The Sun Never Sets On An Optimist


Look out for 8 percent average annual return.' Ed Mendel finds a late-20th century prediction about the massive California Public Employees Retirement System (CalPERS) that turned out to be right. Needless to say, the prediction was a worst-case scenario:

The actuaries said the annual state payment to CalPERS, $159 million in 1999, could soar to $3.954 billion in fiscal 2010-11 — a long-range forecast that scored a near bull's-eye on the $3.888 billion state payment for the fiscal year that began this month.

The investment shortfall was one of several outcomes the fund considered at the time:

If investments hit the earnings target assumed by CalPERS, an annual average of 8.25 percent (since lowered to 7.75 percent and now under review), the state payment this fiscal year would be $679 million.

But if earnings during the decade averaged 4.4 percent, a repeat of the decade from 1966 to 1975, the state payment would be $3.954 billion. If earnings averaged 12.1 percent, a repeat of 1947 to 1956, the payment would be zero…

As it turned out, a scenario based on a 4.4 percent average return was not "down" enough. CalPERS earnings during the last decade averaged 3.1 percent, according to a Wilshire consultants report in March.

If the actual return came in even lower than the lowest-return scenario, shouldn't that make the taxpayer-funded shortfall even larger than CalPERS' actuaries predicted?

Note that the Golden State's public employee pension fund managers continue to forecast magical rates of return. The chief investment officer for the California State Teachers' Retirement System (CalSTRS) says cautious investment outlooks are unpatriotic:

Asked for a breakdown of the assumed 8 percent earnings rate, Chris Ailman, the CalSTRS chief investment officer, said 3 percent is inflation and 5 percent is real growth, reduced further by the nearly 2 percent usually received from stock dividends.

"I would argue, and I have, with people who said it's going to be 6 (percent) or lower that they are basically saying the United States is going to go in the drain in the next 100 years," said Ailman. "I'm not willing to go there.

As Gov. Schwarzenegger's economic advisor David Crane notes here, 6 percent is about the rate of return investment funds got over time during the vastly prosperous 20th century. There used to be (back before the nineties became The Nineties) a rule of thumb: Anybody who promises you more than a 7 percent return per year is not just being unduly optimistic but actively blowing smoke up your anal canal. That's the kind of thing people believed in the industrial age, but this is a time of magic.


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  1. “With all this horseshit around, there’s gotta be a pony here somewhere.”

    Unfortunately, too many people in power still believe this old punchline to be a statement of fact.

  2. Why does reason hate the working man.

  3. Anybody who promises you more than a 7 percent return per year is not just being unduly optimistic but actively blowing smoke…

    Not really. We used to hear that stocks paid 9 percent per year on average, and everyone should expect that. Others said it was closer to 11 percent, not factoring in the difficulty in recovering from the down years. (A 25 percent drop needs a 33 percent gain to get back to even.)

    Of course, that was before the past decade, where stock market returns (including inflation) have been essentially zero (the Dow hit 10,000 in 1999.)

    1. That’s the problem with a pension system tied to an assumed rate of return. Whenever you are in a down period, there are going to be huge, unexpected gaps. I think that Reason may have overblown the whole public pension issue, but it is still a large cost, especially during the down years when the government is the most strapped for cash. The benefit of assuming a lower rate of return is that the government won’t be hit as hard during a recession. Obviously, the 90’s experienced exceptional growth in stocks that will not be seen again, except maybe once every blue moon. If you look at a graph of interest rates over the last fifty years, the 90’s saw lower interest rates than the two decades previous, which probably drove a lot of the stock market growth. Of course, once the dot com bubble burst, low interest rates only seemed to make the problem worse in the 2000’s.

    1. A billion here, a billion there… It’s not ever real money to us.

  4. Depending on the time frame and the index used, I have seen “averages” ranging from 7 – 11%. The one thing most retirement articles are consistant on is the drawdown rate. Based on Monte Carlo simulations, it should not exceed 3%.

  5. …and also, fuck California and their public-employee pensioners.

  6. To bad we can’t tie the future incomes of the pension fund managers to the accuracy of their predictions. If they misjudge and cost the state money within a specific time frame, they have to payback a painful chunk of what the state paid them.

    This might be an area in which a futures market might function well. The state could create a derivative instruments whose values was linked to future contributions to the pension fund. Such a market mechanism could easily provide more robust predictions than the easily corruptible and self-interested unicorn hunts that the technocrats engage in.

  7. Mr. Ailman’s return attribution is entirely inadequate. How do you reap an inflation return on a bond heavy portfolio? Why was he not called on this? Inflation works against fixed income investments not for them.

    Real answer (my guess is as good as anyone’s) is:

    5% on fixed income (70% of holdings)
    8% nominal on equities combined dividend and appreciation (20% of holdings)
    9% on alternatives (10% of holdings)
    6% weighted nominal return
    (2.5%) inflation
    3.5% Net real return

  8. California’s overgenerous/underfunded pensions. The gift the taxpayers keep giving.

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