CalPERS Goes All-In On Pension Accounting Scam; Boosts Stock Allocation To 50%

Starting July 1, 2018 stock markets around the world are going to get yet another artificial boost courtesy of a decision by the $350 billion California Public Employees" Retirement System (CalPERS) to allocate another $15 billion in capital to already bubbly equities.  Of course, if this decision doesn"t make sense to you that"s because it"s not really meant to make sense. 

As Pensions & Investments notes, CalPERS" decision to hike their equity allocation had absolutely nothing to do with their opinion of relative value between assets classes and nothing to do with traditional valuation metrics that a rational investor might like to see before buying a stake in a business but rather had everything to do with gaming pension accounting rules to make their insolvent fund look a bit better.  You see, making the rational decision to lower their exposure to the massive equity bubble could have resulted in CalPERS having to also lower their discount rate for future liabilities...a move which would require more contributions from cities, towns, school districts, etc. and could bring the whole ponzi crashing down. 

The new allocation, which goes into effect July 1, 2018, supports CalPERS" 7% annualized assumed rate of return. The investment committee was considering four options, including one that lowered the rate of return to 6.5% by slashing equity exposure and another that increased it to 7.25% by increasing the exposure to almost 60% of the portfolio.

 

The lower the rate of rate means more contributions from cities, towns and school districts to CalPERS. Those governmental units are already facing large contribution increases — and have complained loudly at CalPERS meetings — because a decision by the $345.1 billion pension fund"s board in December 2016 to lower the rate of return over three years to 7% from 7.5% by July, 1, 2019.

Meanwhile, there was only one dissenting vote on the decision to hike the fund"s equity exposure.  Ironically, the dissent did not come from a rational investor looking to preserve the fund"s assets, but rather from a board member named J.J. Jelincic who wanted to go all-in on the pension accounting scam and hike the fund"s equity allocations to 60% so that discount rates could be raised even higher than the current 7%.

Of course, this is hardly a new topic for us. As we pointed out a year ago in a post entitled "CalPERS Board Votes To Maintain Ponzi Scheme With Only 50bps Reduction Of Discount Rate," each year CalPERS has to weigh mathematical realities against the risk of disrupting the ponzi scheme and forcing several California cities to the brink of bankruptcy with lower discount rates..."mathematical realities" rarely win that fight.

But a CalPERS return reduction would just move the burden to other government units. Groups representing municipal governments in California warn that some cities could be forced to make layoffs and major cuts in city services as well as face the risk of bankruptcy if they have to absorb the decline through higher contributions to CalPERS.

 

“This is big for us,” Dane Hutchings, a lobbyist with the League of California Cities, said in an interview. “We"ve got cities out there with half their general fund obligated to pension liabilities. How do you run a city with half a budget?”

 

CalPERS documents show that some governmental units could see their contributions more than double if the rate of return was lowered to 6%. Mr. Hutchings said bankruptcies might occur if cities had a major hike without it being phased in over a period of years. CalPERS" annual report in September on funding levels and risks also warned of potential bankruptcies by governmental units if the rate of return was decreased.

Under the plan adopted Monday, in addition to their 50% equity allocation, CalPERS will have a 28% weighting to fixed income, up from 20%.  Real assets, which includes real estate, will keep its 13% allocation, while private equity will remain at 8% and CalPERS" liquid portfolio, made up of cash and other short-term instruments, will fall to 1% from 4%.

CalPERS Calls The Top: Largest Public Pension Fund Mulls Dumping $50 Billion Of Stocks

Is the largest public pension fund in the United States getting ready to dump about $50 billion worth of stocks?  According to a new note from Bloomberg, CalPERS" board is meeting for a workshop today in Sacramento to discuss asset allocations for the upcoming year which could include a doubling of the fund"s bond allocation from 19% to 44% which would be funded with a massive $50 billion sell down of equities.

Calpers is looking at a menu of options for its fixed-income target ranging from the current 19 percent to as much as 44 percent, according to a presentation for a board workshop in Sacramento coming up Monday. Equities could be cut to as little as 34 percent from 50 percent. Stocks were the best-performing asset class in fiscal 2017, returning almost 20 percent.

 

“The markets have had a pretty good run and it’s possible Calpers staff is thinking this might be a good time to lock in some of the gains,” Keith Brainard, research director for the National Association of State Retirement Administrators, said in a phone interview.

Unfortunately, as we"ve noted before (see: CalPERS Board Votes To Maintain Ponzi Scheme With Only 50bps Reduction Of Discount Rate), a shift toward higher fixed income allocations may require a simultaneous decrease in the fund"s discount rate assumptions which could drastically increase contribution requirements from various public employers all around the Golden State.

“We’ve cut the return expectation to the point that employers are screaming, ‘We can’t afford it. We can’t afford it,’ ” Jelincic said. “I personally would be willing to take on a little more risk.”

 

The average allocation for public pensions is about 23 percent to fixed income and 49 percent to stocks, according to Nasra data.

 

The Calpers board is scheduled to vote on the allocation in December. Almost all of the fixed-income and stock holdings are managed in-house while more complex assets, such as private equity and real estate, are overseen by outside consultants. Allocations to private equity and real assets would stay at 8 percent and 13 percent, respectively, under all scenarios under consideration.

 

The allocation revisions occur every four years. Calpers is working to provide for a growing wave of longer-living retirees.

Of course, while a more conservative asset allocation may be warranted in the current bubbly equity environment, often logic is quickly dismissed by politicians when it"s implementation could expose a massive ponzi scheme that has been hiding in plain sight for decades and risks the financial solvency of local and/or statewide government entities. 

This battle between math/logic and politicians has played out numerous times in states all across the country and somehow we suspect that "math/logic" will continue to lose...better to bury your head in the sand for a couple of more years and pretend there is no problem.

Teachers Demand $3,200 From Each Kentucky Household To Fund Pension Ponzi For 2 Years

We have written frequently over the past couple of weeks about the disastrous public pension funds in Kentucky that are anywhere from $42 - $84 billion underfunded, depending on which discount rate you feel inclined to use. As we"ve argued before, these pensions, like the ones in Illinois and other states, are so hopelessly underfunded that they haven"t a prayer of ever again being made whole.

That said, logic and math have never before stopped pissed off teachers and/or clueless legislators from throwing good money after bad in an effort to "kick the can down the road" on their pension crises. As such, it should come as no surprise at all that the Lexington Herald Leader reported today that Kentucky"s 365,000 teachers and other public employees are now demanding that taxpayers contribute a staggering $5.4 billion to their insolvent ponzi schemes over the next two years alone. To put that number in perspective, $5.4 billion is roughly $3,200 for each household in the state of Kentucky and 25% of the state"s entire budget over a two-year period. 

Kentucky’s General Assembly will need to find an estimated $5.4 billion to fund the pension systems for state workers and school teachers in the next two-year state budget, officials told the Public Pension Oversight Board on Monday.

That amount would be a hefty funding increase and a painful squeeze for a state General Fund that — at about $20 billion over two years — also is expected to pay for education, prisons, social services and other state programs.

“We realize this challenge is in front of us. That’s obviously part of the need for us to address pension reform,” said state Sen. Joe Bowen, R-Owensboro, co-chairman of the oversight board.

