Pension360

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

Two actuarial associations did not publish a controversial paper by their joint task force, reflecting a split in the profession over whether public pension debt should be measured with risk-free bonds or the earnings forecast for stock-laden investment funds.

Using safe but low-yield bonds to offset or “discount” future pension obligations would cause pension debt to soar, creating pressure to raise the annual rates paid by state and local governments that are already at an all-time high for many.

Critics have been contending for a decade that overly optimistic pension fund earnings forecasts conceal massive debt and the need to take even more money from government budgets or find a way to cut pension costs.

The leading California critics, now mainly at Stanford University, are not professional actuaries. They have backgrounds in finance, like David Crane, and in academic economics, like Joe Nation and Joshua Rauh.

The paper of the joint Pension Finance Task Force paper of the American Academy of Actuaries and the Society of Actuaries, which did not make it through the usual peer review process, was based on the principles of financial economics.

“One of the assertions of the paper is that public pension plans are purported to be default-free obligations so they would be valued using default-free interest rates,” an anonymous former task force member told Pensions & Investments.

Although not as well publicized as criticism from outside the profession, a group of actuaries has been urging the adoption of a risk-free discount rate for about a decade, said Paul Angelo of Segal Company actuaries in San Francisco.

Angelo, chairman of the California Actuarial Advisory Panel, does not favor the use of a risk-free discount rate. He agrees with not publishing the task force paper, saying it lacked the “science” to support the change and relied only on assertions.

For the first time, Angelo said, the actuaries urging a risk-free discount rate went beyond simply reporting debt and seemed to be advocating its use to set the annual payments to the pension fund made by government employers.

The California Public Employees Retirement System and the California State Teachers Retirement System currently assume their pension fund investments, expected to pay two-thirds of future pensions, will average 7.5 percent a year in future decades.

The systems use the 7.5 percent long-term earnings forecast to reduce or “discount” the cost of future pensions, as if it were money in the bank. Thirty-year U.S. Treasury bonds, regarded as risk free, were yielding 2.23 percent last week.

When a much lower rate is used to discount future pension obligations the pension debt or “unfunded liability,” the shortfall in the projected money available to pay future pensions, balloons to a much larger amount.

An example is shown on the “California Pension Tracker” website directed by Joe Nation at the Stanford Institute for Policy Research.

The debt of California public pension systems in fiscal 2013 using a 7.5 percent discount rate is $281.5 billion. Using a lower discount rate of 3.723 percent (the CalPERS rate in 2013 for terminating plans) the pension debt more than triples to $946.4 billion.

The giant California Public Employees Retirement System, covering half of all non-federal government employees in California, is deep in debt even when using its 7.5 percent discount rate.

CalPERS has not recovered from a $100 billion investment loss during the financial crisis. Its investment fund was $260 billion in 2007, dropped to about $160 billion in March 2009 and was $306 billion last week.

In 2007, CalPERS had 101 percent of the projected assets needed to pay future pensions. Now after weak earnings during the last two fiscal years, its funding level is lower than the outdated 75 percent reported in a previous Calpensions post.

A CalPERS spokesman said the funding level for the last fiscal year ending June 30 is an estimated 68 percent. Nearly a decade later, that’s not much higher than the CalPERS funding level of 61 percent in 2009 at the bottom of the financial crisis.

The reassurance that CalPERS long-term earnings average more than 7.5 percent has eroded, dropping to 7.03 percent for the last 20 years. And the outlook is dim: The 10-year earnings forecast from Wilshire and other CalPERS consultants is 6.64 percent.

Girard Miller is probably not rethinking a line from his widely circulated Governing magazine column in 2012 debunking a dozen “half-truths and myths” used by both sides in the public pension debate:

“Pension funds are not going to invest their entire portfolio in 3 percent Treasury bonds right now — or ever — so the risk-free model is not even descriptive of reality and has little normative value.”

The current Economist magazine says (“No love, actuary” Aug. 13-19 issue) it has seen a draft of the joint pension task force report and thinks the two actuary associations should allow the paper to be published.

“American public-sector deficits are more than $1 trillion, even on the most generous of assumptions,” said the magazine. “This is an issue in which debate should not be stifled.”

Some of the debate was aired when the Governmental Accounting Standards Board spent several years developing new rules that took effect in 2013 and 2014. Pension systems can use their earnings forecasts to discount future pension obligations.

But if the projected assets fall short of covering the pension obligations, the system must “crossover” and use a risk-free rate to discount the remainder of the pension obligation. CalPERS did not have to crossover.

The new accounting rules require pension systems to use the “blended” rate to report pension debt. But they can continue to use the previous method based only on their earnings forecast to set the annual rates paid by employers.

The California Actuarial Advisory Panel agreed with the blended rate and suggested a few tweaks in a letter to GASB on Sept. 17, 2010, from the chairman at the time, Alan Milligan, CalPERS chief actuary, who is retiring this year.

An independent “Blue Ribbon Panel” commissioned by the Society of Actuaries issued a report in 2014 that, among other things, endorsed the use of some version of a risk-free discount rate.

“The Panel believes that the rate of return assumption should be based primarily on the current risk-free rate plus explicit risk premia or on other similar forward-looking techniques,” said the panel report.

Angelo said the influential Actuarial Standards Board, which was essentially neutral in Actuarial Standards of Practice issued in 2013, may revisit the risk-free discount rate issue, possibly within a year or so.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Mohamed El-Erian wrote a comment for Bloomberg, The Titanic Risks of the Retirement System:

Imagine an entire enterprise set on course for disaster, driven by the owner’s arrogant pursuit of profit. The members of the management team, from the CEO on down, know better but fail to resist or are ignored. The clients remain totally unaware of the risks until far too late, with catastrophic results — particularly for the poorest among them.

This is the story line of the excellent “Titanic,” a musical now playing at the Charing Cross Theatre in London. As I took in this powerful portrayal of the human failures that brought down a ship thought to be unsinkable, it occurred to me that if we’re not careful, the tragic story could also end up describing the fate of the global retirement system.

With interest rates extremely low and the prices of stocks and bonds at historic highs, finding safe investments that can help guarantee a comfortable retirement has become increasingly difficult. This has put the managers of pension funds and other institutions that invest on behalf of future retirees in a difficult position, driving them to take ever greater risks in hopes of meeting their performance objectives — targets that are unlikely to be met absent a major revamp of economic policies and corporate prospects. As a result, individuals are increasingly being exposed to the threat of losses that cannot be recouped quickly.

The degree of long-term financial security that can be assured depends on three elements: future returns, correlations among different asset classes and volatility. The outlook for all three is becoming more uncertain.

What returns can investors realistically expect? With the combination of central bank activism and less robust economic prospects pushing bond yields into negative territory (most recently in the U.K.), fixed income markets no longer generate any meaningful returns — unless one takes on a lot more default risk by accumulating junk debt issued by corporations and emerging-market governments. In the stock market, high-quality dividend-yielding shares have reached unnerving valuations, leaving more volatile and risky options.

