CALPERS taking on leverage: Is leverage becoming more mainstream?

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willthrill81
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CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by willthrill81 »

The Financial Times recently reported the California Public Sector Pension plan will leverage up to 20% of its assets in an effort to increase its returns (I don't have access to the full article, so perhaps someone else can provide it).

The plan is only 71% funded, and its managers estimated that it had less than a 40% likelihood of meeting its 7% return goal. Given that their only options were to increase funding, increase risk, or reduce payouts, they apparently believed that increasing risk was their best choice.

I'm not so interested in the specifics of CALPERS as I am wondering whether leveraging stocks is becoming more mainstream. It also concerns me that an extended bear market or even lackluster returns might cause serious issues for those employing leverage, similar to what we saw in the Great Depression. Limits were placed on how much stock could be bought with margin accounts, but those limits don't apply to instruments like leveraged ETFs.

Disclaimer: I have a relatively small position in leveraged ETFs myself.

Thoughts?
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Horton
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by Horton »

This is akin to wanting FIRE without the sacrifice of prodigious saving.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by retired@50 »

willthrill81 wrote: Fri Jul 03, 2020 11:03 am ...
I'm not so interested in the specifics of CALPERS as I am wondering whether leveraging stocks is becoming more mainstream.
...
Thoughts?
I hope it's not becoming mainstream, but if CALPERS is willing to do it that will probably justify it for many. I fear bail-out requests in the future for CALPERS.

Regards,
This is one person's opinion. Nothing more.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by willthrill81 »

retired@50 wrote: Fri Jul 03, 2020 3:02 pm
willthrill81 wrote: Fri Jul 03, 2020 11:03 am ...
I'm not so interested in the specifics of CALPERS as I am wondering whether leveraging stocks is becoming more mainstream.
...
Thoughts?
I hope it's not becoming mainstream, but if CALPERS is willing to do it that will probably justify it for many. I fear bail-out requests in the future for CALPERS.

Regards,
Too big to fail?
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by Explorer »

In my opinion, employing leverage does not necessarily mean levering up equity positions although it could.

Leverage makes more sense for debt investment particularly in a guaranteed zero-interest rate environment for at least 2 and half years; add to that the Fed mandate to actually buy bonds/bond ETFs essentially putting a floor under the asset prices.

Simplest example would be what CEFs do in their investment strategy.

I have no clue what CALPERS is doing but I am levering up my debt investments to squeeze more yield out of my investments.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by retired@50 »

willthrill81 wrote: Fri Jul 03, 2020 3:51 pm
retired@50 wrote: Fri Jul 03, 2020 3:02 pm
willthrill81 wrote: Fri Jul 03, 2020 11:03 am ...
I'm not so interested in the specifics of CALPERS as I am wondering whether leveraging stocks is becoming more mainstream.
...
Thoughts?
I hope it's not becoming mainstream, but if CALPERS is willing to do it that will probably justify it for many. I fear bail-out requests in the future for CALPERS.

Regards,
Too big to fail?
Too powerful for CA politicians to ignore. The politicians would probably rather increase taxes on every CA resident than "disappoint" the CALPERS members. The longer the poor level of funding goes on the harder time they're going to have in explaining why they can't seem to beat a Vanguard LifeStrategy fund even though they spend millions on professional money managers. I'd guess that if they would have used index investments from the outset that they'd be better funded.

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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by FelixTheCat »

I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by willthrill81 »

FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
That's an all too common return estimate for pensions. I'm not sure if it's inflation-adjusted, but even if it isn't, it would have historically required something like at least an 80/20 allocation, virtually no fees, and historically average returns, which few are anticipating to occur over the next decade. Cumulatively, it's plausible but has essentially zero 'slack'.
Last edited by willthrill81 on Fri Jul 03, 2020 4:13 pm, edited 1 time in total.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by 02nz »

FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
CALPERS doesn't "guarantee" a 7% return, because that's not how pensions work. The individual employee doesn't get a "return" on "investment" as you do in a 401k account. You get defined benefits based on years of service and salary. The 7% is probably an internal goal/assumption for returns on assets held by CALPERS. If the real return is lower, CALPERS will have a larger funding gap; its obligations to employees covered by CALPERS do not change at all.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by willthrill81 »

02nz wrote: Fri Jul 03, 2020 4:13 pm
FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
CALPERS doesn't "guarantee" a 7% return, because that's not how pensions work. The individual employee doesn't get a "return" on "investment" as you do in a 401k account. You get defined benefits based on years of service and salary. The 7% is probably an internal goal/assumption for returns on assets held by CALPERS. If the real return is lower, CALPERS will have a larger funding gap; its obligations to employees covered by CALPERS do not change at all.
And given that leverage amplifies the downside as well as the upside, if the leveraged instruments go in the opposite direction of what the pension's managers hope they will, that will make an already bad situation even worse.

