Saturday, July 17, 2010 0 comments ++[ CLICK TO COMMENT ]++

CALPERS - An example of the situation facing many pension funds

As if we didn't have enough problems as is, an additional big problem to worry about over the next few decades are the pension funds and their poor performance of late. Fortune has a nice recap of what happened to CALPERS, the largest pension fund in USA, that I belive is representative of the problems faced by other funds. Here are some of the key points that were brought up:

Before clocking a $100 billion loss in early 2009, the California Public Employees' Retirement System, known as Calpers, had the swagger of a hedge fund and the certainty of a saint. Other pension funds followed its lead, loading up on leverage, investing in unrated CDOs, shoving money into high-priced private equity deals and barreling into commodities and real estate.


The question now is whether a loss of nearly 40% of its market value -- the worst loss in the system's 77-year history -- has brought Calpers sufficiently back down to earth to avoid another such debacle, and whether other chastened pension systems have followed suit.

...

Most of Calpers investment losses came from its largely passive investments in baskets of equities, which still account for about half of the system's assets. But the retirement system also got into trouble by adding leverage, reducing oversight and by chasing other hot markets.


After maintaining a low-risk real estate strategy for decades, studies commissioned by Calpers show that it switched gears in 2002, embracing higher levels of risk even as the real estate market began to top out in 2005. By mid-2009, Calpers had a one-year loss of 48.8% in its real estate portfolio and was reporting among the lowest returns of any large pension funds in the country.

In early 2006, it said it would invest $6 billion in commodities, particularly through index futures, news that caused Grants' Interest Rate Observer to respond: "On the timing of this demarche, we hand Calpers the gold medal for Being Late."

Calpers showed even worse timing in the mortgage market. Just before the market tanked, it invested approximately $140 million in unrated collateralized debt obligations (CDOs) and $1.3 billion in complex buckets of loans and debts called structured investment vehicles (SIV). A Calpers lawsuit puts the SIV losses at "perhaps more than $1 billion."



The scenario is similar to what happened to the Harvard Endowment Fund and many other institutional funds. Namely, these funds bet incorrectly that overloading on real estate, commodities, and so forth, would diversify their portfolios. As is obvious now, they didn't gain any diversification benefit, and in fact may have gone into areas they don't understand.

Institutional funds made up quite a bit of the loss from a few years ago but it is doubtful they will gain much in the future. In fact, people who are bearish like me think the chances of posting negative or near-zero returns are much higher than posting a strong positive return.

It'll be interesting to see how these funds manage their assets. Because they are so large, they can easily bid up the price of smaller assets (this is likely what happened in several commodity markets and some types of real estate.) They can create "fake" bull markets in assets without any changes in underlying fundamentals.
 
 
It's a very difficult situation for institutional investors. If you were somewhat concerned like me, you would find almost all assets a bit risky and vulnerable to markdowns. But on the other hand, the historically safe asset, government bonds, aren't cheap either. Some of these funds are set to bet heavily on emerging markets but, repeating Jim Grant's thought, it wouldn't surprise me if they earned another gold medal for Being Late ;)

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