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Pension Funds and why they are actively managed
Old 07-28-2019, 12:48 PM   #1
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Pension Funds and why they are actively managed

In my journey to try and understand why major pension funds are run by intellectual types who believe active investing is far preferable to passive investing.

As Brian Reynolds explains in the two videos below, pension funds are the driving force of the stock market, but are driven by the need for 7 1/2 percent yields. Brian Reynolds sees the stock market as continuing a major bull run for 3-5 more years as states and counties raise taxes to fund pension funds resulting in more investment in markets. Additionally more and more pension funds are reducing cash from 5-10 percent to one percent of the portfolio.

Now in order to avoid valuation issues, pension funds have moved to private credit holdings in order to avoid valuation issues and avoid regulations. These fundings are meant to be held to maturity and as such with yields of 6-8 percent, pension funds meet their needed returns and have the ability to mark what the value of these securities are. As pension funds have come into crisis due to a lack of sufficient assets, this has actually increased not decreased. I think Brian does a great job of explaining in the second video if one is interested and able to listen for 36 minutes. He is matter of fact in explaining that while he knows the valuations are ridiculous and that pension funds are buying the worst of the worst in general, if more money is going their way, this is not going to stop until an actual crisis occurs which he sees as 3-5 years away based on the credit cycle, and expects a continued bull market.

https://www.cnbc.com/video/2019/01/1...trategist.html


Interesting point is from 1990 to 2016 Pension fund assets as related to GDP has increased from 45 Percent of GDP to 135 percent of GDP - so three times as much impact is made by pension funds, which are having funds added at a very quick rate and are actively managed -- so there are 25 Trillion in pension funds assets 2016 vs 2.7 Trillion in 1990. Total value of the stock market in the US is 35 Trillion, so pension funds are actively managing in many private equity and credit situation nearly the entire value of the US stock investment and much of the reported value is determined by the fund managers themselves based on data in the credit and private equity markets where they invest. Pretty interesting ah ha moment for myself and great explanation of the credit boom of the last 25 year.

An interesting second mathematical calculation is the required return for the pension funds, with 35 trillion of assets they need to average 2.7 Trillion in return per year in order to meet their funding requirements. This is 15% of the annual GDP of the Untied States.

https://www.theglobaleconomy.com/USA..._funds_assets/
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Old 07-28-2019, 01:25 PM   #2
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There is another factor, too. A big one. Imagine you are the manager of a pension fund and receive huge bonuses every time you get lucky in the market. You receive a very good salary as well. You decide that passive investing is the way to go, so you go in to tell your boss. His response: "Yes, I've read that. Is two weeks long enough for you to teach your administrative assistant that rebalancing thing?"

Upton Sinclair: “It is difficult to get a man to understand something when his salary depends upon his not understanding it”
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Old 07-28-2019, 01:39 PM   #3
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There is another factor, too. A big one. Imagine you are the manager of a pension fund and receive huge bonuses every time you get lucky in the market. You receive a very good salary as well. You decide that passive investing is the way to go, so you go in to tell your boss. His response: "Yes, I've read that. Is two weeks long enough for you to teach your administrative assistant that rebalancing thing?"

Upton Sinclair: “It is difficult to get a man to understand something when his salary depends upon his not understanding it”
Let us for a moment decide you were given power to direct all pension investing in the United States and you decided a good 60/40 passive investment strategy was the way to go with your 35 trillion as there is no need to be in active investing. How are you going to sell your private assets in order to go into passive when the book value is greater than a years GDP?

Furthermore, you are going to need to make 7.5% and yet 40% of your money is going into a market where 45% of all bonds have a yield less than zero? IF your bonds yield two percent, a good yield in today's passive market, you need a 11.2% annual equity return to equal 7.5%.

Or are you advocating for a drop in the long term return calculation and an increase in the unfunded pension liability? How are you going about this advocating for passive investing for the good of the pension fund in the long term?
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Old 07-28-2019, 01:46 PM   #4
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... Interesting point is from 1990 to 2016 Pension fund assets as related to GDP has increased from 45 Percent of GDP to 135 percent of GDP - so three times as much impact is made by pension funds, which are having funds added at a very quick rate and are actively managed -- so there are 25 Trillion in pension funds assets 2016 vs 2.7 Trillion in 1990. Total value of the stock market in the US is 35 Trillion, so pension funds are actively managing in many private equity and credit situation nearly the entire value of the US stock investment and much of the reported value is determined by the fund managers themselves based on data in the credit and private equity markets where they invest...