While I'm a WA resident, I'm very glad that I do not participate in my state's pension system. The problems that so many states are having with these, coupled with moves like this one, make me very glad to have a 401k with a healthy match.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by Steve Reading »

I don’t know if leverage is more or less mainstream, but there’s nothing unique about leverage. It’s just a negative allocation to cash. If cash is yielding a lot, then you might allocate a positive % to cash. If its yielding next to nothing, then you might bet against cash by shorting it.

Whether betting against cash is “risky” or “magnifies risk” depends on what additional exposure you get from that cash short. If they used the funding to buy treasuries with a maturity consistent with future allocations, then it might not be as risky as one might initially think for instance.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by whodidntante »

Explorer wrote: Fri Jul 03, 2020 3:57 pm I have no clue what CALPERS is doing but I am levering up my debt investments to squeeze more yield out of my investments.
If you don't mind sharing, what exactly are you doing? Futures?
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by garlandwhizzer »

If you must have outperformance, I think leveraging up on less volatile quality assets like the S&P 500 and LT Treasuries has IMO more appeal than aggressive factor based portfolios or active management including private equity and hedge funds. Those who have adopted this leveraged approach have done very well for multiple decades. The portfolio concentrates in only two assets but both tend to ride out storms well and typically when one tanks the other usually makes up for it in large part. So it has been for decades which ironically may not be a good sign going forward. This portfolio has shined as US LC outperformed and inflation and interest rates declined for almost 40 years. That however is unlikely to go on forever. If inflation, SCV resurgence, and INTL outperformance hit, this portfolio will suffer greatly.

There are no techniquesthat I am aware of to produce outperformance that don't likewise increase risk if the market/economy changes. I personally don't believe that robust risk-adjusted returns of leveraged S&P 500 + LTT on backtesting indicates that the same is going to happen going forward. I do not personally believe that CALPERS or anyone else has a good shot at producing a 7% portfolio return going forward for the long term when that portfolio must also contain significant safe fixed income to pay out current retirees. I believe this leveraged portfolio above has the best shot at it, but I wouldn't count on its success. It is a lot easier for CALPERS to accept unrealistic future return assumptions than it is to face a very difficult current reality.

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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by palanzo »

retired@50 wrote: Fri Jul 03, 2020 4:06 pm
willthrill81 wrote: Fri Jul 03, 2020 3:51 pm
retired@50 wrote: Fri Jul 03, 2020 3:02 pm
willthrill81 wrote: Fri Jul 03, 2020 11:03 am ...
I'm not so interested in the specifics of CALPERS as I am wondering whether leveraging stocks is becoming more mainstream.
...
Thoughts?
I hope it's not becoming mainstream, but if CALPERS is willing to do it that will probably justify it for many. I fear bail-out requests in the future for CALPERS.

Regards,
Too big to fail?
Too powerful for CA politicians to ignore. The politicians would probably rather increase taxes on every CA resident than "disappoint" the CALPERS members. The longer the poor level of funding goes on the harder time they're going to have in explaining why they can't seem to beat a Vanguard LifeStrategy fund even though they spend millions on professional money managers. I'd guess that if they would have used index investments from the outset that they'd be better funded.

Regards,
That would be counterproductive as it would just lead to an increase in people leaving California.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by greg24 »

Does one example make an idea mainstream?

Show more work.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by arcticpineapplecorp. »

willthrill81 wrote: Fri Jul 03, 2020 11:03 am The Financial Times recently reported the California Public Sector Pension plan will leverage up to 20% of its assets in an effort to increase its returns (I don't have access to the full article, so perhaps someone else can provide it).
https://www.zerohedge.com/markets/calpe ... urn-target
http://pensionpulse.blogspot.com/2020/0 ... -plan.html
So why is CalPERS considering to add leverage now? Ben Meng, CalPERS's CIO, explains why above: "...one of the undesirable outcomes during a drawdown is we don't have money to deploy to take advantage of a market dislocation, and one of the ways to generate additional liquidity is put on leverage on the total fund. So, we borrow money."

