Wednesday, July 28, 2010

Slip-Sliding Away

Zero return in the last five years--and heading south...

Last month I took a look at the investment portfolio of the Maine Public Employees Retirement System (MainePERS) and suggested that the fund was ill positioned for a deflationary economy. In particular, the pension fund is overweight stocks--and dangerously exposed to the financial sector. Two of its top ten equity holdings are Bank of America and JP Morgan Chase (see the table below).

Those chips should have been taken off the table six months ago. An update at the MainePERS website shows that the fund's shares in Bank of America and JP Morgan Chase decreased in value by 19.2% and 17.9% respectively in the three-month period ending on June 30. We can hope that this was because of a reduced share-count, i.e. that fund managers smartly sold shares before this spring's sell-off, during which stock prices for both companies declined by over 20%. Given that the fund dropped a cool half-billion during the quarter (-6.4%), however, it is more likely that we simply rode the shares down, Six Flags style.

The Maine Center for Public Interest Reporting has posted an alert at its website ( regarding Maine's pension liability and the huge impact it will have on the state budget going forward. The state has underfunded MainePERS by $4.4 billion and must make up the difference out of the General Fund by 2028. The gap is based on the dubious assumption that the MainePERS portfolio can generate returns of almost 8% annually between now and then. The portfolio's recent performance is hardly reassuring in that regard.

Worse, just as the pension gap is growing, so is the shortfall in the state's operating budget, a shortfall now expected to exceed $1 billion in the next biennium. You cannot rob Peter to pay Paul when Peter is flat broke.

Largest Holdings at June 30, 2010:

Top 10 Equity Holdings

Market Value

Exxon Mobil

$ 66,477,991







Procter & Gamble


General Electric


JP Morgan Chase


Johnson & Johnson


Bank of America


Berkshire Hathaway Cl B


Top 10 Equities

$ 427,022,386

For a detailed analysis of states' pension woes,
check out this report by Courtney Collins and Andrew J. Rettenmaier.

From the executive summary:

Many state and local government pension plans' liabilities are calculated using discount rates that are not commensurate with the risk they may pose to taxpayers. Accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds' assets. This typically high discount rate tends to reduce the size of a pension plan's accrued liabilities. However, pensioners have a durable legal claim to receive their benefits and consequently, it is more appropriate to use a lower discount rate in calculating the plans' accrued liabilities.

Due to the use of high discount rates, the liabilities of state and local government pension plans are underestimated. For example, recent reports by the Pew Center on the States and others indicate that assets will cover about 85 percent of the pension benefits owed to participants. But other studies that adopted lower discount rates have found liabilities may actually be 75 percent to 86 percent higher than reported. As a result, taxpayers' role as insurer may be much greater than anticipated.

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