Chasing the 8 percent return

Marketplace Contributor Jul 6, 2012

Chasing the 8 percent return

Marketplace Contributor Jul 6, 2012

Sarah Gardner: When it comes to what qualifies as a respectable return on your investment, times have changed, right? Well not if you’re a pension manager, it seems. Many public pension funds are still promising gains around 8 percent, just like they did before the recession.

8 percent! Who’s getting that these days? Our senior business correspondent Bob Moon has been looking into that “magic” number.

Bob Moon: What better source to consult about this “magic” 8 thing than that old stand-by I’ve used since I was a kid? So tell me, oh Magic 8 Ball: Do pension funds really have a good shot at making the 8 percent returns they’re counting on to meet their obligations to retirees?

Sound of Magic 8 Ball being shaken

Hmmm, it’s telling me, “OUTLOOK NOT SO GOOD.” OK then, so I guess I should settle for the much more modest gains we’ve all gotten used to?

Sound of Magic 8 Ball being shaken

Ah-ha, the answer is, “YOU MAY RELY ON IT.” So there you have it.

And now, consider this: Some experts say the idea of consulting a Magic 8 Ball is no more far fetched than continuing to bet every year on 8 percent gains. Andrew Biggs is a pension expert at the American Enterprise Institute.

Andrew Biggs: Eight percent is the “magic” return, but there’s no such thing as magic.

Even the group representing state retirement-fund managers concedes the median return over the past decade has been less than 6 percent.

At Baltimore’s Sage Policy Group, economics consultant Anirban Basu says it’s going to take a lot to catch up. He believes hitting 8 percent is very unlikely without engaging in seriously risky investments, like junk bonds and private equity funds that buy distressed companies. And in explaining that, he began to sound like someone describing a problem gambler.

Anirban Basu: They run with it as long as they can, and they hope to get lucky.

New York Mayor Michael Bloomberg was quoted recently calling the promise of an 8 percent return “absolutely hysterical.” And even when the city’s pension manager proposed lowering the target to 7 percent, Bloomberg ridiculed that number as “indefensible.” If somebody promises that kind of return, he said, “You take it and just make sure the guy’s name is not Madoff.”

But historically, pension plan managers have gotten lucky — or invested wisely, depending upon your perspective. Keith Brainard speaks for the National Association of State Retirement Administrators.

Keith Brainard: Sometimes people overlook that the investment return assumption that public pension plans use is intended to be a very long-term target. It’s not intended to reflect current economic conditions, or current interest rates, but rather over 20, 30 years or longer.

Even so, some retirement plans have been making slight adjustments. Andrew Biggs of the American Enterprise Institute, says there were protests when California’s Public Employee Retirement System, CALPERS, decided to lower its target below 8 percent.

Biggs: You had elected officials saying, “We can’t afford that, we can’t afford the extra contributions we’d have to make today based on a slightly lower assumed investment return.” But that’s nutty — masking the problem is not the solution.

Biggs says politicians would prefer not to admit taxpayer dollars are needed to make up the difference. He supports new accounting rules that would require greater transparency about pension fund levels.

Biggs: Public pensions think they can get 8 percent returns without taking a lot of risk. The reality is, they can’t. They’re taking more risk. They’re not telling you about it. They’re hiding the risk to taxpayers. Chasing returns is a very, very bad way to go on this.

At Towson University, economist Daraius Irani worries that many workers could find themselves coping with a much smaller nest egg.

Daraius Irani: States and localities may go back and try and renegotiate some of their pension obligations.

Irani says it could come down to a choice between that, or higher taxes to make up the difference.

I’m Bob Moon for Marketplace.

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