More sophisticated investors may be able to access investment vehicles that traffic in less crowded areas — but selecting the right manager is not easy, especially in a “zero sum” world in which one manager’s positive “alpha” is another’s losses.

In principle, the right mix of investments can provide greater return for the same risk. But this works only if the investments don’t move in sync — and correlations among asset classes have lately become unstable and less predictable. Sophisticated long-term investors realize that portfolio diversification, while still necessary, is no longer sufficient for proper risk mitigation. Yet the next operational step is not easy, and it typically involves giving up some potential return.

Then there’s volatility, which increases the chances that an investment will fall in value precisely when a future retiree needs the money. In recent years, central banks have largely been willing and able to repress financial volatility. Now, though, this is changing. Some, such as the Bank of Japan, appear less able while others, such as the Federal Reserve, somewhat less willing.

The repercussions for investment managers depend on where they stand. Those who oversee severely underfunded corporate or public defined-benefit pension plans are in a particularly tough bind: They must achieve high returns to meet their targets, so they face the greatest pressure to take on risks that could be catastrophic if companies and the economy don’t perform well enough to justify existing asset prices. Even better-funded pension plans that have matched their assets to their liabilities will be challenged to maintain historical returns if they take on new entrants.

To avoid disaster, policy makers and investment managers should consider three fixes. First, be a lot more realistic about the returns that can be achieved within traditional risk tolerance parameters. Second, put in place policies to boost savings and income, so people — particularly the most vulnerable — will have more money available to put aside for retirement. Third, be transparent with retirees about the risks that are being taken on their behalf, also offering less risky options with explicitly lower expected returns.

Absent urgent change, the retirement system could end up following the example of the Titanic. Like the ship’s passengers, many individuals would face the risk of devastating consequences. And like the second- and third-class passengers who had a hard time getting on lifeboats, the middle- and low-income segments of the population would be most at risk.

I’m glad Mohamed El-Erian finally decided to get on board and start writing about the pension Titanic which is one financial crisis away from sinking deep into the abyss.

El-Erian follows his former Pimco colleague Bill Gross who recently admonished US public pensions for not facing reality and letting go of their assumed rate of return which can never be achieved without taking undue and dangerous risks.

My former colleague from my days at BCA Research, Gerard MacDonell, had this to say on El-Erian’s titanic piece:

Deep thinker and clearly global guy Mohamed El-Erian probably needs to decide on the sense in which he wants to use the word titanic. Is it a large thing or an overrated thing?

He wrote this and Bloomberg published it:

This is the story line of the excellent “Titanic,” a musical now playing at the Charing Cross Theatre in London. As I took in this powerful portrayal of the human failures that brought down a ship thought to be unsinkable, it occurred to me that if we’re not careful, the tragic story could also end up describing the fate of the global retirement system.

The issue El-Erian chooses to use as a segue into his London theatre preferences and his favorite theme that uncertainty could rise is actually an important one. It would be great to see some reporting on it.

Financial market returns are going to be much lower than pension plans assume. This is an issue for companies offering defined benefit plans, as well as their beneficiaries. And even for defined contribution plans or just 401ks, beneficiaries broadly defined are probably in for a rude awakening.

It is darkly funny that this issue receives such little attention compared to the endless moaning, whining and gnashing of teeth around DA NATIONAL DEBT!!!!

At some risk of being self-referential too, I think this issue of pressure on pensions fits into the point that equities can be BOTH not significantly overvalued AND likely to generate very subpar returns. In slight contrast, bonds may be overvalued, but are now almost certain to deliver low returns, by definition if held to maturity.

Gerard is bright guy but when it comes to pensions, he should refer his readers to my blog because he never worked at one, nor does he really understand the bigger picture.

And what’s the bigger picture I’m referring to? Well, I went over it a week ago when I discussed Chicago’s pitchforks and torches:

There’s an even bigger problem which I want policymakers to wrap their heads around: chronic public pension deficits are deflationary.

Let me repeat that: Chronic and out of control public pension deficits are DEFLATIONARY. Why? Because it forces governments to introduce more property taxes or utility rate increases (another tax) to address them, leaving less money in the hands of consumers to spend on goods and services.

The other problem with raising taxes and utility bills is they are regressive, hurting the poor and working poor a lot more than Chicago’s ultra rich.

Now I’m going to have some idiotic hedge fund manager tell me “The answer is to cut defined-benefit pensions and replace them with cheaper defined-contribution plans.” NO!!! That is a dumb solution because the brutal truth on DC plans is they are failing millions of Americans, exposing them to pension poverty which is even MORE DEFLATIONARY!!

I want all of you to pay attention to what is going on in Chicago because it’s a cancer which will spread throughout parts the United States where chronic pension deficits are threatening municipalities, cities and states. And this slow motion train wreck will have drastic economic consequences for the entire country.

You will recall that chronic pension deficits are part of the six structural factors I continuously refer to when making my case for global deflation. In fact, I referred to these six factors recently in my comment on the bond market’s ominous warning:

[…] I remain highly skeptical that anything policymakers do now will be enough to resurrect global inflation. Readers of my blog know that rising inequality is just one of six structural themes as to why I’m worried of a global deflationary tsunami:

• The global jobs crisis: Jobs are vanishing all around the world at an alarming rate. Worse still, full-time jobs with good wages and benefits are being replaced with part-time jobs with low wages and no benefits.
• Demographics: The aging of the population isn’t pro-growth. As people get older, they live on a fixed income, consume less, and are generally more careful with their meager savings. The fact that the unemployment rate is soaring for younger workers just adds more fuel to the fire. Without a decent job, young people cannot afford to get married, buy a house and have children.
• The global pension crisis: A common theme of this blog is how pension poverty is wreaking havoc on our economy. It’s not just the demographic shift, as people retire with little or no savings, they consume less, governments collect less sales taxes and they pay out more in social welfare costs. This is why I’m such a stickler for enhanced CPP and Social Security, a universal pension which covers everyone (provided governments get the governance and risk-sharing right).
• Rising inequality: Rising inequality is threatening the global recovery. As Warren Buffett once noted, the marginal utility of an extra billion to the ultra wealthy isn’t as useful as it can be to millions of others struggling under crushing poverty. But while Buffett and Gates talk up “The Giving Pledge”, the truth is philanthropy won’t make a dent in the trend of rising inequality which is extremely deflationary because it concentrates wealth in the hands of a few and does nothing to stimulate widespread consumption.
• High and unsustainable debt in the developed world: Government and household debt levels are high and unsustainable in many developed nations. This too constrains government and personal spending and is very deflationary.
• Technology: Everyone loves shopping on-line to hunt for bargains. Technology is great in terms of keeping productivity high and prices low, but viewed over a very long period, great shifts in technology are disinflationary and some say deflationary (think Amazon, Uber, etc.).

