Home > Uncategorized > Solving A Pension Problem…With Leverage? That’s So 2007.

Solving A Pension Problem…With Leverage? That’s So 2007.


A recent story in Pensions & Investments Online suggested that “a number” of pension fund managers are considering leveraging their entire funds. This is right on the heels of a period in which many firms and funds lost huge amounts of money, partly because their leverage was pulled and they were forced to cover assets at bad prices. Memories are very short, or understanding is very poor.

According to the story, using borrowed money to invest as if they have 20% more assets than they actually do, “…would enable the board to reduce its equity exposure and increase allocations to lower-returning and lower-risk assets that offer greater diversification benefits while seeking to meet the board’s expected actuarial return.”

Is it just me, or does this seem like the real problem is that the board’s expected actuarial return is unreasonable? This is, in fact, the problem with most pensions today: in a world where long-term real rates are under 2% and inflation expectations are rising, returns are likely to be thin in all asset classes for a while. In such a case, it is reasonable for actuarial expected returns to decline. They don’t, because it is easy to monkey with that number to make your plan status look better than it is, but they should.

SWIB officials discovered that, like many pension funds, Wisconsin’s exposure to equity risk comprised 90% of the fund’s volatility. The pioneering change also would position the fund to endure a period of high inflation and low economic growth, a scenario of growing concern for many investors.

Here is my unsolicited advice to solve this problem, and I’ll charge less than their consultants: to cut equity risk, sell a bunch of your equities. To position the fund to endure a period of high inflation and low economic growth, buy TIPS. Ta-da! Oh, and you might want to talk to your board and see if you can get the actuarial returns to respond to actual market conditions, rather than take market positions to respond to ad-hoc actuarial return assumptions.

Seriously, people get paid for this?

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Categories: Uncategorized
  1. Rick Patsy
    January 15, 2010 at 8:14 am

    Couldn’t have said it better myself! Unfortunately given the environment that most public plans exist in, it would take some “intestinal fortitude” to resolve the problem as you describe!

    • January 15, 2010 at 8:45 am

      I think the cycle is just going the wrong way…actuarial assumptions are unreasonable, so sponsors take more risk, lose money, need more-unreasonable assumptions to make it look better, take more risk, etc…

      If only we could get it going the OTHER way…get risk better-aligned with benefits so the volatility of the surplus is less, actuarial assumptions can be more reasonable, and changes in the actuarial assumption for return are actually correlated with changes in the actuarial assumption of the discount rate…but I don’t know how to reverse that when sponsors in some sense benefit from mis-stating likely returns.

      Thanks for the note!

  2. Andy
    January 15, 2010 at 9:34 am

    Or… pension payouts could be reduced to a more realistic number via an increase in the age of draw. if 70 became the new 65, wouldnt that help things quite a bit?

  3. January 15, 2010 at 9:48 am

    …and that would ALSO be a rational adjustment. Of course, they’d burn down the capitol building, but…

    All a problem with the initial plan design. If they designed plans so retirement age was indexed to life expectancy, then it would be a self-correcting problem (and “longevity risk” to a pension would be lessened as well). Good point Andy.

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