Monday, September 25, 2017

University of California's Pension Scandal?

Jack Dolan of the Los Angeles Times reports, UC is handing out generous pensions, and students are paying the price with higher tuition:
As parents and students start writing checks for the first in-state tuition hike in seven years at the , they hope the extra money will buy a better education.

But a big chunk of that new money — perhaps tens of millions of dollars — will go to pay for the faculty’s increasingly generous retirements.

Last year, more than 5,400 UC retirees received pensions over $100,000. Someone without a pension would need savings between $2 million and $3 million to guarantee a similar income in retirement.

The number of UC retirees collecting six-figure pensions has increased 60% since 2012, a Times analysis of university data shows. Nearly three dozen received pensions in excess of $300,000 last year, four times as many as in 2012. Among those joining the top echelon was former UC President Mark Yudof, who worked at the university for only seven years — including one year on paid sabbatical and another in which he taught one class per semester.

The average UC pension for people who retired after 30 years is $88,000, the data show.

The soaring outlays, generous salaries and the UC’s failure to contribute to the pension fund for two decades have left the retirement system deep in the red. Last year, there was a $15-billion gap between the amount on hand and the amount it owes to current and future retirees, according to the university’s most recent annual valuation.

“I think this year’s higher tuition is just the beginning of bailouts by students and their parents,” said Lawrence McQuillan, author of California Dreaming: Lessons on How to Resolve America’s Public Pension Crisis. “The students had nothing to do with creating this, but they are going to be the piggy bank to solve the problem in the long term.”

At a UC Board of Regents meeting this month, university officials began discussing next year’s budget and broached the possibility of another tuition increase. Pensions and retiree healthcare topped their list of growing expenses, but it’s unclear whether regents would approve another hike.

Public pension funds are in crisis across the country, and particularly in California. The underlying cause is essentially the same everywhere. For decades, government agencies and public employees consistently failed to contribute enough money to their retirement funds, relying instead on overly optimistic estimates of how much investments would grow.

UC’s pension problem, while not unique, is distinctly self-inflicted. In 1990, administrators there stopped making contributions for 20 years, even as their investments foundered, leaving a jaw-dropping bill for the next generation — which has now arrived.

After setting aside about a third of the new money for financial aid, university officials expect this year’s increased tuition and fees for in-state students to generate an extra $57 million for the so-called core fund, which pays for basics like professors’ salaries and keeping the lights on in the classrooms. But they also expect to pay an extra $26 million from the fund for pensions and retiree health costs, according to the university’s most recent budget report.

UC spokeswoman Dianne Klein said it’s impossible to say precisely how much of the tuition increase will go toward retirement costs because the university pools revenue from a variety of sources, including out-of-state tuition and taxpayer money from the state general fund, to cover expenses.

The steep rise in six-figure pension payments over the last five years was driven by a wave of retiring baby boomers with long tenures at high salaries, Klein said. “UC, as you know, has an aging workforce.”

University officials have attempted to control costs by increasing the retirement age and capping pensions for new hires, but those are long-term fixes that won’t yield significant savings for decades. And the current budget promises $144 million in raises for faculty and staff, a move that will send future pension payments even higher.

The top 10 pension recipients in 2016 include nine scholars and scientists who spent decades at the university: doctors who taught at the medical schools and treated patients at the teaching hospitals, a Nobel Prize-winning cancer researcher and a physicist who oversaw America’s nuclear weapons stockpile.

The exception is Yudof, who receives a $357,000 pension after working only seven years.

Under the standard formula — 2.5% of the highest salary times the number of years worked — Yudof’s pension would be just over $45,000 per year, according to data provided by the university.

But Yudof negotiated a separate, more lucrative retirement deal for himself when he left his job as chancellor of the University of Texas to become UC president in 2008.

“That’s the way it works in the real world,” Yudof said in a recent interview with The Times.

The deal guaranteed him a $30,000 pension if he lasted a year. Two years would get him $60,000. It went up in similar increments until the seventh year, when it topped out at $350,000.

Yudof stepped down as president after five years, citing health reasons. Under the terms of his deal, his pension would have been $230,000. But he didn’t immediately leave the university payroll.

First, he collected his $546,000 president’s salary during a paid “sabbatical year” offered to former senior administrators so they can prepare to go back to teaching. The next year he continued to collect his salary while teaching one class per semester, bringing his tenure to seven years and securing the maximum $350,000 pension.

In 2016 he got the standard 2% cost-of-living raise, resulting in his $357,000 pension.

Asked if he was worth all the money, Yudof said it would be more appropriate to ask the members of the university’s Board of Regents, who agreed to the deal.

Richard C. Blum, who was chairman of the board in 2008, did not respond to requests for comment.

Six of the top 10 pensions recipients last year — each of whom got more than $330,000 — were doctors who taught at the medical schools or treated patients at the teaching hospitals.

For decades, university officials have argued that the generous pension plan is essential to compete with other top schools, especially private ones that offer higher salaries.

Rival medical schools in California, including Stanford and USC, do not provide doctors guaranteed, lifetime pensions. Instead, they offer defined contribution plans in which the employer and employee each pays into the employee’s personal retirement account. When the worker retires, he or she gets the money and the employer is off the hook — no lifetime of continuing payments.

The vast majority of doctors in the U.S. who don’t work for public universities are offered such plans instead of pensions, as are the vast majority of other professionals working in private industry.

Three physician recruiters told The Times that they thought persuading top doctors to work at UC would be easy, given the prestige of the institution and the fact that the hospitals are located in some of the nation’s most desirable places to live.

“I think I could sell it against a higher-paying job in the private sector, even without a guaranteed pension,” said Vince Zizzo, president of Fidelis Partners, a national search firm based in Dallas. Working for a university “is a protected world of guaranteed this and guaranteed that,” Zizzo said. In private practice, doctors are paid based on the number of patients they see and how much they bill. “It’s a much harder life; you eat what you kill.”

Most of UC’s top pension recipients did not respond to requests for comment on this story.

Two interviewed by The Times said they were grateful for the pensions, but the retirement plan played no role in their decision to take jobs at the university early in their careers.

Nosratola Vaziri, a former kidney and hypertension specialist at UC Irvine’s medical school, collected a $360,000 pension last year. He went to work at UCI after finishing a fellowship at UCLA in 1974 and stayed for the next 37 years, contributing to more than 500 scientific articles. Despite offers from other institutions, he never left because he loved the work, Vaziri said.

“Neither salary nor pension were the reason for my choice,” Vaziri said.

Radiologist Lawrence Bassett spent 41 years working at UC hospitals after finishing his residency at UCLA. He specialized in the emerging field of breast imaging and said UC was a great place to benefit from leading research. Asked whether the pension had been a factor in his decision to take the job initially, or stay over the years, Bassett said, “No, honestly it wasn’t.” Bassett’s pension was $347,000 last year.

McQuillan, the author and Senior Fellow at the Independent Institute, a nonpartisan think-tank in Oakland, said it would be simpler, more transparent and ultimately cheaper for UC hospitals and medical schools to compete with other institutions by paying higher salaries.

Pensions involve a guess about how much the employer will have to invest today to pay a retiree a guaranteed amount later. It’s common for public officials to guess low, saving money in the short term, and leaving their successors to figure out how to make up any shortfall.

That’s what has been happening at UC for decades, McQuillan said. “At least with a big salary, there isn’t this ticking time bomb that’s going to explode 30 years down the road.”

Like most public employee pensions — they’re rare in the private sector these days due to the cost — UC’s is funded through regular paycheck contributions from employers and employees. The money is invested in stocks, bonds and real estate around the world with the hope that it will grow enough over time to cover the guaranteed payments in retirement.

