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What Does CalPERS’ Hedge Fund Pullout Mean For the “Average” Investor?

Larry Zimpleman, chairman and president of Principal Financial Group, has written a short piece in the Wall Street Journal today detailing his reaction to CalPERS cutting hedge funds out of their portfolio and what the move means for the average investor.

From the WSJ:

I was very interested (and a bit surprised) to read about the decision of Calpers (the California Public Retirement System) to move completely out of hedge funds for their $300 billion portfolio.

While I haven’t visited directly with anyone at Calpers about the reasons for their decision, from the stories I’ve read, it seems to be a combination of two things. First, it’s not clear that hedge-fund returns overall are any better than a well-diversified portfolio (although the management fees of hedge funds are much higher). Second, hedge funds had only about a 1% allocation in the overall portfolio. So even if they did provide a superior return, it would have a negligible impact on overall performance.

What’s the takeaway for the average investor? First, if you have “alternatives” (like hedge funds) in your own portfolio, they need to be a meaningful percentage of your portfolio (something like a 5% minimum). Second, take a hard look at the recent performance against the management fees and think about that net return as compared to a well-diversified stock and bond portfolio. Hedge funds are, as their name implies, set up more for absolute performance and outperformance during stressed times. If you’re a long-term investor that believes in diversification and can tolerate volatility, hedge funds may be expensive relative to the value they provide, given your long-term outlook.

Principal Financial Group is one of the largest investment firms in the world and also sells retirement products.

Zimpleman’s post was part of the WSJ’s “The Expert” series, where industry leaders give their thoughts on a topic on their choice.

Video: Lessons From Pension Reform in Utah

In the video above, former Utah senator Dan Liljenquist talks about the pension reform efforts he sponsored in Utah from 2008-2011 and what other states can learn from those efforts.

Liljenquist sponsored bills that ended “double-dipping” in the state, moved new hires into a defined-contribution plan and ended pension benefits for Utah lawmakers.

Does Investment Return Affect Pension Costs?

Does Investment Return Affect Pension Costs? Larry Bader, who worked as an actuary for 20 years before moving to Wall Street, tackled that question in the latest issue of the Financial Analysts Journal.

An excerpt of his answer:

Answer: It doesn’t.

Yes, a higher return on plan assets reduces the funding requirements for the pension plan and the expense that the sponsor must report. But the plan’s true economic cost is independent of the investment performance of the plan assets.

To see why this is so, suppose that you establish a fund to pay for your child’s college education and I do the same for my child. We make equal contributions to our respective funds, and we both face the same tuition payments. But being a smarter, bolder, or luckier investor, you grow your college fund to twice the size of mine. Can we now say that your child’s education costs less than my child’s education? Surely not. Our tuition payments are the same; it’s just that you have a larger education fund available to help pay your child’s tuition.

Or think of it this way: Suppose that your college education fund performed miserably and a similar fund that you had set up to buy a small vacation home struck it rich. Would you now say that college tuition has become very expensive but vacation homes very cheap? Can you now afford to buy a vacation mansion — or private island — but not to send your child to college? Behavioral economics suggests that you might think along those lines, but common sense says, “Get over it.”

Similarly, a higher pension fund return does not lower the economic cost of the plan. The economic cost reflects solely the amount and timing of the pension payments, which are unaffected by the size or growth of the assets.

To read the full answer, click here.

Missouri Pension Sues A Dozen Banks, Investment Firms Over Inflating Stock Prices

Public Employees’ Retirement System of Mississippi (PERSM) has filed a class action lawsuit against over a dozen banks and investment firms over alleged violations of the Securities Exchange Act of 1934.

PERSM claims the firms artificially inflated the price of Millennial Media Inc. common stock by “hiding” disappointing revenue results. More from Legal News Line:

PERSM claims Millennial Media, Bessemer Venture Partners, Columbia Capital, Charles River Ventures, New Enterprise Associates Inc., Morgan Stanley & Co., Goldman Sachs & Co., Barclays Capital Inc., Allen & Company LLC, Stifel Nicolaus & Company, Canaccord Genuity Inc. and Oppenheimer & Co. hid information that reflected poorly on the company and, once released publicly, caused the company’s stock price to drop, according to a complaint filed Sept. 30 in the U.S. District Court for the Southern District of New York.

[…]

On March 28, 2012, Millennial Media commenced its initial public offering through which the company and certain shareholders sold more than 11.7 million shares at $13 per share for aggregate gross proceeds of more than $152 million, according to the suit.

PERSM claims through a second stock offering on Oct. 24, 2012, Millennial and its shareholders sold an additions 11.5 million shares of company stock at $14.15 per share for aggregate gross proceeds of more than $162 million.

“Pursuant to the Securities Act, defendants are strictly liable for material misstatements in the offering documents…vissued in connection with the offerings and these claims specifically exclude any allegations of knowledge or scienter,” the complaint states.

On Feb. 19, 2013, after the close of the markets, Millennial issued a press release announcing revenue for the fourth quarter of 2012 of $58 million, sharply below analysts’ expectation of $62.9 million, according to the suit.

