Archive for the 'Retirement' Category

Senate Committee Pans Target-Date Mutual Funds

Kurt Brouwer October 28th, 2009

Many 401(k) plans use target-date (or lifecycle) mutual funds.  A target-date fund is structured to embody a diversified portfolio for a person who plans to retire in a given year, say 2030. The longer the fund is from its ‘target date’ the more its asset mix will favor higher risk investments such as stocks.  As a fund gets closer to its target date, the asset mix would supposedly be changed to reflect more conservative income investments. So, theoretically, a target-date 2030 fund would almost certainly have a much higher commitment to stocks than a target-date 2015 fund would.

This Bloomberg piece notes a Senate Committee report that paints an unflattering picture of this burgeoning group of funds:

Kohl Says Target-Date Funds May Present Conflicts of Interest (Bloomberg, October 28, 2020, Jeff Plungis and Margaret Collins)

Target-date mutual funds suffer from high fees, limited choices and potential conflicts of interest, a Senate committee was told today.

Ouch.  I suspect this report is causing a few migraines in the marketing departments at the large mutual fund companies.

Employers who offer workers the funds as part of their 401(k)s retirement plans typically can’t choose the investment mix, according to a staff report delivered to the Senate Special Committee on Aging at a Washington hearing. Companies often are limited to the administrator’s own mutual-fund offerings, the report said.

…Target-date funds, also known as lifecycle funds, move money from riskier investments such as stocks to more conservative alternatives like bonds as an investor approaches retirement. Contributions have grown 98 percent since they were endorsed as a default option for employers by the 2006 Pension Protection Act, according to Morningstar Inc.

…Target-date funds labeled 2000 to 2010 lost an average 23 percent last year with some dropping as much as 41 percent, according to data compiled by Morningstar, the Chicago-based mutual-fund research company. The average 2050 fund declined 39 percent in 2008, while the Standard & Poor’s 500 Index fell 38 percent.

…More than $140 billion has flowed into target-date funds since 2007, and 96 percent of employers that offer automatic enrollment use them, the Senate report said…

Target-date funds certainly could be useful, but they may not make sense as a default option for 401(k) participants.  A default investment option is the one that a retirement plan must put your contributions in if you have not actually made a selection from the plan’s menu of investment choices yourself.

Plunging pensions & rising taxes

Kurt Brouwer September 17th, 2009

This is part two of the Plunging Pensions series (go here for Part One).

Some other states are starting to wake up and take notice of the mess we have made in California [emphasis added]:

Pension Costs Can Ruin Cities and States (Grand Forks Herald, June 18, 2020)

…As a result, California is “less than 50 days away from a meltdown of state government,” the state controller said last week.

It’s hard to know whether to stare in horror or avert your eyes.

Our advice: Stare. Because in California’s example, there are lessons for Minnesotans and North Dakotans to learn.

One such lesson has to do with public-employee pensions and a state’s fiscal health. California faces unfunded public employee retirement benefits of somewhere between $300 billion and $1 trillion, a panel discussion at the Milken Institute’s State of the State Conference concluded in May.

Joel Kotkin, presidential fellow at Chapman University in Orange County, Calif., and a popular writer on public policy, agrees. “The item that is most killing the state budget is the huge pensions for public employees,” he said in a recent CNBC interview.

“We have to figure out what we’re spending, how we’re spending, and to begin to make the public employees live by something close to the rules that the rest of society does.”

Basically, California governments let many workers retire early and collect generous pension and benefits for life. In Vallejo, Calif., for example, “base pay for firefighters is more than $80,000 per year, and employees can retire at age 50 with a pension equal to 90 percent of their salary,” Governing magazine reported last year.

Vallejo declared bankruptcy in 2008, citing pension benefits it no longer could afford.

The Milken Institute estimates that California has an unfunded pension liability of between $300 billion and $1 trillion.  Unless changes are made, that monstrous shortfall is going to haunt our workers, bankrupt our state and cause even more difficulties than we currently have.