As is often the case, the UC pension fund’s financial trouble didn’t begin when there was too little money; it began when there was too much.

In 1990, after years of strong investment returns, university officials determined the fund had accumulated more than it would owe retirees into the foreseeable future. So they took what was supposed to be a temporary “holiday” from making contributions to the fund. They let employees do the same.

The policy was popular and difficult to overturn even as the fund started slipping into the red.

By the time contributions were reinstated in 2010, the fund had fallen billions of dollars behind.

Since then, university administrators have been scrambling to catch up, borrowing and transferring $4 billion from other university accounts to plow into the pension fund. They also raised the minimum retirement age from 50 to 55.

In 2015, Gov. Jerry Brown offered a $436-million gift of state taxpayer funds in exchange for an agreement from UC President Janet Napolitano to cap the amount of salary that can be used to calculate a pension at $117,000 — a move that will save money decades from now, but does little in the short term.

The deal also required Napolitano to offer new employees the choice of a defined contribution plan.

Despite all these efforts, UC’s pension hole hasn’t shrunk since 2010; it has grown by billions, according to the university’s most recent valuation. That’s because the return on investments has not kept pace with the growth in staff, salaries and departing employees’ pension payments. This year’s stock market gains will help but have not yet been included in the published valuations.

As the university struggles to deal with the problem, Napolitano’s office has become a jealous guardian of pension information.

In December, the nonprofit California Policy Center sent a public records request to UC for an update of a 2014 spreadsheet listing pension payments to the university’s retirees. A school administrator responded with an email saying UC had provided the previous spreadsheet as a “courtesy” and was no longer willing to do so.

When the nonprofit pressed — the information is indisputably public under the law, and other California government agencies routinely provide pension data without delay — the administrator sent an email claiming that the employee who created the 2014 spreadsheet had since retired and nobody could find the query he had used to extract the information from a larger database.

“They lost the computer program? That’s not my problem,” said Craig P. Alexander, a Dana Point attorney representing the nonprofit. The university finally turned the pension data over in May, but only after the Alexander threatened to sue.

Napolitano’s staff also initially refused when The Times requested the pension information in February. It took until June for them to provide usable data — which showed the dramatic rise in six-figure pension payments and revealed for the first time the full amount of Yudof’s pension.
After reading this article, you quickly realize that California has a huge pension problem, or to be more precise, suffers from severe pension delusion syndrome.

In fact, California is the poster child state for rampant pension abuses. Jack Dean of Pension Tsunami has been documenting six-figure pension abuses all over the United States, especially in California where he resides.

Of course, Napolitano's staff wants to keep all this hush, it's an embarrassment and it exposes how grossly mismanaged the entire pension system is at the University of California.

After reading this, I can tell you exactly what UC needs to do with its pension plan:
  • Immediately cap all pensions to a certain amount, including those of these pension "elites" and let them take you to court if they feel you are reneging on their contract.
  • Immediately raise the contribution rate and cut benefits (fully or partially remove cost-of-living adjustments) until the plan gets back to fully-funded status.
  • Make pension contribution holidays illegal at UC and everywhere in California and the United States. Period.
  • Raise the retirement age of UC's professors to 65. If my 86 year-old father who like most doctors everywhere has no pension can still work as a psychiatrist three times a week, these professors can tough it out in academia till 65 (most work well past that age).
  •  Forget shifting new professors to defined-contribution (DC) plans. The brutal truth is they're horrible and will only ensure pension poverty down the road. UC needs to curb pension largess but shifting to DC will only ensure pension poverty and make it harder to attract qualified staff.
  • Follow Canada's CAAT Pension Plan when it comes to the gold standard in pensions for university defined-benefit pensions. CAAT Pension Plan is a jointly sponsored plan where sponsors share the risk of the plan if it goes into deficit. You can read all about this plan here and read their 2016 annual report here.
In fact, one image says it all as far as CAAT Pension Plan is concerned (click on image):

Julie Cays, CAAT's CIO and her small team are doing a great job on the investment front and I feel bad because I haven't covered their annual results more closely.

Now, as scandalous as these pension payouts at UC are, let me be very clear here, the investment operations at the University of California are top-notch.

The Chief Investment Officer and Vice President of Investments at the University of California's Office of the President is Jagdeep Singh Bachher, the former CIO of the Alberta Investment Management Corp (AIMCo) during Leo de Bever's term there.

Bachher is responsible for managing the UC pension, endowment, short-term, and total-return investment pools. He reports directly to the Board of Regents on investment matters and the chief financial officer on administrative issues related to managing a group of more than 60 investment professionals and staff.

Michael McDonald of Bloomberg recently wrote a feature article on Jagdeep Singh Bachher, The Man Running the University of California’s Lean, Mean Endowment Machine:
Jagdeep Bachher stands out among chief investment officers.

First, there’s the headwear. Bachher is a practicing Sikh, and the turban he wears, whether orange, red, or baby blue, is always perfectly paired with his business attire, matching his tie, even his socks.

Second is his obsession with management fees. While institutional investors have gotten more particular about costs in recent years as high-priced hedge funds have struggled to deliver returns above market indexes, Bachher has taken it to the extreme. Since being hired to lead the University of California Regents’ $110 billion pension and endowment in 2014, he’s fired almost half of the outside money managers formerly on his payroll as he’s sought to cut fat and concentrate market bets.

“I truly believe that less is more,” Bachher says. “Let’s do a few things and do them well.” And so he has: While the funds’ performance when he arrived was middling at best, they gained about 15 percent in the 12 months through June. “A high cost structure kills you in the long run,” says Laurence Siegel, former head of investment research at the Ford Foundation. “The basic goal is to keep your money.” Bachher has thrown the funds’ weight behind promising new managers instead and also backed an advisory group with a few other institutional investors called Aligned Intermediary Inc., which researches investment opportunities in green infrastructure with the potential for high returns.

Among his peers, Bachher is known for his charisma, his intellectualism, and being extremely organized—all traits that serve him well navigating the notoriously prickly politics of a state university system. Born and raised in Nigeria, he was precocious from an early age. When he was just 14, his parents moved the family halfway around the world to Canada so their son and his older sister could attend the University of Waterloo, one of the country’s top engineering schools, located in a sleepy Toronto exurb.

Bachher went on to earn a doctorate in management sciences in 2000 from Waterloo’s school of engineering. For his thesis, he studied how venture capitalists decide which companies to back, interviewing dozens of the famously secretive money managers. His insight made him attractive to the money management arm of the Canadian insurer Manulife Financial Corp., which hired him out of school. He later worked for Alberta Investment Management Corp., a $90 billion nonprofit that invests public funds for the province, where he rose to deputy chief investment officer.

While he’s best known for taking a sharp scalpel to the regents’ portfolio, Bachher says his overriding philosophy is simply to borrow the best ideas wherever he can find them. “We’re starting to see the results,” he says. “There’s no change just for the sake of change.”
There is no doubt, Jagdeep Singh Bachher is very smart and he knows what he's doing on the investment side. UC paid billions in fees to hedge funds that only mirrored stock market and he absolutely needed to cut a lot of wasteful fees.

UC recently approved a $1 million bonus for Bachher and given the long-term results, it was well-merited. He has revamped the asset allocation to focus more on privates and he has managed to attract huge international pension stars, including APG chief executive Eduard van Gelderen who left the Dutch asset manager in August to join the University of California’s investment team.

I personally like the fact that he's a practicing Sikh who wears his headwear proudly (click on image):

That is the difference between the US and Canada, the very best rise to the top in the US no matter their gender, ethnicity, color of their skin, religion, sexual orientation or disability. We Canadians talk up diversity a lot but in practice, we can learn a lot from our neighbors down south (we truly suck at diversity, period).