Why am I bringing this up? Because the stock market is acting as if reflationary policies will succeed while the bond market is preparing for a protracted deflationary episode.

And while some think negative yields outside the US are “distorting” the US bond market, I would be very careful here because the fact remains Asia and Europe remain mired in deflation which can easily spread to the United States via lower import prices. So maybe the bond market has it right.

This brings me to an important point, Gerard is right when he says that “bonds are now almost certain to deliver low returns, by definition, if held to maturity,” but he’s missing a crucial point, one that I keep hammering, in a deflationary environment, bonds are the ultimate diversifier.

Put simply, this means despite the fact that ultra low or negative yields are here to stay, you still need bonds in your portfolio to buffer the financial shocks or even the volatile markets that are the product of record low bond yields and everyone chasing yield by taking more risk.

Gerard is right that too many people are focused on the national debt without realizing how the United States of pension poverty is on the road to more debt if it doesn’t fix its retirement system and make it more like the one we have in Canada where our politicians just agreed to enhance the CPP which was the smartest move in terms of bolstering our retirement system.

This brings me to El-Erian’s solution to the pension crisis:

To avoid disaster, policy makers and investment managers should consider three fixes. First, be a lot more realistic about the returns that can be achieved within traditional risk tolerance parameters. Second, put in place policies to boost savings and income, so people — particularly the most vulnerable — will have more money available to put aside for retirement. Third, be transparent with retirees about the risks that are being taken on their behalf, also offering less risky options with explicitly lower expected returns.

Sure, delusional US public pensions need more realistic return targets, after all there’s no big illusion in the bond market, it’s sending a clear message to everyone to prepare for lower returns ahead.

But while low returns are taking a toll on all pensions, especially US public pensions, the most pernicious factor driving pension deficits is record low or negative bond yields.

Importantly, at a time when pretty much all asset classes are fairly valued or over-valued, if another financial crisis hits and deflation sets in for a prolonged period, it will decimate all pensions.

To understand why, you need to understand what pensions are all about, namely, matching assets with liabilities. The liabilities most pensions have in their books go out 75+ years, while the investment life of most of the assets they invest in is much shorter (this is why pensions are increasingly focusing on infrastructure).

This means that a drop in rates will disproportionately impact pension deficits, especially when rates are at record lows because the duration of pension liabilities is much bigger than the duration of pension assets.

So even if stocks and corporate bonds are soaring, who cares, as long as rates keep declining, pension deficits will keep soaring. And if another financial crisis hits, watch out, both assets and liabilities will get hit, the perfect storm which will sink the pension Titanic.

El-Erian is right, the US needs to put in place a system that promotes savings but saving for what, a 401(k) nightmare or something much better like an enhanced Social Security modeled after what the Canada Pension Plan Investment Board is doing?

All these Wall Street types peddling their retirement solution are only looking to gouge consumers with more fees and paltry returns. America definitely needs a revolutionary retirement plan, just not the one Tony James and Teresa Ghilarducci are pushing for.

Also, El-Erian is right, pensions need to be transparent about the risks they’re taking on behalf of retirees but they also need to be transparent about the lack of proper governance at US pensions and the need to implement a risk-sharing model to avoid a Chicago-style solution to the looming pension disaster which is coming to many American cities and states.

Last but not least, policymakers and public pensions have to be transparent and expose the brutal truth on defined-contribution plans as well as explain the benefits of large, well governed defined-benefit plans.

Of course, Bill Gross, Mohamed El-Erian, Gerard MacDonell and many others don’t discuss all this because they aren’t as well informed on all these issues to the extent that I am. I’m not deriding them, just stating a fact, when it comes to the pension Titanic sinking, there’s only one lone wolf who’s been warning all of you about the problem since June 2008 when he first started a blog called Pension Pulse.

With deflation on our doorstep, all of a sudden these experts are warning us of a looming retirement disaster. Where were they over the last decade, sipping the Kool-Aid?

Speaking of sipping the Kool-Aid, J.P. Morgan Asset Management, overseeing $1.7 trillion, says U.S. inflation is picking up. “U.S. inflation has actually come back,” Benjamin Mandel, a strategist for the company in New York, said Thursday on Bloomberg Television. “This idea that U.S. inflation is low and is always going to be low is an anachronism.”

My advice to all pensions is forget what Wall Street is selling you and prepare for the deflation tsunami ahead. The pension Titanic is sinking and you need to prepare for a long bout of low returns, low growth, low inflation and possibly even deflation ahead.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Benefits Canada reports, Ontario Teachers’ acquires U.S. oil and gas assets:

The Ontario Teachers’ Pension Plan – along with RedBird Capital Partners and Aethon Energy Management – will acquire J-W Energy’s assets in north Louisiana and northeast Texas.

Redbird, a North American-based principal investment firm, and Aethon, a Dallas-based onshore oil and gas investor, have partnered with the pension plan to purchase oil and gas upstream and midstream assets. Additional assets obtained in the partnership will be combined with the J-W assets to form a joint group, Aethon United.

“We are looking forward to partnering with Aethon, a proven firm with an exceptional track record and strong alignment with Ontario Teachers’, as well as expanding our strategic relationship with RedBird,” said Jane Rowe, senior vice-president of private capital at Ontario Teachers’. “These assets are a strong fit with our private equity energy portfolio and represent a compelling investment opportunity with an established base of long-life proven reserves and attractive growth opportunities.”

The Texas and Louisiana properties comprise approximately 84,000 acres and 380 miles of gathering and processing infrastructure which, added to Aethon United’s existing assets, results in a 350,000 net acres, the other portion of which is made up from previous deals with Encana, Noble Energy and SM Energy.

Ontario Teachers’ put out a press release on this deal:

Ontario Teachers’ Pension Plan (“Ontario Teachers'”) RedBird Capital Partners (“RedBird”), and Aethon Energy Management (“Aethon”) today announced the acquisition of J-W Energy’s (“J-W”) oil & gas upstream and midstream assets located in northeast Texas and north Louisiana. Additionally, Haynesville and Rockies assets acquired in partnership by Aethon and Redbird are being consolidated with the J-W assets, forming a joint partnership (“Aethon United”).

Located in north Louisiana and northeast Texas, the J-W Energy assets comprise approximately 84,000 net acres and 380 miles of associated gathering and processing infrastructure. The collective reserve base of the J-W assets combines low risk, long life, and highly predictable production with attractive development opportunities.

With this acquisition, Aethon United now operates in excess of 350,000 net acres and 166 MMcfe/d of production. In addition to the J-W Energy assets, Aethon United operates approximately 91,000 net acres in the Haynesville previously acquired from SM Energy and Noble Energy, as well as approximately 181,000 net acres in the Wind River Basin of Wyoming previously acquired from Encana.

