Lessons Learned From CalPERS' 'Savings' and Liabilities

by: Eric Falkenstein

CalPERS, the pension fund in charge of California's $230B portfolio, recently noted it rejected adjusting its expected return over the next 10 years from 7.75% down to 7.5%. That "saved" it $400MM this year. While you shouldn't quibble over things like 0.25%, understand that it basically expects a 5% real return to its investment portfolio.

Here's data from 1990 through June 2010 on CalPERS' performance vs. some common benchmarks:

Avg. Ann Return
Calpers 7.5%
Inflation 2.7%
SP500 5.8%
Gov't Bond 7.2%
Click to enlarge

Over this historical period, interest rates declined from 8% to 3%, which added about 2% to the annual returns (asset prices rise when you decrease the discount rate). That isn't likely to repeat; at best, rates will be stable but probably will increase. This will drag down not only its bond returns, but equity as well (bond and stock returns generally positively correlated).

Thus it is anticipating the same 5% return over inflation that occured with the one-time secular interest rate decline these managers experience over their working life (which tends to make one think it's simply a given).

Either someone invents cold fusion, the Mayan alien astronauts bring us all sorts of manna when they return in 2012, or we will monetize our debt to pay for all these off-balance sheet liabilities. I'm betting on the last.