plans everywhere are in serious trouble. Pension plans in Wisconsin are about
to get in still deeper trouble using leverage.
Inquiring minds note the State of Wisconsin Investment Board Clears Plan to
Borrow to Juice Returns. Other states are considering doing the same. Please
consider Pensions Look to
pension funds needing to boost their returns but frustrated with hedge funds
and private-equity investments are turning to one of the oldest investment
strategies—using borrowed money to boost performance.
The strategy calls for leveraging pension funds' safest
asset—government or other high-grade bonds—while reducing
exposure to stocks.
The State of Wisconsin Investment Board, which manages $78 billion, became
among the first to adopt the strategy when it approved the plan Tuesday. The
fund will borrow an amount equivalent to 4% of assets this year, and as much
as 20% of its assets over the next three years. The pension fund was advised by
four money managers, including Connecticut hedge-fund firms AQR Capital and
Wilshire Consulting, which advises pension funds on investments, says
leverage helps the funds meet their long-term return targets without relying
too heavily on volatile stocks, or tying up their money for long stretches in
private investments. Low interest rates make it impossible to meet those
targets with simple bond investments. Wilshire managing director Steven
Foresti says he has been in discussions with about a half-dozen funds that
are interested in the leverage strategy.
Some advocates of the leveraged approach acknowledge these drawbacks, but say
the strategy makes sense anyway. Most big public pensions have expected
annual rates of return between 7.5% and 8%. Wisconsin, for example, assumes
Many analysts consider those return rates unrealistic. Yet pension funds are
loath to change them because that would require local governments to get more
money from taxpayers to compensate for lower projected returns. Even at an 8%
return, the average public fund will have about 55% more in liabilities than
in assets 15 years from now, due to recent losses and challenges in raising
contribution rates, according to PricewaterhouseCoopers.
"Fixed income is a good hedge in a crisis scenario," says Rick
Dahl, chief investment officer for the Missouri State Employees' Retirement
System, who said he is considering using this strategy. "If I can ramp
up my fixed income to the point where it gets equity-like returns that makes
a lot of sense."
returns are indeed unrealistic. Using leverage to achieve those returns is
suicidal. If someone wanted to use leverage on fixed income or equities (on
the long side) the time to do that was in March of 2009. Let's take a look at
a few charts.
Moody's Baa Corporate Bond Yields
click on any chart for sharper image
As yields decline prices rise.
Let's investigate prices in a wide variety of bond funds.
JNK - Lehman High Yield ETF
CYE - Blackrock Corporate High Yield ETF
iBoxx Investment Grade Corporate Bonds
The iShares iBoxx $ Investment Grade Corporate Bond Fund seeks investment
results that correspond generally to the price and yield performance, before
fees and expenses, of the corporate bond market as defined by the iBoxx $
Liquid Investment Grade Index.
CFT - Barclays Credit Bond Fund
TFI - Lehman Municipal Bond Fund
CXA - Lehman California Municipal Bond Fund
BND - Vanguard Total Bond Market
In addition to the above names, I found a number of corporate bond ETFs that
have been around less than a year such as VCLT - Vanguard Long-Term Corporate
Bond ETF and SCPB Barclays Short Tern Corporate Bond Fund.
Mad Rush Is On
Wisconsin wants to plow into bonds now, after those rallies, with leverage?!
One thing I know for sure is that something everyone is clamoring to get
into, is in or near the bubble phase.
With that in mind, please consider Corporate Bond ETFs
Benefit As Sales Break Records.
investors become more willing to take on risk, corporate bond exchange traded
funds (ETFs) are in turn becoming more appealing. So much so that corporate
bond buying this year has set a record.
Worldwide, investors have purchased more than $2.7 trillion of new corporate
bonds this year, reports Kate Haywood for The Wall Street Journal. Contrast
that with $1.7 trillion in 2008, which is when the financial crisis all but
brought the flow of cash to a standstill.
Junk bond issuers have used about 75% of proceeds from sales to refinance
existing debt, the highest proportion since record-keeping began in 1996.
Corporate bond sales have been a boon to many companies, giving them a
lifeline as they wait for banks to resume normal lending.
“Junk,” or high-yield, refers to a bond rated “BB” or
lower because of a high default risk. The main reason junk bonds have had a
good year is simply that investors have some risk appetite to spare again,
explains Matt Krantz for USA Today.
Anyone looking at those charts should be asking "Where's the
value?" Instead pension plans are asking "How do I get in with
There is no value here and that is precisely why pensions plans have to
leverage up to get the unrealistic returns they expect.
Corporate bonds, municipal bonds, credit bonds, high yield bonds are all
fully valued and then some.
Bubbles form when the Fed floods the world with liquidity. We have seen
bubbles in technology, in housing, in commercial real estate, in credit, in
equities, and now arguably bonds.
No Lesson Ever Learned
That state pension plans are leveraging up is a huge warning sign in and of
itself. That they are leveraging up in the latest "hot thing" makes
it all the more likely a corporate bond disaster is just around the corner.
Thus, it's time to be taking profits in corporate bonds and equities, not
leveraging into them. If corporate bonds collapse, I can all but guarantee
equities go down hard right along with them.
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