Chasing Yield Into Minefields

Tyler Durden's picture

Submitted by Thad Beversdorf via,

I happened to be going through the Red Cross audited financials this morning (this is not typical morning reading for me but I’m doing some due diligence on another matter).  Under the Notes to Financials I came across the organization’s pension assets breakdown and what I found was a bit shocking.

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More than half of the organization’s pension assets are level 3 assets.  For those not up to speed on the level 3 assets here is the definition from Wikinvest.

“Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include certain private equity investments, certain residential and commercial mortgage related assets (including loans, securities and derivatives), and long-dated or complex derivatives including certain foreign stock exchanges, foreign options and long dated options on gas and power). Level 3 assets trade infrequently, as a result there are not many reliable market prices for them. Valuations of these assets are typically based on management assumptions or expectations.”

Now I’m not an expert in ERISA regulations but I was surprised to see this allocation mix for the Red Cross pension assets.  My (limited) understanding is there are fairly strict guidelines and limitations on what portion of overall assets can be allocated to high risk investments; level 3 assets representing the highest risk on the risk continuum. However, as a portfolio manager one is under pressure to generate sufficient yield to sustain cash outflows (obligations) of the pension.   While historically PM’s could achieve 7% returns with quality corporate paper and Treasuries, today that is simply a pipe dream.  Currently the US 10 yr is at all time lows and has continued to decline since 2007, now yielding around 1.8%.  As interest rates declined from 2007 we can see the allocation shift from safe to risky assets by the Red Cross pension.

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Between 2007 and 2008 the Red Cross pension went from 14% of assets allocated to level 3 assets (nonmarketable & MBS) up to 28%.  By June 2009 they had lost 25% of total assets, which meant they had 75% of the assets to generate the same obligations but with interest moving to 0%.  The end result is the chase for yield with 53% of assets today being allocated to level 3 assets.  Why?  Because the obligations of the pension are essentially fixed but the returns are floating with Fed policy deteriorating risk adjusted returns.  And so it’s not really a matter of choice but a mathematical necessity for the PM’s managing the pension to look toward riskier assets for that same 7% return.

And so we see how the Fed policies are directly responsible for ballooning the systemic risk in the financial and socioeconomic landscape.  Not just pensions but actual individual retirees are facing the very same dilemma.  That is, the cost to live is not something most have much control over.  And so because retirees had baked in a 5% to 7% return on their nest egg they must achieve that annual return.  This means for those lucky enough to still have a nest egg after the last two bubble crashes they are forced to venture further out onto the risk continuum.  Risk adjusted returns have deteriorated into negative territory in Europe (it’s the only way an investor would accept a loss going into an investment i.e. negative rates) and we are very close to that here in the US. But there must be some upside to the ZIRP policies to offset the almost unmanageable amount of resultant risk, right?  I mean these policies are meant to help the average American not hurt them, correct??

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The above chart actually shows a decline in weekly earnings of the American worker.

The next chart, however, shows just where the policies’ upside landed.

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Banks benefited most with 400% growth in income, followed by nonfinancial corporations with 280% growth in income but again with no benefit to the American working class incomes. So while risk to the entire system has ballooned by way of forcing pensioners (and all savers) to chase yield into the darkness as a result of the Fed’s policies over the past 8 years there has been absolutely no benefit to the American worker.  However, banks and corporations have reaped significant rewards.  And so I ask the PhD economists who have so gregariously supported the performance of the Fed for the past 8 years to explain just how these policies have helped the American people?  And Zandi, stating you don’t believe the data is not an argument suitable to a PhD.

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A Pimp's love is different's picture

"I happened to be going through the Red Cross audited financials this morning"


FFFS ~ Get a life Thad!

nibiru's picture

Welcome to new version of democratic socialism - printing/corporate welfare is for everyone - but only for those who we will pick. Free speech is also for everyone unless you disagree with what is happening. Everyone is earning their share in this crony capitalism unless they are banks and big corporations 

Sam Clemons's picture

The policies aren't meant to help every day Americans.  They're meant to prevent default on the debt owners.

buzzsaw99's picture

i was going to donate until i read this. /sarc

Yen Cross's picture

    So the Red Cross is a hedge fund now?

Rainman's picture

no, it's a vast .gov-affiliated bureaucracy pretending to be a charity.

philipat's picture

So a strategic merger with the Clinton Foundation would make sense?

scubapro's picture


so the CBs are really over a barrel.  they cannot stop doing what they have been doing until 'growth' comes around to make it possible to contemplate disgorging balance sheets.   but there is not enough growth and it appears to be slowing.

thats about it.  stop intervening and the marginal currency unit with which to buy stocks dries up.   continue to intervene extending the asymtotic curve until things start breaking and we get a much more calamitous decline and crash.   but who cares tptb are extremely wealthy and their lifestyles will not suffer, or they might all just be dead before the chickens come home.

CrabbyR's picture

Well I had to do a double first I thought that your portfolio was controlled By P.M`s then I realized it was Portfolio Vampires

N0TaREALmerican's picture

Is there a triple long ETF I can buy that has the Red Cross in it?

CrabbyR's picture

PV`S should not be confused with PM`S

Bluntly Put's picture

If I was a conspiracy theorist, I'd say there was a concerted effort over time to skim off the retirements of Americans.