Remember what happened to CalPERS during the 2008 crisis, it was unloading stocks in a falling market to make sure it has enough cash to meet its private equity and real estate obligations:

The pressures come as the California Public Employees' Retirement System has had to raise cash to fulfill commitments to private-equity firms and real-estate partners. The giant fund's predicament is another sign of how the market selloff is tightening the screws on pension funds nationwide. Many other pension funds have similar partnerships and could also confront liquidity strains.

Members of the board investment committee at Calpers held a closed-door session on Monday and discussed ways to raise more cash, according to people familiar with the matter. The issue was brought to the attention of the committee after members of the investment staff expressed concern, a person with knowledge of the matter said.

Typically, Calpers keeps less than 2% of its assets in cash, but the recent demands have forced it to raise that level.

"Calpers receives more than enough cash from employers and members to cover its monthly benefit obligations" to retirees and other beneficiaries, a Calpers spokeswoman said Friday.

Under normal conditions, pension funds count on some private-equity partners to distribute investment gains, while pensions owe some partners more capital. During the recent market selloff, however, distributions have dried up while capital calls continue. That's created a mismatch and a cash strain.

Since the credit markets have tightened up and real estate and alternative investments aren't very liquid, Calpers has been compelled to sell off stocks to raise large sums quickly. Those sales are turning paper losses into realized losses.

source: http://pensionpulse.blogspot.com/2020/0 ... -plan.html
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by palanzo »

arcticpineapplecorp. wrote: Fri Jul 03, 2020 9:12 pm
willthrill81 wrote: Fri Jul 03, 2020 11:03 am The Financial Times recently reported the California Public Sector Pension plan will leverage up to 20% of its assets in an effort to increase its returns (I don't have access to the full article, so perhaps someone else can provide it).
https://www.zerohedge.com/markets/calpe ... urn-target
http://pensionpulse.blogspot.com/2020/0 ... -plan.html
So why is CalPERS considering to add leverage now? Ben Meng, CalPERS's CIO, explains why above: "...one of the undesirable outcomes during a drawdown is we don't have money to deploy to take advantage of a market dislocation, and one of the ways to generate additional liquidity is put on leverage on the total fund. So, we borrow money."

Remember what happened to CalPERS during the 2008 crisis, it was unloading stocks in a falling market to make sure it has enough cash to meet its private equity and real estate obligations:

The pressures come as the California Public Employees' Retirement System has had to raise cash to fulfill commitments to private-equity firms and real-estate partners. The giant fund's predicament is another sign of how the market selloff is tightening the screws on pension funds nationwide. Many other pension funds have similar partnerships and could also confront liquidity strains.

Members of the board investment committee at Calpers held a closed-door session on Monday and discussed ways to raise more cash, according to people familiar with the matter. The issue was brought to the attention of the committee after members of the investment staff expressed concern, a person with knowledge of the matter said.

Typically, Calpers keeps less than 2% of its assets in cash, but the recent demands have forced it to raise that level.

"Calpers receives more than enough cash from employers and members to cover its monthly benefit obligations" to retirees and other beneficiaries, a Calpers spokeswoman said Friday.

Under normal conditions, pension funds count on some private-equity partners to distribute investment gains, while pensions owe some partners more capital. During the recent market selloff, however, distributions have dried up while capital calls continue. That's created a mismatch and a cash strain.

Since the credit markets have tightened up and real estate and alternative investments aren't very liquid, Calpers has been compelled to sell off stocks to raise large sums quickly. Those sales are turning paper losses into realized losses.

source: http://pensionpulse.blogspot.com/2020/0 ... -plan.html
Yes but...
Unlike Canada's large pensions, CalPERS isn't fully funded, so if using leverage on illiquid assets doesn't pan out for any reason, they will exacerbate losses and worsen its funded status considerably.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by wootwoot »

greg24 wrote: Fri Jul 03, 2020 9:03 pm Does one example make an idea mainstream?

Show more work.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by asset_chaos »

The pressures come as the California Public Employees' Retirement System has had to raise cash to fulfill commitments to private-equity firms and real-estate partners.

...

Since the credit markets have tightened up and real estate and alternative investments aren't very liquid, Calpers has been compelled to sell off stocks to raise large sums quickly. Those sales are turning paper losses into realized losses.
So illiquid investments are coming back to bite them again in a little more than a decade. They could have learned the lesson in 2008-09 that illiquid investments wreak havoc on the rest of the portfolio during bad times, especially if the illiquid investments have provisions that obligate you to supply capital during bad times. It just seems like gross mismanagement. It's those obligations to supply capital that seems like a killer. We often see written how these illiquid investments are great for institutions: with very long horizons they can be patient and ride out any downturns to earn illiquidity premiums. But if the investment is a capital sink 100% correlated with bear markets, I find it hard to believe that the premiums are even theoretically large enough to justify investment.