Albert Huddleston, Founder & Managing Partner of Aethon, commented, “We are excited to partner with Ontario Teachers’ and continue our long-standing partnership with RedBird to acquire J-W Energy’s high quality, low risk, unconventional assets, which continues to expand our acreage in the Arkansas-Louisiana-Texas area. The J-W Energy assets help to diversify and expand our existing portfolio, and highlights Aethon’s ability to identify attractive E&P assets, offering strong risk-adjusted returns in the current market environment and in the future. We are grateful for the confidence shown in the Aethon Energy team for the series of investments in partnership with us by noted investors Ontario Teachers’ and RedBird, which ratifies our 26 year track record.”

“We are looking forward to partnering with Aethon, a proven firm with an exceptional track record and strong alignment with Ontario Teachers’, as well as expanding our strategic relationship with RedBird” said Jane Rowe, Senior Vice President of Private Capital. “These assets are a strong fit with our private equity energy portfolio and represent a compelling investment opportunity with an established base of long-life proven reserves and attractive growth opportunities.”

“Aethon has been a tremendous partner with RedBird in the build-up of our collective energy investments, and we’re excited to expand this partnership with our friends at Ontario Teachers’ with whom we have a very strong strategic relationship,” said Hunter Carpenter, Partner at RedBird Capital. “This partnership is an example of RedBird’s unique ability to identify proven owners and entrepreneurs like Aethon Energy who are frequently unavailable to traditional institutional capital. Aethon Energy represents a rare combination of investing and operating expertise providing superior historical performance and operating skill.”

About Aethon Energy Management

Aethon Energy Management LLC is a Dallas-based private investment firm that has managed and operated over $1.6 billion of assets, and is focused on direct investments in North American onshore oil & gas. Since its inception in 1990, Aethon has maintained a focus on acquiring under-appreciated assets where opportunities exist to add value through lower-risk development, operational enhancements and Aethon’s proprietary technical knowledge. Aethon’s 26-year track record spans multiple energy cycles and has consistently provided compelling asymmetric returns for its institutional and high net worth investors through disciplined buying and value creation. For more information, go to www.AethonEnergy.com.

About Ontario Teachers’

The Ontario Teachers’ Pension Plan (Ontario Teachers’) is Canada’s largest single-profession pension plan, with $171.4 billion in net assets at December 31, 2015. It holds a diverse global portfolio of assets, 80% of which is managed in-house, and has earned an annualized rate of return of 10.3% since the plan’s founding in 1990. Ontario Teachers’ is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario’s 316,000 active and retired teachers. For more information, visit www.Otpp.com and follow us on Twitter @OtppInfo.

About RedBird Capital Partners

RedBird Capital Partners is a North America based principal investment firm focused on providing flexible, long-term capital to help entrepreneurs grow their businesses. Based in New York and Dallas, RedBird seeks investment opportunities in growth-oriented private companies in which its capital, investor network and strategic relationships can help prospective business owners achieve their corporate objectives. RedBird’s private equity platform connects patient capital with business founders and entrepreneurs to help them outperform operationally, financially and strategically. For more information, go to www.RedBirdCap.com.

J-W Energy Company also put out a press release on this deal:

J-W Energy Company is pleased to announce the closing on July 1, 2016 of the sale of substantially all of the oil and gas assets owned by J-W Operating Company and substantially all of the midstream assets owned by J-W Midstream Company to affiliates of Aethon United LP. The assets included in the transaction are located mainly in the North Louisiana and North Texas areas and are comprised of approximately 95,000 net acres and 380 miles of associated gathering and processing infrastructure. The sale is an exit from the upstream and midstream business by J-W Energy Company, which will continue to own the largest privately-held compression fleet in the U.S. through its wholly-owned subsidiary, J-W Power Company. Over the past ten years, J-W Energy has exited from its drilling, valve manufacturing, gas measurement and wireline businesses as well, as part of a planned reallocation of company resources.

“This exit from the upstream and midstream businesses will allow J-W Energy Company to focus on our compression business, which has been less capital intensive than the upstream and midstream businesses. Despite this sale marking the end of J-W Energy’s long and successful history in the upstream and midstream businesses, we are confident that the dedicated employees of J-W Operating and J-W Midstream will be instrumental in the future success of this endeavor,” said David A. Miller, President of J-W Energy Company.

Wells Fargo Securities, LLC served as the exclusive financial advisor to J-W Energy on the transaction.

You can also read more about J-W Midstream Company here:

J-W Midstream Company is a natural gas gathering and processing company that has been active in the gathering, dehydration, treating, processing and transmission of natural gas for over thirty years. With that experience, we understand the producer’s need for high quality, cost-effective, completely reliable services.

From engineering and construction to contract gathering and processing, J-W Midstream Company is committed to providing a continuously uninterrupted flow of gas to our customers and real value to their bottom lines.

J-W Midstream Company operates more than 400 miles of natural gas pipeline systems in Louisiana and Texas, as well as processing facilities that range from small refrigeration and J-T skids to 25 MMSCFD cryogenic units.

Through an affiliate company, J-W Midstream Company can supply outsourced gas sales and other gas management functions.

So, what is this deal all about and why is Ontario Teachers’ partnering up with Aethon Energy and RedBird Capital to buy J-W Energy Company’s upstream and midstream businesses?

This is how private equity works. J-W Energy is a private company which is an industry leader in the leasing, sales and servicing of natural gas compression equipment, in both standard and custom packages. It has been leasing compressor and compressor/maintenance packages for more than 40 years.

The company was looking to exit its upstream and midstream businesses to focus on its core business which is the compression business. Once this opportunity presented itself, Aethon, RedBird and Ontario Teachers’ pounced to act quickly and acquire these assets.

This was a co-investment where Teachers’ invested a substantial amount alongside its partners and didn’t pay any fees. Along with Atheon and RedBird, Teachers’ will look to develop J-W Energy’s upstream and midstream businesses and because it’s a pension with a very long investment horizon, it doesn’t have the pressure that a traditional private equity fund has to unlock value of these business units during three or four years.

In other words, the deal is a win for J-W Energy Company and if Teachers’ and its partners succeed in improving the operations of the upstream and midstream businesses over the next five to ten years, it will be a win for them, the employees of these businesses and of course, Teachers’ contributors and beneficiaries.

Why invest in energy now? Last December, I wrote a comment on why Canada’s pensions are betting on energy and in November of last year, I met up with AIMCo’s president Kevin Uebelein here in Montreal on the day they announced a major transaction buying a $200M stake in TransAlata’s renewable energy business.

When it comes to energy, focus on what Jane Rowe said in the press release: “These assets are a strong fit with our private equity energy portfolio and represent a compelling investment opportunity with an established base of long-life proven reserves and attractive growth opportunities.”

