San Diego City Employees’ Retirement System overestimates annual pension returns

“They are still overly optimistic"

San Diego County citizens disgusted with massive potholes, deficient sewer and water systems, library closings, ad nauseam should scoff at politicians’ promises that things will get better. They won’t. Already-ruinous pension payments will eat up much more of future budgets — and actually, if the books were honest, those annual pension contributions would be larger still. That’s because both the County (San Diego County Employees Retirement Association) and the City (San Diego City Employees’ Retirement System) grossly overestimate their expected annual pension portfolio returns, thereby lowering governments’ annual contributions and passing the bill to future generations.

Since June 30, the County’s pension fund portfolio has plunged from $8.4 billion to below $6 billion. On February 11, San Diego County Board of Supervisors chairwoman Dianne Jacob declared in a speech that “even if the [stock] market bounces back, the required contribution by the County is expected to triple over the next five years.” And if the market doesn’t bounce back? She didn’t go into that.

During the last week of February, the city council was meeting on the topic of pension-payment obligations. Councilmember Carl DeMaio asked the City’s actuary how many bucks the City would be plunking in the pot “if the market does not suddenly recover.” Answer: the City would set its future annual payment at $100 million more than it is currently plunking in. What does $100 million mean? It’s equivalent to “shutting down every library in the city and closing 37 percent of the park and recreation programs,” says DeMaio.

The County estimates that it will make 8.25 percent per year on its pension portfolio. The City looks for 7.75 percent. Domestic and foreign stocks have been roughly cut in half since peaking in 2007. Common stocks (domestic and foreign) make up more than half of the portfolios of both the County and City. Stocks would have to go up about 20 percent a year for five years just to get back to normal rates of return, says Joe Esuchanko, consulting actuary for the City.

The County, in particular, has been gambling with employees’ retirements. Often-volatile commodities make up 4 percent of its target asset allocation. Alternative equity investments — which could include speculative things like venture capital, buyout funds, and green investments — make up 5 percent. There is actually a slightly higher weighting of international stocks (24 percent) than domestic stocks (23 percent). For a long time, the County had 20 percent of its portfolio in hedge funds but got slaughtered in two of them, and that weighting is now down to 14 percent. Early this month, the County’s chief investment officer, who had championed aggressive investments, abruptly resigned, “but I don’t think the board is looking for radical changes to the portfolio,” says chief executive Brian White. The hedge funds may stay.

The City claims it doesn’t have hedge funds in its portfolio, but it has so-called market-neutral money managers that bet that some stocks will go up and some go down, similar to the hedge-fund strategy. The market-neutral portfolios did poorly in the most recent quarter.

As of September 30, the County’s one-year record was a negative 13.8 percent. For the past three years, it has been up only 4 percent a year — a long way from the 8.25 percent bogey. The City’s pension fund has nothing to brag about: as of September 30, it was down 15.62 percent over the past year and up only 2.47 percent annually over the past three years, both a long way from the 7.75 percent annual target. Those County and City numbers would be down considerably now.

In November, actuarial consultant Esuchanko told the council that as of October 31, the City’s unfunded liability had grown to $2.8 billion and that the pension fund was only 58 percent funded. The council, with the exception of Donna Frye, paid no attention. But early this year, Mayor Jerry Sanders’s bean counters announced that the unfunded liability was $2 billion and the funded ratio 66.3 percent. The difference between 58 percent and 66.3 percent is explained by the “smoothing” process; the City evens out results by factoring in several years of market gains and losses. Today’s funded ratio might well be below Esuchanko’s 58 percent without the smoothing techniques, which, incidentally, are another manipulation by which pension funds paper over big losses. The County uses smoothing too.

William Sheffler, a boardmember of the City fund, thinks the 7.75 percent target is acceptable because about half of it represents inflationary expectations. The County’s White says the board talked about the 8.25 percent expectation in January and will revisit the topic in June.

Market pros overwhelmingly think both the City and County are overestimating future returns. “It’s painfully obvious that public and private pensions are not going to make their long-term goals,” says E. James Welsh of Carlsbad’s Welsh Money Management. “I would say 5 to 6 percent is more realistic,” but political pressure pushes the bogey higher.

Over hundreds of years, stocks have gone up around 9 to 10 percent yearly and bonds around 4 percent. Right now, stocks are in a horrendous bear market and Treasury bonds are returning less than they have for decades. “I would say it should be 7 percent,” says Mike Stolper of Stolper & Company. “Every time the market gets ugly, it becomes politicized and the policy is assaulted, and every time it does well, these morons increase benefits. The problem is corrupt politicians and reactionary responses to stressed markets.”

“I would not go any higher than 5 or 6 percent,” says Neil Hokanson of Solana Beach’s Hokanson Associates. He adds an interesting point: “Studies show that retirees can count on withdrawing 4.2 percent [of their nest eggs] a year and not have to tap their capital, not allowing for fraud or incredibly bad investment outcomes. This is the kind of number investors should be focusing on. With Treasury bond rates so low, how can a pension manager forecast a rate of return much higher than that of corporate bonds?” (Quality corporate bonds of 9 to 14 years’ maturity yield 5 to 6 percent.)