Below, a conversation with Shradha Sharma, Jagdeep Singh Bachher, Chief Investment Officer and Vice President of Investments at University of California talks about the fund, investment strategy and the focus areas of UC investments.

In another discussion below, Bachher discussed the clean energy economy and how to invest in climate change solutions. He also took part in an interesting panel discussion with Arun Majumdar and Sally Benson on the clean energy economy.

Lastly, Bachher took part in a great panel discussion at the Milken Institute on charting new frontiers in asset ownership. It also featured Chris Ailman, CIO of CalSTRS, Hiromichi Mizuno, CIO of Japan's GPIF, and Carrie Thome, Director of Investments, Wisconsin Alumni Research Foundation.

Friday, September 22, 2017

Prepare For The Worst Bear Market Ever?

Barbara Kollmeyer of MarketWatch reports, Jim Rogers says ETF holders will get mauled by ‘the worst’ bear market ever:
Now that the Fed has finally started to peel off the quantitative-tightening Band-Aid, things should start getting back to normal.

That's a good one, given no one really knows what normal is these days. A pullback from the record highs of yesterday looks to be in store, and gold bugs should cover their eyes, because the market has been playing catchup to Fed rate-hike hints.

We’re diving right into our call of the day, which comes from Jim Rogers. In a sweeping interview with RealVision TV, the veteran investor warns another bear market is coming, and that it will be “horrendous, the worst.” It’s the level of debt across global economies that will be to blame, he says.

And retail investors who have been piling into exchange-traded funds will be particularly vulnerable to that next big mauling. For those ETF owners — who are all in on easy S&P plays right now — here’s his message:
“When we have the bear market, a lot of people are going to find that, ‘Oh my God, I own an ETF, and they collapsed. It went down more than anything else.’ And the reason it will go down more than anything else is because that’s what everybody owns,” he says.
Like others, the chairman of Rogers Holdings is worried about bond and stock valuations right now, and about breadth in the market — that is, the number of stocks moving higher versus those heading the other way.

But within this disaster in the making, he sees one opportunity.

“If somebody can just take the time to focus on the stocks that are not in the ETFs, there must be fabulous opportunities in those stocks because they’re ignored,” he says. “Some of them have got to be doing very, very well. And nobody’s buying them, because only the ETFs buy stocks.”

What does Rogers like? Overlooked and hated markets — agriculture and Russian stocks — and he remains a fan of Chinese stocks. The Singapore-based investor owns gold, but says the metal isn't hated enough to buy right now and it’s going to get “very, very, very overpriced” before the current run is over.

It’s a fascinating interview, chock-full of advice. Check it out on Real Vision here.

Final note here, if you were paying attention, you would have heard Rogers‘s prior warnings about dire collapses and crashes over the summer. Here’s another look at some of his crash predictions.
Ah, Jim Rogers is at it again, scaring people on markets with his dire predictions and telling them to find refuge in commodities, agriculture, Russian and Chinese stocks.

Roger's claim to fame was being the co-founder of the Quantum Fund along with George Soros and he still has a very wide following of devoted fans even though he's been utterly wrong on so many of his dire macro calls. He's partially right above and I will get to it in a minute.

It's Friday folks, it's time to sit back, relax and write about what I love most: markets, markets, MARKETS! No more discussions on pension storms from nowhere, whether fully-funded US pensions are worth it or rants on Bridgewater's culture and principles.

Today, we take a deep dive into markets so all my cheap broker buddies who absolutely hate pensions but love my market comments can stop whining like little girlie men and gain some much-needed macro insights (I tell them, if you don't like the content of my blog, pay up and then we can talk about it).

Alright, where is Jim Rogers right and where is he wrong? Like most market participants, Rogers doesn't understand the baffling mystery of inflation-deflation, because if he did, there is no way he would be recommending agriculture (DBA), commodities (GSC), Russian (RSX) or Chinese (FXI) stocks.

In fact, if Rogers understood that global deflation is gaining strength and headed for the US, he would be terrified and shorting the crap out of all these stocks he publicly recommended.

Where is Rogers right? In my recent comment on pension storms from nowhere, going over John Mauldin's dire warning on pensions, I wrote this:
I have been covering America's public and private pension crisis for a long time. It's a disaster and John is right, it's only going to get worse and a lot of innocent public-sector workers and retirees and private-sector businesses are going to get hurt in the process.

But it's even worse than even John can imagine. With global deflation headed to the US, when the pension storm cometh, it will wreak havoc on public and private pensions for a decade or longer. At that point, it won't just be companies breaking the pension promise, everyone will be at risk.

Importantly, if my worst fears materialize, this isn't going to be like the 2008 crisis where you follow Warren Buffett who bought preferred shares of Goldman Sachs and Bank of America at the bottom, and everything comes roaring back to new highs in subsequent years.

When the next crisis hits, it will be Chinese water torture for years, a bear market even worse than 1973-74, one that will potentially drag on a lot longer than we can imagine.

This will be the death knell for many chronically underfunded US public and private pensions for two reasons:
  1. First, and most importantly, rates will plunge to new secular lows and remain ultra-low for years. Because the duration of pension liabilities is much bigger than the duration of assets, any decline in rates will disproportionately hurt pensions, especially chronically underfunded pensions.
  2. Second, a prolonged bear market will strike public and private assets too. Not only are pensions going to see pension deficits soar as rates plunge to new secular lows, they will see their assets shrink, a perfect double-whammy storm for pensions. 
No doubt, some pensions will be hit much harder than others, but all pensions will be hit.
So, I agree with Jim Rogers, the next bear market will be a lot worse than anything we have seen before. And lot of unsuspecting retail and institutional investors riding the Big Beta ETF wave higher and higher are in for a very rude awakening in the years ahead.

What else? Let there be no doubt, exchange-traded funds (ETFs) are driving the market higher, along with central banks and companies buying back shares like there's no tomorrow.

Ben Carlson, publisher of A Wealth of Common Sense blog, recently wrote that saying there's a bubble in ETFs makes no sense, pointing out the following instead:
Closet indexing was the real bubble that is currently popping. You’ve never heard about it because the fund companies could extract such high fees in these funds.
No doubt, closet indexing was the real bubble, and I've discussed this before on my blog, but if Ben thinks the $3 $4 trillion shift in investing isn't a bubble in the making, he too is out to lunch.

Importantly, while Bitcoin is a glaring bubble to me (don't touch anything you can't hedge against!), there is a huge passive beta bubble going on in recent years that has effectively displaced and swamped the previous active alpha bubble and when it breaks, it will  wreak unfathomable damage to markets (overall indexes) for a very long time. ETF disciples will be crushed for years.

Equally important to remember, there is a symbiotic relationship between active and passive investing which Jack Bogle is well aware of. One cannot exist without the other and when everyone jumps on any investment bandwagon -- be it stocks, bonds, commodities, ETFs, etc. -- it doesn't bode well for future returns.

I rolled my eyes this morning when I read Pimco, BlackRock see a multi-year rally for emerging markets. Good luck with that trade, in a deflationary world, I recommend being underweight or even shorting emerging market stocks (EEM) and bonds (EMB).

It was interesting to see bank stocks surge higher this week as the yield curve collapsed but in a deflationary world, I'd be cautious on financials (XLF), they will perform miserably for a very long time.

Of course, the big news this week was the Federal Reserve and the 'great unwinding' of its balance sheet. The Fed didn't raise rates but hinted that rate hikes are coming and that it will proceed with an orderly but significant reduction in its balance sheet (read the FOMC statement here).

