Pension “Armageddon” Got Closer Today

The IMF fears underfunded pension funds could be encouraged to chase returns through riskier investments such as direct credit exposure or by engaging in securities lending in order to improve their funding ratios….The IMF’s comments echoed similar warnings from the OECD in May, when the Paris-based body said pension funds’ move towards riskier asset classes could result in their solvency position being “seriously compromised” in turbulent markets.  The Financial Times

Yesterday I published a post in which I outlined the reasons why pension fund underfunding is likely much worse than the level admitted by the funds themselves and industry professionals.  The biggest culprit is “mark to market” of illiquid investments into which pension managers have “shoe-horned” themselves in order to give the appearance of rates of return that are higher on paper than in reality.  A good friend and colleague of mine, who happens to be very bright, had this comment in response to my post:

Pension funds are collectively insolvent.  Basically the asset managers running these funds have refused to MTM them properly, expecting the assumed X% annual return to normalize.  Sorry, buddy: this IS the new normal (which is why the unfunded situation gets worse every year… assume 8% and get 0% for enough years and the chasm only widens… in fact, by the rule of 72, your funding gap will double every 9 years if that 8% gap is reality).  This is where the rubber hits the road, the issue which is going to punch the middle class in the gut like a steel 2×4.

This is the same dynamic that torpedoed the big bank balance sheets when the housing/subprime credit bubble popped, as big chunks of home equity, mortgage and other credit products were marked close to par when in reality most of it was worth zero. And this is one of the primary reasons that the Fed is devoting significant resources to keeping the stock market propped up:  pension fund insolvency is at risk.

One of the biggest areas of concern for pension funds is their private equity investments. Most pension funds have been literally “throwing” cash at private equity firms who have been shoveling money into real estate rental schemes and, even worse, have fueled the private market Silicon Valley bubble.

No one ever admits to a bubble until after it’s popped and has destroyed trillions in value – just ask Alan Greenspan and Ben Bernanke.   Bernanke never saw the housing bubble that he and Greenspan blew and Janet Yellen can’t see the tech bubble that she and Ben inflated. Fortunately for Ben,  Yellen will get tagged with the Silicon Valley collapse.

It looks like the process has begun.   Dropbox tried to IPO at its private market valuation of $10 billion and had to pull it, as the public market disagreed with BlackRock, who led the last round of funding for Dropbox.  Dropbox has revenues of a little more than $200 milion and zero net income.  The $10 billion valuation was insane.  But the game is over now.

As more Silicon Valley “unicorns” fail to monetize at levels even remotely close to their private market bubble value, the value of the private equity holdings of pension funds will vaporize.  The valuation process for a tech start-up is typically a “bi-nomial” function.  It either works and is a home run or it’s worth close to zero because the company’s technology will never generate income (Amazon?).

This implies that private equity holdings held by pension funds are significantly overvalued on the “mark to fantasy” basis and will eventually be subjected to massive valuation write-downs.  It’s a vicious negative feedback loop that is magnified by the “leverage effect” created by the existing level of pension fund underfunding.

Here’s what the problem looks like visually (source:  Zerohedge):

This graphic shows five of the steepest declines in stock price for tech companies IPO’s in the last Untitledfew years. Note that the steep decline occurs since 2014. This means that private equity funds with investments in comparable companies have mark down their private market holdings to reflect better the valuations given to these companies in the “cash out” market. This also means that pension fund private equity fund holdings are likely already significantly overvalued.

As for real estate?   One of the primary source of funds for the buy to rent portfolios amassed by private equity firms like Blackstone has been pension funds.  A recent merger of two public buy-to-rent REITS valued one of the entities’ current home rental portfolio at 50% of its original carrying (i.e. investment) value.   As with tech p/e investments, this transaction effectively revalues down significantly pension fund investments in this sector.

The bottom line is that pension funds are already significantly underfunded.  Recent developments in the real estate and tech investment private equity market suggest that the level of underfunding is about to be bludgeoned.

8 thoughts on “Pension “Armageddon” Got Closer Today

  1. Excellent discussion of ETFs and the mischief they bring…the part regarding beta was interesting, too

    The Long Road to the Great Mismatch

    Well, it might be happening. The Great Flow of Funds, every single year since 2008, into index products like ETFs (drawn, in every single year but one, from actively managed equity strategies) might be approaching its final chapter. The chart at right, repeated from last quarter’s review, shows the $1 trillion procession of assets that brought ETFs from about 3% of public stock market value in the U.S. in 2007 to 7.5% in 2014 and, more importantly – and startlingly – from about 23% of daily trading volume to almost 27%.
    Thus was created the ETF Divide, the barrier between those companies included in the major ETF baskets and everything else. Those on the inclusion list receive an automatic daily bid and higher valuations; those not on the list languish on the other side of the divide. This dynamic has been accelerating: the all-time record share of ETF trading volume of 37% was set this August 24th, when the prices of more than a few ETFs departed markedly from their net asset values. This is not supposed to happen, but at least it wasn’t boring. Shares of DVY, for example, the iShares Select Dividend ETF, temporarily dropped 35% that morning. However, the NAV of the fund declined by no more than 2.5%, and only 8 of its 99 holdings declined by more than 15%. DVY is no marginal fund; it has $13 billion of assets under management, and its holdings include the likes of McDonald’s and General Electric. It’s a sign.