“In the short-term, yeah, we’re obligated to find this money,” Bowen said. “And everybody is committed to do that. We have revealed this great challenge. We have embraced this great challenge, as opposed to previous members of the legislature, perhaps.”

In presentations on Monday, the pension oversight board was told that total employer contributions for KRS in Fiscal Years 2019 and 2020 would be an estimated $2.47 billion each year, up from $1.52 billion in the current fiscal year. Nearly $995 million of that would be owed by local governments. The remaining $1.48 billion is what the state would owe.

The Teachers’ Retirement System estimated that it would need a total of $1.22 billion in Fiscal Year 2019 and $1.22 billion in Fiscal Year 2020. That would include not only an additional $1 billion to pay down the system’s unfunded liabilities but also $139 million to continue paying the debt service on a pension bond that won’t be paid off until the year 2024.

Of course, the $5.4 billion will do absolutely nothing to avoid an inevitable failure of Kentucky"s pension system but what the hell...

As we"ve said before, the problem is that the aggregate underfunded liability of pensions in states like Kentucky have become so incredibly large that massive increases in annual contributions, courtesy of taxpayers, can"t possibly offset liability growth and annual payouts.  All the while, the funding for these ever increasing annual contributions comes out of budgets for things like public schools even though the incremental funding has no shot of fixing a system that is hopelessly "too big to bail."

So what can Kentucky do to solve their pension crisis?  Well, as it turns out they hired a pension consultant, PFM Group, in May of last year to answer that exact question.  Unfortunately, we suspect that PFM"s conclusions, which include freezing current pension plans, slashing benefit payments for current retirees and converting future employees to a 401(k), are somewhat less than palatable for both pensioners and elected officials who depend upon votes from public employee unions in order to keep their jobs...it"s a nice little circular ref that ensures that taxpayers will always lose in the fight to fix America"s broken pension system.

Be that as it may, here is a recap of PFM"s suggestions to Kentucky"s Public Pension Oversight Board courtesy of the Lexington Herald Leader:

An independent consultant recommended sweeping changes Monday to the pension systems that cover most of Kentucky’s public workers, creating the possibility that lawmakers will cut payments to existing retirees and force most current and future hires into 401(k)-style retirement plans.

If the legislature accepts the recommendations, it would effectively end the promise of a pension check for most of Kentucky’s future state and local government workers and freeze the pension benefits of most current state and local workers. All of those workers would then be shifted to a 401(k)-style investment plan that offers defined employer contributions rather than a defined retirement benefit.

PFM also recommended increasing the retirement age to 65 for most workers.

The 401 (k)-style plans would require a mandatory employee contribution of 3 percent of their salary and a guaranteed employer contribution of 2 percent of their salary. The state also would provide a 50 percent match on the next 6 percent of income contributed by the employee, bringing the state’s maximum contribution to 5 percent. The maximum total contribution from the employer and the employee would be 14 percent.

For those already retired, the consultant recommended taking away all cost of living benefits that state and local government retirees received between 1996 and 2012, a move that could significantly reduce the monthly checks that many retirees receive. For example, a government worker who retired in 2001 or before could see their benefit rolled back by 25 percent or more, PFM calculated.

The consultant also recommended eliminating the use of unused sick days and compensatory leave to increase pension benefits.

Meanwhile, PFM warned that the typical "kick the can down the road approach" would not work in Kentucky and that current retiree benefits would have to be cut.

“This is the time to act,” said Michael Nadol of PFM. “This is not the time to craft a solution that kicks the can down the road.”

“All of the unfunded liability that the commonwealth now faces is associated with folks that are already on board or already retired,” he said. “Modifying benefits for future hires only helps you stop the hole from getting deeper, it doesn’t help you climb up and out on to more solid footing going forward.”

Of course, no amount of math and logic will ever be sufficient to convince a bunch of retired public employees that they have been sold a lie that will inevitably fail now or fail later (take your pick) if drastic measures aren"t taken in the very near future. 

This $700 Billion Public Employee Ticking Time Bomb Is Only 6.7% Funded; Most States Are Under 1%

We"ve spent a lot of time of late discussing the inevitable public pension crisis that will eventually wreak havoc on global financial markets.  And while the scale of the public pension underfunding is unprecedented, with estimates ranging from $3 - $8 trillion, there is another taxpayer-funded retirement benefit that has been promised to union workers over the years that puts pensions to shame...at least on a percentage funded basis.

Other Post-Employment Benefits (OPEB), like pensions, are a stream of future payments that have been promised to retirees primarily to cover healthcare costs.  However, unlike pensions, most government entities don"t even bother to accrue assets for this massive stream of future costs resulting in $700 billion of liabilities that most taxpayer likely didn"t even know existed. 

As a study from Pew Charitable Trusts points out today, the average OPEB plan in the U.S. today is only 6.7% funded (and that"s if you believe their discount rates...so probably figure about half that amount in reality) and many states around the country are even worse.

States paid a total of $20.8 billion in 2015 for non-pension worker retirement benefits, known as other post-employment benefits (OPEB).  Almost all of this money was spent on retiree health care. The aggregate figure for 2015, the most recent year for which complete data are available, represents an increase of $1.2 billion, or 6 percent, over the previous year. The 2015 payments covered the cost of current-year benefits and in some states included funding to address OPEB liabilities. These liabilities—the cost of benefits, in today’s dollars, to be paid in future years—totaled $692 billion in 2015, a 5 percent increase over 2014.

In 2015, states had $46 billion in assets to meet $692 billion in OPEB liabilities, yielding a funded ratio of 6.7 percent. The total amount of assets was slightly higher than the reported $44 billion in 2014, though the funding ratio did not change. The average state OPEB funded ratio is low because most states pay for retiree health care benefits on a pay-as-you-go basis, appropriating revenue annually to pay retiree health care costs for that year rather than pre-funding liabilities by setting aside assets to cover the state’s share of future retiree health benefit costs.

State OPEB funded ratios vary widely, from less than 1 percent in 19 states to 92 percent in Arizona. As Figure 1 shows, only eight have funded ratios over 30 percent. These states typically follow pre-funding policies spelled out in state law. Many of them also make use of the expertise of staff from the state pension system to invest and manage plan assets.

Looking at the problem on a relative basis, you find that several states have accrued net OPEB liabilities totaling in excess of 10% of the personal income generated within their borders.

Pew compared states 2015 OPEB liabilities with 2015 state personal income to show these liabilities in relation to the potential resources that states could draw on to cover the liabilities. The major ratings agencies and other financial research organizations commonly use personal income as a metric to illustrate untapped revenue sources and as an indicator of how flexible states can be in meeting their obligations under changing budget conditions. The research shows significant overall reported OPEB liabilities, but the relative size varies widely. (See Figure 2).

The primary driver for the variation in OPEB liabilities is the difference in how states structure health care benefits for retirees. As a percentage of personal income, the liabilities range from less than 1 percent in 16 states to 16 percent in New Jersey.  Alaska, which has the highest ratio of liabilities to personal income at 42 percent, is a clear outlier among the 50 states because of generous benefit levels that can reach up to 90 percent of premiums for some retired workers. States that provide eligible retirees a monthly contribution equal to a flat percentage of the health insurance coverage premium report the largest liabilities—and could face the greatest fiscal challenges because their costs automatically increase as plan premiums do.

