Underfunded pensions mauled in bearpit of expectations

It’s not until you’re actually in the country that the real depth of the funding problem in US state pension plans becomes clear, as does the truly arduous environments that the investment professionals at those funds are operating within.

Investments, and the investment department, are viewed as the end, the answer, the only solution; which creates an environment of enormous pressure for the investment team. Not only that but also the interaction between the staff, and those with the ultimate responsibility, the board, seems to add an extra layer of unwanted tension.

The investment committee’s public meeting at CalPERS is a case in point. There are 13 members, up on a stage, with chief investment officer Joe Dear, and other agenda presenters sitting at a table facing them. An auditorium of around 200 capacity fills the bear-pit like environment that looms behind the presenters’ table.

At the April committee meeting, the trustees of CalPERS asked questions of the investment staff such as: “Why are the asset class returns X per cent, but the total portfolio return is Y per cent.”

Now CalPERS has just spent the past year looking at its strategic asset allocation, and a new, sophisticated approach has been approved. I know the basic tenets of diversification would have been covered in that process.

Another question from the stage was about the manager selection process focusing on hiring the top performing managers. The investment staff member presenting at that time reminded the committee that academic evidence shows the exact opposite is actually true, and research shows it is better to sell the highest performing manager: rather, that the fund looks at selecting managers, and strategies, that interact with every other capital allocation.

In the makeup of a board, the time commitments, and experience there is a political force at play. That is clear. But there is another political reality that it seems everyone – except the politicians in the US – is prepared to accept. Investments are not the golden ticket to move these funds out of their underfunded status.

And over the Sacramento River at CalSTRS, staff are preparing to lobby the legislature on how investments will not be enough to get them out of the underfunding situation.

On the other side of the country a much smaller fund, the Policemen’s Annuity and benefit Fund of the City of Chicago, is 35 per cent funded! Its chief investment officer, Sam Kunz, spends a lot of effort looking at building the most efficient portfolio, but concedes below a certain funding level there isn’t much he can do.

Meanwhile north of the border, in Canada, underfunding is still an issue, but it’s the expectations that are more reasonable.

Mark Wiseman, chief investment of the CPPIB, has a lot of conditions in his favour – a long time horizon and a modest real return target of 4 per cent. You can almost hear the clemency in the voices of the Canadians as they speak about their southern neighbours, and that’s not just because the exchange rate is in their favour.

“To meet solvency, US state plans need 7 to 8 per cent, that’s not sustainable in terms of capital market returns,” Wiseman said.

The solution for public funds in the US, it seems, is inevitable and one that policy setters will need to embrace, and the sooner the better.

Investments are only one part of a three-way partnership in pension fund investment management and there will need to be some decisions made on contributions and/or benefits if American workers are going to receive their expected retirement income. And we all know – expectation IS reality.