But the above number shows that stock market is overvalued, whether it is bought by active investors or passive idexers.

Indeed, please read the following excerpt from a recent article in Fortune.

Quote:
... The TMC to GDP ratio is a favorite yardstick of Warren Buffett, who's stated, that "it's probably the best measure of where valuations stand at any given moment." (We'll refer to the measure as the "cap ratio.")

Today, the value of all stocks to national income stands at 146.4. That's the second highest reading in the past half-century, exceeded only by the 148.5 posted at the peak of the dot.com bubble on March 30, 2000. The cap ratio has averaged around 80 over the past decade, so it now exceeds that benchmark by 80%.

See: https://fortune.com/2019/07/17/warre...ratio-tmc-gdp/.

PS. Note that the ratios cited in the above article are in percentage points. It means that the value of all stocks is now 1.464 times the GDP.
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Old 07-28-2019, 01:56 PM   #5
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But the above number shows that stock market is overvalued, whether it is bought by active investors or passive idexers.

Indeed, please read the following excerpt from a recent article in Fortune.




See: https://fortune.com/2019/07/17/warre...ratio-tmc-gdp/.
Yes, totally agree, if you listen to the video you will understand the reason behind this. 25 years ago junk bond markets and private credit placement did not exist. LTC and the nobel prize teams competing for calculations of holding credit interests created a credit boom with the FED"s full backing. With the credit explosion corporations are using the credit boom to purchase their stock back forcing values up beyond their value. So there is no value that will not result in more stock buying purchasing until the credit boom comes to an end. As Brian Reynolds explains, he thinks this will continue to 3-5 years as virtually all active managers are aware the stock market is overvalued by almost all metrics.

If you listen further, he fully expects the government to ultimately back the pension funds because it's for the blue collar worker and we helped the bankers the last time.
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Old 07-28-2019, 01:58 PM   #6
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Regardless of reality, if a company can find an active manager who claims that his secret sauce stands a very good chance of achieving the 7.5% annual return they need, doesn't that benefit the current corporate management? And hiring an active manager with a pedigree serves as a good defense if (as may be likely) the returns aren't very good at the 5 year point. By then, the folks who made the decision have likely departed, and they avoided pumping resources into the pension plan.
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Old 07-28-2019, 02:17 PM   #7
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Regardless of reality, if a company can find an active manager who claims that his secret sauce stands a very good chance of achieving the 7.5% annual return they need, doesn't that benefit the current corporate management? And hiring an active manager with a pedigree serves as a good defense if (as may be likely) the returns aren't very good at the 5 year point. By then, the folks who made the decision have likely departed, and they avoided pumping resources into the pension plan.
I think there is no single active manager that does not believe what they are doing. You are hired to run a pension fund to make 7.5% and the market pays a 2% yield, you by default must be in private markets to earn that return because that is where you can earn it, this is not a philosophical argument, it is an explanation of the current flow of funds. This is who the board of directors demand. As always CALPERS rules pension rules (nearly 1/2 trillion:
Quote:
We need private equity to be successful, we need more of it, and we need it sooner rather than later" for its superior expected returns and diversification benefits from lower than expected volatility and drawdowns, CIO Yu Ben Meng told the investment committee on March 18.
https://www.pionline.com/article/201...e-equity-shift

Does any one think ‎John Meriwether · ‎Myron Scholes · ‎Robert C. Merton didn't believe they could make 20%+ on convergence trading by using leverage? This was the start of the entire cycle. It is the passive market gurus who sell pension funds their active management models. Merriwether even started a second fund in 2007 with the same models (went bust again in 2009) and presently has a third fund he opened in 2010 utilizing the same basic strategies and selling hedge fund portfolios to pension funds. These same strategies are now copied by most pension funds to goose returns.
The difference was LTCM was a few billion in funding, now there are trillions doing this and it has transformed the funding of corporations and finance in a way that cannot be stopped by merely transforming to passive investment.
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Old 07-28-2019, 03:09 PM   #8
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Let us for a moment decide you were given power to direct all pension investing in the United States and you decided a good 60/40 passive investment strategy was the way to go with your 35 trillion as there is no need to be in active investing. How are you going to sell your private assets in order to go into passive when the book value is greater than a years GDP?
Most large pension funds are diversified far beyond just the stock market, so the stock market assets would be probably well under half. Further, many funds are already passive. Finally, in aggregate passive portfolios will own the same stocks that the pension funds own right now. Mostly the mix will change. It is not like they would be selling something that they weren't also buying. This change isn't going to be universal and it will not happen overnight, so I think this argument is for impossibility is flawed.

