Public pensions all around the country like to play a clever little game that allows them to drastically understate the current value of their future liabilities and therefore pretend that their ponzi schemes are something other than insolvent frauds. Of course, we're talking about the artificially high discount rates that pension boards consistently use to understate their net underfunding levels...a topic that we've written about frequently over the years.
Alas, at least in the opinion of Yale's Chief Investment Officer David Swensen, those 7.5% annual returns that pensions love to rely on, even if they've never managed to actually achieve them, are going to be increasingly difficult to hit over the coming years. As Swensen told Bloomberg, despite achieving a 13.5% annual return over the past 32 years, he is now preparing university officials for much lower returns averaging around 5% for the foreseeable future.
The investment chief, who was interviewed by former U.S. Treasury Secretary Robert Rubin, also said he’s expecting lower returns for the university’s endowment, which he’s run for 32 years with a 13.5 percent average annual rate of return.
For the past 12 to 18 months, Swensen said he has been warning university officials to expect much lower returns in the future, as little as 5 percent annually, which would be down from previous assumptions of 8.25 percent.
“It’s not a very popular change,” he said. “We’re victims of our own success.”
Meanwhile, as we pointed out a couple of months ago (see: Pension Ponzi Exposed: Minnesota Underfunding Triples After Tweaking This One Small Assumption...), the state of Minnesota recently provided a beautiful illustration of exactly what happens when public pensions decide to ditch their inflated discount rates for more realistic assumptions...their net underfunding tripled to $50 billion...here's more from Bloomberg:
Minnesota’s debt to its workers’ retirement system has soared by $33.4 billion, or $6,000 for every resident, courtesy of accounting rules.
The jump caused the finances of Minnesota’s pensions to erode more than any other state’s last year as accounting standards seek to prevent governments from using overly optimistic assumptions to minimize what they owe public employees decades from now. Because of changes in actuarial math, Minnesota in 2016 reported having just 53 percent of what it needed to cover promised benefits, down from 80 percent a year earlier, transforming it from one of the best funded state systems to the seventh worst, according to data compiled by Bloomberg.
The Minnesota’s teachers’ pension fund, which had $19.4 billion in assets as of June 30, 2016, is expected to go broke in 2052. As a result of the latest rules the pension has started using a rate of 4.7 percent to discount its liabilities, down from the 8 percent used previously. As a result, its liabilities increased by $16.7 billion.
Unfortunately, lower returns was only part of the bad news that Swensen had for U.S. investors as he described the current disconnect between "fundamental risks that we see all around the globe with the lack of volatility in our securities markets" as "profoundly troubling."
David Swensen, Yale University’s longtime chief investment officer, said the lack of market volatility in the current geopolitical environment is a major concern and warned that another crash is possible.
“When you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling,” Swensen, 63, said Tuesday during remarks at the Council on Foreign Relations in New York. That “makes me wonder if we’re not setting ourselves up for an ’87, or a ’98 or a 2008-2009,” he said, referring to previous market crises.
“The defining moments for portfolio management” came in those years, “and if you ignore that you’re not going to be able to manage your portfolio,” Swensen said.
Asked why Yale’s uncorrelated assets are higher now than in 2008, he said, "I’m not worried about the economy so much, what I’m concerned about is valuation."
Of course, we're sure these warnings will provoke pension managers all around the country to promptly reassess their optimistic return assumptions and adjust future pension benefits accordingly to preserve the solvency of their funds for future generations of pensioners...