Public Pensions Beat the Market

July 2008 By GIRARD MILLER

News headlines fail to mention fruits of diversification.

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Now that the stock market has fallen by 20 percent from its August 2007 highs, the news media has begun to run stories that chronicle the investment losses of public pension funds. I can't blame them for putting the numbers out there for everybody to see, which is their job. But I would like to take issue with the tone of these reports. They are way too negative.

In fact, it seems to me that there is a "man bites dog" story here. Public pension funds have saved taxpayers and employees billions of dollars by investing prudently through diversified and very savvy portfolios.

Think about it: Stocks are down dramatically, yet the data show that public pension fund losses nationally were about 4 percent. I'd like to know how many taxpayers and employees with an IRA, 401(k) or 457 plan can boast a similar record - bet it's not many.

Of course, there may be worse to come, in absolute returns. And there is no question that the funding ratios of many public plans will decline this year and next as these negative numbers work their way into the actuarial reports. That means that ad hoc cost-of-living allowances will be much harder to justify, and in the future, employer costs may rise slightly as those unfunded liabilities grow a little.

But let's look at the other side of this story. Public pension funds, including one of the very largest run so ably by Chris Ailman of the California state teachers' plan, have wisely used fixed-income portfolios and other diversification tools to offset U.S. stock market losses. Ailman, as you'll recall from my previous column on honest CIOs, told his constituents last summer that the tide was changing. In the case of CalPERS, the California Public Employees' Retirement System, its commodity investments returned 70 percent, which helped to offset some of those stock-market losses. Wasn't it just last week that everybody was bemoaning the presence of pension funds in the commodities markets, as if that were a bad thing?

So let's not get into the doomsday mentality during this market correction and stagflation malaise. Markets are cyclical, and we'll survive this lousy period, over the coming years. All is not lost.

And for those pension funds with deeply underwater funding ratios, there might be a glimmer of hope in the debt markets. Take a look at my companion column on OPEB bonds and the contrarian financial strategy that might become feasible for them if investment markets worsen.

Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities. More biographical information.