Conversely, those states with fixed-dollar premium subsidies provide a smaller benefit and report lower liabilities. Their exposure to health care cost inflation is also lower, because a fixed-dollar subsidy does not rise with the plan premium.  Lastly, the states that only provide access to a retiree health plan, with no subsidy, have the lowest liabilities as a percentage of personal income.  Although these plans do not make an explicit monthly premium contribution to retirees, many offer retirees a reduced premium through a group rate, which is an implicit subsidy. The Governmental Accounting Standards Board (GASB), the private, independent organization that sets accounting and financial reporting standards for U.S. state and local governments, requires plans to recognize these implicit subsidies in plan financial reporting.

Meanwhile, the cost increases of healthcare premiums seem to massively exceed inflation and/or wage growth year after year.

In contrast, a number of states with higher premium contributions—including California and New Jersey—reported significantly greater liabilities beginning in 2014, reflecting increases in assumed future costs.   California’s plan actuary attributed $7.1 billion of the state’s $7.9 billion liability increase to changing demographic assumptions to account for longer retiree life expectancy in that year.New Jersey’s 2014 hike included a 5 percent increase in liabilities caused by changes in its mortality assumptions and a 9 percent jump linked to changes in health care cost assumptions. For states with the largest year-over-year change in OPEB liabilities, changes in assumptions were the largest driver in increasing costs.

But we"re sure it"s OK, it"s not as if there is a massive wave of baby boomers that are about to retire and ask for these benefits to be paid anytime in the near future...

The Disturbing Trend That Will End In A Full-Fledged Pension Crisis

Authored by Shannara Johnson via HardAssetsAlliance.com,

Some experts think it will be the trigger for the next financial collapse. Others call it a “national crisis” of unprecedented proportions.

But what all of them agree on is that there’s no way US pension funds can keep their promises to the next wave of retirees.

Right now, millions of Americans are hard at work believing their pensions will be their saving grace for retirement. But the predicament pension funds across the United States find themselves in does not just spell trouble for the distant future.

The crisis is happening as we speak.

Though the challenges are well known by now, many believe that public-sector pension funds will be maintained and the gaps filled by strong investment returns, increasing employee contributions, raising taxes, or some combination of the three. They hope with these measures and ongoing strong asset returns, liabilities can be reduced and pensions salvaged. Unfortunately, this is wishful thinking at best.

Even though the facts are on the table, state and local governments continue to underestimate the crisis at hand. According to Hidden Debt, Hidden Deficits, a 2017 data-rich study of US pension systems by Hoover Institution Senior Fellow Joshua Rauh, almost every state or local government has an unbalanced budget - due to runaway pension fund costs that are continually chipping away at already inadequate budgets.

In 2016, Rauh stated, “while state and local governments across the US largely claimed they ran balanced budgets, in fact they ran deficits through their pension systems of $167 billion.” That amounts to 18.2% of state and local governments’ total tax revenue.

According to the 2017 report, total unfunded pension liabilities have reached $3.85 trillion. That’s $434 billion more than last year. Amazingly, of that $3.85 trillion, only $1.38 trillion was recognized by state and local governments.

The difference between funded levels under Governmental Accounting Standards Board (GASB) metrics and more realistic expectations reveals a massive amount of “hidden debt,” commonly referred to as unfunded liabilities. Under GASB metrics, public pension systems assume they will see annual returns of 7.5%. This assumption ignores the increased risks associated with stocks, hedge funds, real estate, and private equity to realize these returns.

Using that 7.5% annual return, unfunded liabilities for city and state plans are $1.38 trillion. However, when we use a more conservative return of 2.8% based on the Treasury yield curve, unfunded liabilities balloon to $3.85 trillion. Realistically, the truth probably lies somewhere between these two numbers, which still results in a huge increase in unfunded liabilities.

An Alternative Approach

Massive financial market losses in 2000–2001 and 2008–2009 led many pension funds to invest in high-fee and higher-risk alternatives such as hedge funds and private equity. But this strategy only exacerbated the funding gap over the past decade, failing to deliver expected returns.  

The California Public Employees’ Retirement System (CalPERS) is one of the largest public pension funds with over $300 billion in assets and nearly 2 million members. After years of poor performance—including a meager 0.6% net return in the most recent fiscal year—the fund is now embracing a lower-cost, diversified investment approach, including exposure to gold.

Failing to meet its 7.5% return objective for several years, CalPERS recently has adopted a “Funding Risk Mitigation” strategy to meet the challenges of a maturing workforce, negative cash flow, longer life expectancies, and underperforming investments.

The facts clearly show that the states’ pension systems are on a losing track and retiree benefits are at risk of being slashed.

South Carolina: Canary in the Coal Mine

The looming pension fund crisis could leave already cash-strapped Americans without a safety net for retirement.

Take South Carolina, whose government pension plan covers around 550,000 individuals. One out of nine residents are invested in the plan… which is $24.1 billion in debt.

According to the Post and Courier of Charleston, government workers and their employers have seen five hikes in their pension plan contributions since 2012, and there’s no end in sight. And this isn’t an anomaly but the norm for many states throughout the country.

The worst-funded US state is currently New Jersey, closely followed by Kentucky and Illinois. By the end of 2016, New Jersey had a $135.7 billion deficit in its pension funds—$22.6 billion more than the year before—while Illinois’ gap grew by $7.6 billion.

This disturbing trend is all too real, with nearly one million US workers and retirees covered by pension plans on the verge of collapse. As GDP growth remains minimal, the situation is less than ideal for those who are depending on these pensions for their golden years. And with the uncertain future of Social Security and Medicare hanging in the balance, it’s a scary thought that for many Americans, even this promised safety net isn’t guaranteed.

Corporate pensions, too, are “in the worst position to meet obligations in more than a decade,” states a recent Bloomberg article. Suffering from deficits due to an overallocation to long-term bonds with diminishing yields, corporate pensions are struggling to meet their ever-increasing obligations.

Demographics Don’t Help

Shifting demographics in the US and around the world only further complicate the pension crisis. We are living longer and experiencing lower birth rates than in past decades. This dilemma increases the number of retirees while decreasing the pool of workers. The population of Americans 65 years of age and older has grown by 35% over the last 50 years.

Americans born in 2010 can anticipate to live nine years longer than those born in 1960. Today, retirees are collecting pensions for up to 20 years. If the well runs dry, Social Security, at this point, is not the answer. This leaves Millennials and Gen-Xers in a financial bind. Even those who aren’t in line to receive a pension will be affected indirectly by the falling value of retirement assets worldwide.

Crisis Insurance for the “Golden Years”

As governments and corporate employers may no longer be able to step up to their promises, it is important to take your retirement savings into your own hands. A strong portfolio should include a mix of stocks, solid funds, and physical precious metals.

For many centuries, hard assets like gold have preserved wealth and will undoubtedly continue to do so. Unlike the dollar, stocks, bonds, or pension funds, gold is an asset without counterparty risk, that means its value doesn’t depend on someone else’s ability or willingness to keep their promises.

Financial professionals often advise investors to hold 5% to 15% of their investable assets in gold bullion—depending on age, risk tolerance, and available cash flow.

With the current state of pension plans in steady decline, now is a good time to consider hard and secure assets like precious metals.

