Actuary: CalPERS Should Slash Assumed Rate to 7.25%

(March 7, 2012) — The largest public pension in the United States may slash its assumed rate of return on assets to 7.25% from 7.75%, as recommended by Alan Milligan, California Public Employees’ Retirement System (CalPERS) Chief Actuary.

An agenda item released by the fund on the revised discount rate stated the following:

“In order to keep economic assumptions current, it is essential to review actuarial assumptions periodically. The price inflation assumption is currently 3% and this assumption was last reviewed in 2004. The real wage inflation assumption is currently .25% above price inflation (3.25%) and was last reviewed in 1998. The real discount rate assumption was last reviewed in March 2011 and is currently 4.75% above inflation (7.75%).”

Milligan’s recommendation will proceed to CalPERS’ board, which will vote on whether or not to accept the proposal.

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Last month, in an interview with the Public Retirement Journal, Milligan told the Journal that he hadn’t seen anything in the current environment that would cause him to recommend a drop of more than 0.25% in the discount rate — the same recommendation he gave last year. Milligan is responsible for developing CalPERS actuarial policies, overseeing actuarial staff and operations, and advising the CalPERS Board of Directors. He also serves as Chair of the California Actuarial Advisory Panel, the independent body created to provide information on pensions, OPEBs, and best practices to the Legislature, Governor, and local agencies, the fund outlined in a release.

CalPERS is not the only scheme to face resistance and concerns over its projected returns.

In January, Robert North, New York’s chief actuary, recommended that the city’s schemes lower its assumed annual rate of return on assets to 7% from 8%.

Meanwhile, New York State’s pension system lowered its rate from 8% to 7.5% in 2010; the Illinois State Employees’ Retirement System made a similar cut, from 8.5% to 7.75%. In September of last year, Joe Dear, the investment chief of CalPERS, expressed that a 7.75% return may be tough to meet. In an interview with aiCIO featured in its Summer Issue, Dear commented on the fund’s stellar returns, lowering expectations of future similarly stellar performance by saying: “Honestly, and not taking anything away from the team here, our 20.7% returns in fiscal 2011 were largely the result of market beta. Public equities are about half our $234 billion portfolio, and it is no secret that public equities significantly increased in value over the past year.”

Summarizing his perspective on CalPERS’ 2011 investment return and his future outlook, Dear told aiCIO: “Obviously, a 20% return undermines the statements of public pension fund critics—that we are unable to reach our target. I think that’s important—that there is still a lot of earning power in these assets—but let’s be clear: There won’t be a string of 20% years in a row.”

(March 7, 2012) — Constructing a benchmark away from a market capitalisation-weighted index would help investors’ risk-adjusted returns from passive equity, according to Goldman Sachs Asset Management.

Presenting at the National Association of Pension Funds annual investment conference in Edinburgh this morning, Paul Craven Head of EMEA Institutional Business at GSAM told a group of pension fund investors that usually benchmarking can lead to bad decision-making.

“As a trustee, we set asset managers a benchmark, which is where they start – if we can set them a better benchmark, why not start from there?”

Some 78% of investors in the seminar said they had some form of passive investment; Craven said by altering the benchmark against which they set their equity allocation, they could earn a better return.

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The approach set out by GSAM would be to cut out the highest risk beta, or market return, stocks from a range of equities — then weight the remaining stocks according to the intrinsic value of the company, which could be worked out by adding the value of the company assets to its potential for growth. To invest in a range of countries, investors should look at those with the highest growth. “Sometimes factors look different but when put together they combine to make something better,” Craven said.

He quoted figures showing that combining the two factors resulted in a higher return for the GSAM index approach than the market-weighted index – or the two factors used separately. The approach also boasted a better risk-adjusted return.

“Consider what happened in the 1980s – 44% of the MSCI world index was made up of Japanese stocks due to their market cap, despite the GDP being in the teens in terms of value,” Craven said. “The same happened in the early 2000s when IT stocks made up 37% at the peak of the bubble, despite contributing only 5% of revenues. This approach will not give an investor the massive upside of a bubble, but it will protect them from the pain of the crash.”

GSAM is in the final stages of putting together a range of indices with an index provider focussed on this approach.