high investment returns

Arizona’s Largest Pension May Boost Retiree Benefits, Lower Employee Contributions

The Arizona State Retirement System (ASRS) says there could be a permanent benefit increase on the horizon—the first since 2005. System officials also indicated that public workers could see their contributions decrease.

ASRS is 77 percent funded – but officials say higher investment returns, better cash flow and reduced liabilities have opened the door for the potential benefit increases.

From the Arizona Republic:

Paul Matson, chief executive of the $32 billion Arizona State Retirement System, said he expects retirees could see a permanent benefit increase, of undetermined size, sometime in the next three or four years. The last increase for the pension fund and its more than half-a-million members came in 2005. Benefit hikes are made possible by excess investment earnings, largely from the stock market, he said.

Similarly, an improving financial backdrop for the pension system also could mean that more than 200,000 public-sector workers in Arizona — along with the cities, counties, state agencies, school districts and other entities that employ them — could start paying slightly lower contributions to support the system, Matson added.

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At a time when public pension programs including the Arizona State Retirement System remain significantly underfunded, Matson’s assessment was surprisingly upbeat. But recent fixes and long-term trends have put the system in much better shape, he said.

“We have a strong, healthy system that’s fully sustainable on the retirement and health sides,” he said in an interview with The Arizona Republic. The program provides retirement, health and long-term disability benefits.

In an interview with the Arizona Republic, ASRS chief executive Paul Matson expounded on the reasons behind the proposed benefit increase:

Matson cited three main reasons for the improvement:

– Changes in certain benefit formulas have reduced the system’s liabilities. Working with the Legislature over the past decade, the Arizona State Retirement System has closed loopholes and made other adjustments. One involved new workers joining the system. In prior years, many new hires were allowed to purchase retirement-service credits at a cost of about 40 cents on the dollar. That unsustainable practice and about a dozen others have been restricted or eliminated, Matson said.

– Contribution increases have boosted the system’s cash flow and assets. Employees and their employers each currently make contributions into the system equivalent to 11.6 percent of worker salary. That’s up from an unsustainably low 2.5 percent a dozen years ago. As noted, the recent trend of contribution hikes eventually will be followed by modest decreases, before contributions level out around 6.75 percent many years down the road.

– Higher investment returns have bolstered the system’s assets. The stock market has been on a tear, rising about 200 percent between the bottom in early 2009 and the recent peak in September of this year. Although prices have retreated over the past few weeks, the trend for most of the last five years has been favorable. The Arizona State Retirement System generated an average yearly compounded return of 14.2 percent over the five years through June 2014, including a gain of 18.6 percent in the most recent year. Those returns are after expenses.

Matson did say he doesn’t expect investment performance to be quite as good, year in and year out, as it has been the previous 5 years.

ASRS has 551,000 members and manages $32 billion of assets.

Pension Funds Need To Stay Out of the “Bargain Bin” When Shopping For Hedge Funds

More than ever, pension funds are negotiating fees with hedge funds in an effort to lower the expenses associated with those investments.

That sounds like a wise course of action. But a new column in the Financial Times argues that pension funds need to stop shopping in the “bargain bin” for hedge funds—because the hedge funds that are willing to negotiate fees are also the ones who deliver lackluster returns.

From the Financial Times:

With many pension funds facing deficits, and needing investments that will generate high returns, the promise of hedge funds has an obvious appeal.

The problem is, like the star chef, the small number of hedge funds that have made staggering amounts of money for their investors over several decades already have too many clients and are closed for business.

Among these are Renaissance Technologies’ Medallion Fund, founded by the mathematician James Simons, which has long been all but shut to new money, and Seth Klarman’s Baupost Group, which last year returned $4bn to clients and has a highly select number of investors.

At the same time investors in hedge funds, such as pension managers, are loath to pay high fees for their services, and must enter into tough negotiations to bring these fees down. This makes sense.

But few of the handful of truly top tier hedge funds have any need to lower their fees for new investors and tend to politely show such requests to the door.

Mediocre hedge fund managers on the other hand cannot afford to be so dismissive, and are more than happy to gather more assets to play with.

The outcome is that many pension funds end up forcing themselves to shop in the hedge fund equivalent of the reduced aisle in a supermarket. They should stop. At the root of this problem is the flawed thinking that a large number of investors have been either seduced into, or institutionally obliged to believe in: the idea that hedge funds constitute an “asset class” all of their own, distinct from other types of active fund management.

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Wholesale shopping for hedge funds is a bad idea. Instead of deciding to bulk invest in hedge funds as a questionable means of diversification (the HFR index shows the majority of hedge funds have underperformed the S&P 500 while being correlated to it), investors should only seek out the select few.

And if the best are closed to new investment they must find something else to do with their money.

The author puts the situation in context by comparing hiring a hedge fund to hiring a caterer. From the column:

You are planning a party and have decided to hire a caterer. A trusted friend has recommended two of the best in the city. One is a famous chef who has won numerous awards for his cooking, and another is a younger caterer who previously worked for one of the best restaurants in the world.

You call them both, only to have second thoughts. The first, the famous chef, is simply too busy with existing work to help you.

The other is unbelievably expensive, costing at least double what a regular caterer would charge. But you need your guests to be fed, so you look for an alternative option. You find a cheaper company on the internet and book them.

Come the party the food arrives late. When you taste it, the hors d’oeuvres are stale and the wine tastes like biro ink. Embarrassed and enraged, you mutter under your breath about the money you have wasted, vowing to never hire a caterer ever again.

This flawed thinking resembles the way too many institutional investors select hedge fund managers.

Pension360 has previously covered studies that suggest problems with the way pension funds select managers.

Photo by Gioia De Antoniis via Flickr CC License

Indiana Pension Fund Assets Hit Record High

Recent data revealed that assets of the Indiana Public Retirement System (INPRS) hit at all-time high of $30.2 billion in 2014.

Fund officials attribute the record to “great” investment returns. The fund returned 13.7 percent in fiscal year 2013-14, which ended June 30. That number falls well short of what the S&P 500 returned over the same period, but the INPRS improved its funding ratio because of a confluence of factors, including employers making full contributions into the system.