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Furthermore, you are going to need to make 7.5% and yet 40% of your money is going into a market where 45% of all bonds have a yield less than zero? IF your bonds yield two percent, a good yield in today's passive market, you need a 11.2% annual equity return to equal 7.5%.
Yes. "Need." That is probably why those 100 year, 8%, dollar denominated Argentine bonds sold out last year. Adopting a passive strategy would definitely mean abandoning belief in Santa Claus, the Easter Bunny, and the tooth fairy. That is definitely an obstacle but being in denial does not change the market reality. They "need" what they cannot have. Continued belief that the impossible is just out there waiting to be found is probably the strongest argument for not changing to passive strategies.

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Or are you advocating for a drop in the long term return calculation and an increase in the unfunded pension liability? How are you going about this advocating for passive investing for the good of the pension fund in the long term?
The unfunded liability is not changed by changing yield assumptions. It is a number which, though no one knows it, is still fixed. If changing a return assumption would change the number, then it is a simple matter of choosing ten or twelve percent and the problem is solved.
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Old 07-28-2019, 04:37 PM   #9
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I get a pension fund statement every year. Every two years, by stature, it includes the audited financial numbers/opinion based on 'ongoing' pension plan and 'windup'. I pay attention to it. Fortunately the plan is small, my former employer (megacorp) always keeps both in the plus 95 percent category. Even in the downturn they made significant additional contributions to bring the plan up to snuff. According to Mercer, most plans today are in very good shape.
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Old 07-28-2019, 07:46 PM   #10
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An interesting article:

Quote:
... One challenging facet of setting the investment return assumption that has emerged more recently is a divergence between expected returns over the near term, i.e., the next five to 10 years, and over the longer term, i.e., 20 to 30 years. A growing number of investment return projections are concluding that near-term returns will be materially lower than both historic norms as well as projected returns over longer timeframes. Because many near-term projections calculated recently are well below the long-term assumption most plans are using, some plans face the difficult choice of either maintaining a return assumption that is higher than near-term expectations, or lowering their return assumption to reflect near-term expectations. ...

https://www.nasra.org/files/Issue%20...sumptBrief.pdf
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Old 07-28-2019, 09:31 PM   #11
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Any consideration of the Federal TSP? AFAIK its the largest penson system larger than CALPERS and it is entirely passive.
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Old 07-28-2019, 09:41 PM   #12
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Any consideration of the Federal TSP? AFAIK its the largest penson system larger than CALPERS and it is entirely passive.
It's big, but as a defined contribution plan it's in a very different situation than a defined benefit plan.
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Old 07-28-2019, 10:28 PM   #13
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What I found an interesting proposition in the video was the chain of events that will continue to keep the bull market moving. The pension funds will be getting massive injections from tax raises which go to the pension funds via private capital deals which are used by corporations to buy back stocks. This is trillions of dollars 1.2 trillion in contributions in 2015 and increasing by the year, as an example city of Chicago is instituting a new service tax for their 28 billion shortfall. Illinois doubled the gas tax and added a dollar to a pack of cigarettes to pay pension payments.
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Old 07-29-2019, 06:02 AM   #14
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There are many DB plans that focus on lower risk liability matching strategies and are not chasing growth. These tend to be the well funded plans and frequently are not open to new hires at various organizations.
They may still meet the definition of Active but as a liability matched portfolio they are lower risk.
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Old 07-29-2019, 08:19 AM   #15
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Backing off just a bit, to cite a situation that may have bearing on the broader subject of troubled pension funds.

The chart below, shows historical Fed fund numbers that may seem strange to younger folks. I am reminded of when I rode the train into Chicago, and sat next to a guy who was involved with the Chicago Teacher's Pension Fund.

It was around 1982... He told me that the fund was being run by crazy people, who were projecting the future earnings of the fund to be at a rate set by the Fed back in 1980. Accordingly, the assets in the fund were freed to be used for other purposes, as the long term viability was assured. As I recall, the long term growth was projected to be @ about 12% to 14%.