And I thought the Bank of Canada is flirting with disaster. The Fed is either oblivious to deflation headed to the US or it's terrified and wants to try to shore up big banks to prepare them for the catastrophic losses that lie ahead (ironically, this tightening will prop up the US dollar, lower import prices and exacerbate deflationary headwinds but it's a race to shore up banks before deflation strikes to mitigate the damage).

Maybe I'm wrong on deflation. This week, my friend Fred Lecoq sent me a comment from Pennock, A Possible Secular Bottom For Inflation, which you can all read here.

And my former colleague from the Caisse, Caroline Miller who is now the Global Strategist of BCA Research, put out a conference call titled "Should Bond Bears Come Out of Hibernation Or Will They Face Extinction?". You can watch it for free here.

Is the Maestro right on bonds? I don't think so. I respect Caroline a lot but I remain firmly in the deflation camp and following the Fed's statement, the bond market remains unimpressed and unconvinced that growth or reflation is coming back anytime soon.

In fact, I even called out bond king Jeffrey Gundlach on Twitter after he tweeted something silly following the Fed's announcement (click on image):

I think what is going on right now is the bond market is waiting for some announcement on tax cuts but it will be too little too late. Tax cuts will provide temporary relief but by the time they work through, the US economy will be well on its way to recession.

Again, let me be crystal clear here on my top three macro conviction trades going forward:
  1. Load up on US long bonds (TLT) while you still can before deflation strikes the US. This remains my top macro trade on a risk-adjusted basis.
  2. A couple of months ago I said it's time to start nibbling on the US dollar (UUP) and it continued to decline but I think the worst is behind us, and if a crisis strikes, everyone will want US assets, especially Treasuries. I'm particularly bearish on the Canadian dollar (FXC) and would use its appreciation this year to load up on US long bonds (TLT).
  3. My third macro conviction trade is to underweight/ short oil (USO), energy (XLE) and metals and mining (XME) as the global economy slows. Sell commodity indexes and currencies too.
Admittedly, oil prices are stubbornly hovering around $50 a barrel, and the higher they go, the better for energy, commodities and commodity currencies but I would be very careful here, this isn't another major reflation trade like in early 2016, it's just a counter-cyclical move in a major downtrend. 

What about tech stocks (XLK) and biotech stocks (XBI)? They look toppish to me and while there are some fantastic moves in individual biotech shares, I would tread carefully here too. 

Again, I'm not worried about when the tech bubble will burst. I'm far more worried about deflation headed to the US, wreaking havoc on the global economy and public and private risk assets for years to come. 

Be very careful in these markets. there is no question there is plenty of liquidity and trading opportunities abound. Every day, I look at ETFs and thousands of stocks I track and even my personal watch list and see lots of green and red (click on images): 

But I'm still in full-on defensive mode, all my money remains in US long bonds (TLT) and I'm undecided on whether I'm going to get back into trading biotech and tech companies for the remainder of the year.

These are markets for traders but you need to be good and take huge risks to make the big coin, buying the right stocks on big dips which sounds easy until you get caught and get your head handed to you.

Going into the end of the quarter, I expect some window dressing from big funds, there will be trading opportunities but you need to be very careful here, the US economy is definitely slowing. A lot of this slowdown has been reflected in the weak USD but as the rest of the world also slows, you will see their currencies sell off relative to the greenback.

Stay sharp, don't get too excited, sweep the table when you see profits, and be prepared for the worst bear market we have yet to experience (forget all your trading and investment books, read Hegel, Marx, and Nietzsche instead).

Or you can relax and listen to the Oracle of Omaha who recently predicted the Dow will hit 1 million and that may actually be pessimistic. He may be right but he won't be around to witness this and neither will you or I.

In the meantime, I'm with the former New York City mayor who said Tuesday in an interview with CBS News' Anthony Mason: "I cannot for the life of me understand why the market keeps going up."

The reason why the US market keeps going up is that it's the best and most liquid market in the world and after the USD slide, it's relatively cheap (on a currency, not valuation basis) but not without risks.

Second, take the time to watch the FOMC press conference from earlier this week. Madame Chair doesn't understand why inflation expectations aren't picking up yet. I suggest she and everyone else read this comment on retail sales and the end of reflation as well as my comment on deflation headed to the US. Does anyone else think Neel Kashkari should be named the next Fed Chair?

Lastly, the New York Times published a nice article last weekend, False Peace for Markets?, profiling a young 38-year old trader, Christopher Cole who runs Artemis Capital, and is betting big that volatility won't stay at historic lows for long. Watch him below discussing taking the long road with volatility.

I've already covered the silence of the VIX in great detail and it's worth noting Mr. Cole could come out of this a hero or a big zero depending on when markets break down. He could be right, and I myself am defensive right now, but markets can stay irrational longer than you can stay solvent.

Thursday, September 21, 2017

Are Fully-Funded US Pensions Worth It?

John J. McTighe, Jim Baross and David A. Hall wrote an op-ed for The San Diego Union-Tribune, Why full funding of pensions is a waste of money:
Stark headlines have appeared over the past few years proclaiming that public pension plans in California are woefully underfunded and that basic services like police, parks and libraries may suffer as a result.

In fact, full funding of public pension plans isn’t necessary or even prudent for their healthy operation, according to a recent analysis by Tom Sgouros of the Haas Institute in Berkeley.

In the private sector, pension systems need to be 100 percent funded to protect the pensions of workers in case of bankruptcy. In the public sector, however, while governments may encounter periodic budget ups and downs due to economic cycles and fluctuating revenues, they are not going away. Public employees are hired and begin contributing to the pension system during their working lives. Their contributions help pay the benefits of retirees who worked before them. Once they retire, contributions from employees who replace them will help pay their retirement benefits, and so on, indefinitely.

Full funding of a public pension plan amounts to covering the total future benefits of all current workers. The Hass Institute analysis describes this as a waste of money because it equates to insuring against a city or county’s disappearance. According to the report, the real question of a pension plan’s fiscal viability is whether it can continue to pay its obligations each year, in perpetuity — not whether it can cover all future obligations immediately. This is why some fiscal credit rating agencies consider a 70-80 percent funded ratio adequate for public pension systems.

Imagine you sign a lease to rent an apartment for 12 months at $1,000 a month. Your ultimate obligation is $12,000, but should the landlord refuse to rent to you if you can’t show you have $12,000 available at the outset of the lease (100 percent funding)? No, the landlord simply wants assurance you can pay your rent each month.

If you’re a homeowner, you probably have a 30-year mortgage. Your mortgage allows you to own your home without fully funding the purchase. If, for example, you have a $300,000 home with a $150,000 mortgage, it might be said that your homeownership is at a 50 percent funded ratio. That’s not reckless; it’s prudent use of debt.

Each of these examples involves an ultimate obligation to pay off all the debt by a specific date. Public pensions are different in that the obligation is open ended, but so are the income sources.

Let’s consider a pension fund that has 70 percent of what it needs to pay all retirees decades in the future. During any given year, the pension fund must pay promised benefits to current retirees. Provided that annual contributions from the employer and current employees, combined with investment returns, are equal to benefit costs, the fund operates at break-even.

If at the end of the year the fund is at 70 percent, it’s a wash. The fund can go on indefinitely under these conditions. According to the Haas report, America’s public pension systems were, on average, 74 percent funded as of 2014.

There are two strong reasons not to move to 100 percent funding.

First, doing so would require significant, unnecessary expense to employees, employers and taxpayers.

Since public pensions can exist indefinitely at 70 percent or 80 percent funding, why not use those funds for more immediate needs?

There’s a larger concern, though.