Councilmember Donna Frye has a very practical reason why she believes target rates should be reduced: “If they had more reasonable expectations for returns, they would want to invest in something more stable and consistent,” she says of City fund managers.

Jim Gleason, who was on the City pension board for a dozen years until 1972 and was the major plaintiff in a successful suit against the retirement board, says, “They are still overly optimistic. They should scale back from 7.75 percent,” although he doesn’t recommend a specific figure. Reason: “It’s a different world we are playing in.”

Amen to that. Stocks have rallied recently, but few think another bull market is at hand. There is a 20 percent chance of depression and continued deflation and a strong possibility that it will be many years before stocks get back to their 2007 levels. It’s no time to roll the dice.

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The County estimates that it will make 8.25 percent per year on its pension portfolio.

This^^^^ is why gov is in the mess it is in, and why citizens don't believe a word out of a politician or public union members mouth.

The fact is we will be LUCKY to get a return as high as the rate increase of GDP.

Response to post #1: Right now, GDP is contracting at a 5 percent rate. Should be able to do better than that. Best, Don Bauder

Response to post #3: Some day, somebody in San Diego will wake up to this disaster. Best, Don Bauder

Right now, GDP is contracting at a 5 percent rate. Should be able to do better than that.

The DJIA lost over 50% of it's value in the last 18 months-I would take a negative 5% over that anyday of the week!

Do you think anyone is returning 5% currently? ( We know Brandes isn't).

Response to post #5: Yes, short funds and short ETFs are making money (until the last couple of weeks, anyway). Best, Don Bauder

Bean counters and "fiscal conservatives" have turned us into balance sheet fanatics. Tax collections are down. California is struggling. Yet many want us to shore up the balance sheet of the government pension plans. You've cited our local, San Diego Systems. They should only be helped if they have a liquidity crisis and cannot pay their current obligations. I believe we're a long ways from that situation. However, if our government employee systems continue their fast and loose investment strategies with their investments, then funding formulas need to be changed. They'll needs to be something based on long-term return on investments, not the feast and famine formulas now used.

Some believe the accounting industry in the private sector worships the earnings statement, turning the balance sheet into a useless "plug." In government, the accounting industry has become balance sheet zealots. Governments do not even need balance sheets, BUT should CERTAINLY take into account the "people's" ability to fund services they want at a reasonable cost and NOT pass those costs on to future generations!

Balance sheets are relevant if there is a chance the entity will be liquidated. Balance sheets make sense, for the non-government part of our economy, but they've been decimated by deference to the earnings statement. Most business balance sheets do not come close to presenting economic reality.

Governments, on the other hand are perpetual entities, and as we experienced with Orange County, they exist after bankruptcy too. Are balance sheets worthless?

Two things matter in government finance - liquidity (cash flow) and stewardship, the spending of tax dollars properly. It is the latter that has been the overarching problem in our culture.

In my opinion, if we manage to get our voracious spending habits under control the rest will fix itself.

Response to post #7: You are correct: both the City and County are too aggressive with employees' funds. The hedge funds and so-called market neutral funds should be expunged from the portfolios. The common stock percentage should be lowered. I agree that in the private sector, both Wall Street and corporations have become obsessed with earnings statements and have ignored balance sheets. That's one reason debt is out of control. However, debt is out of control in the public sector, too -- federal, state, local governments. The Federal Reserve's balance sheet is a mess, and eventually we will have to pay for it. Ditto for government debt. Best, Don Bauder

Yes, I fear we will be faced with even less city infrastructure repairs ... It was already underfunded, the mounting number of needs will sit while $$ goes to this underfunded pension. Overstating the anticipated revenue seems to be a popular practice, just look at the state level, 6 weeks after they sign the budget they find they are another $8Billion in the hole.... they were only off by 20% !!!!

Not to spread panic, but has anyone considered the worst case scenarios?

What if stocks don't recover for more than a decade?

What if China pulls the plug on our Treasury?

What if another major war, famine, or infectious disease breaks out?

All the projections seem to be based on the last 30 years of unprecedented peace and stability...ignoring the rest of human history.

Consider what happened to the Dutch empire after the tulip craze...did they EVER recover?

If the assumptions of our leaders are examined, I think we'll find that we've been kidding ourselves, and that the promises made to pensioners will turn out to be no more real than fairy-dust.

Response to post #9: The City wants to plug a few infrastructure holes by issuing bonds of the exotic variety -- very dangerous, as American consumers have learned to their sorrow. The City is grossly understating the budget deficit. The state plays similar tricks, only with more money. Best, Don Bauder

Response to post #10: Any institution -- private or public -- should consider the worst case scenarios. The New York Times on Sunday (March 22) had an interesting piece on how soon stocks may recover -- seven years is quite possible. Would China pull the plug? It wouldn't be in its interest, but if it only cut back on purchase of U.S. paper, and began selling only a little, it would have a big effect on the U.S. Who can predict war, famine, infectious disease? You raise very good points. Best, Don Bauder

Not to spread panic, but has anyone considered the worst case scenarios?

