge?
10) Speaking of hedging: The average age of California teachers is 43.1; we have more than two decades or longer until we will be drawing on these funds in retirement. Why do we need to hedge?
Thank you for your assistance. We look forward to your answers.
Originally published as: 10 Questions for a Pension-Fund Manager