Commentary - CalPERS gambles on risky investment move
https://www.elkgrovenews.net/2020/06/calpers-gambles-on-risky-investment-move.html
By Dan Walters |
CalMatters Columnist |
The
California Public Employees Retirement System, the nation’s largest pension
trust, benefited greatly from the runup in stocks and other investments during
the last few years, topping $400 billion early this year.
CalPERS
needed it because it was still reeling from a $100 billion decline in its
investment portfolio during the previous decade’s Great Recession and was
tapping state and local governments for ever-increasing, mandatory
“contributions” to keep pensions flowing and reduce its immense “unfunded
liability.” But it faced a backlash from local officials who said vital
services were being cut to make their CalPERS payments.
Just when
CalPERS appeared to be climbing out of its hole, the COVID-19 pandemic erupted
early this year, sending the economy into a tailspin. Virtually overnight, the
fund saw its value take
a $69 billion hit as the stock market — CalPERS’ biggest investment
sector — tanked. Stocks have since recovered, but CalPERS is still down about
$13 billion from its high early this year.
Further
investment erosions would, almost automatically, trigger even greater CalPERS
demands for contributions from government employers, but the recession is also
eating into their tax revenues, creating substantial budget deficits.
It
underscores CalPERS’ vulnerability to capital market gyrations. Investments
more immune to fluctuations would be safer but they offer very low returns and
CalPERS could not safely meet its lofty earnings goal — an average of 7% a
year.
It’s a
vicious circle of conflicting demands and priorities, driven by an official
policy of providing generous, inflation-adjusted pensions for government
workers, bolstered by the political clout of public employee unions.
CalPERS
desperately needs an escape route and has chosen the perilous path of debt. It
plans to borrow billions of dollars — as much as $80 billion — to fatten its
investment portfolio in fingers-crossed hopes that earnings gains will outstrip
borrowing costs. It mirrors the recent and risky practice of local governments
borrowing heavily to pay their pension bills via “pension obligation bonds.”
“More
assets refers to a plan to use leverage, or borrowing, to increase the base of
the assets generating returns in the portfolio,” the system’s chief investment
officer, Ben Meng, wrote
in the Wall Street Journalrecently. “Leverage allows CalPERS to take
advantage of low interest rates by borrowing and using those funds to acquire
assets with potentially higher returns.”
What could
possibly go wrong?
The new
scheme is an implicit admission that CalPERS can’t meet its 7% mark without
increasing its exposure to the vagaries of the market. “There are only a few
asset classes with a long-term expected return clearing the 7% hurdle,” Meng
wrote.
Perhaps,
then, the real problem is the 7% goal, much higher than those of private
industry pension plans.
CalPERS
and other public systems use higher earnings projections because they need them
to pay for the expensive pensions that politicians have awarded. Inferentially,
if they fall short of the mark, they can tap employers — i.e. taxpayers — to
close the gap. However, that option is pretty much maxed out, which may explain
why the very risky borrow-and-invest approach is being adopted.
This is
serious stuff, so risky that the Legislature should dump its informal hands-off
policy toward CalPERS and order up a comprehensive and independent examination
of the system’s assets, liabilities and long-term prospects of meeting its
pension obligations.
CalMatters
is a public interest journalism venture committed to explaining how
California’s state Capitol works and why it matters. For more stories by Dan
Walters, go to calmatters.org/commentary
Elk Grove News is media partner of CalMatters.
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