What if stocks don't recover for more than a decade?

Funny you made that statement-it is exactly what Ron Paul said a couple days ago-and he may be a little bit off on the length, but he is probably closer to the mark than anyone else;

Ron Paul: Believer in small government predicts 15-year depression By Phil Davis

Published: March 22 2009 09:07 | Last updated: March 22 2009 09:07

Pension trustees and insurance company portfolio managers look away now. Your increased commitment to government bond holdings in recent times is about to blow up spectacularly.

At least, that is the view of Ron Paul, the US congressman who ran against John McCain in last year’s Republican Party presidential nomination.

But the credibility of both western governments and their currencies is waning, and has been ever since the gold standard was abandoned in 1971, says Mr Paul. And that means even “safe” investments are far from safe, he claims.

“People will start to abandon the dollar as current and past economic policies create a steep rise in interest rates,” Mr Paul says.

“If you are in Treasuries, you will need to be watchful and nimble to time your escape.”

Unfortunately, cashing out will not protect the value of investments, he insists, because “fiat” currencies will all decline over the coming years as measures to try to haul the world economy out of recession fail. “The current stimulus measures are making things a lot worse,” says Mr Paul.

“The US government just won’t allow the correction the economy needs.” He cites the mini-depression of 1921, which lasted just a year largely because insolvent companies were allowed to fail. “No one remembers that one. They’ll remember this one, because it will last 15 years.”

At some stage – Mr Paul estimates it will be between one and four years – the dollar will implode. “The dollar as a reserve standard is done,” he says. He sees little hope for other currencies where central banks have also created too much liquidity dating right back to the early 1970s.

Full post here;


Response to post #13: We're intoning a dirge here and stocks are up 4% to 5% today (March 23). The market seems to like Obama's plan for taking toxic assets off the books of financial institutions by, among other things, subsidizing hedge funds and private equity groups so they can gamble on the garbage. I do believe there will be a huge rally this year, bringing the Dow Jones Industrial Average to 9,000 at yearend, but I'm not sure this rally will last that long. It could run out of gas in a couple of weeks and recede. But later in the year -- boingggggg. However, I don't know how long it will hold that 9,000 level going into 2010. Best, Don Bauder

I do not think the DJIA will close at or over 9,000 this year.

In fact I am hoping that todays rally holds tommorrow, and we start digging out of this hole...... bit by bit.

I am getting more and more upset with these huge bailout numbers being gifted out to the Fortune 100.

I think now, after very carefully thinking this out-that we should have let all the banks/AIG go BK, because what is going on right now is all the wealthy hedge funds, banks, private equity groups-they are taking ALL the profits and the taxpayers (and their children and grandchildren) are getting stuck with ALL the losses (bailout costs) that the banks themselves created.

It is really a perverse form of socialism.

It is getting me more and more bent out of shape with every new "bailout" (read welfare for the ultra rich).

Middle class America are losing jobs, homes, healthcare, you name it, but we are subsidizing the wealthy with these welfare "Bailouts".

I know the masses, like me, have had just about enough.

Response to post #15: It is subsidization of the superrich -- the same superrich whose reckless gambling almost destroyed the global financial system. This is shameful and in the end it won't work. In the short run, it may pump enough money into the economy to make people feel there is a recovery. That is why I look for a rally at yearend. But there is no free lunch: you don't throw so much money out of airplanes without a consequence, and that's what's coming after 2009. Best, Don Bauder

So, Don, are you predicting a "dead cat bounce" later this year?

You could be right.

I'm afraid, however, that the recent news from China regarding their doubts over our economy spell the end for the USD as the world's reserve currency.

I'm skeptical of any real recovery this year. So the market moves you're predicting seem to be based on outguessing investor psychology.

You may be right that they'll be bright and optimistic later this year, but if so I predict they'll quickly recover their senses and realize that without fundamental changes to the way in which the whole world does business there is no sustainable future.

I'm thinking now that we should have let the titans of wall street fail, instead of bailing them out. Seems we're throwing good money after bad, and in the end there will be nothing left.

Worst of all, as you noted, the billionaires are the ones getting the help while simultaneously the little guys are getting stomped.

Historically, that can only go on so long before there's a revolution.

Response to post #17: I still expect a big rally later this year. But I am skeptical about 2010 and 2011. All this money that the U.S. is creating now will have its side effects. The Federal Reserve's balance sheet is in tatters, for example. Obama had a chance to introduce real change, but he went with old hacks -- Schapiro at the SEC, Larry Summers, Geithner, etc. They all sleep with the Wall Street crowd. So the financial services industry drove the world to the brink and is now cleaning up in the so-called recovery period. I hope the public wakes up. I'm not sure that it will. Best, Don Bauder

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