And, just to put a human face to this, consider these stories of what our out-of-control pension laws have wrought.  The Grand Forks Herald continues:

“According to the data compiled to date, the highest paid public employee retiree in the state is Bruce Malkenhorst, the former city administrator, clerk, finance director and treasurer of the city of Vernon, Calif.,” the Sacramento Bee noted in an editorial.

“Vernon is a tiny industrial enclave near Los Angeles. He earns $499,674.84 a year or $41,639 a month in pensions.

“The local governmental agency with the most retirees earning $100,000 or more is the Sacramento Metropolitan Fire District. Fifty former employees of the Sacramento Fire Department receive pensions of more than $100,000.”

A pension of almost $500,000 per year for a small town treasurer?  Assuming he lives 30 years past retirement, that would be $15,000,000 and probably much more with cost-of-living increases (see the SacBee’s State Worker Blog for more).

Just to put the last point in perspective, the City of Sacramento is paying out $5 million per year to just 50 retired firefighters.  Now, I admire firemen and I have friends and relatives who do that work, which is dangerous and hard.  I don’t begrudge them a thing, but does anyone think this is sustainable.  $5 million per year for just 50 retirees from one modest-sized city?

In addition to underfunded state and local pension plans, we have the underfunded biggies — Social Security and Medicare. This chart from investment firm, TCW, demonstrates the rapidly-rising liabilities at just the Federal level.  The biggest unfunded liability is Medicare, but there are many more:

Source: TCW / Jeffrey Gundlach

As you can see the Feds owe vast sums stretching as far as the eye can see.  Yet, there is a steady stream of applicants for more Federal backing — private pensions, state and local pensions and so on.  The Feds are the backer of last resort, but that backing is getting mightily stretched.

Either governments rein in the soaring costs of public pensions or they face an increasing likelihood of bankruptcy, as we saw in the case of Vallejo, CA.  Stopgap measures will not work for very long and the longer we wait to address this, the worse it will get.  Even raising taxes won’t help for very long because states such as California have tax rates among the highest in the nation.

And, our top Federal income tax rates are already high compared to the global rates, as this chart illustrates.  How much higher can they go?

Source: Carpe Diem

Taxpayers are the ones who will be left holding the bag when all the politicians’ pension promises blow up.  I also believe that public retirees are at risk because taxpayers are increasingly restive and unwilling to accept tax hikes.  Yikes.

Update:  I had a few questions about the chart above which tracks the top personal income tax rates around the world.  One CPA I had lunch said that the average seemed low because many of the European countries have high rates of 40% or even 50%.  And, that is true. The U.S. does not have the highest country rate, that honor goes to Denmark I believe.  But, the U.S. rate is well above the worldwide average.

By the way, the data underlying this chart is from a study done by accounting firm, KPMG.  The study can be found here.

I come away from this with three points.  First, the study found that there has been a steady downward decline in global income tax rates, even in Europe.  For example, the average rate in Europe was 41% in 2003 and now it is 36%.  Part of this decline has been the introduction of flat tax rates in several Eastern European countries.

Second, that there is wide disparity in rates with Europe generally having the highest rates, averaging 36%.  But, in South American the top personal income tax rate is about 26%.  In Asia, the highest rate is Japan at 50% for the top personal rate.  The lowest rate seems to be Hong Kong, which is 15%.

Third, the U.S. seems to be bucking the trend as we have before Congress a number of proposals to significantly and substantially increase our income tax rates.  For example, there have been discussions of income tax surcharges to pay for healthcare reform.  There is also a strong likelihood that the Bush tax cuts will be phased out, which would be an effective tax increase.  Those alone will be controversial. Adding additional income taxes or additional payroll taxes to deal with Social Security or Medicare, would be both very difficult and very divisive.

See also:

Plunging Pensions

Plunging Pensions

Kurt Brouwer September 11th, 2009

Good piece from MarketWatch on the mounting problems we are experiencing with pension plans, both private and public.  Many corporate and public pension plans are underfunded and that means taxpayers are probably on the hook.  Why you ask? C’mon.  You and me and other taxpayers are the payer of last resort.