New Cali Budget Warns CalPERS Contributions "On Track To Double" In 6 Years

In his latest budget proposal, California Governor Jerry Brown, who continues to vehemently pursue various multi-billion dollar pet projects like the high-speed rail and the so-called "Delta Water Fix" despite his state teetering on the brink of insolvency, has finally admitted that CalPERS, California"s public pension system, is a total disaster.

Apparently Brown finally came to the realization that a 65% funding ratio is slightly less than ideal, especially since we"re on the precipice of a massive wave of Baby Boomer retirements, and warned that the "state’s contributions to CalPERS are on track to nearly double by fiscal year 2023?24."

As of June 30, 2016, CalPERS reported that the state plans’ unfunded liability totals $59.5 billion and is 65 percent funded, meaning that CalPERS only has 65 percent of the funding required to make pension payments to state retirees.

Without the supplemental payment, by 2023?24, the state’s contribution is estimated to reach $9.2 billion ($5.3 billion General Fund), due to anticipated payroll growth and the lower assumed investment rate of return.

But don"t worry, it"s nothing that a little extra taxpayer-funded bribe to organized labor can"t fix...how does an extra $6 billion sound?...is that sufficient to buy your votes for a few more election cycles?

The May Revision includes a one?time $6 billion supplemental payment to the California Public Employees Retirement System (CalPERS) in 2017?18. This action effectively doubles the state’s annual payment and will mitigate the impact of increasing pension contributions due to the state’s large unfunded liabilities and the CalPERS Board’s recent action to lower its assumed investment rate of return from 7.5 percent to 7 percent.

And for those who might be worried that a doubling of California"s annual pension contributions seems like a huge burden for taxpayers to absorb...fear not, because they"ve basically already doubled over the past 5 years...so Brown has experience in "managing" such catastrophes.

Moreover, once we get to 2030 the whole problem just kind of magically fixes itself.

Of course, as we noted last December (see "CalPERS Board Votes To Maintain Ponzi Scheme With Only 50bps Reduction Of Discount Rate") the above contribution forecast is nothing but a pipe dream as even CalPERS" own finance committee chair admits that the pension"s discount rate still needs to come down materially from the current level of 7%.  Per our prior post:

A few weeks ago we asked whether CalPERS would rely on sound financial judgement and math to set their rate of return expectations going forward or whether they would cave to political pressure to maintain artificially high return hurdles that they"ll never meet but help to maintain their ponzi scheme a little longer (see "CalPERS Weighs Pros/Cons Of Setting Reasonable Return Targets Vs. Maintaining Ponzi Scheme").  The decision faced by CALPERS was whether their long-term assumed rate of return on assets should be lowered from the current 7.5% down to a more reasonable 6%.  Well, we now have our answer and it seems the board erred on the side of maintaining the ponzi with a decision to reduce the fund"s discount rate by only 50 bps, to 7%, to be phased in over 3 years.

While a 50bps decrease to a 7% discount rate will still trigger roughly $1 billion in incremental annual contributions from various California government entities according to Eric Stern of the California Department of Finance, it is still a long way from the fund"s estimated returns of just 6.2% over the next decade which happens to match exactly their returns from the past decade.

Meanwhile, Richard Costigan, chairman of the CalPERS finance committee, who vowed that "this is just a start," more or less admits that the decision was politically motivated to allow "municipalities and other government agencies some breathing room before they absorb the impact."

Of course, you could never get re-elected if you told the whole truth...

After 'Modest' 250% S&P Returns, Corporate Pension Funding Levels Roughly Same As 2008

We spend a lot of time writing about public pensions because the aggregate underfunding levels, $3 - $5 trillion on the low end, are simply staggering and at some point they will be realized for the ponzi schemes that they are and the systemic risk they represent to the global financial system.  Until then we"ll just keep shouting into the abyss.

And while we don"t spend as much time on corporate pensions, for some companies their underfunded defined benefit obligations will almost certainly result in their demise at some point in the future.  As a recent study from Pensions & Investments points out, the top 100 corporate pensions were underfunded by over $250 billion at the end of 2016.  Moreover, despite a 250% S&P rally from the 2009 lows, corporate pensions have only managed to improve their funded status from 79.1% in 2008 to 84.5% today. 

The aggregate funding deficit for P&I"s universe rose to $258 billion as of Dec. 31, up 5.3% from a deficit of $245 billion the previous year.

The average funding ratio of the 100 largest U.S. corporate defined benefit plans continued to slide in 2016, dropping to 84.5% from 85.1% at the end of 2015 and 85.7% at the end of 2014, Pensions & Investments" annual analysis of corporate SEC filings shows.

“The big story on DB plan funding is how little it"s recovered from the big downturn in the recession,” said Alan Glickstein, Dallas-based senior retirement consultant at Willis Towers Watson PLC.

The average funding ratio for P&I"s universe was 108.6% at the end of 2007, which plunged to 79.1% at the end of 2008 at the peak of the financial crisis.

Meanwhile, the bottom 10 corporate pension funds alone, as ranked by funded percentage, were underfunded by nearly $70 billion. 

And while a $250 billion funding shortfall is significant, at least investors can take some solace in the fact that corporate pensions, unlike their public counterparts, are using somewhat reasonable discount rates to calculate the present value of their future funding obligations.  According to P&I, the average corporate pension used a discount rate of 4.39% in 2016...

The average discount rate used to calculate plan liabilities began to decline in 2008, dropping to 4.05% in 2012 from 6.45% in 2008. The average discount rate used by the plans in P&I"s universe was 4.39% in both 2015 and 2016.

...compared to 7.5% for several public pensions like CalPERS in California.

But, it"s no big deal...if public pensions lower their discount rates to force them inline with private corporate assumptions it would only increase net underfundings by $3.5 trillion...no biggie....taxpayers can definitely absorb that.

California Taxpayers Expected To Nearly Double Public Pension Contributions Over Next 5 Years

The California Policy Center (CPC) has just updated it"s annual study on pension contributions required from local California municipalities and, to our complete "shock", the conclusions are brutal for Cali taxpayers.  Among other things, the study found that California taxpayers will be forced to double their contributions to CalPERS over just the next 5 years alone from $5.3 billion in 2017/2018 tax year to $9.8 billion in 2022/2023.

• In Fiscal Year 2017-2018, California local governments will make over $13 billion in pension contributions to CalPERS, county pension plans and single employer plans.


• Local government pension contributions to CalPERS will total $5.3 billion in Fiscal 2017-2018 and are projected to rise to $9.8 billion in Fiscal 2022-2023 – an increase of 84%.


• In Fiscal Year 2015-2016, at least 26 California cities and counties devoted over 10% of their total revenue to pension contributions. San Rafael, San Jose and Santa Barbara County shouldered the highest pension burdens – exceeding 13% of revenue.


• Major local governments that have recently surpassed the 10% pension contribution to total revenue threshold include Contra Costa County, Berkeley and Newport Beach.

Meanwhile, 20 California cities were found to already spend more than 10% of their annual revenue on pension contributions, with San Rafael at closer to 20%.  And, given that it"s highly unlikely these towns are willing to cut 10% of their budgets over the next 5 years, we can only assume that taxpayers are about to get slammed with massive tax hikes.

