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What is Your Pension Really Worth?

Last week, we posted an article from Michael Lewitt, Vice President and Portfolio Manager at Cumberland Advisors called "The Pension Dilemma" that talked about how America’s largest pension fund, the California Public Employees Retirement Systems (CALPERS) reported an abysmal 1% return on its investments for the past year (ending June 30, 2012).

CALPERS has been in the news lately for several reasons:

  1. The California state pension is a bellwether for other state-run retirement systems across the U.S. that are also forced to face one of the most challenging periods in history: low interest rates, volatile markets and slow economic growth.
  2. CALPERS missed their own internal targets by more than 7.2% and then blamed their underperformance partly on picks made by individual investment managers (which CALPERS declined to name).
  3. The CALPERS underperformance has shaken the confidence that many investors have in their own pension funds.

What Does This Means for the Average Investor?

Retirement planning is a passion for us here at the Portfolioist. Yes, go ahead and laugh at the use of the word “passion” if you must—but that’s how we truly feel—especially in these turbulent economic times.

If you are a frequent visitor to our blog, you know that we’ve written about retirement planning—a lot. And we’re going to continue to do so, because we strongly feel that every investor (at any age) needs to make investing for retirement paramount—especially in these uncertain economic times.

This is why we found the news about the CALPERS underperformance so disturbing. If one of the country’s largest pension funds—with access to some of the most brilliant financial minds in the nation—can’t make more than a 1% return, how can the average investor hope to retire one day?

We talked to Geoff Considine, a leading contributor to the Portfolioist, to find out what (if anything)  average investors who trusted their retirement to their local pension plan can do.

Geoff, you’ve seen all of the articles about CALPERS’ disappointing performance for the year. It looks like they blamed the current low interest rate environment along with the volatile economy. Do you buy it?

There is no question that the last twelve months have been challenging for investors.  There is also no question that we are working with some almost historically-unprecedented economic conditions, such as record low Treasury yields and the Euro-zone crisis.  However, pensions need to be designed to cope with all sorts of market conditions.  Given the very unusual market conditions, it is not unreasonable that CALPERS underperformed its benchmark.  Underperforming the benchmark is quite different from the issue of whether the fund can realistically achieve its target for long-term performance.  One year’s returns data is essentially irrelevant to that question.

Over the same time period (ending June 30, 2012) the Dow Jones Industrial Average actually rose 3.8%. How could CALPERS miss the mark by more than 2 percentage points?

The fact that both the U.S. stock market and the bond market rose during this period – both by more than the aggregate return of CALPERS’ portfolio—is definitely notable.  However, the performance of a stock index such as the Dow Jones is not an appropriate benchmark for a pension plan, which of course, raises the next question: “What should the benchmark be?”

CALPERS official benchmark returned 1.7% over this 12-month period, so the pension underperformed on this basis, but by far less.  CALPERS benchmark portfolio, against which they judge their performance, is a combination of standard and custom indexes.

How does a pension fund’s methodology differ from one that an individual investor uses?

This is where things get interesting. CALPERS has an investment policy that includes active management from a range of money managers and asset classes.  One of the key questions for the individual investor is the extent to which they want to use passive vs. active approaches in their portfolios.  The simplest approach is to invest in a Target Date Fund or Target Date Folio.  For example, in our Target Date Folios, we focus on passive allocation to a broad range of asset classes and keeping investment costs low.  There is plenty of room to debate what an optimal asset allocation looks like, but we need to remember that CALPERS and other large pension plans are investing for a population of people of varying ages. In other words, CALPERS can design their plans for a population with an average lifespan that matches the U.S. average.  An individual investor needs to plan for the fact that he or she may live well beyond that average lifespan.

Is there any estimate of when investors in the CALPERS pension will be back on track for retirement? I know no one has a crystal ball, but I’m sure this question is top-of-mind for most folks.

CALPERS has been focusing on the fact that the plan has returned an average of 7.7% per year over the past twenty years and that the plan’s target return for the portfolio is 7.5%.  A year with a 1% return would need to be followed by a year with a 14.5% return to get the annualized return over two years up to the target rate of 7.5%.  I don’t see that happening in the next year.  Furthermore, while the returns from CALPERS over the past twenty years are impressive, we all know that past returns are, at best, a weak predictor of the future.

We’ve been reading a lot about states going bankrupt. How does that affect state employees pensions?

While people are focusing on the poor performance of CALPERS portfolio over the last year, the real issue is that CALPERS and other state pensions are (by many estimates) massively under-funded.  A 2010 analysis by Stanford University found that California’s public pensions face a total shortfall of $450 Billion between their projected future assets and the benefits that the pensions have promised to provide.  That is the first problem.  Pension plans are hugely under-funded.  The second problem is that many states’ finances are in bad shape across the board.  In other words, it is not as though surpluses from other parts of the states’ budgets can be used to cover the unfunded portion of pension plans.  The shortfall in pension plan funding is a huge debt that the states keep rolling forward.  Eventually, however, the mismatch between assets and liabilities (the promised pension benefits) have the potential to drive states into bankruptcy unless major changes are made.  The current solutions being proposed (such as raising retirement ages and reducing benefits for new hires) don’t come close to solving the problem.

What can investors who trust their retirement to a large pension plan do now?

I believe that individuals and their plan representatives must be more proactive in judging the ways in which pension plans operate.  CALPERS paid about $1 Billion to external managers last year.  That’s a lot of money.  Are the people contributing to the plan getting a good value for this level of cost?  (This question also applies to individuals who have 401(k) plans, too see, “Are 401(k) Fees Consuming 30% of Our Lifetime Savings?”).  Most people have no idea how much of their money they are paying in fees and whether the fees are justified by the pension’s risk management and performance. If you are currently enrolled in a pension plan, know that you have the right to speak to your plan administrator and voice your concerns regarding how the pension is managed. I would then open a low-cost IRA (or other investment vehicle) that you control and add to it as much as you at this time. I would also try to minimize my fixed costs in retirement now—like paying down long-term debts such as a mortgage.

Thanks for the insight, Geoff. We’ll keep an eye on how the CALPERS story plays out over the next few months (or even years).


The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services.

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