First was the housing bubble that afforded banks outrageous profits while offloading their risks onto first derivatives and then the central bank.Then that popped and wiped out equity in homes and caught people underwater.

Now we have the fed suppressing interest rates allowing corps to buy back their own stock with debt float and guaranteeing wall street a fixed buyer from pension funds seeking yield.

But that's just tin foil hat talkery.

Yancey Ward's picture

This is almost certainly a typical pension plan allocation today, and it will only get worse- all those longer dated bonds these plans held, let's say, a decade ago at the last cycle high have either been sold to lock in the capital gains, or have been retired by the issuer and replaced with the lower returning ones.  You think it is bad now, wait to see what another five years of this interest rate environment does to these plans.

NoWayJose's picture

ZIRP is fine with me - for my PMs...

Wantoknow's picture

The PhD economists who have supported this policy are shills for the banks.  They are paid well to provide whatever patina of glamour the economics profession still has to the support of these self serving policies.

Even elementary economic theory will point out the issues raised above. However, don't expect to see it easily.  The relevant curriculum in undergraduate economics has been divided among microeconomics, macroeconomics and money and banking.  The issues raised above generally fall between.  One has to look closely.

Still, its clear enough if you just look and think a bit.  Just go look at an ISLM diagram in any undergraduate textbook and consider the meaning of high nominal money creation, and low aggregate demand. One will see that national income, real investment and real interest rates are more likely lower rather than higher.  We neglect the technical issues.

Thus returns to investors will be low, opportunities to meaningfully invest will be low and the income of the populace will be low.  These policies of neoliberalism are just the opposite of the correct ones for national economic health.  But they do increase the real values of financial assets which is what matters to those who control the money supply. Markets first and always.  Is that not the rallying cry? 

Look at (M/P)V=Y.  This is the most famous Fisher Equation.  It is also the LM curve as in ISLM.  Here M/P represents real balances which may be viewed as financial wealth or proportional to financial wealth, V is the velocity of money and Y is GDP or the national income. The velocity of money can be thought of as an interest rate making Y, the GDP the return on financial wealth.  If real incomes are fixed, Y is fixed.  If you want to get richer and can manipulate interest rates force V lower to make M/P higher. It is a simple present value analysis of the national income where V is the rate of discount.

Those holding financial assets and power can force this relation by making V lower by making rates of interest lower.  This is done by increasing the nominal money supply.

This is really very simple yet I wonder how many who read this will understand it.  If you don't it is easy to be lied to by those who have a vested interest in forcing M/P higher at whatever expense and there is an expense. In the end putting pressure on V to move lower will put pressure on Y to move lower. But this a longer argument.

 Nevertheless, the road to riches for the few and the road to poverty for the many is to raise monetary growth while suppressing aggregate demand.  Lets try another way to think about it. Printing money allows the printer to buy up assets.  But buying up assets raises their price.  To reduce this effect and keep asset prices relatively low chase those who cannot print money out of the market.

Yes, prices themselves will do this but only by increasing the need to print more money can the assets be captured.  This introduces inflation and is too obvious. It is also inefficient as it reduces real balances or real financial wealth.  Cutting aggregate demand generally will squeeze the wages and salaries of the unconnected and drive them from the market.  Indeed, they will sell the assets they have to generate some income which can be purchased more cheaply.

 It is all very simple.  You can rip people off by printing money and spending it without generating inflation which is counter productive to the goal.  You just have to squeeze down real output to reduce and eliminate inflationary pressure.  For those at the top falling real incomes in general is not their problem.

This can be made a great deal more complicated very easily but the issues are basic and cannot be argued away no matter how much the attempt is made.  Now, doesn't this argument suggest that lowering money creation while increasing aggregate demand would be the better idea?  Of course it would.  That's what an ISLM diagram says too.

Of course financial wealth will fall as real balances M/P falls (to keep it simple) which will annoy the financial industry.  The poor markets will take it on the chin.  But financial wealth exists for a reason other than to make individuals wealthy.  Wealth is actually a side effect happily discovered by those with an interest in finance centuries ago.

Financial wealth is the present value of national income in nominal terms and represents a measure of the exchange value of a dollar; in real terms the real productivity of the economy.  Its size is not to be set by whims of the greedy but by the internal structure of the economy.  It exists because it must exist and its size is a technical matter.  It cannot grow by itself without bound; not without destructive consequences.  Who owns it is actually another matter altogether.

No economist who denies the basic message of an ISLM diagram is to be trusted.  He is very much a lliar by skillful means most likely for the benefit of his employers. Do take this last point seriously.

truthynews's picture

PhD economist here.  Not all of us support the easy money policies of the Fed, and I agree that the Fed has wrecked markets by taking away accurate price signals creating malinvestment during booms.  However, there are other factors that have contributed to stagnate wages as well, such as competing with cheap labor around the world.

gregga777's picture

The sole, true mandate of Goldman Sachs' Feral Reserve System is to make the rich richer, by stealing from the poor and middle class, thereby greatly increasing income and wealth inequality. Any muppets, er, I mean suckers, er, whatever, that did not not lose everything in the bursting of the previous two bubbles are scheduled for pauperization in the upcoming bursting of the third Feral Reserve System boom-bust cycle this century. The Feral Reserve System criminals are extremely proficient at enriching their obscenely rich masters. They will lie to anyone and everyone about their true purposes observing but their actions shows all that anyone needs to understand their evil purposes.