05/23/2016 - Assuming Big Returns On Pension Funds: A Lot Can Go Wrong
Article highlights the challenges & pitfalls of pension funds who are assuming year-over-year returns of say 4% or even 8% in a world of negative interest rates & low investment yields .. worse is the use of pension funds by governments to borrow money, invest it with the pension funds & get “yield” from the pension funds as it were free money .. “Take the Ontario government’s $5-billion deficit. The province can issue long bonds paying interest at 2 per cent in real terms. If the ORPP can reliably earn 4-per-cent real, let’s lever the two-percentage point difference: Borrow $250-billion, invest it with the ORPP and the profit will balance the budget. Better yet, borrow $500-billion, invest with the ORPP, and – presto – a $5-billion surplus! The federal government can do even better. The real yield on their long bonds is zero. If the Canada Pension Plan Investment Board (CPPIB) can reliably earn 4-per-cent real, Ottawa can borrow, say, $500-billion, invest with the CPPIB, and boost their bottom line by $20-billion. Free money! What could go wrong? Well, nothing – if 4-per-cent real, year-in year-out, is really a slam-dunk. But in reality, plenty. In fact, many U.S. state and local plans, including the Detroit plan that went bust in 2013, tried this trick – so beguiled by assumed high returns that they forgot their duty to make actual payments. It is one thing for individuals to shoot for the moon – gamble their own money and retirement. It is something else to do it on others’ behalf – especially millions of others, with failure meaning not just individual but societal hurt.”