You may draw your own conclusions as to why the fund is essentially insolvent, but the chart may help to understand how these things happen.
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Old 07-29-2019, 09:42 AM   #16
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Originally Posted by Running_Man View Post
In my journey to try and understand why major pension funds are run by intellectual types who believe active investing is far preferable to passive investing.

As Brian Reynolds explains in the two videos below, pension funds are the driving force of the stock market, but are driven by the need for 7 1/2 percent yields. ....
As I recall from previous threads, you keep trying to tell us why some people/groups use active investing over passive, but before I get very interested in the "why", I want to know the results.

As an analogy, someone might give me a 100 reasons why some fuel additive will increase my mpg. They'll tell me it lubricates the upper cylinder, cleans the fuel injectors, cleans the intake valves, etc, etc. And every one of those things may have some valid scientific basis. But, what I need to know is:

A) Does it actually increase mpg?

B) Can I reasonably expect it to increase mpg in my car?

C) How much improvement can I reasonably expect?

and equally important:

D) If I do get an improvement, will the gas saving exceed the money spent on the elixir?


A "need for 7 1/2 percent yields" doesn't help me to perform any better. If I'm going broke and "need" 50% yields, the market does not care. I get what I get.


I'll try to dig up the other thread you were on, I think you showed Yale or Harvard having exceptional returns. As I recall, the records were tough to follow, a lot of money flowing in/out, so maybe this has more to do with timing of those deposits/withdrawals than actual investment returns. It would be hard to parse all this out, and I don't even think the data is available. And maybe the timing was intentional? Who knows.

But for the sake of the conversation, let's give them the benefit of the doubt. What does this mean for an investor here on this forum? Do we have access to these investments? Is there a Yale/Harvard tracking ETF?

To put that another way, I'm not saying no one can beat the market. Logically, that would be trying to prove a negative, so it really can't be done. But in practical terms, OK, so let's assume a group has found a way to consistently read investor sentiment and can take contrarian views on the right things, in the right amount, at the right time, consistently enough to profit from it. What can I do to get some of that? I don't see available funds/ETFs doing it, so what's my game plan?

It's not enough for me to be shown that some one can do it (like throwing a 100 mph fastball), if I need to be able to do it (and I can't).

-ERD50
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Old 07-29-2019, 09:59 AM   #17
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As I recall from previous threads, you keep trying to tell us why some people/groups use active investing over passive, but before I get very interested in the "why", I want to know the results. ...
Yes. He's pretty consistent: " ... major pension funds are run by intellectual types who believe active investing is far preferable to passive investing. " The only problem is that this is his own "fact," completely unproven and IMO probably false. He often also argues that academics who advocate passive investing are on someone's payroll, the goal being to fool the public and leave the arena for these mythical "intellectual types."

Problems are rife with this, the most obvious one is 18 years of biannual S&P SPIVA report cards that consistently show that active investing is on average a losing strategy. No opinions or payoffs involved. Then there is the William Sharpe paper (https://web.stanford.edu/~wfsharpe/a...ive/active.htm) that shows this to be mathematically inevitable, with no opinions involved in the proof.

Now comes the dust and chaff.
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Old 07-29-2019, 10:06 AM   #18
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It seems to me if people don't agree with the thread premise and have made their views know in previous discussions there's no point in disagreeing once again. It only disrupts the thread and makes it look personal, which I am sure is not the case. Why not just walk away and allow the discussion to progress?
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Old 07-29-2019, 10:17 AM   #19
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It seems to me if people don't agree with the thread premise and have made their views know in previous discussions there's no point in disagreeing once again. It only disrupts the thread and makes it look personal, which I am sure is not the case. Why not just walk away and allow the discussion to progress?
Fair enough point. But is it a good idea to thus implicitly accept a premise that is arguably false? Not everyone will recognize this and many may not have seen other threads. (PM to discuss if you like. I will drop off the thread.)
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Old 07-29-2019, 10:19 AM   #20
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Fair enough point. But is it a good idea to thus implicitly accept a premise that is arguably false? Not everyone will recognize this and many may not have seen other threads. (PM to discuss if you like. I will drop off the thread.)
I'm confused as well, but will also drop it.

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