More Pension Math: Investment Earnings

Triggered by recent earnings reports from CalPERS and CalSTRS, some readers have asked why California’s pension funds are underperforming the overall stock market. Eg, for the fiscal year just ended June 30, 2018, CalSTRS and CalPERS earned only ~two-thirds the stock market. While the question is best asked of their Chief Investment Officers, one reason might be portfolio construction designed to minimize contribution volatility. CalSTRS’s most recent CAFR discusses volatility on page 29 here.

Other readers have inquired about the impact of investment earnings on pension costs. The answer: Not much. Far more important is liability growth. As explained here, rapid liability growth results from a deliberate effort by California pension funds to suppress the size of pension promises when they are created. That lie works only so long — and then it reverses with a vengeance because of accretion, as explained here. To its credit, last year CalSTRS took a small step towards truth-telling by dropping its discount rate for reporting liabilities, though the drop was only ~10 percent of that required.

As a near-quadrupling of the stock market since 2009 makes clear, rising stock markets cannot overcome fast-growing liabilities. Absent reforms that reduce liabilities, California governments and school districts will divert ever-larger amounts from services to pension costs.