Outperforming Your Pension Fund Portfolio

by: MyPlanIQ

With many public pension funds under-performing in recent years, state and local governments have to increase current employees' contributions to fund the benefits. Employees and retirees in public sectors are feeling greater pressure to take care of their own finance.

A Bloomberg article in October 2010 reported that the largest pension fund, Calpers (California Public Employees' Retirement System), had $240 billion in unfunded liabilities. Let's take a closer look at Calpers' portfolio and its performance.

Based on Calpers' latest annual report for fiscal year ended 6/2009 (we cannot find the annual report for fiscal 2010), the following shows its last 10 years; performance:

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The following table shows the asset allocation from the same report. It is reasonable to assume Calpers' risk profile is about 60-70% in risk assets and 40-30% in fixed income.
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From the same Bloomberg article, it was reported that Calpers achieved about an 11% return in its 2010 fiscal year (7/2009 to 6/2010). With that in mind, we estimated that Calpers achieved about 3.2% annualized return from 7/2001 to 6/2010.

3.2% in the last nine years can only barely keep up with the CPI increase. So it is with Calpers, one of the largest public pension plans that has plenty of resources to hire high power hedge fund managers, venture capital investment managers, influence corporate governance and invest in real estates in its own fund: The last two financial downturns have inflicted severe damage to the behemoth.

It is a natural question to ask: Can an individual do better than pension funds like Calpers? For California public employees, they are entitled to invest in defined contribution or deferred compensation retirement plans such as the California State University and Public Employees Savings Plus Plan (or see the original plan 401(k)/457 page for more details). The investment choices could be found in this current fund performance document.

Currently, the plan consists of 12 funds. These funds enable participants to gain exposure to three major assets: U.S. Equity, Foreign Equity, and Fixed Income. The list of minor asset classes covered:

Foreign Large Blend: EFA, VEU, GWL, PFA
Intermediate-term Bond: AGG, CIU, BIV, BND
Mid-cap Blend: IJH, IWR, JKG, VO, MDY, EMM, PJG, DON, EZM, MVV
Short-term Bond: CSJ, BSV, VCSH

For a moderate portfolio, our strategy invests in a fixed equal amount in U.S. Equity and Foreign Equity (both are about 30%) and about 40% in Fixed Income. The strategy looks at the allocations monthly and decides whether to re-balance the portfolio using the best funds available in an asset class.

The portfolio's performance is as follows:

From 12/31/2000 To 01/10/2011

2006 2007 2008 2009 2010 2011 1 Yr 3 Yr 5 Yr Inception
Annualized Return (%) 12.49 8.94 -24.91 22.15 10.84 -0.19 8.01 0.88 3.95 5.78
Sharpe Ratio (%) 120.39 59.36 -114.7 127.65 91.57 -3.82 68.11 2.97 16.7 34.88
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Refer to the portfolio page for more detailed year over year returns and risk statistics.

From the portfolio historical data, we derive 4.9% annualized return from 7/2001 to 6/2010. This beats Calpers' pension fund by additional 1.7% annually.

Notice the Strategic Asset Allocation strategy only uses the 12 funds available in the plan, and adheres to buy-and-hold principles with periodical re-balance and fund selection. With only three major classes (U.S. Equity, International Equity and Fixed Income) in the plan, the strategy periodically selects best funds from each asset class and re-balances the portfolio. This does show the benefit of fund selection (mainly through style rotation such as large cap to small cap value, etc.).

The takeaway is that a public employee can do better than his pension fund by adopting sound asset allocation strategy and manage his/her portfolio periodically. One does not need to have fancy hedge funds, private equity or venture investment to achieve better returns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.