Historically, when pensions in California approached 100 percent funding due to unusually high investment returns, policymakers reduced or skipped annual contributions, under the flawed assumption that high market returns were the new normal. They also increased benefits without providing adequate funding, again expecting investment returns would cover the cost. When investment returns returned to normal, these decisions had long-term negative consequences.

Some people speculate that future investment returns will be lower than past returns, requiring higher contributions from workers and taxpayers to sustain pension funds. In truth, no one knows.

The prudent course is to review returns each year and make gradual course corrections, as needed. That’s why independent auditors regularly evaluate and advise public pension funds on necessary course corrections.

So when you hear concerns about public pensions being underfunded, understand that ensuring 100 percent funding isn’t critical to the healthy functioning of a public pension system, and it can be very expensive.

Both the city and county of San Diego pensions systems are quite stable at a 70-80 percent funding ratio.

Wouldn’t the tax dollars required to get them to 100 percent funding be better spent on other needs — like police, parks and libraries?


McTighe is president of Retired Employees of San Diego County. Baross is president, City of San Diego Retired Employees’ Association. Hall is president, City of San Diego Retired Fire and Police Association.
Back in February, Ryan Cooper of The Week wrote an article on this, Public pensions are in better shape than you think:
The beleaguered condition of state and local pension plans is one of those ongoing disaster stories that crops up about once a week somewhere. The explanation usually goes something like this: Irresponsible politicians and greedy public employee unions created over-generous benefit schemes, leading to pension plans which aren't "fully-funded" and eventual fiscal crisis. That in turn necessitates benefit cuts, contribution hikes, or perhaps even abolishment of the pension scheme.

But a fascinating new paper from Tom Sgouros at UC Berkeley's Haas Institute makes a compelling argument that the crisis in public pensions is to a large degree the result of terrible accounting practices. (Stay with me, this is actually interesting.) He argues that the typical debate around public pensions revolves around accounting rules which were designed for the private sector — and their specific mechanics both overstate some dangers faced by public pensions and understate others.

To understand Sgouros' argument, it's perhaps best to start with what "fully-funded" means. This originally comes from the private sector, and it means that a pension plan has piled up enough assets to pay 100 percent of its existing obligations if the underlying business vanishes tomorrow. Thus if existing pensioners are estimated to collect $100 million in benefits before they die, but the fund only has $75 million, it has an "unfunded liability" of $25 million.

This approach makes reasonably good sense for a private company, because it really might go out of business and be liquidated at any moment, necessitating the pension fund to be spun off into a separate entity to make payouts to the former employees. But the Government Accounting Standards Board (GASB), a private group that sets standards for pension accounting, has applied this same logic to public pension funds as well, decreeing that they all should be 100 percent funded.

This makes far less sense for governments, because they are virtually never liquidated. Governments can and do suffer fiscal problems or even bankruptcy on occasion. But they are not businesses — you simply can't dissolve, say, Arkansas and sell its remaining assets to creditors because it's in financial difficulties. That gives governments a permanence and therefore a stability that private companies cannot possibly have.

The GASB insists that it only wants to set standards for measuring pension fund solvency. But its analytical framework has tremendous political influence. When people see "unfunded liability," they tend to assume that this is a direct hole in the pension funding scheme that will require some combination of benefit cuts or more funding. Governments across the nation have twisted themselves into knots trying to meet the 100-percent benchmark.

While all pensions have contributions coming in from workers, the permanence of those contributions is far more secure for public pensions. Plus, those contributions can be used to pay a substantial fraction of benefits.

Indeed, one could easily run a pension scheme on a pay-as-you-go basis, without any fund at all (this used be common). That might not be a perfect setup, since it wouldn't leave much room for error, but practically speaking, public pension funds can and do cruise along indefinitely only 70 percent or so funded.

This ties into a second objection: How misleading the calculation for future pension liabilities is.

A future pension liability is determined by calculating the "present value" of all future benefit payments, with a discount rate to account for inflation and interest rates. But this single number makes no distinction between liabilities that are due tomorrow, and those that are due gradually over, say, decades.

Fundamentally, a public pension is a method by which retirees are supported by current workers and financial returns, and one of its great strengths is its long time horizon and large pool of mutual supporters. It gives great leeway to muddle through problems that only crop up very slowly over time. If huge problems really will pile up, but only over 70 years, there is no reason to lose our minds now — small changes, regularly adjusted, will do the trick.

Finally, a 100-percent funding level — the supposed best possible state for a responsible pension manager — can actually be dangerous. It means that current contributions are not very necessary to pay benefits, sorely tempting politicians to cut back contributions or increase benefits. And because asset values tend to fluctuate a lot, this can leave pension funds seriously overextended if there is a market boom — creating the appearance of full funding — followed by a collapse. Numerous state and local public pensions were devastated by just this process during the dot-com and housing bubbles.

I have skipped past several more technical objections from Sgouros (whose paper is really worth reading). But the fundamental point here is fairly simple. Accounting conventions are supposed to help people think clearly about their financial health. But in the case of public pensions, they have warned of partly imaginary danger, pushing governments to stockpile vast asset hoards that are much larger than is necessary, and created a goal which is itself rather dangerous. The next time you see someone complaining about a pension funding shortfall, check the details carefully.
Let me begin by directing your attention to Tom Sgouros's paper, Funding Public Pensions, where he examines whether full pension funding is a misguided goal (click here to read it).

I too think this paper is well written and well worth reading as it raises many excellent points. First, public pensions are not private corporations and the solvency rules shouldn't be as onerous on them as they should be for companies which can go bankrupt.

In my last comment, I went over Boeing's huge pension gaffe, funding its pension with its company shares. Boeing has a funding ratio of 74 percent, which according to this study is no big deal if you're a public pension plan, but it's more concerning if you're a private corporation.

In June, I covered how GE botched its pension math and last month, I covered America's corporate pension disaster where I stated the following:
A few observations from me:
  • Pensions are all about matching assets and liabilities and since the duration of assets is much lower than the duration of liabilities, the decline in rates has disproportionately hurt private and public pensions because liabilities have grown a lot faster than assets.
  • Unlike public pensions which use an assumed rate-of-return of 7% or 8% to discount future liabilities, corporate pensions use a market rate based on corporate bond yields (see below). This effectively means that the way American corporations determine their future liabilities is a lot stricter and more realistic than the way US public pensions determine their liabilities.
  • Companies hate pensions. Instead of using money from corporate bonds to top up their pensions, they prefer using these proceeds to buy back shares, rewarding their investors and propping up executive compensation of their senior managers.
  • The pension crisis is deflationary and will only ensure low rates for a lot longer. Shifting out of defined-benefit plans into defined-contribution plans will only exacerbate pension poverty.
Now, let me thank Mathieu St-Jean, Absolute Return Manager at CN Investment Division, for bringing the top article to my attention. I commented on his LinkedIn post but lost it and there was a very nice actuary who corrected me, stating the discount rate corporate pensions use is A or AA, not AAA bond yields.

The point is that corporate pensions use a market rate, not some assumed rate-of-return based on rosy investment assumptions. Some argue this is way too stringent while others argue it is far more realistic and if US public pensions used this methodology, their pension deficits would be far worse than they already are.
In a more recent comment on how new math hit Minnesota's pensions and drastically impacted their funded status from just a year ago (from 80 percent to 53 percent), Bernard Dussault,  Canada's former Chief Actuary, shared this with me after reading that comment:
As you may already well know, my proposed financing policy for defined benefit (DB) pension plans holds that solvency valuations (i.e. assuming a rate of return based on interest only bearing investment vehicles as opposed to the return realistically expected on the concerned actual pension fund) are not appropriate because they unduly increase any emerging actuarial surplus or debt of a DB pension plan.