Makes me glad I don't have any skin in this particular game. But since pension funds have been going in for these illiquid investments since Swensen/Yale popularized them decades ago, there might be a lot more pension funds borrowing to try to fill in the holes made by their obligations to illiquid investments.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by palanzo »

asset_chaos wrote: Fri Jul 03, 2020 10:51 pm
The pressures come as the California Public Employees' Retirement System has had to raise cash to fulfill commitments to private-equity firms and real-estate partners.

...

Since the credit markets have tightened up and real estate and alternative investments aren't very liquid, Calpers has been compelled to sell off stocks to raise large sums quickly. Those sales are turning paper losses into realized losses.
So illiquid investments are coming back to bite them again in a little more than a decade. They could have learned the lesson in 2008-09 that illiquid investments wreak havoc on the rest of the portfolio during bad times, especially if the illiquid investments have provisions that obligate you to supply capital during bad times. It just seems like gross mismanagement. It's those obligations to supply capital that seems like a killer. We often see written how these illiquid investments are great for institutions: with very long horizons they can be patient and ride out any downturns to earn illiquidity premiums. But if the investment is a capital sink 100% correlated with bear markets, I find it hard to believe that the premiums are even theoretically large enough to justify investment.

Makes me glad I don't have any skin in this particular game. But since pension funds have been going in for these illiquid investments since Swensen/Yale popularized them decades ago, there might be a lot more pension funds borrowing to try to fill in the holes made by their obligations to illiquid investments.
I think you will find that quote is from 2008-2009.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by willthrill81 »

greg24 wrote: Fri Jul 03, 2020 9:03 pm Does one example make an idea mainstream?
Take a look at all the threads that have cropped up in the last year involving leveraged ETFs.

Beyond that, I'm asking for others' views. If one of the largest pension plans in the world is going in for leverage, then the concept must not be viewed as too far out in left field.

It's too bad that you seem to find others' asking genuine questions in a theory sub-forum offensive.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by geerhardusvos »

When is the Bogleheads forum going to IPO? Because I’m going to 10x lever that s*** 8-) :mrgreen:
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by CurlyDave »

FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
It is a kind of wishful thinking.

They need a portfolio of a certain size if they are to meet their projected obligations. The larger the assumed return, the smaller the portfolio that will suffice.

If the returns are assumed to be lower, the portfolio shortfall will be larger and state taxes must be increased to make larger contributions to the portfolio. This is painful for elected officials.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by TheDDC »

CurlyDave wrote: Sat Jul 04, 2020 12:22 am
FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
It is a kind of wishful thinking.

They need a portfolio of a certain size if they are to meet their projected obligations. The larger the assumed return, the smaller the portfolio that will suffice.

If the returns are assumed to be lower, the portfolio shortfall will be larger and state taxes must be increased to make larger contributions to the portfolio. This is painful for elected officials.
An expectation of 7% is not outrageous. It’s what we would expect from our own portfolios. We’ve instead gotten 10%+ annual performance on average. Regarding risk, I never understood why pension fund managers believe they need to pay anyone huge fees to invest these sums of money. If we as individuals think that paying fees is bunk, doesn’t that theory scale when you are talking multi-billion $ pension funds? I wonder if the exec director of these pensions funds would entrust Edward Jones go manage their own purse.

I am a state employee and have no problem with pensions and believe they fulfill one critical leg of the stool, full disclosure. They are a good thing to have. However, the crackdown on high pension management fees can only help performance in my opinion.

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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by palanzo »

CurlyDave wrote: Sat Jul 04, 2020 12:22 am
FelixTheCat wrote: Fri Jul 03, 2020 4:08 pm I've never had a pension. How can CALPERS guarantee a 7% return based on their investments? Is it calculated or wishful thinking?
It is a kind of wishful thinking.

They need a portfolio of a certain size if they are to meet their projected obligations. The larger the assumed return, the smaller the portfolio that will suffice.

If the returns are assumed to be lower, the portfolio shortfall will be larger and state taxes must be increased to make larger contributions to the portfolio. This is painful for elected officials.
CALPERS is not fully funded. They may increase contributions from their members but I doubt CA will increase taxes. More people will just leave.
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Re: CALPERS taking on leverage: Is leverage becoming more mainstream?

Post by TechFI »

In before CALPERS pension system goes bust...
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