Unfortunately, as our readers are undoubtedly aware, the reality is even far more bleak than the numbers above would suggest because they use CalPERS" 7% discount rate to calculate underfunded levels.  But, as we pointed out back in December (see "CalPERS Board Votes To Maintain Ponzi Scheme With Only 50bps Reduction Of Discount Rate"), even CalPERS" finance committee chair admitted that 7% is too high and the decision to not move it lower was politically motivated to allow "municipalities and other government agencies some breathing room before they absorb the impact."

In its August 2016 actuarial reports, CalPERS included projections of future contribution rates through Fiscal Year 2022-2023. We used these documents to determine total contribution amounts and then recalculated the totals to reflect the impact of CalPERS’ recent decision to change the rate at which it discounts future liabilities from 7.5% to 7%. Although CalPERS did not update its projections, it provided employers with a circular containing guidance on how to adjust

the August 2016 amounts. We used this guidance in our own calculations.

So what"s to blame for these skyrocketing pension costs?  Well, as CPC points out, in Newport Beach at least part of the problem is attributed to a gaggle of lifegaurd "captains" raking in over $100,000 per year which serves as the basis for calculating their massive pensions.

The city of Newport Beach contributes to CalPERS. Its net pension liability in 2016 was $264 million, and its plans were only about 68% funded. Pension contributions grew from $20 million in 2014-2015 to $31 million in 2015-2016, and are projected to reach $52 million in 2022-2023. One reason for the increase is that the city is accelerating its repayment of the unfunded liability. The new funding schedule is expected to save the city $129 million over 30 years.

One unusual contributor to Newport Beach’s pension burden is its team of lifeguards. While many of the city’s beach lifeguards receive relatively modest compensation, the city employed 10 Lifeguard Captains and Battalion Chiefs in 2015, all of whom received more than $100,000 in wages. Lifeguards hired before 2011 were eligible for the 3%-at-50 pension formula. That year, the city council voted to lower the benefit for newly hired lifeguards to 2%-at-50, but due to the California Rule, already employed lifeguards were unaffected. Lifeguards hired after the implementation of PEPRA are on the 2.7% at 57 pension formula.

In February, the Daily Pilot reported that the city was shelving several projects due to increasing pension costs. The projects in jeopardy include a new library and fire station in Corona del Mar, a new restaurant for the Newport Pier and new junior lifeguard headquarters.

In conclusion, CPC offered this sobering reality check to California taxpayers:

Despite the strong economy and a buoyant stock market, pension cost burdens faced by California local governments have continued to grow – with many now devoting more than 10% of revenue to retirement contributions. With the Great Recession now eight years behind us, the risk of a new downturn is increasing. The result would be a further spike in pension burdens on local governments. Unless the state enables more aggressive pension reforms than those allowed under the 2013 PEPRA legislation, several California cities and counties will find themselves forced to slash other spending. The less fortunate will simply be unable to pay the bills they receive from CalPERS or their local retirement system.

Calexit - Beat The Crowd

Submitted by Dennis Miller via MillerOnTheMoney.com,

Our country has become bitterly divided. No matter who won the election, I predicted we would soon be reading about states wanting to secede from the union.

Even before President Trump was sworn in, the California movement, known as Calexit, began. The first step is to ask voters to adopt a state Constitutional Amendment revoking the U. S. Constitution as the supreme law.

YesCalifornia.org makes this appeal:

“As the sixth largest economy in the world, California is more economically powerful than France and has a population larger than Poland. Point by point, California compares and competes with countries, not just the 49 other states.

Since 1987, California has been subsidizing the other states at a loss of tens and sometimes hundreds of billions of dollars in a single fiscal year.

…In our view, the United States of America represents so many things that conflict with Californian values, and our continued statehood means California will continue subsidizing the other states to our own detriment, and to the detriment of our children.”

They outline reasons why citizens should vote for secession. Point 9 is a bit different, “California has some of the best universities but in various ways, our schools are among the worst in the country.”

I’m unable to determine if the claim “hundreds of billions of dollars” is accurate. How is it calculated? Is a post office or military base returning money back to the state? Creditloan.com indicates California receives $.78 back for every $1.00 is sends to the federal government. Maybe they have a point.

Different values causes divorce

Our founding fathers felt the values of the King of England conflicted with the values of the colonies. Many Americans cheered the British on when they opted out of the European Union. For both situations, oppressive taxation, different values and cost and control of the central government was a motivating factor.

Be careful what you wish for

Things are not all sunny in the land of milk and honey. Currently the California Public Employees’ Retirement System (CalPERS) is woefully underfunded. The Mercury News editorial, “CalPERS again falls short of addressing deficit” reports the fund has lowered the projected earnings estimates from 7.5% down to 7% in 2019. They add one inconvenient truth:

“To understand how far short this move falls, consider that CalPERS announced Wednesday that it hadn’t hit a 7 percent average over the last 20 years and, going forward, it estimates that there’s only roughly a 1-in-4 chance that it will meet that target.

… CalPERS consultant warns that the pension system should anticipate only an average 6.2 percent in each of the next 10 years.

… That places the system’s shortfall at about $170 billion, which averages more than $13,000 of debt for each California household.”

The optimistic vision of the secessionist movement overlook a major factor. The California political class is predominantly socialists, redistributing wealth through progressive taxation and free programs to voters to maintain their power. If secession brings an economic windfall it would quickly be spent. As Margaret Thatcher warned, “The problem with socialism is you run out of other people’s money.”

Beat the Crowd

George Bernard Shaw said, “A government that robs Peter to pay Paul can always depend on the support of Paul.” In many cases Peter quietly moved away and took his money with him.

Remember when top professional golfer, Phil Michelson created quite a stir complaining about California taxes, while putting his home up for sale? He would have been better off staying quiet about his reasons. California Political Review reports:

“Tiger Woods moved from Orange County, California to Orange County, Florida. In the first year of that move, he saved $13 million in taxes. Is it worth $13 million a year taken by government to live in California? Woods said no. Now it looks like Phil Michelson is about to make the same decision. He earns $60 million a year-he would save north of $5 million a year to move to a free State, like Florida or Texas.”

The New York Post reports:

“Billionaire David Tepper has moved from New Jersey to Florida, and the loss of his income tax could leave a $140 million hole. … Forty percent of the state’s revenue comes from personal-income tax – a third of which is collected from less than 1 percent of taxpayers. Tepper was New Jersey’s wealthiest resident.”

It’s not just the heavy hitters

When we moved to Phoenix we joined a local club in order to meet people. Each month new members stand up and introduce themselves. We noticed a large number of Californians. While my survey is unscientific, I’ve asked many why they moved. Every one mentioned how expensive California is to live. One former Californian remarked, “There are a lot of California refugees in Arizona and Nevada.”

We lived in Georgia when they passed a state income tax. While it’s progressive, the top rate (6%) kicks in at $7,000. At the time I was in my peak earning years and could live anywhere.

I was an early immigrant. The first time I paid GA income tax, I realized our other taxes did not go down. What did I get back from the government for confiscating an additional 6% of my earnings? We quickly moved to Florida, with no state income taxes. Florida is full of refugees fleeing other high tax states.