PERSM claims Millennial also gave disappointing revenue guidance for 2013 and disclosed that it would acquire Metaresolver Inc.

“Millennial Media’s poor results, weak guidance and its need to acquire Metaresolver arose out of ongoing problems with the company’s then-existing technologies…which were driving clients away,” the complaint states. “In response to this partial disclosure of the true state of the company’s proprietary software and related technologies, Millennial Media’s stock price fell $5.38 per share, or 37.54 percent to close at $8.95 per share of February 20, 2013.”

On Aug. 13, 2013, Millennial issued a press release announcing the company would acquire Jumptap Inc. and, due to ongoing company problems, Millennial’s stock price fell $1.60 per share or 18.82 percent to close at $6.90 per share on Aug. 14, 2013, according to the suit.

PERSM claims on Nov. 13, Feb. 19 and May 7, the company’s stock fell again, to $6.32, $6.15 and finally to $3.36 per share.

As a result of the defendants’ materially false and/or misleading statements and omissions, Millennial’s common stock was offered at artificially inflated prices and traded at inflated prices during the class period.

“However, as the truth about Millennial Media’s operations and outlook became known to investors, the artificial inflation came out and the price of Millennial Media’s common stock fell, declining 86.56 percent from its class period high,” the complaint states. “These price declines caused significant losses and damages to plaintiff and other members of the class.”

The suit is classified as a class action because PERSM filed on behalf of everyone who purchased Millenial Media stock during the period where it was allegedly inflated.

Illinois Governor Candidates Talk Pensions in First Debate

One of the hottest issues in the race for Illinois governor is also one where the candidates differ starkly: how to fix the state’s retirement system.

So it’s no surprise that pensions came up during the race’s first debate.

There were no revelations here; Pat Quinn and Bruce Rauner both used the time to double-down on their stances. From the Associated Press:

Quinn signed legislation last year that would fully fund the retirement systems by 2045, in part by cutting benefits. Public-employee unions have sued, saying the overhaul violates a provision of the constitution that says benefits can’t be reduced.

Rauner supports letting retirees keep the benefits they’ve been promised but freezing the systems and moving employees to a 401(k)-style plan in which workers are not guaranteed a certain level of benefits. He said that plan — similar to what most private-sector workers have — wouldn’t save much money to start but would save billions in the long term.

“I don’t believe it’s right to change the payments to a retiree after they are already retired, and that’s what Gov. Quinn did,” Rauner said.

But Quinn called Rauner’s plan “risky” because workers’ retirements would depend largely on market performance. He said he deserves credit for making Illinois’ full pension payment each year he’s been governor — something his predecessors didn’t do. That contributed to Illinois having the worst-funded pension systems of any state in the U.S.

Illinois’ pension reform law has spent the last 6 months being fast-tracked through lower courts. A ruling on the constitutionality of the law could come before the end of the year.

The Only State Where Retirees Have Enough Income

A new study has analyzed Census Bureau data to determine in which states the typical retiree is living a “healthy” retirement – that is, a retirement where one earns at least 70 percent of their pre-retirement income.

The study found there was only one state where the median retiree had enough retirement income: Nevada.

From Time.com:

Financial advisers generally agree you need at least 70% of pre-retirement income to maintain your lifestyle after calling it quits. Many say 80% to 85% is a more appropriate target.

But even using the lower bar, Nevada is the only state where the typical retiree has sufficient income to live comfortably in retirement, according to a study from Interest.com, a division of Bankrate, a financial information provider. The District of Columbia also makes the cut. But every other jurisdiction in the nation falls short, underscoring the scope of the retirement income crisis in America.

Nationally, the median income for those who are 65 and older equals just 60% of the median income for those aged 45 to 64, the study found. In Nevada, median income for those past 65 is 71%. In Washington D.C., the figure is 74%. States that get close to the minimum retirement income level are Hawaii (69%), Arizona (68%) and Mississippi (68%). At the bottom are Massachusetts (49%) and North Dakota (49%).

The national rate represents a jump of 10 percentage points over the past decade. But that is not as encouraging as it may appear, reflecting trends where older Americans stay on the job longer and young workers fail to see significant wage gains. The share of Americans working past 65 has been increasing for 20 years and reached 18.9% this May, one of the highest levels in the last half century.

Just below Nevada were Mississippi and Arizona, state where retirees benefit low costs of living, as well as Hawaii, a state that carries a “strong pension culture”.

Near the bottom of the list was Massachusetts.

Study: Pension Trustees Spend Less Than 5 Hours Per Quarter Evaluating Investment Decisions

Survey results recently released by Aon Hewitt reveal that most pension trustees in the UK only spend about five hours each quarter evaluating investment decisions. The survey did find, however, that trustees were spending more time on investment evaluation in 2014 than they did in 2013.

From Investment and Pensions Europe:

Pension boards and trustees are opting for fiduciary management because they can often only spend five hours each quarter scrutinising investment decisions, according to Aon Hewitt.