First, we find that faltering industrial companies have failed to adequately fund their pension plans and that leads to the Feds as the funder of last resort [emphasis added]:

Companies’ Pension Problems Could Hit Taxpayers (MarketWatch, September 3, 2020, Andrea Coombes)

When the agency that insures traditional pension plans is running a $33.5 billion deficit — the largest in its 35-year history — should you be worried? If you’re a worker or retiree counting on a traditional pension, the answer is probably not. But if you’re a taxpayer, start worrying.

Though it will likely take years, it’s all but inevitable that at some point the Pension Benefit Guaranty Corp., the agency responsible for guaranteeing pension benefits for some 44 million Americans, will need to either cut those benefits or raise a lot of cash, experts say.

Given that slashing payouts to older people is considered political suicide, the likely scenario is that the U.S. government will pony up funds to shore the agency’s finances.

Pensioners “don’t have to worry,” said Douglas Elliott, an author of numerous studies on the PBGC and a fellow at the Brookings Institution, a Washington-based public-policy think tank.

“The taxpayer has to worry.

This is the crux of the matter.  When pension plans fail, taxpayers are the funders of last resort.  The problem is that all kinds of pension plans — Social Security, state and local pensions, the Pension Benefit Guaranty Corporation — are all sinking into fiscal insolvency.  And, then there is Medicare and Medicaid. What happens if they all go broke? MarketWatch continues:

… “There’s a point where the Social Security fund starts to run out of money if they don’t change anything. That’s a similar analogy to the PBGC,” said David Kudla, chief executive of Mainstay Capital Management LLC, an investment advisory firm that often works in the auto industry. “At some point, they either need to charge higher premiums or reduce benefits to current beneficiaries or have a capital infusion from the U.S. government,” he said. “The third [option] is probably the most likely.”

…If taxpayers do eventually bail out the PBGC, it could be a bitter pill for some of them. “You [pension recipients] would be getting a bailout from taxpayers who never had a defined-benefit plan,” Bovbjerg said. “If you have a 401(k), you don’t have guarantees like that,” she said…

In my opinion, it’s not a matter of if taxpayers bail out PBGC, but when taxpayers bail it out.  Unfortunately, this issue of corporate pension failures is far from the full extent of the problem.

Next, as this opinion piece from the Wall Street Journal demonstrates, we find another huge problem, the underfunding of public pension plans:

Public Pensions Cook the Books (Wall Street Journal, July 6, 2020, Andrew C. Biggs)

Public employee pension plans are plagued by overgenerous benefits, chronic underfunding, and now trillion dollar stock-market losses. Based on their preferred accounting methods — which discount future liabilities based on high but uncertain returns projected for investments — these plans are underfunded nationally by around $310 billion.

The numbers are worse using market valuation methods (the methods private-sector plans must use), which discount benefit liabilities at lower interest rates to reflect the chance that the expected returns won’t be realized. Using that method, University of Chicago economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to the market collapse, public pensions were actually short by nearly $2 trillion. That’s nearly $87,000 per plan participant. With employee benefits guaranteed by law and sometimes even by state constitutions, it’s likely these gargantuan shortfalls will have to be borne by unsuspecting taxpayers…

Public pension plans have been quietly accumulating huge long-term liabilities with very little public notice.  But, a few factors have brought this issue to the public’s attention.  First, the bankruptcy of Vallejo, CA and other cities, with pension liabilities a significant part of the bankruptcy filing.  Second, the huge pension payouts being received by public employees.

Budget Busting Pension Plans

On a daily basis, we are seeing alarming news about the pension crisis in towns and cities across the state of California and the nation.  What the heck is going on?  In a nutshell, while you were out living your life, your local and state politicians were making pension promises that extend many years into the future.  And, in many cases, the required funding simply is not in place.  To make things worse, these promises were made to our firefighters, police and other employees of the government.  These are the people who make everything in a given town work.

