What if 8% is Really 0%?

Leo Kolivakis's picture

Via Pension Pulse.

Mebane Faber of Cambria Investment Management sent me an excellent paper he authored, What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed:

is well known that pension funds in the United States are underfunded
even if they achieve their projected 8% rate of return. The scope of
pension underfunding increases to an astonishing level when more
probable future rates are employed. A reduction in the future rate of
return from 8% to the more reasonable risk-free rate of approximately
4% causes the liabilities to explode by trillions of dollars. As bond
yields declined over the past twenty years, pension funds moved toward
more aggressive equity-based portfolios in an attempt to reach for this
8% return.

By investing in a portfolio with uncertain outcomes, pension funds
could experience increasingly volatile and even negative returns.
Paradoxically, in an effort to chase the universal 8% rate, pension
funds may be laying the groundwork for returns even lower than the risk
free rate.

In an effort to offer an empirical basis for this possibility, we
conclude the paper with a relevant comparison - the return of a
hypothetical Japanese pension for the past two decades. We believe
that pension funds need to at least prepare for the unfathomable: 0%
returns for 20 years. Most pension funds, regrettably, have not
adequately stress tested their portfolios for these scenarios.

So how does a pension manager get 8% in the current environment? Mr. Faber writes:

government bonds yielding about 4% plan sponsors must invest in other
outperforming assets to bring the cumulative return to 8%. The problem
with allocating assets away from the risk-free rate is that they are, by
definition, risky and uncertain. If a
pension manager is employing the benchmark 60% stock/40% bond
allocation, the 60% in equity or diversifying assets must return
approximately 11% to achieve 8% total returns.

second major problem outlined in this paper is that pension managers,
in an attempt to deal with the realities of underfunding, may be tempted
to chase higher performing and riskier asset classes, and may end up
compounding the underfunding problem even more through exposure to these
risky asset mixes.

Interestingly, according to Biggs, the
targeted equity allocation does not correlate with projected return.
Even worse, as shown in Exhibit 1 (above), funds
using the highest return assumptions have the most underfunded
pensions, a scenario that could be called, “fingers crossed and eyes

Mr. Faber goes on to write:

focus on illiquid assets (private equity, venture capital and
timberland investments, for example) made the Endowment Model
particularly attractive to funds that in theory have long time horizons,
such as endowments and pensions.

Yet, as real money investors
sought diversification through the same methodology, their portfolios
were, in fact, becoming more correlated to each other while portfolio
risks were becoming more concentrated and increasingly dependent upon
illiquid equity-like investments.

Most real money funds were not prepared for the following stress scenario to their portfolio:

  • US and Foreign Stocks declining over 50%
  • Commodities declining 67%
  • Real Estate (REITs) declining 68%

figures above are the peak drawdowns from the bear markets of
2008-2009, and, importantly, they all occurred simultaneously. It is
critical that pension funds – especially funds pursuing high equity
allocations – consider all possible stresses to portfolio viability.

Mr. Faber then asks a simple question:

funds prepared for a lengthy bear market in equities like when stocks
declined nearly 90% in the 1930’s? Are funds prepared for both raging
inflation of the 1970’s and 1980’s and sustained deflation like Japan
from 1990 to the present? It is our
opinion that most funds do not consider these outcomes as they are seen
as extraordinary and beyond the scope of either feasible response or

He's absolutely right, the majority of pension funds are hoping -- nay, praying --
that we won't ever see another 2008 for another 100 years. The Fed is
doing everything it can to reflate risks assets and introduce inflation
into the global economic system. Pension funds are also pumping billions
into risks assets, but as Leo de Bever said, this is sowing the seeds of
the next financial crisis, and when the music stops,
watch out below. Pensions will get decimated. That's why the Fed will
keep pumping billions into the financial system. Let's pray it works or
else the road to serfdom lies straight ahead. In fact, I think we're
already there.

Below, Mebane Faber talks about the
benefits of the ETF he manages, Cambria Global Tactical ETF (NYSE:GTAA).
I thank him for sharing this paper with me.

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pitz's picture

What about stress-testing for a melt-down in the value of the dollar or a melt-down in the value of bonds and REITs?  Seems to me that the 'fad' over the past decade, to increase bond allocations, will prove to be a colossal failure for pension funds.  All too often, we heard that pension funds could 'immunize' their portfolios using more bonds, from asset-liability gaps.  Certainly this must have a downside, as the Greek situation is showing us that bonds cannot sustainably perform when there are real shortfalls in the economy and the ability of the issuing governments to pay.

akak's picture

Yes, Leo, there is no (governmental) Santa Claus.

Egg Management Fee's picture

about a 4 percent return itd, no thanks. he thinks hes outperforming but hes not, another mutual fund scam.  good luck with that. nice name though, global tactical etf, should be renamed 'ill underperform and charge u high fees' etf

mickeyman's picture

Having large investors who can't sustain losses in the market is a good way to ensure a market collapse. Well done everyone involved!

