Wishful Thinking in a World Without Yield

The need for higher returns can breed desperation for anyone with a portfolio—large or small

By Jason Zwei

      Alex Nabaum


At first glance, the Pennsylvania Public School Employees’ Retirement System, one of the largest pension plans in the U.S., doesn’t sound anything like you or me. 

It commands $66 billion in net assets, spent $515 million last year on management fees, and has more than 40% of its net assets in exclusive investments like buyout, venture-capital and hedge funds.

Yet, at the most basic level, this gigantic retirement plan is just like you and me: It is struggling to raise returns in a low-interest-rate world.

That can breed desperation, and wishful thinking, for anyone with a portfolio large or small.

“The challenge we all face as investors is that the collapse in interest rates makes achieving historical rates of return very difficult,” says John Skjervem, chief executive of Alan Biller and Associates, an institutional investment consulting firm in Menlo Park, Calif. 

When cash and bonds yield close to zero, “stacking the traditional assets on top of that isn’t enough.”

For its part, the Pennsylvania school pension fund, also known as PSERS, for years has pumped billions into hedge funds and private equity. 

Those strategies purport to be able to thrive even when public markets lag. 

The giant fund had less than 25% of its assets in publicly traded stocks at last year’s end, even after some of the biggest bull markets in history.

To help run its money, mostly in private markets, PSERS uses roughly 170 external managers. 

The typical public pension plan uses about 55 outside firms, up twofold since 2006 as institutions race to move money outside the public markets.

Although a few rare managers (and their clients) will earn superior returns, combining dozens or even hundreds of managers can be a recipe for mediocrity.

According to the Public Plans Database compiled by the Center for Retirement Research at Boston College, PSERS has four times as much of its portfolio in hedge funds and nearly triple the allocation to private-equity funds as other large public pension systems.

Even with such a high weight in these alternative assets, as of 2020 PSERS had returned an average of 7.7% annually over the prior 10 years. 

That ranked it 94th among 133 peers for which data was available.


The message for you and me? 

You can’t earn a higher return from alternative assets just because you need to. 

Only the earliest and most skillful (or luckiest) can get the best returns.

And while it’s flattering to join the exclusive world of private wealth management, just remember to ask: If funds with tens of billions in assets don’t earn superior returns this way, why should I believe anyone who says I can?

Richard Ennis, a consultant who has advised pension funds since the early 1970s, estimates in a recent research paper that underperformance at public retirement plans—mainly from overpaying for alternative-asset managers who could be replaced by cheap index funds—totals nearly $70 billion annually.

In a statement, PSERS said that it recently trimmed its exposure to private markets and has maintained “strong investment results and a watchful eye on risk.”

Another problem PSERS shares with many smaller investors is unrealistic expectations.

In mid-2009, the 10-year Treasury note yielded nearly 4%, whereas today it produces only a whisker more than 1.5% in income. 

Yet public pension plans have barely shaved their assumptions about how much their assets will earn.

In 2009, the typical pension system was reckoning on an 8% average annual future return. 

Even after 12 years of relentlessly falling interest rates, that assumption has dropped only slightly to 7%, according to the National Association of State Retirement Administrators.

PSERS is assuming it will get 7.25%. That’s roughly what it earned over the past decade—but much of that came from a bond market that now yields next to nothing.

Expectations built on little more than hope quickly become targets that are difficult to hit. They can also be hard to resist.

Pension trustees are often political appointees or come from other backgrounds without financial expertise, points out Olivia Mitchell, an economist who directs the Pension Research Council at the University of Pennsylvania’s Wharton School. 

So, she says, “it is not surprising that consultants, investment managers and actuaries can suggest ‘new’ investment options without emphasizing the additional costs, liquidity problems and risks.”

Against the backdrop of pressure to raise returns, six of PSERS’ 15 trustees recently demanded that its top two officials be fired. 

The pension plan is being investigated by federal authorities after it released an inaccurate report in 2020 that overstated its returns over a nine-year period. 

PSERS is also being investigated over multimillion-dollar investments in local real estate. 

A spokeswoman declined to comment on the investigations.

In the face of prolonged low interest rates, all investors face three basic choices, says Mr. Skjervem, the consultant who formerly managed roughly $100 billion as chief investment officer of the Oregon State Treasury.

You can raise your existing holdings of traditional risky assets like stocks, even though no one thinks they’re cheap.

You can add a bunch of new and exotic bets and hope they don’t blow up on you.

Or you can grit your teeth and stay the course, through a period of what may be lackluster returns, until interest rates finally normalize.

“People are looking for the silver bullet, the magic wand, the get-out-of-jail-free card,” says Mr. Skjervem. 

“There isn’t one.”

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