Hope is Not An Investment Strategy - Blaine Rollins

Guest Commentary: Hope is not an investment strategy

By Blaine Rollins
Posted: 05/11/2011 01:00:00 AM MDT

The Public Employees' Retirement Association of Colorado is responsible for 450,000 current and future retirees, so it would be tragic for PERA's investment assets to run out — not just for its members, but also for the Colorado economy. Unfortunately, our state government leaders have tethered the fortunes of PERA to "return" assumptions they predict will run like Secretariat. By the time they realize that the 1970s super horse can't be matched, it may be too late to avoid disaster.

Municipal Defined Benefit Pension accounting is extremely complex — and easily manipulated. When I recently studied municipal financial accounting, it became clear that I could draw up any end result I wanted, given small changes in the pension assumptions.



The most abused area of municipal pension accounting? The "discount rate" used for future pension obligations. This is the interest rate assumption used to "discount back" all the future guaranteed payments to retirees. Corporations typically use a conservative discount rate to ensure there's no shortfall in the funds that make up an individual's future, defined benefit payments. For example, AT&T uses a 5.8 percent discount rate, Procter & Gamble 5 percent. Municipal pension accounting is more aggressive. Currently, most states are using a 7.5 percent to 8 percent estimate. In Colorado, PERA is at 8 percent. But the probability of making 8 percent per year for the next 30 years on a $38 billion investment fund is slim.



So why do Colorado's elected officials allow such aggressive accounting to be applied to our state's largest liability? Maybe because the PERA plan has outperformed the 8 percent benchmark by 1 percent over the past 25 years. Perhaps, but over the past 25 years the U.S. economy had significant economic tailwinds that were great for stocks and venture capital investments. Also, falling inflation has benefited bonds and fixed payment investments. Those easy gains in bond prices could be a thing of the past as the dollar continues to depreciate and commodity prices move higher. America's debt will cause its economic growth to be more constrained, causing stock and private equity returns to be lower.



Colorado should use pension assumptions that more accurately estimate future liabilities. True, a change in PERA's discount rate from 8 percent on 2009 financials to 5.5 percent on 2010 financials would raise its total pension liability from $56 billion to about $77 billion. And given $37.5 billion in PERA investment assets at the end of 2010, this would put the funded ratio at 48.7 percent, much lower than the 2009 stated funded ratio of 67.2 percent. But it also marks a starting point of conservatism for everyone in Colorado to help ensure that state contributions into the fund remain high enough now that we'll have a funded retirement plan later.



As we say in the investment world, "Hope is not an investment strategy." Betting PERA member retirement plans and Colorado taxpayers' future on a 30-year, 8 percent return assumption is fiscally irresponsible. With no changes to state or member contributions or benefits, it is easy to see how the PERA assets will fall to zero in the next decade. At that point, Colorado will either need to stop all payment to PERA retirees or raise taxes significantly. Both roads could lead to a collapse in the Colorado economy.



Colorado is looking at a $40 billion underfunded pension liability. This works out to be $17,000 per taxpayer should the plan fail. Colorado needs to come clean with taxpayers and admit that this is the true amount of pension debt. State leaders are betting our public employees' future retirement, and all of our personal and business investments into Colorado, that PERA will return more than 8 percent annually for the next 30 years.



I don't want to be the one to tell Colorado teachers they will not get their retirement check because the state's accounting assumption was too aggressive. But as of today, our leaders at the Capitol are making that bet.



Blaine Rollins is a managing director of 361 Capital and former portfolio manager of the Janus Fund.



Read more: Guest Commentary: Hope is not an investment strategy - The Denver Post http://www.denverpost.com/opinion/ci_18035453#ixzz1M4U3eEIN
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