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Tuesday, April 22, 2014

"Alternative Investments" Need Another Name

A couple of weeks ago we released the TEXPERS annual Asset Allocation report, a survey of our members’ investments for the prior year. We noted in our press release that so-called ‘alternative investments’ increased among our members’ investments when compared to last year’s ratios. It got us to thinking: when did ‘Main Street’ investments become ‘alternative’ investments?

For example, years ago it used to be that a city Treasurer, among all their other duties, might run the city’s pension fund by investing in rock solid U.S. government bills, notes and bonds. The Treasurer’s rationale was that they would never be accused of wild speculation with the retirement money of their city’s police, firefighters and municipal employees. They could rightly be viewed as tending conservatively to their fiduciary responsibility. It was an easy choice for them. But the Treasurer often had to go through Wall Street to secure those bonds.

Then, when some began to realize that keeping just slightly ahead of inflation wouldn’t properly maintain their pension obligations, the investment duties were outsourced to a pension organization responsible for making better investments and administering benefits. The investment portfolios tended to a 60% stock to 40% bond ratio, as that was the best thinking on what qualified as a diversified portfolio. Again, that money flowed through Wall Street investment houses.

Over time, another modest change occurred. Pension managers began adding foreign investments to their mix, with companies listed on foreign stock exchanges taking priority. That was considered appropriate diversification. And because the companies were on foreign exchanges, or represented in American Depository Receipts (ADRs) on U.S. exchanges, they had a sense of legitimacy in their own right. And this was yet more money flowing through Wall Street investment firms.

While those dynamics are still at work, today’s pension managers are seeking even broader diversification of their assets. Wall Street stocks and bonds aren’t the only assets that generate returns. Today’s pension boards recognize there is a much wider world of investment opportunities available out there. Oil and gas leases. Commercial buildings. Home rentals. Commodity investments. The list could go on and on.

Many of those investments used to be called “Main Street” because they lived outside Wall Street’s reach.

But it seems that, in many ways, the term Main Street seems to have been replaced by the ‘alternative.’ We talked about this phenomenon last year, when a Wall Street Journal article made it seem like the Texas Teachers Retirement System was really off the rails in its off-Wall Street, private equity investment strategy. Remember their headline, “Pensions Bet Big with Private Equity”? Wasn’t that a bit pejorative? It was in our view. The Wall Street Journal article seemed alarmed that the TRS had been so successful with its private equity investments!

Now, please realize there are a lot of people who would like all investments routed through Wall Street stocks and bonds. They tend to live in New York, or other major investing centers, like Chicago, London, etc. That’s how they make money.

By using the word ‘alternative’ they can imply ‘risky’ or ‘out of the ordinary.’ For those invested in the inner workings of the stock exchanges, those sorts of investments may seem risky and out of the ordinary, but to those beyond the Hudson River they are ordinary, and often less risky than volatile stock markets.

Our point is simply this: our Wall Street friends tend to define terms to their advantage, but the perceptive reader should always remember that Main Street, “alternative” investments are just as lucrative, or sometimes even more so, than what is available through Wall Street financiers. – Max Patterson

Monday, April 14, 2014

More Hyperbole Unsupported by Facts about the Future Health of Pensions

Ray Dalio, founder and co-chief investment officer of the Bridgewater Associates hedge fund, has produced the latest attack on public employee pensions. Falio is reportedly worth $14 billion, according to Forbes. Why are so many billionaires targeting public pension systems these days?

But we digress.

Dalio’s group is reported as estimating that public pensions will require $10 trillion for public pensions to meet their financial obligations 30 years from now, but their $3 trillion in investible assets today won’t allow them to reach that goal. Bridgewater Associates projects that pensions would need to earn 9 percent annually to cover their expenses. We’re not going to dig into their numbers, because we have better things to do with our time, but here a couple of observations:

First, pensions themselves don’t even project out 30 years. Twenty years is the more common standard by people in the business of running pensions. Thirty years is a reach from the get-go. Anything dire can be projected out 30 years. In our eyes, their projections were dubious from the beginning.

Second, 8 percent average annual returns are indeed possible over 20-year periods, despite the Bridgewater Associates forecast that pensions might more realistically achieve four percent or less.

We beg to differ with their forecast.

We have only to look at several TEXPERS member systems who proved in TEXPERS annual Asset Allocation Report that they can achieve outstanding results over 20-year periods. Here are the standout performers for the 20-year period in Texas:

Big Spring Firemen's Relief & Retirement Fund 9.87%
Dallas Police and Fire Pension System 9.04%
El Paso Firemen and Policemen's Pension Fund 8.91%
Amarillo Firemen's Relief and Retirement Fund 8.73%
Lubbock Fire Pension Fund 8.66%
Houston Municipal Employees Pension System 8.64%
Austin Police Retirement System 8.39%

The reason that Texas pensions have been successful is that they are flexible. The pensions of yesterday might have had an investment ratio of 60 percent U.S. stocks and 40% U.S. bonds. Today’s pensions are much more diversified, as our latest report also uncovered. 

Sixty survey respondents representing approximately $170.3 billion in total assets allocated their investments in much different fashion in 2013. The report showed that 32% were using alternative strategies (real estate, private equity, energy, etc.), while 25% were invested in international equities, 22% were in domestic equities, 20% were invested in fixed income, and 1% held short-term securities/cash.

We agree that billionaires must have special insights to achieve their wealth, but they should stick to what they know and leave pensions alone. They should recognize that public employee pension plans have different liabilities when compared to private, corporate and foundation pensions. These differences greatly affect how each one invests. We would suggest to Mr. Dalio that unless he sits on a public fund board or is a consultant to public funds, he should focus on his business and not speculate or draw conclusions from mathematical equations. – Max Patterson