The consultancy said the increasing complexity of investment decisions was driving those in charge of pension assets into the arms of fiduciary managers, but that only one-quarter of those using such providers were employing indices to measure successful performance.

Drawing on the results of a UK survey of nearly 360 investors worth £269bn (€344bn), the Aon Hewitt Germany’s head of investment consulting Thorsten Köpke said the questions facing UK investors were also relevant concerns for their German counterparts.

The survey also found that 73% of pension boards and trustees were only spending five hours a quarter on investment decisions, a 10-percentage-point increase over the 2013 survey results – meaning they placed significant trust in managers to monitor investments, according to the consultancy.

However, interest in fiduciary management was largely dependant on the size of a fund’s portfolio, the survey found.

It also found that those managing more than £1bn in assets were more inclined to delegate responsibility for only part of their portfolio, while those with less than £500m in assets delegated the entire portfolio.

Köpke added: “The last few years have seen occupational schemes in Germany as in England – both small and medium-sized ones – work with fiduciary managers.”

The data came from Aon Hewitt’s Fiduciary Management Survey 2014.

Chart: A History of New Jersey’s Pension Payments

Public pension plans are funded in part by state contributions. But, for various reasons, states often fail to make full payments into their pension systems and instead opt to use the money elsewhere in the budget.

The above chart shows the payment history of New Jersey over the last 20 years. The dark blue bars represent the dollar amount the state was required to contribute to the system; the light blue bars show how much the state actually contributed.

The last time New Jersey paid its full pension payment was 1996. Since then, payments have fallen either well short or been non-existent.

New Jersey’s state-run pension systems were collectively 64.5 percent funded and were running a $47.2 billion deficit as of 2013.

Chart credit: New Jersey Pension and Health Benefit Study Commission report

NASRA: Moody’s “Manipulated” Pension Data To Overstate Pension Liabilities

The National Association of State Retirement Administrators (NASRA) issued a strongly-worded letter yesterday accusing rating agency Moody’s of using “manipulated” pension data to paint a bleak picture of public pension systems around the country.

From Reuters:

The letter, dated Oct. 8, follows the publication of a report by Moody’s last month that claimed public pension liabilities had tripled to $2 trillion from 2004 to 2012 and that public pension funds had been taking on greater risk to make up the shortfall.

“With Moody’s latest report, concerns regarding the potential mischaracterization and misuse of these manipulated pension numbers have been more than realized,” the National Association of State Retirement Administrators said in the letter.

The unusually sharp rebuke from NASRA signals its growing impatience with Moody’s, which has taken the strongest stance of all the major ratings agencies over the risks it believes public pension funds could pose to municipal finances.

The letter is also the latest twist in an ongoing debate over the politically charged issue of public defined benefit pensions. The right says the plans are unsustainable and a drag on local tax payers and the left see them as a financial safety net that keep retired municipal workers out of poverty.

Read the full letter below:

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Photo by Andreas Poike via Flickr CC License

Illinois Pension Case Stays On Fast Track; Arguments Set For November

Illinois’ pension reform law is going to get its day in court soon. A judge on Wednesday scheduled arguments for and against the law for next month. That means a final ruling on the law could be made by the end of the year.

The law’s opponents and defenders have one thing in common: they both want a ruling on the law’s legality sooner than later.

From Reuters:

Sangamon County Circuit Court Judge John Belz, who is overseeing five consolidated lawsuits filed by labor unions and others, set Nov. 20 for arguments for and against the constitutionality of the law passed by the Illinois legislature last December.

Public labor union coalition We Are One Illinois and other parties have been seeking an expedited ruling in the wake of a July 3 Illinois Supreme Court decision in an unrelated case that determined health care for retired state workers is a pension benefit protected by a provision in the state constitution.

The same provision, which prohibits the impairment or diminishment of retirement benefits for public workers, is the focus of the lawsuits against the state’s pension reform law. The new law, which is currently on hold, reduces and suspends cost-of-living increases for pensions, raises retirement ages and limits the salaries on which pensions are based.

In documents filed with the court on Friday, Illinois Attorney General Lisa Madigan argued that the high court’s July 3 ruling only dealt with retiree health care subsidies being part of the contractual relationship Illinois has with members of the state’s public pension systems.

“The court did not address whether such benefits are immune from the state’s exercise of its police powers. That issue was not before the court,” Madigan’s court filing noted.

In its defense of the pension reform law, Illinois is leaning heavily on its so-called police powers trumping the constitutional provision against reducing public employee retirement benefits. Those powers include the state’s ability to properly fund education, healthcare and public safety. Those sectors would experience substantial cuts if the state’s already large pension burden grows, Madigan said in the filings.

We Are Illinois released the following statement on Wednesday:

“As we have always maintained and the recent Kanerva decision confirms, the pension protection clause of the Illinois Constitution is absolute and without exception. There is no merit to the State’s purported justification for the unconstitutional diminishments and impairments that SB1 imposes. We are hopeful for a swift resolution in the plaintiffs’ favor, so that we can work with legislators willing to develop a fair—and legal—solution to our state’s challenges, together.”

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