Nevertheless, while assuming a realistic rate of return as opposed to a solvency rate would decrease the concerned USA DB pension plans' released debts, any resulting surplus would not appear realistic to me if the assumed long-term real rate of return were higher than 4% for a plan providing indexed pensions.
I think Bernard is on the same page as Tom Sgouros, but he too raises concerns over the use of an inappropriate long-term real rate of return higher than 4%.

This week, I discussed US pension storms from nowhere, going over John Mauldin's dire warning on public pensions where I stated the following:
I have been covering America's public and private pension crisis for a long time. It's a disaster and John is right, it's only going to get worse and a lot of innocent public-sector workers and retirees and private-sector businesses are going to get hurt in the process.

But it's even worse than even John can imagine. With global deflation headed to the US, when the pension storm cometh, it will wreak havoc on public and private pensions for a decade or longer. At that point, it won't just be companies breaking the pension promise, everyone will be at risk.

Importantly, if my worst fears materialize, this isn't going to be like the 2008 crisis where you follow Warren Buffett who bought preferred shares of Goldman Sachs and Bank of America at the bottom, and everything comes roaring back to new highs in subsequent years.

When the next crisis hits, it will be Chinese water torture for years, a bear market even worse than 1973-74, one that will potentially drag on a lot longer than we can imagine.

This will be the death knell for many chronically underfunded US public and private pensions for two reasons:
  1. First, and most importantly, rates will plunge to new secular lows and remain ultra-low for years. Because the duration of pension liabilities is much bigger than the duration of assets, any decline in rates will disproportionately hurt pensions, especially chronically underfunded pensions.
  2. Second, a prolonged bear market will strike public and private assets too. Not only are pensions going to see pension deficits soar as rates plunge to new secular lows, they will see their assets shrink, a perfect double-whammy storm for pensions. 
No doubt, some pensions will be hit much harder than others, but all pensions will be hit.

This brings me to another point, how will policymakers address this crisis when it really hits them hard and they can't ignore it because pension costs overwhelm public budgets?

Well, Kentucky's public pensions may be finished but I am truly disheartened by the moronic, knee-jerk response. Tom Loftus of courier-journal reports, Kentucky pension crisis: Are 401(k) plans the solution?. I note the following passage:
Keith Brainard, research director for the National Association of State Retirement Administrators, said risk doesn't disappear under a 401(k) plan.

"These proposals shift that risk from the state and its public employers and taxpayers and put it all on the workers. In fact, there’s going to be more risk because they are no longer in a group that can manage the risk much better," he said.

Whether the moves actually will save the state money is a question being hotly debated.

Jason Bailey, executive director of the Kentucky Center for Economic Policy, of Berea, said, “Moving employees into 401(k)-type plans are actually more expensive … and harms retirees while making it much more difficult to attract and retain a skilled workforce.”
I will keep hammering the point that moving public sector employees to a 401(k) plan shifts retirement risk entirely onto employees, leaves them exposed to the vagaries of public markets, and ultimately many of them will succumb to pension poverty just like private sector employees with DC plans. Moreover, the long-term effects for the state of Kentucky are not good, they will raise social welfare costs and cut economic growth as more people retire with little to no savings.

Another point I need to make to the John Mauldins of this world, the pension crisis is deflationary. Period. I don't care if it's DB or DC pensions, a retirement crisis putting millions at risk for pension poverty will exacerbate rising inequality and necessarily impact aggregate demand and government revenues (collect fewer sales taxes).

Don't get me wrong, the US has a whole host of problems with their large public DB plans, and chief among them is lack of proper governance. Sure, states aren't topping them up, pensions still use rosy investment assumptions to discount future liabilities, but the biggest problem is government interference and their inability to attract and retain qualified investment staff to manage public and private assets internally.

On top of these issues, some decently-funded US pensions are getting hit with brutal changes to accounting rules. I recently discussed how this new math hit Minnesota's pensions but as other states adopt similar rules to discount future liabilities, get ready, they will get hit hard too.

This is why on top of good governance which separates public pensions from the government, I believe we need to introduce some form of risk-sharing in public pensions so when the plans do experience a deficit, contribution rates increase and/ or benefits are cut until the plan regains fully-funded status again.

In my recent conversation with Jim Leech on pensions and Canada's Infrastructure Bank, the former President and CEO of Ontario Teachers' shared this with me on how OTPP regained its fully-funded status:
Basically, there are two levers Ontario Teachers' Pension Plan uses when the plan goes into deficit to restore fully-funded status:
  • It partially or fully removes cost-of-living adjustments (conditional inflation protection) and
  • It raises the contribution rate from the base of 9% to an agreed upon rate (a special levy)
After the plan ran into deficits after the 2008 crisis, the contribution rate was increased to 13% and since it is a jointly sponsored plan, both teachers and the government needed to contribute this rate.

However, unlike 1997 where benefits were increased, now that the plan is fully-funded,  the new agreement is simply to restore full inflation protection and reduce the contribution rate back to the base case of 9% (can never go lower).

The key here is there are no increases in benefits, it's simply restoring full inflation protection and reducing the contribution rate going forward to the base rate of 9%.
Lastly, a dire warning to John Mauldin and residents of Dallas. All roads lead to Dallas. The great state of Texas will survive and rebuild after Hurricane Harvey but get ready for major increases in property taxes when the pension storm cometh and deflation hits the US.

And there will be no escape (to where? Illinois, New Jersey or Kentucky?!?). The pension storm will strike us when we least expect it and it will wreak havoc on the US and global economy for a very long time.
Now, I want to be careful here, the United States isn't Greece, it can print its reserve currency and in theory inflate its way out of debt or keep servicing its debt in perpetuity as long as long-term growth is decent.

But there are limits to debt and there are a lot of reasons to believe growth will be very subdued over the next decade, which means interest rates will remain at ultra-low levels for a very long time, especially if my worst fears of deflation hitting the US come true.

It's also worth noting that public pension liabilities are long-dated and unlike corporate pensions, there is no solvency threat to treat them the exact same way as their corporate counterparts.

Equally important to keep in mind that in the past when US public pensions reached fully-funded status, state and local governments stopped topping them out, took contribution holidays and increased benefits to buy votes just (like they did in Greece!!). This too exacerbated pension deficits which is why I would make contribution holidays illegal and enshrine it in the constitution.

There is plenty of pension blame to go around: governments not topping out pensions, unions who want to stick to rosy investment assumptions and refuse to share the risk of their plan, and huge myths on just how widespread the US public pension crisis truly is.

John Mauldin's warning on the pension storm is informative but he too perpetuates myths because he has a right-wing agenda in all his comments just like those union members above have a left-wing agenda in writing their comment.

Ironically, I'm probably more of an economic conservative than John Mauldin. I hate Prime Minister Justin Trudeau's new tax plan because it's dumb policy and hypocritical on his part but when it comes to health, education and pensions, I believe the federal government must offer the best solution in all three because it makes for good economic policy over the long run.

I've said this before and I will say this again, expanding and bolstering large, well-governed public pensions in Canada and elsewhere is good pension and economic policy over the long run.

Period. I don't care what John Mauldin or Joe and Jane Smith think, I know I'm right and the proof is in our Canadian pudding!

Now, let me get back to Tom Sgouros and the articles above because I'm not going to give them a free pass either. They're right, US public pensions can be 70 or 80 percent underfunded in perpetuity but funded status matters a lot and things can degenerate very quickly.

Importantly, when the funded status declines, governments and workers need to contribute more to shore up public pensions, and this will necessarily mean less money for other services.

Also worth noting rating agencies are increasingly targeting US public pensions, and as their credit rating declines, state borrowing costs go up.

