The OC Register (hat tip David W) gives an advance warning that CalPERS is likely to show a loss in the billions on its roughly $300 billion portfolio when it reports its investment results next week. From the story:

The California Public Employees Retirement System – the nation’s largest – lost about 2 percent of its market value in the fiscal year that just ended, according to unofficial numbers published last week on the CalPERS website. This came despite doubled-down efforts to beef up its bottom line. The value of CalPERS investments was $293.7 billion on June 30, down from $301.9 billion one year earlier, according to CalPERS’ daily valuation report. That number accounts for daily movement of some assets but not others, which are updated quarterly.

Yves here. Mind you, CalPERS holds out private equity as its salvation from flagging returns in the rest of its portfolio. But private equity is now at roughly 10% of total assets (it also has 10% allocated to real estate). Even if it showed a 15% year to year gain, that would still only partially offset the losses it reported on its liquid assets. In other words, CalPERS is almost certain to show a net loss, but we don’t yet know exactly how large.

Let us contrast this result with some public market market benchmarks over the same time period. Mind you, these are merely changes in index levels, so they don’t include dividend or interest income (in a world awash with information it’s frustrating not to have ready access to the right databases so I could get either the total return data on the indexes shown or comparable indices. Reader additions in the comments section very much appreciated).

S&P 500 1.7% Russell 3000 0.0% Bloomberg Investment Grade Corporate Bond Index 7.4% S&P High Yield Corporate Bond Index 6.7%

Update courteously provided by Jim Haygood:

Total returns from June 30, 2015 to June 30, 2016: S&P 500 stock index ….. 3.99%

Barclays Aggregate …… 6.00%

60/40 stock/bond mix …. 5.03%

Haygood also adds: “Undershooting the standard 60/40 domestic benchmark by 7 percentage points is a serious miss.”

Back to the original post:

One element that may explain CalPERS’ poor results is that it has a very high allocation to foreign stocks, 50% (and public equities account for 51% of CalPERS’ holdings). The strong dollar and weak fundamental outlook in many countries would drag down returns.

This poor showing confirms board member Jj Jelincic’s charge, that Chief Investment Officer Ted Eliopoulos, an attorney and protege of state treasure Phil Angelides, is not qualified to hold the post. Ironically, he’d make a much better CEO, since that role is highly political and plays much better to his strengths. But CalPERS’ dud results also highlights a much bigger set of problems.

Bear in mind that the fact that CalPERS is now underfunded is to a large degree the result of the financial crisis. It took hits and had to continue to meet retiree obligations out of diminished asset levels.

Independent of CalPERS’ poor performance relative to the markets, long-term investors of all sorts, such as people saving for retirement, life insurers, and pension funds are being slaughtered by central bank policies. They face the ugly prospect of either earning way too little in the way of return or being forced to take on far too much risk for the returns they do get. And since bank profits, and hence long-term viability, are also being crushed by the QE, ZIRP, and in more and more countries, negative interest rates, something will have to give at some point. Maybe one of those dreaded populists will defy orthodox thinking and engage in massive deficit spending, hopefully on infrastructure. But if not, US banks are pushing the Fed hard to increase interest rates. The taper tantrum of 2014 and the market upset of early 2016 shows how financial assets fare at the prospect of central banks trying to back themselves out of their corner, even when they promise to do so very very slowly. Players like public pension funds don’t have the latitude to go into cash and short-duration, low risk instruments to minimize the impact of this sort of change. They don’t do market timing, since the academic research shows that investors who do typically do far worse than those who stick to an orthodox allocation (witness the lackluster performance of hedge funds in recent years). But these are hardly normal times.

CalPERS, like virtually all of its peers, is in deep denial about its fix. It still maintains a return target of 7.5% even though Governor Jerry Brown pressed for the pension system to lower it to a less unrealistic 6.5%. CalPERS’ response was to invent a Rube Goldberg process by which it would lower its targets in those years it beats its 7.5% return target over the next 20 years till it gets to 6.5%. That is an oversimplification but directionally correct. As the Los Angeles Times pointed out in an editorial last November:

CalPERS resisted Brown’s proposal because it would raise pension costs sharply for governments; for example, the state’s annual contribution alone would increase from about $4.7 billion to $6.7 billion before declining. But pensions are a pay-me-now-or-pay-me-later obligation, and covering more of the cost early on can save money in the long run. Just as important, clinging to overly optimistic earnings assumptions hides the real cost of the benefits offered. And if a city can’t pay that bill when it ultimately comes due, its only options are grim ones, including slashing its workforce, eliminating services and, in the worst case, cutting pensions through bankruptcy. No one wins under those scenarios. The Legislature should take advantage of the state’s current flush coffers to pay down its unfunded pension liability on a faster timetable than CalPERS has proposed, and cities that can afford to do so should do the same.

Needless to say, the lousy fiscal year 2015-16 returns highlight that CalPERS is putting its head in the sand. If CalPERS does indeed show a zero return for the past year, which is what Eliopoulos warned was the likely result in last month’s board meeting, that means its average return for the last ten years would be a mere 6.0%. How realistic is it to expect CalPERS to meet, much the less beat, 7.5% with deflationary trends only strengthening around the world?

And CalPERS’ political expediency only plays into the hands of the enemies of public pension funds.The OC Register, itself a regular critic of CalPERS, quoted several academics and legislators who regularly chastise the giant pension fund. Some are simply demanding that the state allocate more from its general budget to reduce CalPERS’ shortfall on a one-time basis (something Brown wanted to do in return for lowering the return target), or as the Los Angeles Times suggested, increasing the charges made to the various government bodies that rely on CalPERS to manage their employees’ retirement funds.

The failure to act puts CaLPERS and other state pension funds at risk of intervention. While CalPERS’ is effectively accountable to no one, by virtue of having a protected status in the state constitution and an exceptionally weak and cronyistic board, if it continues with its delusional posture that it can earn its way out of its underfunded position, pushback is inevitable. For instance, Stanford lecturer David Crane, who depicts public employees as special interests taking advantage of their position, has called for the state legislature to “change pension fund board governance in favor of citizens.” Given the constitutional issues, I’m not certain as to the mechanism for putting this into effect, but a year or two more of lackluster performance combined with no change in the return target will lead to vastly more bad press and calls for official action.

And now it is obvious why CalPERS’ CEO, Anne Stausboll, retired on June 30. She refused to address CalPERS’ existential issue and dumped the problem on her successor. This is not leadership. It’s opportunism and cowardice. And CalPERS’ staff and beneficiaries will bear the cost of her neglect.