The migration continues. In 2013 the Tax Foundation published a State Migration Calculator and great graphic:

The high tax socialist states are losing billions in adjusted gross income, while states like Texas and Florida are growing. The Washington Examiner reports the trend is continuing and concludes, “The growth in no-income-tax and right-to-work states was fueled largely by net domestic migration rather than international migration (Emphasis mine), according to the 2016 Census estimates.”

The landscape is changing

The election of President Trump sent shock waves through much of the political class. Many public union pensions are woefully underfunded. They donated millions to Hillary Clinton’s election campaign and expected federal bailouts. They knew they could count on Mrs. Clinton; she has a great track record of rewarding her political donors. Today no one knows what the new administration will do.

In the meantime, the scramble is on. The politicians in states that have been heavily supporting Paul have a huge base, not because they have won over the hearts and minds of Peter; but rather because the working class got tired of being fleeced and left. The politicos have to find ways to make good on all their free programs. Cutting benefits will cause citizens to storm the palace. They must find ways to generate more revenue.

Brian Daniels warns us, The Growing Specter of State “Exit Taxes” as Residents Abandon High-Tax States:

“To be clear, it is not legal for states to charge a true exit tax on citizens changing their residency from one state to another (this is not the case for the federal government, which does charge a large exit tax).

So what do high-tax states do to try and prevent their residents from moving their legal residence to low- or no-tax states? In a word, they audit them.”

When a taxpayer is audited, the agency issues an assessment for unpaid taxes. It’s not “innocent until proven guilty.” You must prove they are wrong or the assessment stands.

Once you intend to leave you are of no value to the politicos. Most people do not have the means to go to court. For some, it becomes a government shakedown to extract as much wealth as they can on your way out the door.

What about Calexit?

With the mindset of California voters, who knows what will happen?

I don’t recommend holding any California government debt, including holdings in bond funds. While the probability of secession may be small, might they establish their own currency and try to renegotiate their debt? Holding California debt is an unnecessary risk to take with retirement money.

Should they vote to secede, Californians would face a choice of leaving or staying. If you choose to leave, expect a hefty exit tax. If you are thinking about leaving, why wait? Walk quietly and beat the rush!

Pension managers are next

Pension Funds represent the retirement accounts for basically 99% of the working class.  Because they don"t have many choices, unlike Ultra High Net Worth Individuals.  Global Pension Assets stand at a staggering $35 Trillion according to Willis Towers Watson:

• At the end of 2015, total pension assets were estimated at USD 35.4 trillion, which represents a decrease of 0.5% compared to USD 35.6 trillion at the end of 2014


• Pension assets relative to GDP reached 80% in 2015, which represents a decrease of 4% from the 2014 ratio of 84%


• The largest pension markets are the US, UK and Japan with 62%, 9% and 8% of total pension assets in the study, respectively

USD 35.4 Trillion is a lot of assets, no matter how you look at it.  In any systemic analysis we often forget about such huge pools of capital.  Mostly, these assets are sitting in stocks and bonds, some real estate - all traditional.  They don"t invest in alternatives (because of regulatory rules, mostly).  

Well, recently Harvard Management Company, the unit that manages Harvard"s USD 35 Billion endowment, fired half of its staff:

In what may be the most stunning move in the asset management space in years, the WSJ reports that Harvard University’s endowment, which manages just shy of $36 billion, will undergo a "radical overhaul" in the way the world’s wealthiest school invests its money by outsourcing management of most of its assets and lay off roughly half the staff in the process.

According to the WSJ, about half of the 230 employees at Harvard Management Company will leave as part of a sweeping change by the university’s new endowment chief, N.P. “Narv” Narvekar. This means that the endowment will shut down its internal hedge funds and let go traders by the middle of the year. Additionally, the internal team in charge of direct real-estate investments is expected to spin out into an independent entity that Harvard is expected to invest with. Only management of Harvard’s natural resources portfolio and passively managed exchange-traded funds will remain in house.

Is this a sign of things to come?  Well, yeah - Pension Funds like Calpers for example have struggled in recent years... REALLY STRUGGLED.  "Struggled" is an understatement - they lost $30 Billion in 2015.

Many fund managers and traders often scratch their heads at how something can be possible, when there is an apparent sea of consistent strategies offering moderate, if not conservative, returns (like 20% per year.)

But such funds like Harvard and Calpers are rife with politics, and staffed with people that generally don"t understand markets.  Of course there are exceptions - but having a $30 Billion loss without any hedging in place - well, that"s really unprofessional, to say the least.

Of course, once again, who suffers?  It"s not going to be the Pension managers, or the hedge funds they "outsourced" to manage the funds - it"s the beneficiaries - working people.  Retirement plans, pension plans - can blow up.  Or in the best case, as is the case now, they can dwindle down so poorly to the point that retirees get only a fraction of what they are expecting.

There"s really no solution to this problem, except for working people to stand up to their pension managers - which they do from time to time, but the Pension Funds are staffed with a political Chinese Wall of staffers with "quick answers" to shut down their inquiries.  

With the renovations Trump is doing to the system of American Government - is the public pension system next?  Harvard"s move may be a sign of things to come.  And it needs reform, losing $30 Billion like Calpers is at best, shameful.  At worst, illegal.

For a great book to learn about how the markets REALLY work, checkout Splitting Pennies, or see some more great books on the markets here.

To learn how to trade and invest checkout Fortress Capital Trading Academy

In Massive Blow To California Unions, A Second Court Rules That Pension Benefits Can Be Reduced

Back in September, we noted that, in a surprisingly logical decision particularly for a state like California which is typically devoid of all reason, a court upheld the rights of Marin County (and it"s taxpayers) to reduce final year salary levels utilized to calculate pension payments.  The ruling was meant to protect taxpayers against "salary spiking," a practice whereby union employees artificially drive up their final year salary, by taking cash vacation payouts or 1x bonus payments for example, in an effort to game the annual pension payment they"ll then receive in perpetuity. 

Now, according to Pension & Investments, a second California court in San Francisco has made a similar ruling, finding that while a public employee does have a "vested right" to a pension it is only to a "reasonable pension."

A second California appeals court panel has said that vested pension rights can be reduced or eliminated in California as long as employees still receive a pension that is “substantial” and “reasonable,” court filings show.

The Dec. 30 decision by a three-member panel in San Francisco affirmed a state pension reform law that went into effect in 2013 and eliminated the right of participants of the $302.4 billion California Public Employees" Retirement System, Sacramento, to enhance their pension by buying retirement credits. A lower court in Alameda County in 2015 had ruled that the pension enhancement benefits could be eliminated.

The enhanced benefit, known as an airtime service credit, allowed CalPERS participants to increase their retirement benefit by up to five years by making additional contributions from their salary.

Meanwhile, the San Francisco court cited the Marin Country decision from August which found that employees have a right to a pension but "not an immutable entitlement to the most optimal formula of calculating the pension."  The August decision in Marin County was pivotal because, for the first time, it brought into question a 5-decade California rule which held that pension benefits could not be cut.

The panel cited another state appeals court"s decision in August, which said the $2.1 billion Marin County Employees" Retirement Association, San Rafael, did not have to count pay given to employees for being on an on-call status toward retirement benefits.

That decision also cited the 2013 pension reform law, which applies not only to CalPERS but to most other public pension systems in California.

The law put in place anti-spiking provisions that prevent pension benefit increases from unused vacation and leave, bonuses, terminal pay, among other things.