There is something else that bothers me, apart from the fact that a lot of US public pensions would be chronically underfunded if they were using the discount rate Canada's large public pensions use to discount future liabilities, there are no stress tests performed on US public pensions to see just how solid they really are.

For example, the Federal Reserve stress tests banks but nobody is looking at the health of large US public pensions and what they can absorb in the form of a severe deflationary shock (to be fair, nobody is doing this in Canada or elsewhere either).

Now, let's say your US public pension is 70 percent funded, and a huge deflationary shock that lasts a very long time sends long bond yields to zero or even negative territory. I don't need to perform a stress test, I know all pensions will get clobbered but chronically underfunded and even "decently" funded pensions will be at risk of a death spiral they simply will never recover without huge increases in contributions along with huge haircuts in benefits.

"Come on Leo, over the very long run, pensions can withstand whatever the market throws at them, they have a very long investment horizon." True but some pensions are in much better shape than others to withstand financial shocks.

Last February, Hugh O'Reilly, CEO of OPSEU Pension Trust (OPTrust) and Jim Keohane, CEO of Healthcare of Ontario Pension Plan (HOOPP), wrote an op-ed, Looking for a better measure of a pension fund’s success, where they underscored the importance of a pension plan's funded status as the ultimate measure of success.

I can tell you without a doubt that HOOPP, OPTrust, Ontario Teachers' Pension Plan, OMERS and other large Canadian pensions will get hit too if another financial crisis hits us but they're in a much better position to absorb this shock because of their fully-funded status. Also, some of them (HOOPP and OTPP) have adopted a shared-risk model which means they can increase contributions and/or decrease benefits if their plan runs into trouble in the future.

I keep stating pensions are all about matching assets and liabilities but more importantly, they are about fulfilling a pension promise to allow plan beneficiaries to retire in dignity and security.

So, if you ask me, there is no doubt that the funded status of a public pension matters a lot. Maybe US public pensions can't attain the fully-funded status of their Canadian counterparts but there is a lot of room for improvement, especially on the governance front and adopting a shared-risk model.

Demographic pressures are hitting all pensions, we simply cannot afford to be complacent about the funded status of large public pensions or else we risk seeing Kentucky's pension problems all over the US.

No doubt, we need to be careful when looking at the US public pension crisis, not to overstate it, but it's equally irresponsible and dangerous if we understate it and think they're on the right path and their funded status is much ado about nothing.

In my last comment on Boeing's huge pension gaffe, I stated flat out:
It's high time the United States of America adopts a single payer healthcare system like Canada and the rest of the civilized world has done and privatize and enhance Social Security for all workers, adopting the Canadian governance model to make sure it's done well.
There will be tremendous opposition to these much-needed reforms from healthcare insurers, insurance companies, and mutual fund companies but it makes good economic sense to go through with them whether you're a Democrat, Republican or independent.

Below, an older clip where Tom Sgouros discusses the wealth flight myth (2011). He's obviously very bright and I agree with him on the wealth flight myth and think you should all take the time to read his paper, Funding Public Pensions, keeping my comments above in mind.

If you have anything to add, feel free to email me at and I will gladly post them in an update to this comment.

Update: Tom Sgouros was kind enough to share this with me after reading my comment:
"Thanks for the note and the kind words. I'm with you on the discipline question, by the way. I just think the current system of discipline -- which is mostly just about people yelling at the mayor if he makes a bad pension decision -- isn't working very well. Discipline isn't consequences a decade down the line. Discipline is having your checks to retirees bounce or your budget not balance in the very near term. The closer we can get to a system like that, the better off systems will be in the long term, in my opinion."
I thank him for sharing his feedback on this post.

Also, Jim Leech, the former President and CEO of Ontario Teachers' Pension Plan shared his thoughts on the second article at the top of this post:
This article has two fundamentally flawed assumptions:

1. It assumes that the public employer sponsor will never become insolvent/bankrupt ie taxpayers will always pay higher and higher taxes to fund pension promises - NOT. There is a practical limit to how much property, income and other taxes can be levied, public services cut and public infrastructure deteriorates before the economic viability of a municipality/state is destroyed and everyone leaves town.

2. As important, there is a serious intergenerational equity issue that is ignored. When a fund is in:
  • A. Balance - there is enough $ (comprising existing assets, future contributions and future earnings on the funds) to pay for past earned benefits and future benefits yet to be earned
  • B. Surplus - the current generation of retirees/employees/taxpayers have overpaid for the benefits (earned and to be earned)
  • C. Deficit - the current generation of retirees/employees/taxpayers have underpaid for the benefits; future generations of taxpayers/employees will have to pay more than the value of the benefits. ie the next generation is saddled with a debt for nothing. This is particularly troublesome as longevity increases, ratio of retirees to employees increases and workforces (plan members) shrink.

But the biggest "false news" is the example used (mortgage debt). Of course the bank does not require the borrower to have 100% of the principal and future interest payments in cash upfront. But the bank sure as heck wants some proof that the borrower can realistically meet the future payment stream (proof they ask for is: net worth statement, insurance, income verification, etc)

That is the same for the pension fund valuation. You need to show that net worth (assets on hand) plus future inflows (contributions and earnings on fund) are sufficient to meet the future payment stream.
I thank Jim for sharing his wise insights with my readers and highly recommend you read our recent discussion on pensions and the Canada Infrastructure Bank.

Suzanne Bishopric, the former CIO of the UN Pension Fund, echoed some of Jim's concerns in her comments which she shared with me:
The pay as you go system is likely to create intergenerational inequities because:
  1.  Demographic changes in recent years have meant the next generation is likely to be smaller (think of China and Finland), so a higher proportion of the tax revenue is required from one generation to the next, to cover the retirement benefits of retirees. Do we want to exploit our children this way?
  2.  Income generating opportunities are not uniformly distributed across time. One generation (think of Southern Europe today) may have higher unemployment rates and less stable working opportunities than did their parents' generation. If each generation sets aside money as they earn it, for example, via payroll deductions, they will support themselves without placing further burdens on the next generation. Our children should not have to be responsible for our generation, which has not left better opportunities for them.
  3. Market volatility being what it is, one generation could have the misfortune of needing funds to support their retirement right when the market has reached a nadir. This is an especially severe problem in the USA, where most retirement funds are segregated into small personally managed individual accounts. When combined with low interest rates, amateur expertise, lack of access to higher returning asset classes and limited scope for competitive pricing contribute to the underfunding of retirement assets.
I thank Suzanne for sharing her thoughts with my readers.

Wednesday, September 20, 2017

Boeing's Huge Pension Gaffe?

Katherine Chiglinsky, Julie Johnsson, and Brandon Kochkodin of Bloomberg report, Down $20 Billion, Boeing Stuffs Pension Fund With Its Own Shares:
Like so many companies in America, Boeing Co. has largely neglected the gaping deficit in its employee pension as it doled out lavish rewards to shareholders.

What’s raising eyebrows is how it plans to shore up the retirement plan.

Last month, Boeing made its largest pension contribution in over a decade. But rather than put up cash and lock in the funding, the planemaker transferred $3.5 billion of its own shares, including those it bought back in years past. (The administrator says it expects to sell them over the coming year.)

It’s a bold move, and one cheered by many on Wall Street. Yet to pension experts, it isn’t worth the risk. After a record-setting, 58 percent rally this year, Boeing is betting it can keep producing the kind of earnings that push shares higher. If all goes well, not only will the pension benefit, but Boeing says it will be able to forgo contributions for the next four years.

But if anything goes awry, the $57 billion pension -- which covers a majority of its workers and retirees -- could easily end up worse off than before.