    This 7-year one-way flow of funds commenced in 2008, the first time equity mutual fund flows turned negative against a surge of ETF inflows. When this procession ends, the distortions upward (high valuations and artificially low volatility) will reverse, accompanied by a contraction in valuation multiples and higher volatility. The favored will come into disfavor. (Bob Dylan couldn’t have been thinking of the stock market in 1963 when he penned the final lines of that particular song: “And the first one now / Will later be last / For the times they are a-changin’.”) One can’t know, of course, in any absolute way; there can only be signs.

    One of the challenges here is that far more money is in these index instruments than the securities in which they are invested can really bear. The mismatch between the seemingly substantial liquidity of the ETFs — to judge by their trading volume — and the real liquidity of their underlying holdings might become obvious only when the funds stop flowing in. In Wall Street parlance, indexation might be one of the most crowded trades ever. Therefore, one might want to keep an eye on the flow of funds. One place to look is BlackRock. BlackRock has $4.7 trillion of AUM, of which about 23% is in ETFs; that’s roughly half of all the ETF assets in the U.S. Including index funds for institutional clients, 60% of BlackRock’s assets are in index products. Accordingly, if one is interested in the continued propensity of investors to place more funds in ETFs, BlackRock might be a good indicator.
    The accompanying table displays the net flow of funds into BlackRock, by quarter, for the past 2 ½ years. It’s almost metronomic: more or less $15 to $30 billion per quarter. There were only two anomalous figures. In the 2nd quarter of 2013, BlackRock received only $5.5 billion of net inflows to its index products. On the other hand, the firm overall had net outflows; therefore, the index products accounted for more than 100% of the net flows.

    http://www.horizonkinetics.com/docs/Q3%202015%20Commentary_FINAL_PRINT.pdf

  2. Imagine to have your pension fund holdings based on the “FANG” companies (Facebook,Amazon,Netflix and Google)
    You better hope that Grandma sends the printing press on a regular service so you don´t get a hickup in the house of cards.
    Amazon is probably “sucked totaly dry” by Bezos, my guess is that when or if AMZN goes belly up there will be investigations and trials because the company is probably empty due to plundering from his side.

  3. The funny thing is that a lot of these pensions are Gov’t based. These retirees are administrators, cops, and politicos that know where the bodies are buried. Makes me wonder what happens when past government workers and their civilian counter-parts reach for their proverbial pitchforks. All I can say is welcome to my world. I’ve known for the past 10 years that there was no fucking way the system was going to let me retire. Too much fraud, manipulation, and most small business ventures are risky. So I went all in on PMs and I work for one of those large corporate firms. I’ll be working until I drop from exhaustion or until they fire me or kill me. The country has taken too many wrong turns. We’re going down and its going to hurt like hell.

  4. You don’t have to be “very bright” to see what is going on. 1) you can’t get something for nothing. 2) Sticking your head in the sand will not make it go away.

  5. I am a retiree of Lucent Technologies. They just cut their pensions by 40%. There is nothing in the press about this. They were once the most traded stock on the NYSE.

  6. WOW… Just WOW. I’ve been a pariah among family and friends/acquaintances for many years with incessant rants about the unsustainability of the current status quo. “We don’t want to hear it”, they say. “Your nuts” they say. I read a good one the other day – ‘how long to make a chicken sandwich from scratch’? ‘Six months’!!! It’s the fault of every dumbshit, apathetic, false idol worshipping numbnuts in this country over the age of 18, for the predicament we all face. For all of you drawing a comfortable pension, my advice is to give it up now and figure out how to live without it now, because that inconvenient reality is Damb near NOW. When foodstamps and pensions and salaries and the rest cease to exist, as Gerald Celente often states “when people lose everything, and have nothing left to lose, they lose it” !!!

  7. To HONEST REAL MEDIA OUTLETS and other various citizen journalists + anyone else in the whole world with an internet connection and who can read ,

    Subject: Hugest Possible Story Ever ->

    “ Huge News Story – NEW YORK BUS DRIVER BEING TRACKED AND STALKED FOR OVER A MONTH BY SHADOW-STATE ANTI-GRAVITY MILITARY CRAFT ” // “ Anti-gravity Military Crafts & Alien UFOs & Chemical Spray Tankers Jets Now In Our Air Daily Above Our Heads ! ”
    { Update: Here is he is stalked on November 9th all the way home form work, over 9 miles by two anti-gravity military industrial craft. He also notices multiple people on the side of the road also witnessing the craft: https://www.youtube.com/watch?v=Q2ski-aCHnY He then has conversations with them, and they also testify that they clearly see these anti-gravity craft gliding around about a half mile away from then at about 400 ft about the gorund. Multiple citizen witnesses are witnessing these craft, launched from the ALBANY INTERNATIONAL AIRPORT silently hovering low in the night sky near between Clifton Park and Albany New York. }

    { Summary: A fellow in upstate New York ( YouTube channel: “RadioEast1” ) has recently filmed many videos of Military Industrial Complex ANTI-GRAVITY SILENTLY LEVITATING CRAFT now levitating in daylight, but mostly at night, in full public (yet most everyone is presumably distracted) view. The Shadow-State appears to have at least a dozen or so ANTI-GRAVITY JET-shaped craft stationed at the ALBANY NEW YORK INTERNATIONAL AIRPORT and perhaps elsewhere already. }

    The following is a compilation video of SHADOW-STATE ANTI-GRAVITY STALKER (SCOUT) craft hovering far around ALBANY INTERNATIONAL NY AIRPORT, mostly during the night, but sometimes in daylight/dusk:

    Please view this early November 2015 produced compilation video and download/record extra copies to prevent censorship ======> https://www.youtube.com/watch?v=t6qheKQBwXI

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