STUMP » Articles » Public Pensions Watch: Don't Go Chasing Waterfalls....or Alternative Asset Classes, pt 1 of many » 2 September 2014, 01:14

In Dallas Pension Learns About Concentration Risk, I should have also noted that it learned illiquid/alternative asset risk as well.

This is something infecting multiple pension plans, not only in the U.S. This puts me in mind of the various European funds that got taken by Madoff, because they were desperate for the returns.

I want you to think about being in an area where having only 80% of current promises are covered are broadcast as being “good” (note: they’re not …. seriously, the actuaries aren’t kidding about this). Insurers are considered insolvent well before they get down to only 80% of the promises covered. That tells you about the state of things among public pensions in the U.S.

And even to get to that level of “good”, so many games are played.

One item is that the value of the liabilities, in current actuarial practice, are based on discount rates that the clients themselves pick. The higher the discount rate chosen, the smaller the liabilities look. Thing is, this discount rate is supposedly tied to the expected return on assets and there are limits to plausibility if one invested to back pension promises the way insurers have to invest to back annuity promises.

If the pension plans invested in U.S. Treasuries, they would be able to do no better than the rates on Treasuries over the period for the particular bonds… you may have heard that the interest rates are fairly low right now.

If the pension plans invested in liquid equities, one might be able to claim about 7% long-term returns or so… so to boost it even above that, one needs harder-to-measure, higher-risk, and potentially higher-return assets.

And thus the push for “alternative assets” in public pension funds.

Over the next several days, I will be looking at the use of “alternative assets” and the various pitfalls as the pension plans chase the waterfalls of elevated returns. As with the Dallas pensions, some of these dangers are already being realized…. but there are many more that have yet to implode.