“It’s an irresponsible thing to do certainly from the perspective of the plan participants,” said Daniel Bergstresser, a finance professor at the Brandeis International Business School. “Ideally, you would like to put assets in the pension plan that won’t fall in value at exactly the same time that the company is suffering.”

Under Chief Executive Officer Dennis Muilenburg, Boeing’s pension shortfall has widened as the Chicago-based company stepped up share buybacks. The $20 billion gap is now wider than any S&P 500 company except General Electric Co. And relative to earnings, Boeing shares are already trading close to the highest levels in a decade, a sign there might be more downside than upside.

‘Good Value’

Boeing disagrees and sees the strategy as a win-win.

“We continue to see Boeing stock as a good value,” spokesman Chaz Bickers said. “This action further reduces risk to our business while increasing the funding level of our pension plans. Our employees and retirees benefit as well since this action provides funding earlier, giving the plan sponsor more flexibility to grow the plans’ assets.”

It’s too early to tell how things will play out -- especially for a company whose shares have historically been sensitive to the ups and downs of the economy -- and early returns are mixed. Gains have slowed markedly since Boeing transferred 14.4 million shares to its pension on Aug. 1, but the 2.4 percent advance is still more than the S&P 500. (The plan has the option to dispose of the shares at any time.)

Analysts see Boeing climbing to $262.86 a share in the coming year, supported by a near-record $423 billion backlog of jet orders that’s equal to about seven years of factory output. That would be good for a 7.2 percent gain from Thursday’s price of $245.23, and roughly in line with analysts’ estimates for the broader market. In the previous 12 months, Boeing stock nearly doubled.

Price Targets

Of course, Boeing isn’t the only company to opt for stock instead of cash when it comes to its pensions. GE’s plan holds more than $700 million of shares and IBM had about $28 million of stock in its U.S. pensions. But Boeing’s transfer is notable because it was one of the largest in recent memory and happened just one day after the company’s shares reached an all-time high.

Pension experts and academics have long debated how much company stock is too much for retirement plans, particularly because workers’ livelihoods become even more intertwined with their employer’s fortunes when they own shares. The dangers came into full view when Enron’s collapse a decade ago saddled its employees with millions of worthless shares in their 401(k)s.

With pensions like Boeing’s, the risks to the company can be greater when share prices plunge because employers are on the hook to cover any shortfall. And for Boeing, the deficit is already considerable.

“It would have been a cleaner decision to contribute cash to the pension,” said Vitali Kalesnik, the head of equity research at Research Affiliates. “Boeing to a degree is a very cyclical company.”

Boeing’s pension went deep into the red after the global financial crisis in 2008 hurt aircraft sales, while delays in its 787 Dreamliner program burned up cash. Record-low interest rates in the years since hurt pension returns across corporate America, and made it hard for Boeing to claw its way out.

Pension Freeze

At the end of 2016, its pension had $57 billion in assets and $77 billion in obligations -- a funding ratio of 74 percent, data compiled by Bloomberg show.

Boeing froze pensions for Seattle-area Machinist union members last year under a hard-fought contract amendment. It also switched non-union workers to a defined contribution plan.

And the stock transfer last month, combined with a planned $500 million cash payment this year, would be equal to all the company’s contributions during the previous five years. Nevertheless, it still leaves Boeing with roughly $15 billion in unfunded pension liabilities, although the shortfall should gradually shrink over the next four years, according to Sanford C. Bernstein & Co.

To be clear, Boeing has the money. In the past three years, the company generated enough excess cash to buy back $30 billion of its own shares.

But using equity instead of cash does have its advantages. It allows Boeing to conserve its free cash flow -- a key metric for investors -- by transferring Treasury shares that were repurchased at far lower values than today’s prices. In addition, Boeing will get a $700 million tax benefit, which will offset the cost of its $500 million cash contribution.

Risk Strategy

The strategy shows how Boeing can “look at risk differently, be proactive and manage that today, and take that uncertainty out over the next five years,” Greg Smith, Boeing’s chief financial officer and chief strategist, told an investor conference on Aug. 9.

It’s not the first time Boeing has plowed stock into its underfunded pension. In 2009, the company contributed $1.5 billion. The shares jumped 27 percent that year and 21 percent in 2010. By 2011, the plan had cashed out.

But this time, Boeing’s valuation is much higher. With a price-earnings ratio of 23, the stock is more than three times as pricey as it was at the start of 2009. Given the nature of Boeing’s business, its earnings could be vulnerable to geopolitical shocks or an economic slowdown that saps demand for air travel.

What’s more, the longer its pension remains under water, the more expensive it becomes to maintain. The Pension Benefit Guaranty Corp., a government agency that acts as a backstop when plans fail, has tripled its rates for companies with funding deficits, and more increases are on the way.

There’s a limit to how long Boeing can put off underfunded liabilities. Over the next decade, the company expects to pay out about $46 billion to retirees.
In June, I covered how GE botched its pension math. Last month, I covered America's corporate pension disaster.

Just when I thought I can't read anything else that shocks me, this little gem of an article appears over the weekend.

Let me begin by stating while Boeing (BA) is a great company and part of the Dow, this is a stupid and highly irresponsible idea. Not only does it violate the prudent investor rule, it makes you question whether Boeing's senior managers are utterly clueless when it comes to managing their pension plan in the best interest of all their stakeholders.

Please indulge me for a minute. Have a look at the 10-year weekly chart of Boeing (BA) below (click on image):

No doubt, following that big dip in 2008, Boeing's shares have surged to record highs, and the company did a good move funding its pension with shares in 2009, even if it was equally irresponsible.

But if Boeing's senior managers and all those genius analysts on Wall Street think shares are going to continue marching higher at a time when deflation threatens the US and global economy, they're in for a rude awakening.

Importantly, and let be crystal clear here, now is not the time to load up on Boeing shares or the shares of Industrials (XLI) which have done extremely well since 2009 led by Boeing (click on image):

Now is the time to take your profits and run and for speculators and short-sellers to start shorting the crap out of these companies.

I know, Boeing isn't married to this position, it can get out of it at any time, but if you ask me, it's a lazy and highly irresponsible way to allocate risk. Boeing should look at what HOOPP, OTPP and other large well-governed Canadian pensions are doing in terms of allocating risk intelligently across public and private markets all over the world.

I'm actually shocked Boeing's unions accept this mediocre handling of their pension plan. If you work at Boeing, make sure you're saving and diversifying away from your company. You don't want to end up like Enron and Nortel employees who suffered a massive haircut to their pension.

One by one, companies are breaking their pension promise. Will Boeing be next? Probably not but if they continue with this nonsense, even this giant will be breaking its pension promise.

More worrisome, it already shifted non-union workers to a defined-contribution plan and it will be a matter of time before it shifts all workers to a DC plan. And you know what I think about DC plans, they are terrible, shift retirement risk entirely onto employees and exacerbate pension poverty.

It's high time the United States of America adopts a single payer healthcare system like Canada and the rest of the civilized world has done and privatize and enhance Social Security for all workers, adopting the Canadian governance model to make sure it's done well.

Companies should solely focus on their core business; most of them (not all) are completely inept at managing pensions.

Below, Prime Minister Justin Trudeau dropped the gloves Monday in his fight with Boeing, saying the government won't do business with a company that he's accusing of attacking Canadian industry and trying to put aerospace employees out of work.

I disagree with our PM on many issues but I agree with him here and think Boeing's allegations relative to Bombardier are utterly ridiculous. Boeing can crush Bombardier like a little bug, it's a much bigger and better-managed company and doesn't need to resort to frivolous lawsuits.

As for its latest move on funding its pension, a year from now, you will all realize how right I was to call this Boeing's huge pension gaffe.