42 Years Driving for Dolly Madison Cakes

Columns such as these two below have been attacked by unions as an attack on public employees.  I view it differently.  I come from a union family.  My father drove a Dolly Madison Cakes delivery truck for 42 years and he was a member of the Teamsters Union.  My mother still receives a very modest monthly check from the Teamsters.

My view of this issue is that if a city or county makes a promise to its employees, it should keep it.  But, if the city goes bankrupt, then of what value is the promise?  Both sides — taxpayers and employees — should be on guard to make sure that promised benefits are reasonable and sustainable because if they are not, then everyone loses.

This is no longer a boring and arcane topic of interest only to local politicians, municipal employees, union officials and pension plan actuaries.  We posted on this several months ago when pension obligations threatened the city of Vallejo, CA.  Now we see that the city of  Vallejo, California has broken a union contract after having to seek court approval for doing so (see CalPensions).

The $3 Billion Pension Miscalculation

The Sacramento Bee makes an important — and politically explosive — point in the following piece.  About 10 years ago, the State of California got taken to the cleaners on employee pensions [emphasis added]:

Pension hike of a decade ago backfires (Sacramento Bee, June 22, 2020, Dan Walters)

A milestone on California’s meandering journey toward fiscal insolvency occurred exactly a decade ago when the Legislature enacted a massive increase in state employee pensions on the expedient assumption that it would cost taxpayers nothing.

Although the new pensions would generate almost countless billions of dollars in extra income for retirees in the years ahead, the CalPERS board, dominated by union representatives, told legislators that taxpayers wouldn’t have to bear the load because investment income, which was flowing into the pension trust fund from high-tech stocks, would continue indefinitely.

As it has done in so many ways, California took the good times for granted and assumed lavish investment returns would buoy public pension plans forever.  Unfortunately, reality has hit home, not once, but twice.  First, the tech bubble blew and now the real estate bubble and tumbling stocks have done the same.

“They (CalPERS) anticipate that the state’s contribution to CalPERS will remain below the 1998-99 fiscal year for at least the next decade,” said a final Senate analysis of the 1999 legislation that expanded state pensions, allowing Highway Patrol officers, prison guards and other “safety” workers in some cases to get more than 100 percent of their salaries.

…Within a few years, dot-com bubble had burst, CalPERS had suffered major losses and the state’s burden for pensions had pushed into the multibillion-dollar range, not counting the heavy impact on local governments that had cavalierly followed the state’s lead on boosting pension benefits (see Oakland ‘Mulls’ Bankruptcy).  

The situation was ripe for a backlash, such as an initiative measure that would rein in public pensions, but union-controlled CalPERS lowered the political heat by offering employers a “smoothing” policy that would protect them against immediate jolts, spreading out the increases over a number of years.

By and by, the economy improved, albeit through an unsustainable explosion in real estate development, and the pension issue dropped from the political radar screen. But now we’re mired in the worst recession since the Great Depression, CalPERS’ investments have dropped by nearly a third and the state is paying more than $3 billion a year into the pension fund, nearly 10 times what it paid a decade ago when CalPERS made its bogus assertion to lawmakers…

I would say that’s a bit of a miss.  California is being forced to pay $3 billion a year (10 times what it paid a decade ago and far more than estimated) and we are now hearing that another billion or so is needed.  Eventually, a billion here and a billion adds up to real money.

This is an example of how little credibility we should give to legislative estimates of future pension costs.  Either our legislators — in Washington or Sacramento or anywhere else — don’t know or they simply don’t want to know what a given pension will really cost.  But, shame on us for believing their estimates.

This problem — plunging pensions — is one that will be plaguing us for many years.

Stay tuned for Plunging Pensions (Part Two) — next week.

