Commentary
Bryan Jung wrote recently in these pages about a Consumers’ Research warning that investment fund BlackRock’s investments in CCP China could have a deleterious effect on investors’ portfolios.
William Hild, the executive director of Consumers’ Research, had also sent a letter to 10 of the nation’s governors warning that their public employee pension funds placed with BlackRock were at greater risk:
“...Chinese firms are not held to the same transparency standards as their western counterparts, so foreign investors are often hard-pressed to appreciate the true risk profile of what they’re investing in…You could lose your shirt when a Chinese company’s performance falls and have no legal recourse.”
The Wall Street Journal recently reported that ratings agency Fitch has advised that Evergrande and Kaisa, two major developers in CCP China, defaulted on their overseas corporate dollar bonds (OCDBs). (I warned readers in another venue about the increasing risk of OCDBs as early as January 2018, based on reporting from the South China Morning Post and a warning from Normura Securities.
So why invest in such risky ventures in China (or BlackRock)?
Simple: the governors and their pension fund managers are chasing yield. They need to get returns that are well above the market, and one of the easiest ways to do that is to take on greater risk.
States have assumed absurdly high rates of return, the compounded annual growth rate (CAGR) in their pension fund actuarial computations. That rate, as the name implies, assumes that the return will be earned, year on year, every year, without a losing year.
New York State, for example, just recently reduced its CAGR to 5.9 percent. But it had used a 6.8 percent CAGR until just this past September and 7 percent before that. (New York City’s CAGR remains at an absurdly high 7 percent.) Mike Bloomberg, the former New York City mayor, reportedly said of it in 2012, “If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff.”
Private pension plans, by contrast, are required by the Pension Benefit Guaranty Corporation (PBGC) to use a rate currently in the range of 3 percent, and an even lower rate for those pension plan participants who are closer to retirement.
That’s because ERISA, the Employee Retirement Income Security Act, that Congress passed to protect private pensions, created the PBGC to ensure plan participants would not lose their pensions entirely. Like the FDIC for bank accounts, PBGC steps in with insurance to make plan participants at least partially whole when a pension plan fails.
But state and local governments are exempted from ERISA, which gives politicians and their sometimes nefarious instinct for self-interest free rein. Why show a conservative 3 percent CAGR in an actuarial computation when it would show a state’s plan to be severely underfunded when a bit of actuarial sophistry—assuming a much higher rate—would make the pension look fully or even overfunded to an untutored eye?
After all, if the pensions are “fully funded” at, say, a 7 percent CAGR, that means politicians can skip making pension contributions and instead use the funds for more popular—and visible—goodies, like new school buildings and technology, parks, playgrounds, bike lanes, highways, and libraries. After all, in the mind of many politicians, their first job is to either get re-elected or set the groundwork for higher office.
The inherent risk of the outrageously high CAGRs used in most state pension plans should move pension participants and their representatives in unions and the legislature to demand more realistic actuarial assumptions in the determination of pension funding levels.
The Consumers’ Research warning—and common sense—should dictate disinvestment in any country where the government allows anything other than robust investment transparency in corporate structures and financial reporting.
