You really can’t make this stuff up. Pension funds refuse to read the writing on the wall: We are living in a reduced return world. It’s as simple as that. Yet instead of taking their lumps, and I’m not even talking about funding what they should have paid years ago into the plan, they are reaching for returns. If you’ve learned anything from my posts to you about investing, it’s that you cannot “hope” for the market to do something for you. You do not want to “reach” for returns. And yet that’s what pensions are doing.
It’s not teachers, firemen, and policemen doing this. They leave it to the pros. And what are the so-called pros doing? The ones on the board of directors loaded with money managers and politicians? They’re talking about ridiculous terms (this group that is schooled in boardroom talk) like standard deviation. What is standard deviation? It basically means what you can stand to lose. According to this article the standard deviation to get 7.5% is 17. Good luck with that! The WSJ writes:
In 1995, a portfolio made up wholly of bonds would return 7.5% a year with a likelihood that returns could vary by about 6%, according to research by Callan Associates Inc., which advises large investors. To make a 7.5% return in 2015, Callan found, investors needed to spread money across risky assets, shrinking bonds to just 12% of the portfolio. Private equity and stocks needed to take up some three-quarters of the entire investment pool. But with the added risk, returns could vary by more than 17%.
Nominal returns were used for the projections, but substituting in assumptions about real returns, adjusted for inflation, would have produced similar findings, said Jay Kloepfer, Callan’s head of capital markets research.
The amplified bets carry potential pitfalls and heftier management fees. Global stocks and private equity represent among the riskiest bets investors can make today, Mr. Kloepfer said.
“Stocks are just ownership, and they can go to zero. Private equity can also go to zero,” said Mr. Kloepfer, noting bonds will almost always pay back what was borrowed, plus a coupon. “The perverse result is you need more of that to get the extra oomph.”