The board of CALPERS lowered the pension fund’s assumed rate of return to 7.5% from 7.75%. This is based on lower inflation expectations. This is the first change since 2003. This rate is unrealistic. If the rate is lowered, the state will have to add more money to the pension plan or reduce benefits. The median rate is 8% as reported by Wishire Associates.
These assumed rates are asscoiated with lunacy. Where arethese rates going to come from? Fixed income? Treasury rates will not give you 2% under 10-years. Where is the total return going to come from in fixed income? What about equities? The equity risk premium over the last decade is negative. It is highly unlikely that stocks will be able to produce a consistent 8% return. This means that pensions cannot give there assumed rate and this has nothing to do with inflation expectations.
Think about the inflation expectations argument. If the Fed is going to set inflation expectations at 2%, then thereal return on bonds for the next decade will have to be 5.5% on a yield basis. If we are at the low end of the rate cycle, then the only way we are going to get positve real yields is that the bonds will have to take a lose. Assume that bodsn cannot get this type of yield or return, there has to be even more pressure on equities to deliver s strong return which is not going to happen.
Can we get this from alternative assets? Unlikely for the those pensions which are large and will not be able to generate alpha on a signficant basis. This will not come from commodities which have been in a super cycle for the last decade.
I would like to know what is the portfolio that will be able to generate a 7.5% return over the next few years because I would like to invest in it. It is possible but this is not going to be a riskless investment.
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