Target Return Of 7.75% Very Challenging In The Near-term

By Cam Hui on October 12, 2011

“Joseph Dear, the CIO of CALPERS, appeared on CNBC yesterday to discuss the near and long term outlook for the markets. His comments are highly instructive for other investors in formulating an investment policy, either for themselves or on behalf of a pension or endowment fund. Here is the key quote about CALPERS’ return expectations [emphasis added]:

In the short-term, it’s a little more nervous making. You look at 2% interest rates, your equity markets aren’t going to do a great job, I don’t think. So our target return is 7 3/4 becomes challenging in the near term.

They are projecting a 7.75% return on assets??? 10-year Treasuries are yielding around 2% and so are stocks. As I wrote before in my post “A stock market bottom at the end of this decade“, equity returns are likely to be relatively flat for another decade or so. If capital returns from stocks are near zero, then any way you combine stock and bond returns, you aren’t likely to get a return expectation above 3%.

Back in November 2007, I wrote in my very first post on this blog that hedge fund returns were highly correlated with equity returns and it was unclear why investors were paying 2-and-20 fees to achieve such a return stream. That assessment hasn’t changed. In today’s risk-on/risk-off world, buying hedge funds can be considered to be buying risk. Risky returns are highly correlated with equity returns. Therefore an investment policy of buying hedge funds could be construed as buying a return stream that is expected to correlated to risky assets, i.e. stocks.

Joseph Dear may be right in the very long term. However, my former experience as a portfolio manager for institutions tell me that pension fund staff turn over every 3-7 years. In many cases, pension fund officers are incentivized on the performances of the funds that they oversee. In effect, 3-7 years is a reasonable estimate of the maximum time horizon that an investment manager can expect with a pension fund officer.”

That sounds about right. While CalPers CIO Joseph Dear is busy projecting the “long Haul” pension funding strategy this writer is projecting a short term stay for this CIO, which is consistent with the term of his last gig. Unfortunately, for taxpayers, the boom (I’m a HERO), or bust (I’m getting out of Dodge) strategy of this CIO doesn’t serve the Pleasanton community at all, and that includes the elementary school children who will be paying for the current shennanigans that = CalPERS, and this CIO‘s risky strategy.

This is important because the taxpayers guarantee a 7.75 rate of return on the the 60% of assets under Calpers management, while also paying 7.75% interest on the 40% of unfunded liabilities. This year CalPERS needs to return about 13% for Pleasanton to break even. They are down about 10% for the First quarter of FY 2011-12, which began July 1st.