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The Math Doesn’t Work

 

The Math Doesn’t Work

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The biggest public pension in the United States has just 68% of the assets it needs to pay for future benefits. At some point in the not too distant future, the rubber will meet the road.

The Wall Street Journal reports that Calpers, which currently has $341.5 billion in assets, has a target allocation of 50% to stocks and 22% to bonds, leaving the remaining 22% invested in things like real estate, private equity and other alternative investments. With stock valuations and interest rates where they are, and a target return of 7%, it’s probable that some tough decisions will need to be made in the coming years.

If we assume that stocks do 5% a year for the next decade, and bonds return 3% over the same time, then the third bucket would need to generate 16.6%, net of fees, to hit the 7% bogey. And if we do enter an environment where stocks do 5% and bonds do 3%, then the chances that $75 billion (22% of $341B) can generate returns of 16% is slim to none.

One step that pension funds can make is to lower the assumed rate of return. Unfortunately, there are real costs involved in doing this. A year ago, Calpers voted to lower the discount rate form 7.75% to 7%, which “will result in average employer rate increases of about 1 percent to 3 percent of normal cost as a percent of payroll.” A lower discount rate also raises the present value of future liabilities, which makes today’s funded status worse, not better.

I’m far from an expert in this area, but it’s obvious that some difficult decisions will need to be made, because unless the market bails them out, the math doesn’t work.

Source:

Pension Funds’ Dilemma: What To Buy When Nothing Is Cheap?


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