Monday, January 30, 2012
By Ed Mendel

The nation’s two largest public pension funds last week reported slim annual investment earnings, CalPERS 1.1 percent and CalSTRS 2.3 percent, as experts continue to say hitting their long-term earnings target, 7.75 percent, will be difficult.

While CalPERS reported weak earnings in 2011, a prominent private-sector investment manager, Robert Arnott of Research Affiliates, told the board last week he thinks the most they can expect from stocks and bonds next decade is 4 percent.

Another major investor, Laurence Fink of BlackRock, told the CalPERS board during a similar educational session in 2009 that during the next 15 years: “You’ll be lucky to get 6 percent on your portfolios, maybe 5 percent.”

A Wall Street Journal columnist, Jason Zweig, said last week Warren Buffet’s Berkshire Hathaway pension fund projects a return of 7.1 percent. He said William Bernstein of Efficient Frontier Advisors expects roughly 6.5 percent from stocks.

Consultant Girard Miller said in Governing magazine this month, while discussing 12 basic public pension issues, that earnings “closer to 7 percent” are more realistic until global debt is reduced.

The California Public Employees Retirement System board decided last March to leave its earning assumption unchanged at 7.75 percent, despite a recommendation by actuaries to lower the forecast to 7.5 percent.

Even a small drop in the earnings forecast could boost the annual employer payment to the pension fund. CalPERS, which may revisit the forecast in March, is not turning a deaf ear to the experts.

“Like all talented investment managers, and Rob Arnott is one of the most talented, he laid out a problem—in a low return environment conventional approaches to asset management are likely to disappoint—and a solution—invest unconventionally,” the CalPERS chief investment officer, Joe Dear, said by e-mail when asked for a comment.

“He did not say we can’t earn our target rate of return. He said to do that we’ll have to have an investment strategy that is different. Much of what he suggested, such as fundamental indexing, and higher exposures to emerging markets, we are already doing. The low return environment makes achieving our return objective more difficult, but not impossible.”

Why experts think this is a “low return environment” was explained by Pension Consulting Alliance, a CalPERS and CalSTRS adviser, in a report in October to the Rhode Island state pension fund, which was overhauled by legislation in November.

“Factors that provided a tailwind in the past are expected to present a headwind,” said the PCA report by Allan Emkin.

Low interest rates (the 10-year U.S. Treasury bond yield dropped from more than 8 percent in 1990 to about 2 percent now) means that the bond portion of investment portfolios will have lower yields.

Large government and private-sector debts run up in recent years means debt repayment can crowd out purchases and projects, limiting economic growth and potentially lowering stock returns.

Population trends in developed economies such as the United States, Europe and Japan (getting older and growing slower) mean their economic growth is likely to be slower, potentially lowering stock returns.

Under Rhode Island investment policy, the report shows a 50.3 percent probability of exceeding a 6.75 percent annual return during the next decade, the highest in a range decreasing to a low of a 36.9 percent chance of exceeding 8 percent.

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