When you are a pension the size of an Ontario Teachers’ you will seek attractive opportunities in down-beaten sectors across public and private markets and use your long investment horizon to realize big gains. This is a competitive advantage all of Canada’s large pensions have over traditional private equity funds, namely, they have very deep pockets and a much longer investment horizon to ride out short-term cyclical swings.

Teachers’ isn’t the only large Canadian pension looking to capitalize on energy opportunities. Lincoln Brown of Oilprice.com reports, Two Pension Fund Groups Bid for TransCanada’s $2B Mexican Pipeline:

A TransCanada Mexican pipeline is drawing significant interest from pension funds. Canada Pension Plan Investment Board, Public Sector Pension Investment Board and Borealis Infrastructure Corp. have created a consortium in order to purchase up to 49.9 percent of the business, which has been estimated to be worth some US$2 billion.

Caisse de Depot et Placement du Quebec’s new Mexican joint venture, CKD Infraestructura Mexico SA, are also interested in purchasing stakes, along with three other unnamed businesses.

That information comes from a source with knowledge of the situation who spoke to Bloomberg but asked not to be identified. TransCanada spokesman Mark Cooper has confirmed the company is seeking investors but would not comment beyond that. The Calgary-based company is trying to sell its minority stake in the pipeline, along with power plants in the northeastern United States to generate cash to buy Columbia pipeline Group Inc. That deal is estimated at US$10.2 billion.

Mexico is increasingly drawing the attention of investors. The country recently began a US$411 billion plan for its infrastructure, focusing on transportation and energy. Canada Pension and the Ontario Teacher’s Pension Plan already made an investment last month in a toll road operator in Mexico.

In June, the company announced it would build and operate a US$2.1 billion natural gas pipeline in Mexico. The company said it would parent with Sempra Energy’s IEnova unit, with TransCanada owning a 60 percent stake in the venture. The effort will be backed by Mexico’s state-owned power company and is expected to be in service by 2018. TransCanada recently made news in the United States when it announced a lawsuit against the state because of the suspension of the controversial Keystone XL pipeline project.

Lastly, Benefits Canada recently reports, Ontario Teachers’, PSP increase stakes in sustainable investment firm:

The Ontario Teachers’ Pension Plan and the Public Section Pension Investment Board will buy out Banco Santander’s interest in Cubico Sustainable Investments. The three firms launched the London-based renewable energy and water infrastructure company in May 2015.

After the acquisition, PSP Investments and Ontario Teachers’ will each own 50 per cent of Cubico’s shares.

Cubico’s initial portfolio included 18 water, wind and solar infrastructure assets with a net capacity of 1.2 gigawatts. The company has since acquired four new assets, bringing its net capacity to 1.62 gigawatts. Cubico’s 22 assets are in Brazil, Italy, Ireland, Mexico, Portugal, Spain, United Kingdom and Uruguay.

“Our increased participation in Cubico is aligned with PSP Investments’ long-term investment approach and strategy to leverage industry-specific platforms and develop strong partnerships with liked-minded investors and skilled operators,” Guthrie Stewart, senior vice-president and global head of private investments at PSP Investments, said in a release.

“Cubico’s flexible investment and acquisition approach fits well with Ontario Teachers’ approach to private investments,” Andrew Claerhout, senior vice-president of infrastructure at Ontario Teachers’ said in the release.

As you can see, Canada’s large public pensions have been busy hunting for traditional and alternative energy deals all around the world. They’re using their internal expertise and their expert network of partners to capitalize on opportunities as they arise, and that is why they are way ahead of their global counterparts when it comes to opportunistic, long-term investing.

Institutional investors aren’t racing each other; even still, it’s interesting to see how they stack up against one another.

Corporate ERISA plans posted a higher median return in the second quarter of 2016 than any other plan type, according to Northern Trust data; public pensions came in second, with endowments trailing.

The ranking holds when the timeline is expanded to the last 5 years.

More from PlanSponsor:

In the second quarter of 2016, the corporate Employee Retirement Income Security Act (ERISA) plans category fared best among all plan types with a median return of 3%, Northern Trust finds. Public funds were close behind with 1.7% in gains, while foundations/endowments netted 1.5% in the second quarter.

“Differing returns across plan types were driven largely by the duration of their fixed-income investments,” explains Bill Frieske, senior investment performance consultant, Northern Trust Investment Risk and Analytical Services. “In an effort to de-risk their defined benefit pension plans, corporate ERISA plan sponsors have been lengthening the duration of their fixed-income programs. Interest rates declined in the second quarter, which increased returns for long duration bonds and helped boost corporate ERISA plan returns.”

[…]

For public funds, returns were dampened by a larger allocation to international equities (15% at the median), which produced the lowest median return of the major asset classes. For foundations and endowments, returns were muted by weak performance from a significant 11% allocation to private equity, “the second lowest returning major asset class at 0.2%.”

Long-term data reported with the quarterly results shows corporate ERISA plans have enjoyed 5-year trailing returns of 7.5%, while public funds earned 6.9% and foundations/endowments netted 5.7%.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Darrell Preston of Bloomberg reports, Bill Gross’s Admonishment Supported By Illinois Pension Fund:

Illinois’s largest public pension agrees with Bill Gross’s admonishment that it’s time to face up to the reality of lower returns and reduce assumptions about what funds can make off stocks and bonds.

Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV. Public pensions, including the California Public Employees’ Retirement System, the largest in the U.S., are reporting gains of less than 1 percent for the fiscal year ended June 30.

Illinois’s largest state pension, the $43.8 billion Teachers’ Retirement System, plans to take another look at how much it assumes it will make in the coming year as part of an asset allocation study, said Richard Ingram, executive director. Currently it assumes 7.5 percent, lowered from 8 percent in June 2014. Plans for the study were in place before Gross made his remarks.

“Anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality,” Ingram, whose pension is 41.5 percent funded, said in a phone interview. The fund has yet to report its June 30 return.

Lowering how much pensions assume they can earn from investment of assets could put many in the difficult position of having to cut benefits or ask for increased contributions from workers and state and local governments that sponsor them or risk seeing the amount of assets needed to pay future benefits shrink. The $3.55 trillion of assets now held by public pensions is about two-thirds the amount needed to pay retirees, according to Federal Reserve data.

Since the financial crisis, the interest rates earned on bonds have remained low as stock prices have brought strong returns some years and more modest returns in other years. Calpers earned 0.6 percent in the fiscal year ended June 30, with an average gain of 5.1 percent over 10 years.

Illinois is struggling with $111 billion of pension debt, and more than half of that, or about $62 billion, is for the Teachers’ Retirement System. The partisan gridlock that spurred the longest budget impasse in state history only exacerbated the problem. Governor Bruce Rauner and lawmakers have made no progress in finding a fix for the rising liabilities that helped sink Illinois’s credit rating to the lowest of all 50 states.