These “anti-spiking” provisions apply to current workers.

“While a public employee does have a "vested right" to a pension, that right is only to a "reasonable" pension — not an immutable entitlement to the most optimal formula of calculating the pension,” the appeals panel wrote in August.

That decision put into question the so-called California rule, which held for five decades that pension benefits could not be cut.

The California Supreme Court has agreed to hear an appeal on the Marin County case, although no schedule has yet been set for oral arguments.

* * *

For those who missed it, below is our note on a previous California court"s decision regarding a Marin County public pension.

Many public employees utilize a tool, known as "salary spiking," to boost their annual pensions payment in retirement and we taxpayers get to foot the bill.  So what is "salary spiking?"  Typically, a public employee"s pension benefit in retirement is equal to some percentage of their highest annual pay which is often their final year on the job.  Fortunately for public employees who plan ahead, there are all sorts of fun games that can be played to "spike" your final year salary so that you actually earn more in retirement than you did on the job.  In fact, a recent report by the Los Angeles Times found that there are 60 ways to "spike" your final year salary in California including taking cash payouts for accrued vacation time, special 1x bonuses related to graduate degrees (though we"re sure you really needed that extra degree as you head off into retirement), "longevity" bonuses, etc. 

One example of salary spiking comes from former Ventura County CEO, Marty Robinson, who offered up a textbook example of how to stick it to taxpayers by planning ahead.  Robinson"s official salary heading into her final year on the job was $228,000.  That said, Robinson "spiked" her final year salary by cashing out $34,000 in unused vacation pay, taking an $11,000 bonus for a graduate degree and collecting more than $24,000 in extra pension benefits the county owed her.  Adding all the 1x payments, Robinson earned nearly $300,000 in her final year which entitled her to an annual pension payment of $272,000 or the rest of her life...nearly 20% higher than the salary she received for actually working. 

But, as the Los Angeles Times pointed out, Robinson is not alone:

Former Sheriff Bob Brooks, for instance, added a $30,500 "longevity" bonus (for working more than 30 years), which boosted his pension to $272,000 a year, almost 20% higher than his base salary.

Former Undersheriff Craig Husband added nearly $92,600 in unused vacation time, resulting in a $257,997-a-year pension, nearly 30% above his working pay.

Fire Capt. T.N. Roberts, for instance, padded his final year"s pay by nearly $130,000, resulting in a pension 84% higher than his base compensation. He gets $159,598 a year in retirement pay.

In fact, the problem is pervasive.  In Ventura County, 84% of the retirees receiving more than $100,000 a year are receiving more than they did on the job. In Kern County, 77% of retirees with pensions greater than $100,000 a year are getting more now than they did before.

Well, turns out that the party might be over for the "salary spikers" in California.  In a surprisingly logical decision, particularly for a state like California which is typically devoid of all reason, a court upheld the rights of Marin County (and it"s taxpayers) to reduce final year salary levels utilized to calculate pension payments.  According to Bloomberg, the court found that while a public employee does have a "vested right" to a pension it is only to a "reasonable pension."   

“While a public employee does have a ’vested right’ to a pension, that right is only to a ’reasonable’ pension-- not an immutable entitlement to the most optimal formula of calculating the pension.”

Of course the Marin Association of Public Employees intends to take their fight to the Supreme Court in an effort to defend their right to manipulate pension benefits and defraud taxpayers of billions.

As we"ve noted multiple times, public pension funds around the country are currently underfunded by about $2 trillion.  The under-funding has ballooned materially since the "great recession" as asset returns have suffered while pension liabilities have grown due to lower discount rates.

Meanwhile, taxpayers have been forced to cover the difference through higher contributions while employee contributions have remained fairly flat. 

We eagerly await the next court"s decision on this topic and wish the best to California taxpayers.

Slow death of the hedge fund era

2016 was a bad year for hedge funds, pension funds, and university endowments.  In fact, the last several years have been horrible.  But until now, there haven’t been many alternatives.  Hedge Funds became popular for investors who wanted to achieve more than the 4% or 6% offered by traditional managed investments like mutual funds.  Although their history evolved from the idea of ‘hedging’ the market (hedge funds could sell AND buy, can you imagine?) this quickly evolved into an asset class where managers employed strategies based on mathematics in order to achieve above than average and above than expected returns.  And some private funds such as Renaissance do very well year in and year out – continued to this day.  But the majority suffer from strategy fatigue, and failure to bring in a new generation of ‘quants’ that can do anything more than copy, paste, and cold call.  If we skip all the Soros bashing about how he manipulates politics (which, on the surface, is not a bad investing strategy if you have the money to do it, and to control both sides – this is a Rothschild invention not a Soros invention) – the Soros family of funds outperformed their peers by a significant multiple.  These funds were trading the markets, unlike what some may want us to believe.  Some of their policies to ‘influence’ foreign markets (historically, from the 80s) may have been seen as unethical – and it may be.  But the returns have always been spectacular.  We’ll see soon if Robert can continue the family legacy of great returns – it looks like – yes he can!  

But the few examples of extraordinary funds with consistent returns like Renaissance, they’re an anomaly.  The industry in general has suffered from poor returns, which when combined with the standard 2/20 fee model – can be disastrous for investors’ confidence.  Bloomberg ran a story recently with verbage such as "The year Big Money ditched Hedge Funds:

“There has been a massive blowback from public pension funds and private endowments,’’ said Craig Effron, who co-founded his Scoggin Capital Management nearly 30 years ago. An investor told him recently that many chief investment officers are so fed up that they would prefer to entrust their cash to a trader who charged no management fee, over one who did, even if they expected the latter to make them more money.

Public retirement plans from Kentucky to New York, New Jersey and Rhode Island have decided to pull money from hedge funds. So did a state university in Maryland and other endowments. MetLife Inc. and other insurers followed suit. Money-losing firms were forced to reduce their fees. Client withdrawals ($53 billion in the last four quarters) drove some managers out of business, including veteran Richard Perry, who until recently had managed one of the longest-standing and better-performing firms.

It"s not surprising that investors - especially institutional investors, are abandoning such strategies.  As they say in trading, "you"re only as good as your last trade."  According to Barclay Hedge Fund Data, 2016 is a little better than 2015, but not much:

4.89% is a good return, but it"s not much better than you can acheive with traditional mutual funds or tax free munis.  Certainly it"s not a compelling reason to drain your IRA from the markets and invest with hedge funds.  But, this is just an average, there are strategies out there that overperform this index, such as this one.

In the Pension Fund world, Calpers which is a head above its peers, hemorrhaged more than $30 Billion in losses due to poor strategy management:

The California Public Employee Retirement System (CalPERS) is about to report the world’s largest public employee pension suffered an actuarial investment loss of $30.8 billion last year.

CalPERS manages the defined pension plan investments and record keeping for 3,007 California state and local government entities. The pension plan is also responsible for paying the pension benefits to 611,078 retirees and will eventually be responsible for paying retirement benefits to another 868,713 active and 335,908 inactive government workers.

Despite Governor Jerry Brown last summer demanding CalPERS immediately “lower its investment risk and volatility of returns” by reducing its “assumed” annual investment return from 7.5 percent to 6.5 percent, the CalPERS board voted 7- 3 on November 15, 2015 only to slowly reduce the investment return expectation over the next decade.