Bruce Krasting's picture

Leo says (regarding the Fed's efforts to avoid a catastrophe):

"Let's pray it work"

So Leo is down to praying.

Do you realize how silly that sounds? I'm not knocking praying. But whoever one would pray to simple does not have the power (nor the interest) to stop the "great unwind" that is happening.

Nor does the Fed Leo. They have admitted as much in the past few weeks. Monetary policy has shot it's wad. If you're praying for the Fed to solve this I would suggest that you focus your prayers in a different direction.

If you said, "I'm praying that the people who are going to get hurt because of a decade of sub par growth will get by okay"; it might make a difference.

But you're praying that the stock market goes up every month. Deaf ears on that one...

Thisson's picture

The Keynesian clowns in charge of this economy only know that they can delay the day of reckoning by printing money, and that is what they intend to do for as long as possible. 

They don't know how to fix the real economy and they have no interest in doing so since they benefit from skimming rents from the current system.

Stuck on Zero's picture

My wife took her IRA money and purchased a condo with it through a "Self-Directed IRA."  Her rate of return on rent is about 6-8%.  In her IRA she was getting %0.3.

mayhem_korner's picture

Watch what happens when some of the smarter boomers opt for lump sums (where they can).  Can you spell i-m-p-l-o-s-i-o-n?

rsnoble's picture

I got 20 years in a pension.  I get 'critical status' letters every few months, it's ranked near the top for funds in worse shape.  Social Security is probably going away, markets are on life support, cashed out my 401k after being off work for 3 years. 


ZackAttack's picture

To me, the answer to what will happen if real returns approach 0% is pretty clear. Pensioners, like the rest of humanity, will receive a lot less than they expected. Deflation is our future and it would be wise to plan accordingly. Looking at US demographics and those of Japan before us, I can't imagine any other outcome.

Actually, that's the best case. A far worse case is if, knowing that pensions and 401Ks are the last real capital in the system, governments and banks simply seize control over them.


Thisson's picture

A bunch of old people will die earlier than they expected, because they will run out of money to properly care for themselves (proper food, health care, etc.)

akak's picture

Statists and Keynesians Unite!

You have nothing to lose but your useless eaters!

apberusdisvet's picture

Leo's point is well taken, because when the planned implosion of the markets happen, the pensions will be worthless and the sheeple will beg for the NWO.  The process is getting ramped up via the various wars of chaos, directed by the elites using the US Military.  The internet scares the shit out of them.  In America the police state vise will get worse.  If I were younger, I'd be on the next plane to Chile.

rsnoble's picture

As much as a conspiracy theorist that I am(im a conspiracy theorist because there's lots of conspiracies lol) I don't fully buy into the 'planned implosion' thing.  I think we've just followed the path of every other empire and their stupid mistakes right to the very end and there's a rich group of assholes that are aware of it and are taking advantage of the situation.

I do agree about the net.  I can't wait for hammer time on craigslist, I fuck the IRS every chance I get when I can sell shit locally vs. getting fucked royal via eGay and paypal fees.

I heard the US has 5% of the population in the world and 25% of the inmates so yes, that's a problem.  Either that or we just have a bunch of dumbasses that won't follow the law.  Of course the land of decreasing opportunity puts people in dire situations.  The thing that scares me are the for-profit private prisons.  They'd have no reason to let you go.

Mercury's picture

Even with 8% annualized returns (remember when it was 9, 10, 11, 12% ?) it's almost a certainty that there will be protracted periods of zero or negative growth (like the dead zone that stretched from the late 60's to the early 80's).

Plus, now that we're firmly on the Jersey side of Baby Boomer demographics it's probably not the best time to be expanding the public sector and/or defined benefits.

Marty Rothbard's picture

If you consider the rate of monetary inflation, 8% probably isn't even treading water.  Every 401k plan should have a precious metals option.  Does anyone have an estimate of what the rate of increase in M3 is?

nmewn's picture

"Pensions will get decimated."

This is the point we have been trying to make to you all these years Leo. These guys have to be invested at all times.

Whereas, the self directed do not. I would dare say all of "us" came through 08-09 just fine, we were agile because we had freedom of movement.

And again, a 50% loss requires a 100% return in order to get back to where you were before you incurred the loss. One cannot apply "new" money going in to an upside down investment as saying the investment has recovered X amount from the bottom.

This is an old money manager trick that disregards the original lost principle...its akin to watching the tread mill rushing underneath your feet at the gym and your mind telling you you're going forward.

Peter Pan's picture

Too bad they never thought of gold and silver.

Vendetta's picture

they are keeping other people's money as the props to keep the system 'up', while the mobile capital is moving behind the scenes to the hard stuff

Badabing's picture

They did but got smacked!