Lagging Returns

Others also have reported meager returns recently, including a 0.19 percent gain for New York state’s $178.1 billion retirement system and a 1.5 percent increase in New York City’s five pension funds with $163 billion of assets, the smallest gain since 2012.

Government-retirement systems have lagged return targets after U.S. stocks declined last year and bond yields hold near record lows, leaving little to be made from fixed-income investments. Large plans have an average of 46 percent of their money in equities, with 23 percent in bonds and 31 percent in other assets such as private equity, Moody’s Investors Service said in a July 26 report, citing its review of fund disclosures.

“If investment returns suffer, you have to look at reality until we return to a more normal investment environment,” said Chris Mier, a municipal strategist with Loop Capital Markets in Chicago. “Some pensions don’t like changing those assumptions because then their liabilities increase.”

Pensions’ push into stocks and other high-risk investments have exacerbated pressures on the funds because of the “significant volatility and risk of market value loss” at a time when governments have little ability to boost contributions if returns fall short, Moody’s said in its report.

Dialing Back

Public pensions over 30-year-or-so horizons traditionally could hit targets for returns of 7 percent to 8 percent. But that was in an era before the Fed began holding down interest rates to stimulate the economy and returns in the stock market were not high enough to offset lower fixed-income investments.

Public pensions have been reducing assumed rates of returns, cutting from a median of 8 percent six years ago to 7.5 percent currently, said Keith Brainard, who tracks pensions for the National Association of State Retirement Administrators. Now “more than a handful” are below 7 percent, he said.

“We’ve seen a pronounced decline in return assumptions,” said Brainard.

Public pensions have been hurt by the Fed’s zero-rate policy that Gross says has led to “erosion at the margins of business models” such as the ones used for funding public pensions, which depend on assumptions about returns over time horizons of 30 years or more.

“Pensions have to adjust,” said Gross. “They have to have more contributions and they have to reduce benefit payments.”

Bill Gross is right, low returns are taking a toll on US pensions, especially delusional public pensions that refuse to acknowledge that ultra low and even negative rates are here to stay, and that necessarily means they need to assume lower returns ahead, cut benefits and increase contributions.

Of course, astute readers of this blog know my thoughts, cutting benefits and increasing contributions is the easy part. So is hiking property taxes and utility rates to fund unfunded public pensions, just like Chicago just did. Sure, it takes political courage to admit your public pensions are effectively bankrupt and require drastic measures to get them back to an acceptable funded status, but that isn’t the hard part.

It’s much harder introducing real change to US public pensions, change that I discussed in the New York Times three years ago when I wrote about the need for independent, qualified investment boards and governance rules that mimic what Canada’s large public pensions have done.

Importantly, apart from years of mismanagement, the lack of proper governance is a huge factor as to why so many US public pensions are in such dire straits yet very few politicians are discussing this topic openly and in a constructive manner.

And instead of cutting their assumed rate of return, what are US public pensions doing? What else, they’re taking more risks in alternative investments like private equity and hedge funds.

Unfortunately, that hasn’t panned out too well (shocking!). Private equity’s diminishing returns and hard times in Hedge Fundistan are hitting public pensions very hard.

In fact, Charles Stein of Bloomberg reports, Hedge Funds Make Last Place at $61 Billion Massachusetts Pension:

Public pension funds have soured on hedge funds.

The New Jersey Investment Council last week voted to cut its target allocation to hedge fund managers by 52 percent, following similar moves by pensions in California and New York. The institutions are disappointed by the combination of high fees and modest returns the hedge funds have delivered.

The chart below explains some of that unhappiness. In the 10-years ended June 30, the $60.6 billion Massachusetts public fund realized a 3.2 percent average annual return, net of fees, from the hedge funds in which it invests. That was the worst performance of seven asset classes the fund holds, according to data released last week for the Pension Reserves Investment Trust Fund. Private equity, with a 14.4 percent annual gain, was the top performer. The fund overall returned 5.7 percent a year.

It’s not that Massachusetts picked especially bad managers. Its hedge fund returns are roughly in line with industry averages. The fund weighted composite index created by Hedge Fund Research Inc. gained 3.6 percent a year over the same stretch.

Unlike some of its peers, Massachusetts hasn’t reduced its roughly 10 percent allocation to hedge funds. Rather, the pension in 2015 began making investments in the asset class through managed accounts rather than co-mingled accounts. The strategy has resulted in fee discounts of 40 to 50 percent, said Eric Nierenberg, who runs hedge funds for Massachusetts’ pension.

“We are hedge fund skeptics,” he said in an e-mailed statement. The investments made through the new structure have performed “considerably better” than the pension’s legacy holdings, Nierenberg said.

[Note: If you are looking for a managed account platform for hedge funds, talk to the folks at Innocap here in Montreal. Ontario Teachers’ Pension Plan uses their platform for its external hedge funds and they know what they’re doing monitoring operational and investment risks on Teachers’ behalf.]

I guarantee you over the next ten years, returns on all these asset classes will be considerably lower, especially private equity. And the most important asset class for all pensions in ten years will likely be infrastructure, but even there, returns will come down as more and more pensions chase stable yield.

The crucial point I want to drive home is this:  Yields are coming down hard across the investment spectrum and all pensions need to adjust to the new reality. Low returns are taking a toll on all pensions, especially US public pensions, but it’s record low and negative yields that are really hurting them. There is no big illusion in the bond market; it’s sending an ominous warning to all investors, prepare for lower returns ahead.

On that note, back to trading my biotech shares because when they start running, they run fast and hard and I need to capitalize on these rallies (click on image):

Sometimes I wonder how are hedge funds commanding 2 & 20 for mediocre returns when I can’t get more large pensions to subscribe or donate to my blog? Oh well, go figure.

U.S. public pension funds take a more aggressive approach to risk than their private — or foreign — peers.

Why? A recent paper examined the regulatory incentives that make U.S. public pensions different than their counterparts in the private sector and in other countries.

From the Economist:

As a recent paper* by Aleksandar Andonov, Rob Bauer and Martijn Cremers shows, that different approach is driven by a regulatory incentive—the rules that determine how pension funds calculate how much they must put aside to meet the cost of paying retirement benefits. Usually, the bulk of a pension fund’s liabilities occur well into the future, as workers retire. So that future cost has to be discounted at some rate to work out how much needs to be put aside today.

Private-sector pension funds in America and elsewhere (and Canadian public funds) regard a pension promise as a kind of debt. So they use corporate-bond yields to discount future liabilities. As bond yields have fallen, so the cost of paying pensions has risen sharply. At the end of 2007, American corporate pension funds had a small surplus; by the end of last year, they had a $404 billion deficit.

American public pension funds are allowed (under rules from the Government Accounting Standards Board) to discount their liabilities by the expected return on their assets. The higher the expected return, the higher the discount rate. That means, in turn, that liabilities are lower and the amount of money which the employer has to put aside today is smaller.