See also:

New York City

New Jersey

Hidden Pension Fiasco

Mutual Funds that Hedge

Kurt Brouwer August 18th, 2009

Morningstar’s Fund Spy column has a piece on five mutual funds that employ various hedge-fund-like strategies.  Here are short takes on two of the five.  Both of these are interesting funds [emphasis added]:

Five Mutual Funds to Help You Hedge (Morningstar, August 17, 2020, Russel Kinnel)

Harbor Commodity Real Return (HACMX)

…If inflation comes back, this fund could provide some protection. I particularly like it for portfolios that are heavily weighted to fixed income and, therefore, are vulnerable to a spike in inflation. Run by PIMCO in a fashion similar to Pimco Commodity Real Return Fund (PCRDX), this fund tracks a basket of commodities and then adds in a Treasury Inflation-Protected Securities overlay that effectively gives you exposure to TIPS as well as commodities. We recommend the Harbor fund over the PIMCO fund because of its low expense ratio. Beware of the fund’s volatility and be sure to keep it to a single-digit weighting in your portfolio. Ideally, it should be held in a tax-sheltered account…

I don’t really understand why he would only hold Harbor Commodity Real Return in a tax-sheltered account.  Certainly, there is an income component to this fund, but that just means you would want to consider the taxation issue when putting it in a portfolio.  And, since Kinnel is recommending a single-digit weighting (that is, 3% or 5% etc.), it should not have a big impact on taxes.

To learn more about the Harbor Commodity Real Return Fund, check out its web site here.

The Pimco Commodity Real Return Fund has a much longer track record and it is a larger fund in terms of assets.  Despite the expense ratio issue, I would still opt for the Pimco version.

Our firm has a position for some clients in PCRIX, which is the institutional version of Pimco Commodity Real Return Fund.

Hussman Strategic Growth (HSGFX)

This long-short fund takes the edge off market downturns. John Hussman takes long positions in individual stocks but offsets some of that market exposure by shorting indexes. While that has limited the fund’s upside, it has made it a standout in difficult times. It lost 9% in 2008 but enjoyed positive returns in every other calendar year since its inception in 2000. The fund’s expense ratio recently fell to 1.04%…

To learn more about Hussman Strategic Growth, I recommend reading some of Hussman’s commentary at his web site, which is here.

The piece goes on to discuss three more mutual funds that do some form of hedging.  It is worth reading the whole article.

California Pension Plan: Betting the house

Kurt Brouwer July 25th, 2009

From the New York Times [registration may be required] we get this report on the California Public Employees Retirement System (CalPERS), which is the largest pension plan in the nation.  CalPERS has struggled of late due to investment losses and funding issues.  It also has a credibility problem after helping bring about the current crisis in California public pensions.

Now, the investment chief for CalPERS is doing something that is quite unusual in that he is calling for the system to essentially bet billions on risky assets in the hopes of making a big gain [emphasis added below]:

CalPers Hopes Riskier Bet Will Restore Its Health (New York Times, July 23, 2020, Leslie Wayne)

Big as California’s budget woes are today, so are the problems lurking in its biggest pension fund.

The fund, known as Calpers, lost nearly $60 billion in the financial markets last year. Though it has more than enough money to make its payments to retirees for many years, it has a serious long-term shortfall. Meanwhile, local governments in the state are pleading poverty and saying they cannot make the contributions that would be needed to shore it up.

California’s public pension funding problem is one of the thorniest financial issues facing the state. The state made an unwise and almost certainly unsustainable deal to substantially raise public pension payouts approximately 10 years ago.  CalPERS played an important role in that disastrous decision (see Budget Busting Pensions).

The New York Times continues:

Those problems now rest largely on the slim shoulders of Joseph A. Dear, the fund’s new head of investments. He is not an investment seer by training, but he thinks he has the cure for what ails Calpers, or the California Public Employees’ Retirement System, the largest in the nation with $180 billion in assets.

Mr. Dear wants to embrace some potentially high-risk investments in hopes of higher returns. He aims to pour billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure.

