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
Their oversight board must be sharing in the Sports tickets, hookers and Vegas “conferences” otherwise why do something that flies in the face of reason?
Moving into US treasuries would be called rebalancing or maybe slightly changing the composition of the portfolio. That would not be an unreasonable move this far into an old tired bull market. Hedge funds and “complex” investments make me more nervous.
Wow. And it’s not like active trading won’t get sheared by the High-Frequency Trading toll booth… Time for the CA teachers to take a day off and go sack CALSTRS management ASAP.
Sounds like at least one hedge fund has a really good salesman who can put fear into Ailmans stomach and greed in his heart.
Now I know nothing about the tax implications of the investment fund of California TEACHERS but wouldn’t it benefit their members if a large portion of their bond portfolio consisted of California municipal SCHOOL BONDS?
CA public schools used to be amongst the top in the USA. They have suffered from under investment. Invest in your members/employees and you invest in your success.
I think these government pension systems are non-profit hence no tax. Taxes are paid by the teachers as they draw the pensions. Muni’s are contra-indicated. As DeDude says, a portion in shorter term Treasuries would be rebalancing or at least treading water. Hedge funds? Alternative investments? Better to buy a “Ranch” in Nevada. At least there will always be customers.
I am pretty sure that the pensions are guaranteed, so the teachers don’t give a damn. As a California tax payer, I am of course, annoyed. It almost makes me want to run for office.
Good point – all CA taxpayers (whether teachers or not) should be upset.
Didn’t read the article. I guess it was CalPERS that was getting OUT of the hedge fund game.
It really help to fact a little before engaging in opinions…
For example:
California public school teachers do not pay Social Security taxes or earn Social Security benefits. Instead, they participate in the California State Teachers’ Retirement System (STRS). Retirement benefits are a very important and significant element of teacher compensation.
California teachers pay into their STRS system through an 8.15% withholding on gross wages (a rate higher than Social Security’s 6.2% but less than STRS rates in other states; in Louisiana the withholding rate exceeds 20%).
It’s a defined benefit plan, funded jointly by the state, local school districts and the teachers – in that respect it is somewhat similar to Social Security.
The California Teachers’ Retirement System (CalSTRS) represents the second largest public retirement system in the country and has a $70 billion unfunded liability
— One of the likely reasons they are trying to juice return. Although keep in mind, that $70 billion has to be covered over a 30 year period. More like a very long term loan, but still they are going to have to scramble to make the annual payments.
The bulk of the pension funds’ revenue comes not from contributions but from investment income.
This is stand practice for just about all defined benefits plans, corporate or governmental.
A traditional conservative approach would be to have a 50/50 balance between stocks and bonds. However as the years passed – particularly with the rise of the long bull market of 1982-2000 – the much better returns of stocks made it natural for administrators to increase the former over the latter. And then, with the collapse of yield since 2008, it just about became imperative to be heavily in stocks.
So, is taking on more risk bad? Yes, but what are the really viable alternatives?
Not sure how any of your observations are relevant to the questions to be asked of the fund managers . . .
And as we saw in Illinois (Lottery sued for not paying winnings), there is no reason to think that cannot happen in California