Investing in riskier assets is thus an attractive option for a public-sector employer, which can tap only two sources of funding. It can ask its workers to contribute more, but since they are well-unionised that can lead to friction (after all, higher pension contributions amount to a pay cut). Or the employer can take the money from the public purse—either by cutting other services or by raising taxes. Neither option is politically popular.

Unsurprisingly, therefore, the academics found that American public pension funds choose a riskier approach.

The Illinois Teachers’ Retirement System will consider revising its assumed rate of return downward as part of an upcoming asset allocation study, according to a report by Bloomberg.

Return targets have been in the news lately, as the country’s largest pension funds have announced investment results that underperform assumptions. Bill Gross went on Bloomberg TV last week and called for pension funds to revise return targets downward to 4 percent.

More from Bloomberg:

Illinois’s largest state pension, the $43.8 billion Teachers’ Retirement System, plans to take another look at how much it assumes it will make in the coming year as part of an asset allocation study, said Richard Ingram, executive director. Currently it assumes 7.5 percent, lowered from 8 percent in June 2014.

“Anybody that doesn’t consider revisiting what their assumed rate of return is would be ignoring reality,” Ingram, whose pension is 41.5 percent funded, said in a phone interview. The fund has yet to report its June 30 return.

[…]

Public pensions over 30-year-or-so horizons traditionally could hit targets for returns of 7 percent to 8 percent. But that was in an era before the Fed began holding down interest rates to stimulate the economy and returns in the stock market were not high enough to offset lower fixed-income investments.

Public pensions have been reducing assumed rates of returns, cutting from a median of 8 percent six years ago to 7.5 percent currently, said Keith Brainard, who tracks pensions for the National Association of State Retirement Administrators. Now “more than a handful” are below 7 percent, he said.

[…]

Fund managers that have been counting on returns of 7 percent to 8 percent may need to adjust that to around 4 percent, [Bill] Gross, who runs the $1.5 billion Janus Global Unconstrained Bond Fund, said during an Aug. 5 interview on Bloomberg TV.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Rory Carroll and Edward Krudy of Reuters report, Low investment returns taking a toll on U.S. pension funds:

For the second straight year, U.S. public pension funds have fallen well short of their investment targets, swelling their vast unfunded liabilities and placing a greater burden on municipalities to offset the underperformance through increased contributions, estimates show.

The funds, which guarantee retirement benefits for millions of public workers, logged total returns of around 1 percent for the fiscal year ending June 30, while private pension funds earned more than triple that, according to preliminary estimates from consulting firms Wilshire Consulting and Milliman, respectively. Those figures could change as complete data for the period becomes available.

That is a poor showing relative to the 7 percent or more that pension funds seek to earn annually.

The shortfalls could add fuel to the growing debate about the long-term viability of public pensions – which financier Warren Buffett once referred to as a “gigantic financial tapeworm.”

The funds have suffered from years of underfunding exacerbated by states lowering their contributions when the funds were performing well, political resistance to increasing taxpayer contributions, overly optimistic return assumptions and retirees living much longer than they used to.

The 100 largest U.S. public pension funds were just 75 percent funded, according to a 2015 study conducted by Milliman.

The pension funds have been challenged by a multi-year environment of rock-bottom interest rates and mixed stock market performance.

Public pension funds likely did worse than private funds, because the public funds had more money in short-term bonds which, during the fiscal year, underperformed the long-term bonds that private pension funds favor, said Ned McGuire, vice president and member of the Pension Risk Solutions Group at Wilshire Consulting.

Complete data on the public funds isn’t available yet, but early reporters reveal significant underperformance.

The California Public Employees’ Retirement System (CalPers) and The California State Teachers’ Retirement System (CalStrs), the two largest public pension funds, returned 0.6 percent and 1.4 percent respectively, in the 12 months ending June 30. That is a huge miss compared with the 7.5 percent they need to reach fund their liabilities in the long run.

The New York State Common Retirement Fund, the nation’s third-largest public pension fund, earned just 0.19 percent return on investments, missing its 7 percent target.

The Wisconsin Retirement System, the ninth-largest U.S. public pension fund, had a return of 4.4 percent for its core fund in fiscal 2016, well below its assumed rate of return of 7.2 percent.

In response to missing its target, also known as its “discount rate,” CalPers on Monday said it was reviewing the changing demographics of its members, the economy and expectations for financial markets.

“We will conduct these reviews over the next year to determine if our discount rate should be changed sooner rather than later,” CalPers said in a statement.

Public funds had a return of just over 1 percent, while corporate funds had a return of 1.64 percent, according to a report released on Tuesday by Wilshire Trust Universe Comparison Service, a database service provided by Wilshire Analytics.

At the same time, the top 100 corporate funds returned 3.3 percent, according to Milliman. Becky Sielman, an actuary at Milliman, said the most recent underperformance is harder to handle because it continues a troubling trend for public and private funds.

“It’s easier to absorb one down year followed by a good year,” she said. “Likely what we have here for many plans is two down years in a row.”

There is a lot to cover here and while these reporters do a good job giving us a glimpse of what is going on at US public and private pensions, their analysis is incomplete (it’s not their fault, they report on headline figures). As such, let me dig deeper and take you through the key points below.

The first thing I would say is returns are coming down everywhere. Pension funds, mutual funds, insurance funds, hedge funds, private equity funds, and sovereign wealth funds. Why? Well, when interest rates around the world are at record lows or even negative territory, financial theory tells you that returns across the investment spectrum will necessarily come down.

You can’t manufacture returns that aren’t there; the market gives you what the market gives you and when rates are at record lows, you need to prepare for much lower returns ahead. This holds true for institutional and retail investors.

Interestingly, I posted an article on Twitter and LinkedIn yesterday on how a big Wall Street cash cow is slowly getting cooked. The article explains why many big banks are seeing fees from wealth and investment management divisions fall, putting a crimp in critical revenue at a time when Wall Street is having an increasingly tough time matching their return on equity targets.

In fact, Wall Street is now bracing for its worst two years since the financial crisis. With fees coming down, the big banks’ revenues are getting hit which is why they are in cost-cutting mode, preparing to navigate what will likely be a long deflationary slump. The only good news for Wall Street banks might be the $566 billion business of packaging commercial mortgages into securities (and even that isn’t good news if the CMBS market crashes).

But make no mistake, record low rates are hitting all financial companies (XLF), including life insurers like MetLife (MET) which plunged more than 8.5% Thursday after reporting earnings well below expectations and a $2 billion charge related to its planned spinoff of its US retail business.

On Friday morning, following the “blowout” US jobs report, yields backed up in the US bond market but nothing frightening. At this writing, the yield on the 10-year Treasury note backed up 6 basis points to 1.57% but the bond market isn’t worried of major gains ahead (quite the opposite).

