Climbing the Risk Ladder

by Dave Schuler on September 1, 2012

Here’s a great example of how public pension funds, in a desperate grab at realizing the high returns their financial strategies require for them to remain solvent, are undertaking increasingly risky bets investments:

NEW YORK — Wall Street investors aren’t the only ones feeling the sting of Facebook Inc.’s falling stock: So are some of the country’s troubled government pension funds.

Public employee retirement funds from around the country took part in the Menlo Park, Calif., social networking juggernaut’s May 18 initial public offering and plowed millions of dollars into Facebook stock before its value plunged.

Facebook shares continued their decline Friday, falling $1.03, or 5.4%, to a record low of $18.06, or less than half their $38 offering price.

Although public pension funds staked only tiny portions of their multibillion-dollar portfolios on Facebook’s fortunes, the stock’s poor performance has added to the funds’ woes. Chronic underfunding and poor returns could lead pension funds to pursue riskier investments such as hedge funds, private equity, commodities and real estate, or even cut benefits for retirees.

Three pension funds have joined a class-action lawsuit against Facebook and its underwriters. The suit, filed in U.S. District Court in Manhattan, N.Y., alleges that lead underwriters led by Morgan Stanley gave only some select investors a heads-up that Facebook’s revenue forecast had soured.

Sometimes you eat the bear, sometimes the bear eats you.

CalPERS, the California public employees’ pension fund, owns more than a million shares of Facebook stock. Doesn’t putting that many eggs in a basket that has never made a profit and might not even have a plan to do so sound sort of risky to you? I mean for CalPERS not for Mark Zuckerberg. I’m sure he’s doing fine. That Facebook employees sold so much of their own stock as soon as the window had re-opened should show you which way the wind is blowing.

It should be noted that this is one of the great problems with defined benefit programs. Unless they are fully funded and managed extremely conservatively, the earnings they realize just may not be enough to pay what they’re required to pay.

{ 9 comments… read them below or add one }

Andy September 1, 2012 at 3:33 pm

Calpers is huge though, something close to 1/4 trillion in assets. It makes me wonder if they are too big to fail just like the big banks.

Dave Schuler September 1, 2012 at 4:34 pm

CalPERS’s peak was around $250 billion and I believe its total assets have declined about 30% since then. Yes, a loss of more than half the value of a million shares is a drop in the bucket for the fund. I still have to wonder.

Separate question: what effect do these enormous institutional investors have on the market?

jan September 1, 2012 at 9:01 pm

I can’t believe that CalPERS has a million shares of facebook stock! What were they thinking?

Drew September 2, 2012 at 7:20 am

A couple of factoids for perspective…

“alternatives” (meaning alternative investment classes, that is, alternative to traditional public stocks and bonds) have their origins in the early days of venture capital when wealthy families, the Whitney family in particular, passed the hat to make early stage investments. Things evolved from there, with venture capital and then private equity as a whole becoming institutionalized, along with real estate and forest land etc.

The hallmarks of the class are high risk and illiquidity. High “beta” in academic jargon. Therefore, they are not suitable as a sizable proportion of an institutional portfolio, and perhaps not at all for an individual. Further, they traditionally were exempted from SEC regulation under Rule 144A. That’s just a fancy way of saying buyer beware, or, alternatively, this is for sophisticated and well healed investors only. Dodd Frank has changed that, and not for the better.

In the early days, a pension fund or endowment might have a 2-4% allocation of the portfolio to alternatives, to goose returns. More recently, I’ve seen as much as 15%. That’s too much IMHO. The class obviously has a place in a portfolio. I’d suggest 5-9% is reasonable.

As for Dave’s question on market influence. I think you are asking can a CALPERS move a securities price. Perhaps a tad. Here and there. But more importantly, when they make allocation decisions, they can make or break investment firms. Their influence is ginormous.

Interestingly, as a final note, my 14 year old daughter noted that Facebook was “dead” when all the hub hub about the IPO was going on. I guess Twitter has come to the fore. I don’t use either.

But it reinforces one of the fundamentals of investment: only invest in what you understand. Investment bankers are absolute wizards at packaging.

Drew September 2, 2012 at 7:31 am

I guess, as a follow up, buying Facebook is probably more just a bad, but singular, investment decision.

More generally, these public pension funds, with their bizarro 8 and 9% return projections are going to get desperate and make portfolio allocation decisions that could prove disastrous. PE can give them those returns, but only at the risk of volatility and periods of fallow outgoing cash flow. It’s insane.

So here is a question for everyone. What in the world is the Fed thinking by driving down “safe” asset returns? Qui bono?

Drew September 2, 2012 at 8:01 am

Amidst all the mis and disinformation about PE, especially over at OTB, I offer you all this.

http://www.nypost.com/p/news/opinion/opedcolumnists/look_who_parks_their_cash_at_bain_88KSQrw8BXciEidja2ZQXN#.UEIO3tQLHys.email

Look who benefits from PE investing.

jan September 2, 2012 at 9:05 am

Drew

I saw that list of pension investors with Bain, yesterday. The misinformation being dished out on a daily basis, during the lead-up to the GE, makes one’s head spin. Bain has been one of those companies who has stayed out of the limelight of contention until now, when the dems are compelled to throw sticks and stones at anything that moves in Romney’s life.

Drew September 2, 2012 at 11:43 am

Jan

The limited partner list in almost any PE firm is a bunch of public worker pension programs, college endowments etc.

It doesn’t fit the narrative to show that stalwart Dem voters are big beneficiaries of PE. And you won’t hear it from the press or Dem pols. To hear them talk, you’d think only the general partners make any money.

The dishonesty is stunning.

steve September 2, 2012 at 6:46 pm

@Drew- Strawman. People on the left believe in markets, investing in the stock markets and think PE firms are just fine. The issue is Romney’s claim that he knows how to create jobs because he ran Bain (during the longest bull market in our history). What we know is that he was good at making money. We have no idea whether, on net, his efforts lead to more or less jobs in the US. I am not sure it matters that much. What I would like to know is how he plans to increase employment in the US. He appears to be keeping this a secret. So far, all he has offered are ideas offered in the 2000s.

Steve

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