Practically, the slow death of the hedge fund industry is merely a milestone in its evolution.  Just like robotic strategies are now replacing traditional managers with a suit and tie, the structure of investments is evolving, too.  Hedge Funds aren"t going to go away anytime soon, but how they are structured, how the fees are charged, and the strategies that they use, will rapidly change in 2017.  For example, some strategies such as managed accounts have a fee structure that charges only a percentage of profit, called "performance fee" - with no other fees.  See one example the Magic FX strategy, for QEP/ECP US investors only - which charges a 30% performance fee from the profit.  In this model, if the strategy doesn"t perform for investors, there is no fee.  This type of pay for performance model has been around for years, but will become more useful in a climate of diminishing returns and investors angry at paying fees for getting no results or even losing money.  It really is crazy, why investors should pay managers millions of dollars for losing money - it just shows how programmed investors are by traditional media, as we explain in Splitting Pennies the book.

Bloomberg also notes that, while assets have only trickled out - this may be a sign of a larger trend:

While clients have only pulled a net 2 percent of assets so far, Tony James, the president at Blackstone Group, the largest investor in hedge funds, predicted in May that the industry would shrink by roughly a quarter over the next year. Hedge fund closures (782 in the first nine months) are on track to be the most since 2008, and startups (576) the fewest.

Any manager still standing applauds a smaller industry. Less money under management means fewer crowded trades and more chances to find the elusive alpha. Interest rates on the rise in the U.S., while still near zero or negative in the rest of the world, should also help. The Trump presidency, which promises less regulation, more infrastructure spending and the potential return of prop trading by banks, could also be a boon.

Where will the assets go?  The alternative investment industry is large - institutional funds, pension funds, hedge funds, are but a small part.  According to Barclay Hedge, there are 342 Billion in Managed Futures:

And, although the change from Q2 to Q3 of 2016 is a small percentage of @ $9 Billion, it is a positive figure, and shows that managed futures is one place funds are flowing into.  CTAs, CPOs, and other types of managed investments that have a track record should all benefit from the poor performance of traditional managers, especially those which don"t charge a management fee.  But in any scenario, investors only started to loathe the management fees when performance suffered.  When performance is good - who doesn"t mind paying for it?

And finally - it may shed light on the still standing FX manager industry.  While these hedge funds have suffered volatile returns, losses, and fee congestion - some FX managers have continued to perform year in and year out with the use of complex algorithms, that work in FX but not in other markets.  Now may be the time for institutional investors to take another look at such algorithmic FX strategies.

To get an education about the benefits of FX investing, checkout Fortress Capital Trading Academy.

Here"s a list of books to add to your bookshelf to get started:

read some of these books and articles:

Wall Street and the Bolshevik Revolution.  

Armand Hammer: The Untold Story

A People"s History of the United States

Clinton Cash: The Untold Story of How and Why Foreign Governments and Businesses Helped Make Bill and Hillary Rich

Former Fed Advisor: State Pensions Time Bomb Spells Disaster For The US

Underfunded government pensions to the tune of $1.3 trillion, with a gap that just can’t be filled, is the ticking time bomb facing the US economy which faces dramatic cuts in public services - and potentially riots reminiscent of Athens six years ago - according to former Federal Reserve advisor, and President of Money Strong, Danielle DiMartino Booth.

As she picks apart the danger signs with the US on the precipice of recession, it’s the impending pensions crisis that keeps her awake at night, sharing the gloomy sentiment laid out in an extensive March 2016 Citi report titled "The coming pensions crisis."

With few people taking part in what little recovery the US has had, and given how stretched pensions are, checks are going to have to be written from Washington sooner than you think, DiMartino Booth told Real Vision TV in an interview. “The Baby Boomers are no longer an actuarial theory,” she said. “They"re a reality. The checks are being written.”

A Bulldozer Couldn’t Fill the State Pensions Gap

The $1.3 trillion pensions deficit just takes into account state and municipal obligations, and with promised returns of 8% and funds compounding at 3% for decades it will take nothing short of an economic miracle to recover.  “The average state pension in the last fiscal year returned something south of 1%. You cannot fill that gap with a bulldozer, impossible,” DiMartino Booth said. “Anyone who knows their compounding tables knows you don"t make that up. You don"t get that back unless you get some miracle.”

The last time we saw significant market weakness, the baby boomers pretty much accepted that they would be retiring at 70 instead of 65, she added. “Well, guess what? They"re turning 71. And the physiological decision to stay in the workforce won"t work for much longer. And that means that these pensions are going to come under tremendous amounts of pressure.

“And the idea that we can escape what"s to come, given demographically what we"re staring at is naive at best. And it"s reckless at worst,” DiMartino Booth said. “And when you throw private equity and all of the dry powder that they have -- that they"re sitting on -- still waiting to deploy on pensions’ behalf, at really egregious valuations, yeah, it"s hard to sleep at night.”

Pension Fund Underfunding is Ground Zero

The interview with Real Vision was held in Dallas, which DiMartino Booth said is Ground Zero for the pensions crisis, where returns for the $2.27 billion Police and Fire Pension System have suffered due to risky investments in real estate made over a decade ago. Huge withdrawals are now taking place, amid concerns over the future viability of the pension scheme, which commentators say could be flat broke in a little over ten years.

“We"re seeing this surge of people trying to retire early and take the money. Because they see it"s not going to be there. And if that dynamic and that belief spreads-- forget all the other problems,” DiMartino Booth said. “The pension fund -- underfunding is Ground Zero.”

The gravity of the situation with the lack of returns is magnified by the fact that the underperformance has been going on for between ten and 15 years. Calpers, the California Public Employees’ Retirement System is a case in point, amid reports that it returned just 0.6% last year compared with its long term target of 7.5%. With the legal language tightly written on pensions like this across the country, such that states and municipalities won’t be able to break free of their obligations, DiMartino Booth thinks the endgame will evoke memories of the Winter of Discontent in London in 1979 and more recently the riots in Athens as key public services are cut.

Angry Country, Angry World – The Wealth Effect is Dead

“This is where the smile comes off my face. We are an angry country. We"re an angry world. The wealth effect is dead. The inequality divide is unlike anything we"ve seen since the years that preceded the Great Depression,” she told Real Vision TV. “Where"s the money going to come from? And the answer is, for now, they cut services. I"ve just written about the Winter of Discontent and the rubbish piled up in central London streets in 1979, as Thatcher was coming in. I worry about the ambulance not getting there in time. I worry about firefighters being cut to the bone and policemen.”

The seriousness of the issue might not have hit home yet in Denver, where the state budget for tulips had to be cut recently to top up the pension fund, she said, but what happens when you are not talking about flowers anymore and when you are talking about a very populous state like Illinois?

“If the actuaries are going to force the checks to be written and reduce the rate of returned assumptions to anything remotely related to reality, then we won"t be laughing anymore looking in the rear view mirror at the riots in the streets of Athens a few years back,” DiMartino Booth warned.

Visit Real Vision TV to watch this exclusive full interview, free to all. Real Vision TV is a video-on-demand channel for finance, offering over 500 videos from 200 of the world’s sharpest investment minds. Think of it as what CNBC could have been if it actually focused on quality of content.