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The Nation's Largest Pension Plan Approves Leverage to Meet Its Targets

Let's discuss leverage and where we are in the investment cycle.
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Leverage Now Hey Why Not

Despite huge stock market gains over the last decade, U.S. pensions are hundreds of billions of dollars short of what they expect to need to pay public worker retirement benefits.

As a result of underperformance Retirement Fund Giant Calpers Votes to Use Leverage, More Alternative Assets.

The board of the nation’s largest pension fund voted Monday to use borrowed money and alternative assets to meet its investment-return target, even after lowering that target just a few months ago.

The move by the $495 billion California Public Employees’ Retirement System reflects the dimming prospects for safe publicly traded investments by households and institutions alike and sets a tone for increased risk-taking by pension funds around the country.

Without changes, Calpers said its current asset mix would produce 20-year returns of 6.2%, short of both the 7% target the fund started 2021 with and the 6.8% target implemented over the summer.

Board members voted 7 to 4 in favor of borrowing and investing an amount equivalent to 5% of the fund’s value, or about $25 billion, as part of an effort to hit the 6.8% target, which they voted not to change. The trustees also voted to increase riskier alternative investments, raising private-equity holdings to 13% from 8% and adding a 5% allocation to private debt.

Borrowing money to increase returns allowed Calpers to justify the 6.8% target while maintaining a more-balanced asset mix, concentrating less money in public equity and putting more in certain fixed-income investments, fund staff and consultants said.

When Bubble Meets Trouble

John Hussman's latest missive is When Bubble Meets Trouble

I expect that the coming decade – and possibly even the next 12 months – will be a disaster for the U.S. stock market. Emphatically, our own investment discipline doesn’t require forecasts or rely on projections. Rather, our investment stance will change as valuations, market internals, and other observable factors change. My real concern is for passive investors – particularly charitable organizations whose missions would be compromised by a loss of over 50% in their equity investments (and whose missions might be enhanced by avoiding even part of that), and retirees who have barely enough to enjoy their future, but with most of it dependent on the temporarily bloated prices they see printed on a page or flashing on a screen.

Measured from current extremes, I expect that the unwinding of this bubble will drag S&P 500 total returns below Treasury bill returns for least a decade, and possibly two. Yet like other bubbles, I expect that most of the damage will come off the top, resulting in market conditions that are reasonably investable within a year or two. Presently, the valuation measures we find best correlated with actual subsequent market returns are at the most extreme levels in U.S. history. Moreover, as I’ve detailed before, the low level of interest rates does nothing to improve those prospective returns. For a review, see the section titled “The mapping between observable valuations and expected returns is independent of the level of interest rates” in Alice’s Adventures in Equilibrium.

Repeat Message

The thing is John has been saying these things for years. So have I but he has gotten more grief for it. 

A few of Jeremy Grantham’s observations about speculative bubbles should not be missed. Not just because they agree with our own thinking, but because hearing the same concepts in different words, from a different speaker, can often deepen one's understanding.

How high the peak is has no bearing at all on what the fair value is. What it does change is the amount of pain that you get to go back to fair value and below. I’ve been very clear about what I consider a definition of success – and that is only that, sooner or later, you will have made money to have sidestepped the bubble phase.”

This is a point I’ve emphasized often, but it can’t be repeated enough: amplifying a bubble doesn’t somehow avoid its consequences – it makes those consequences worse. Amplifying a bubble doesn’t even create “wealth” for the economy as a whole, only temporary opportunities for wealth transfer between individuals. That’s because the wealth isn’t in the price – it’s in the future stream of cash flows. If one holder sells, the next buyer has to hold the bag, and ultimately it’s the cash flows that matter. The only thing progressively higher valuations do is to progressively lower the long-term returns that investors will subsequently enjoy if they buy (or hold) at those valuations.

One of the things that you may have noticed is that our downside targets for the markets don’t simply slide up in parallel with the market. Most analysts have an ingrained ‘15% correction’ mentality, such that no matter how high prices advance, the probable maximum downside risk is just 15% or so (and that would be considered bad). Factually speaking, however, that’s not the way it works. The inconvenient fact is that valuation ultimately matters. That has led to the rather peculiar risk projections that have appeared in this letter in recent months. Trend uniformity helps to postpone that reality, but in the end, there it is. Given current conditions, it is increasingly likely that valuations will begin to matter with a vengeance. – John P. Hussman, Ph.D., March 7, 2000

I know that many of you believe that the current episode of speculative enthusiasm will persist forever –that the Fed will make it persist. We’ve already established that market returns are likely to be flat or poor even if the market achieves what Irving Fisher disastrously projected as a “permanently high plateau” in 1929, and valuations remain forever above extremes never seen before last year. Investors should also consider what might happen if valuations merely touch their historical norms – even 20 years from today – and growth in fundamentals matches that of the past 20 years. The simple arithmetic implies that the S&P 500 would actually lose value on a total return basis.

Will Hussman's Message Be Heard or Acted On?

Scroll to Continue


The one word answer is "no". 

The two word answer is that "It, can't" which many will miss. 

Here's a longer more complete assessment that will have some puzzled: "It is mathematically impossible for Hussman's message to be heard and acted upon, in aggregate."

At an individual level, investors do have a choice. You or I or even a fund like Hussman's can indeed take action. 

But given for every buyer there is a seller, someone must hold every stock, every bond, every dollar, every ounce of gold, and every Bitcoin, 100% of the time. 

No Escape

In aggregate, there is no escape. 

The bigger the pension plan, the harder it is to escape. 

Rather than heed Hussman's warning, Calpers opted to double down with leverage. How long the strategy works is a mystery. 

When the crash comes (and it will) it will be interesting to see how Congress acts. 

Thanks for Tuning In!

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