Dutch pensions forced to disinvest out of gold



Problem Is's picture

"What if 8% is Really 0%?"

Then all the mistakes you made on your high school math papers would have to be corrected, Leo...

Kreditanstalt's picture

But they're all invested in the same things - the same funds, the same stocks, the same bonds, the same corporates.

HOW, short of a contrarian stance, can any of them ever hope to outperform?

"On a clear day, you can see (INFLATION!) forever..."

Kayman's picture


"HOW, short of a contrarian stance, can any of them ever hope to outperform?"

Exactly. Adjusted for inflation 8% is a pipe dream.

In the aggregate, pensions cannot outgrow the economy.

ElvisDog's picture

I have control over one of my IRA's and can invest in whatever I like. I would suggest others do the same. If you change jobs, never roll it over into the company plan. Always take personal control of it. The company IRA was a complete joke. You had a choice of one of six incredibly lame American Funds funds. Their money market fund paid a negative yield.

Thisson's picture

I've hedged my bets.  Half is in SH hoping for a Japanese style decline; Half is in Gold/Silver.

A Man without Qualities's picture

Exactly, net result is they will not outperform inflation, and that's before you take off the huge amount of fees, charges, etc, which probably reduce returns by 2% in the long run.  Let's just hope people die sooner than the actuaries expect, or we're truly fucked.

J U D G E M E N T's picture

I have moved all my 401k funds to the "Stable Fund"

I am hoping that if there is a 2008 like event in the near

future, I can move back in for another run-up. 

Arrowflinger's picture

"I have moved all my 401k funds to the "Stable Fund""

That may have been a hideously bad move. Unless you are sure the Fed bought up the MBSin your "stable value" fund, said fund is probably chock full of toxic assets.

Bailout of the monoline insurors reinstated the bandaid over the festering toxicities and mark to fiction accounting keeps the odor of the rotten corpus from causing panic.


Out of the frying pan and into the fire....


ebworthen's picture

"Bailout of the monoline insurors reinstated the bandaid over the festering toxicities and mark to fiction accounting keeps the odor of the rotten corpus from causing panic."

I like it.

Cash is the only thing "safe" yet currency values are being debauched.

I'd say Gold and Silver but I feel the winds of confiscation and/or transaction controls.

Enceladus's picture

You should look at the prospectus for your "Stable Value Fund" in your 401k.

The last one I reviewed was invested 33% Foreign bond, 33% MBS, and 33% US Treasuries. I could see several scenarios that might make this fund less than 'Stable'

So.... you say money market, again read the prospectus, over night repos, European banks counter party risk. Then Google 'breaking the buck' and the FDIC. Don't make assumption and remember stability is a relative value

ebworthen's picture


Those big pools of slow money are perfect for the sharks to take their prey in.


akak's picture

Government "Guaranteed" Pensions: 1880s - 2010s


Guy Fawkes Mulder's picture

Best thing from Leo I've seen in a while...

SheepDog-One's picture

Even Leo has sworn off the unicorn dew and rainbow glitter enemas.

Peoples pensions and 401K's are goin down, act while theres still a chance, cash them in and do whatever you deem best. 

Hulk's picture

Got Gold? No? Cash in your soon to be bankrupt pension fund and convert...whilst you still can...time is running out...Take the fucking haircut now, it will be nothing compared to the haircut we are all going to get...

Popo's picture

When everyone in the world is hurting for cash,  who's going to buy your gold?   It isn't collapses that drive gold north.  It's the fear of collapses.

Thisson's picture

Who's going to "buy" your gold?  The same people that "buy" your dollars now.  Gold is money.  And when the dollar is recognized as toilet paper, people will want money instead of dollars.

akak's picture

And you can't eat it either!


Owning gold is not just for bad economic times, or "the shit hitting the fan" if you will, but most especially for AFTER those bad times --- to carry one's savings through the economic and monetary turmoil, which holding fiat paper has a notoriously, consistently bad record of NOT being able to do.

As others have said here and elsewhere, if you have to spend your gold during the depths of an economic crisis, you didn't plan well.  But if must spend it, at least it will ALWAYS have value --- the same cannot be said of government-controlled fiat currency.

silvertrain's picture

you got it..Gold/silver is for the ride back up when things get moving again, it will be the first and only asset that people trust..
Also there may be times when people dont have money but may have other assets in which they could trade for, farmland,tractors, business, cre, etc. etc. etc..

sgorem's picture

+1000. I did, 1/2/2007. took the hit, bought gold and silver. saw this shit coming a long time ago after the dotcom.fuck bubble burned me. good advice to all if they get out.

Seasmoke's picture

there is alot of public leeches lives in Bernankes hands......Good Luck with that !

sgorem's picture

MY "pension" is sitting down at the local bank. I'm just not hungry enough yet to go and "withdraw" it. It is diversified though, in $1's, $5's, $10's, $20's, $50's, and $100's.