CalPERS’ High-Risk Bets to Guarantee Government Employee Pensions

It is a bellwether moment for state and local government pensions funds around the country. CalPERS, the pension fund for California state government employees, is turning to high-risk strategies to juice its investment returns.

The Wall Street Journal reports on how CalPERS plans to inflate the value of state government employee pension accounts.

The board of the nation’s largest pension fund voted Monday to use borrowed money and alternative assets to meet its investment-return target, even after lowering that target just a few months ago.

The move by the $495 billion California Public Employees’ Retirement System reflects the dimming prospects for safe publicly traded investments by households and institutions alike and sets a tone for increased risk-taking by pension funds around the country.

Without changes, Calpers said its current asset mix would produce 20-year returns of 6.2%, short of both the 7% target the fund started 2021 with and the 6.8% target implemented over the summer.

Board members voted 7 to 4 in favor of borrowing and investing an amount equivalent to 5% of the fund’s value, or about $25 billion, as part of an effort to hit the 6.8% target, which they voted not to change. The trustees also voted to increase riskier alternative investments, raising private-equity holdings to 13% from 8% and adding a 5% allocation to private debt.

Borrowing money to increase returns allowed Calpers to justify the 6.8% target while maintaining a more-balanced asset mix, concentrating less money in public equity and putting more in certain fixed-income investments, fund staff and consultants said.

CalPERS is taking this step because California state government employees are gifted with guaranteed pension payouts after they retire. But rather than reduce their promised pensions to more sustainable levels or require government employees to contribute more to their own retirements, CalPERS will make riskier bets instead. What could possibly go wrong?

Lessons About Alternative Investments from Dallas

The Dallas Police and Fire Pension System is a case study of what can go wrong with alternative investments for a pension fund. Check out how they “diversified” their pension portfolio with alternative investments in 2016:

The Dallas Police and Fire Pension System, once applauded for a diverse investment portfolio that included Hawaiian villas, Uruguayan timber and undeveloped land in Arizona, finds itself needing to dig out of a deep hole.

A $1.2 billion change last year in the difference between the value of its assets and what the pension owes retirees left the $2.6 billion fund with just 45 percent of the assets needed, down from 64 percent at the end of 2014. The pension, which was 90 percent funded a decade ago, could be out of cash in 15 years at the current rate of projected expenditures, according to a Segal Consulting report last month.

It didn’t quite last that long. Later that year, the public pension fund saw the value of their alternative investments all turn south at the same time. It got so bad that Dallas police officers and firefighters mounted a run on the pension fund. After failing to raise property taxes to bail out the pension fund, the city’s solution was to shrink the size of its police force. That action has led to other costly problems for the public.

Lessons About Leverage and Trading on Margin

Leverage, or trading on margin, is a concept you usually hear about with stock market investing. It’s a strategy that can produce high returns, but which comes with significant risks. Here’s a video describing how it works.

If the investment is successful, margin is a way of potentially amplifying the return on the non-borrowed portion of the money invested. But it’s also a way to amplify the pain if the investment made with the borrowed money shrinks in value.

CalPERS’ board is turning to high-risk investing strategies because they don’t think they can guarantee an investment return of 6.8% without it. Do you think CalPERS board is so good at investing they will never have losses? And when they do have losses, do you think they won’t try to get taxpayers to bail them out?

Craig Eyermann is a Research Fellow at the Independent Institute.
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