That’s right, he wants to load up on many of the very assets that have been responsible for the fund’s recent plunge. Calpers’s real estate portfolio has tumbled 35 percent, and its private equity holdings are down 31 percent. What is more, under Mr. Dear’s predecessor, Calpers had to sell stocks in a falling market last year to fulfill calls for cash from its private equity and real estate partnerships. That led to bigger losses in its stock portfolio.

CalPERS has made very significant investments in illiquid real estate and private equity partnerships.  Selling stocks last Fall to help keep those partnerships going may or may not have been a huge mistake, but it is certainly unusual behavior.

From the Sacramento Bee, here is a report on a billion dollar bust in CalPERS’ real estate portfolio.  The details do not sound encouraging:

…CalPERS made aggressive investments in real estate at the worst possible time, when inflated property values had peaked and were already beginning to decline.

As The Sacramento Bee’s Dale Kasler detailed in a recent article, one CalPERS real estate misstep stands out in particular. In February 2007, CalPERS invested $922 million in a deal with LandSource Communities Development LLC that involved thousands of homes and lots in seven states including Florida, Arizona and California.

A month before the investment was finalized, Lennar Homes, a principal partner in the LandSource deal, announced it was writing off $500 million in real estate assets because of deteriorating market conditions. That should have served as a clear warning to CalPERS, but it did not.

Sixteen months later, LandSource filed for Chapter 11 bankruptcy. Depending on what assets the partnership sells to pay off creditors, CalPERS could lose its entire investment, nearly $1 billion...

In fairness, CalPERS made lots of money from its real estate investments over the years, so a billion dollar writeoff won’t break the bank.  However, the bankruptcy of a private real estate deal like this one should be a warning light that the partnership investments the plan already holds may have other unwelcome surprises.

Joseph Dear, CalPERS’ new investment head seems to be a smart guy and he is certainly well connected in a political sense.  He also seems to be a gutsy guy in that he is definitely making a bet — in effect, betting the retirement future of many Californians  — that the private partnerships he likes will outperform more traditional investments.

…He [Joseph A. Dear] was hired in large part for his management skills and political savvy - honed in Washington, where headed the Occupational Safety and Health Administration in the Clinton years. He does not have an M.B.A. or any other advanced degree in finance. Harvard, Yale or Wharton is not on his résumé. Instead, his lone degree, in political economy, is from Evergreen State College in Olympia, Wash.

Most recently, Mr. Dear headed the Washington State public pension fund, which gained a reputation as a daring investor under his oversight. It risked more of its portfolio - 25 percent - on private equity than any other public fund. The bet pushed the Washington State Investment Board, which now has $67 billion in assets, into the top 1 percent of its peer group in performance during the boom years, according to Wilshire Associates. But in the fiscal year that ended last month, the fund lost 27 percent of its value, or $18 billion.

Calpers has a lot riding on Mr. Dear’s effort to achieve above-market performance. The fund just posted a loss of 23 percent, the worst in its history. That leaves it 66 percent funded, the lowest level in two decades, meaning it has only $66 on hand for every $100 in benefits promised to 1.6 million California public employees and their families.

… “Calpers is significantly underfunded, and they have decided that they will roll the dice,” said Edward A. H. Siedle, president of Benchmark Financial Services, which audits pension plans. “Is that appropriate if you have just lost 25 percent of your portfolio? These are high-risk, illiquid, unregistered products where there is tremendous valuation uncertainty. I would bet you any amount that five years from now, this plan will not have outperformed the market.”…

On one hand, I applaud CalPERS and its new head of investments for taking a bold and contrarian stand.  It may work and, if so, I will be very happy.  On the other hand, I question the motivation behind this move.  Is it the desire to follow a sound investment principle of adding to solid holdings when they have fallen in value? Or, is it a move like that of a gambler who suddenly decides to double down in order to erase a series of losing hands?

Via: Calculated Risk

See also:

Budget Busting Pensions

10 Rules for Investing

Oakland ‘Mulls’ Bankruptcy

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