In fact, while everyone is getting excited about the latest jobs report, I retweeted something from @GreekFire23 which should put a damper on expectations of a Fed rate hike any time soon (click on image):

Before you dismiss this, you should all take the time to also read Warren Mosler’s analysis on Trade, Jobs, SNB buying US stocks, German Factory Orders.

My take on the July US jobs report? It definitely surprised everyone to the upside but when you dig a little deeper, the employment picture is hardly as strong as the headline figure suggests.

Either way, I remain long the US dollar for the remainder of the year and as I wrote in my comment on “sell everything except gold” two days ago, I remain long the biotech sector (IBB and XBI) and short gold miners (GDX), oil (USO), metal & mining (XME), energy (XLE) and emerging market (EEM) shares. I also still consider US bonds (TLT) as the ultimate diversifier in a deflationary world.

Enough on my investment thoughts, let’s get back to analyzing the article above. Investment returns are coming down as rates hit record lows but that is only part of the picture.

Importantly, all pensions around the world are getting slammed by lower returns but more worryingly by higher future liabilities due to record low rates.

Remember what I keep harping on, pensions are all about managing assets AND liabilities. When risk assets (stocks, corporate bonds, etc.) get hit, of course pensions get hit but when rates are at record lows and keep declining, this is the real death knell for pensions.

This is why I keep warning you deflation will decimate all pensions. Why? Because deflation will hit assets and more importantly, liabilities very hard as it means ultra low and possibly negative rates are here to stay. [For all you finance geeks, the key thing to remember is the duration of pension liabilities is much bigger than the duration of pension assets so a drop in rates, especially from historic low levels, will disproportionately and negatively impact pension deficits as liabilities soar.]

This is the reason why UK pensions just got hammered following the Bank of England’s decision to cut rates. Lower rates mean pensions have to take more risk to meet their actuarial return target in order to make sure they have enough money to cover future liabilities.

But lower rates also mean public and private pensions need to get real about their investment assumptions going forward. When I went over whether CalPERS smeared lipstick on a pig, I didn’t blast them for their paltry returns but I did question why they’re still holding on to a ridiculously high 7.5% annualized investment projection to discount future liabilities. And CalPERS isn’t alone, most US public pensions are delusional when it comes to their investment projections. There’s definitely a big disconnect in the pension industry.

By contrast, US corporate plans use corporate bond yields to discount their future liabilities and most of them practice much tighter asset-liability matching than public pensions. This effectively means they carry more US bonds in their asset mix as they derisk their portfolios which explains why the top 100 corporate funds returned 3.3% as of the fiscal year ending in June when public pensions returned only 1% during the same time (domestic bonds outperformed global equities during this period).

But if you go look at the latest report on Milliman’s Pension Funding Index, you will see despite higher returns, corporate plans aren’t in much better shape when it comes to their funded status:

The funded status of the 100 largest corporate defined benefit pension plans dropped by $46 billion during June as measured by the Milliman 100 Pension Funding Index (PFI). The deficit rose to $447 billion at the end of June, primarily due to a decrease in the benchmark corporate bond interest rates used to value pension liabilities. As of June 30, the funded ratio decreased to 75.7%, down from 77.5% at the end of May.

The decision of the U.K. to separate themselves from the other 27 European Union countries will cause the most damage (compared to expectations) to the balance sheet of employers with a fiscal year that ends on June 30, 2016, and collateral damage to pension cost for fiscal years starting on July 1, 2016. The impact on pension cost could vary depending on the selection of a mark-to-market methodology or smoothing of gains and losses.

The projected benefit obligation (PBO), or pension liabilities, increased to $1.839 trillion at the end of June from $1.785 trillion at the end of May. The change resulted from a decrease of 23 basis points in the monthly discount rate to 3.45% for June, from 3.68% for May. The discount rate at the end of June is the lowest it has been in 2016 and is the second lowest in the 16-year history of the Milliman 100 PFI. Only the January 2015 discount rate of 3.41% was lower. We note that the funded status deficit in January 2015 was $427 billion. The highest funded status deficit in dollars was $480 billion in October 2012.

And again, US corporate plans use corporate bond yields to discount their future liabilities. If US public pensions adopted this approach, most of them would be insolvent. 

I leave you with something I wrote in my last comment on Chicago’s pension woes:

There’s an even bigger problem which I want policymakers to wrap their heads around: chronic public pension deficits are deflationary.

Let me repeat that: Chronic and out of control public pension deficits are DEFLATIONARY. Why? Because it forces governments to introduce more property taxes or utility rate increases (another tax) to address them, leaving less money in the hands of consumers to spend on goods and services.

The other problem with raising taxes and utility bills is they are regressive, hurting the poor and working poor a lot more than Chicago’s ultra rich.

Now I’m going to have some idiotic hedge fund manager tell me “The answer is to cut defined-benefit pensions and replace them with cheaper defined-contribution plans.” NO!!! That is a dumb solution because the brutal truth on DC plans is they are failing millions of Americans, exposing them to pension poverty which is even MORE DEFLATIONARY!!

I want all of you to pay attention to what is going on in Chicago because it’s a cancer which will spread throughout parts the United States where chronic pension deficits are threatening municipalities, cities and states. And this slow motion train wreck will have drastic economic consequences for the entire country.

I cannot over-emphasize how important it is to get pension policy right. Good pension policy based on facts, not myths, is good economic policy for the very long run.

The problem with US public pensions isn’t their nature (we under-appreciate the benefits of DB plans), it’s the ridiculous investment assumptions, poor governance and lack of risk-sharing that underlie them.

The deadline is closely approaching for the New Jersey Senate to approve a ballot measure that would ask voters whether the state’s constitution should be amended to require full pension contributions be made on a quarterly basis.

The deadline is Monday, and even the bill’s sponsor – top Democrat Steve Sweeney – says the bill might not get to a vote.

From Bloomberg:

Lawmakers face a Monday deadline to authorize a ballot measure, which if approved by voters in November would require the state to pay what it owes to pension plans that have less than half of what’s needed to cover obligations. Senate President Steve Sweeney, a Democrat and union official who sponsored the bill, said Thursday he won’t put it up for a vote until he wins an agreement on transportation funding. He accused two unions of trying to illegally coerce the vote.

The constitutional amendment would put the state on track to make full actuarially required contributions by 2022 and cut the unfunded liability by $4.9 billion over three decades. The quarterly payments would strain the state’s cash flow, Moody’s Investors Service and S&P Global Ratings said. Republican Governor Chris Christie, whose signature isn’t required, has called the measure a “road to ruin” that would mandate massive tax increases.

“Getting the funding up is going to be painful,” said Tamara Lowin, director of research at Rye Brook, New York-based Belle Haven Investments, which oversees $5.3 billion of municipal debt. “Making it a forced, fixed expense and making it senior to appropriation debt is a credit weakness, despite the fact that it will eventually bring the state to fiscal stability.”