That’s the retirement sorted then


I guess the brilliance of these scams is that the people who don’t respond can be eliminated and those that do can get gouged for what pittances they probably possess. How could one not fall for the impeccable qualities of Mrs Grace Innocent?

The “bigger” point about the FANG sell off


While the press is waxing lyrical about the unprecedented loss caused by a sell off in FANGs (Facebook, Amazon, Netflix & Google) we should note that it overlooks one factor. Before getting to that, to start with the sell off in gross dollar terms it is unsurprising given the already highly inflated value of the base stocks. So if A $500bn market cap Facebook loses 4% it is equivalent to $20bn. On one day FB lost a Fiat Chrysler. It’s math. Let’s not forget that Bitcoin is now worth $165bn but let’s not let that bubble spoil the party.

The problem that faces financial markets is the advent of ETFs. While stupefyingly simple to understand as an investor it is that same simplicity that breeds complacency. ETFs are simple products that enable investors to pay much lower fund management fees to buy easy to understand baskets- whether coal, gold, oil or FANGs. There are 106 ETF products that own Facebook as a Top 15 holding with that averaging between 5% and 10% of the entire fund.

Yet on the way up things are rosy. It is what happens on the downside that has yet to be fully tested. Around two years ago, CM wrote a report which warned of the risk of ETFs on the downside, especially levered ETFs (i.e. you buy a 2x levered FANG fund which means if FANG stocks go up 5% you theoretically get 2x the return for any given move up or down.

However in times of uncertainty (i.e. heightened risk) the options markets that price risk move magnitudes on the downside vs the upside. Meaning for an ETF to replicate what it proclaims on the brochure becomes much more difficult meaning the fund may under or overshoot the promises. Also in certain markets (e.g. US & Japan) where stocks on the exchange have limit up/down rules on the physical stock, should a market crash ensue, the ETF prices on the theoretical values of stocks that may not have opened for trading. What that means is that the ETF may reflect a market that is 10-15% below where it actually eventually opens. Meaning poor ETF buyers get gouged. However the computer algorithms in the ETF end up chasing, not leading the market which in and of itself creates more panic selling further reducing market confidence. Where a market might have traditionally fallen  3% on a given piece of bad news, ETFs tend to react in ways that might cause a market to retreat 6%. Indeed market volatility is amplified by ETFs.

At the moment market behavior is exceedingly complacent about risk. Before GFC highly complex products like CDOs and CDSs were the rage. 99% had next to no clue how they operated but they found their way into the local government investment portfolios of even small country towns in Australia.

ETFs on the other hand are strikingly simple to grasp but that also means we pay far less attention to the risk that goes with them. That is the bigger worry. People complacently thinking their portfolios are safe as houses may wake up one morning wondering why some flash crash has caused Joe and Joanne Public’s retirement nest egg to get decimated.


Pistol whipping Johann Bund

Retirement increasingly looks like an auction with dummy bidders because no-one else wants to raise their hand. The German Bundesbank is warning that by 2060, the retirement age should be 69 not the current 67 proposal by 2029. Yes I get that people are living longer but that disguises the fact that the pension pot is emptying too quickly.

Naturally Chancellor Merkel’s team came out suggesting that the Bundesbank was too negative because  immigration will help slow down the declining workforce alleviating the need to raise retirement ages again. German elections are to be held in autumn 2017 and Merkel doesn’t need more negative news flow to dent her already flagging popularity.

Merkel’s popularity sunk 12 points after the Munich terrorist attack, the second lowest showing since the start of the current government in 2013. Only 34% said they were satisfied with her handling of the refugee crisis.

Pensions are going to be a huge problem and as I showed with the US, unfunded portions due to the inability to generate significant returns will strangle authorities. They can babble on all they wish over actuarial assumptions, but the reality is that people will be forced to retire with less, despite tipping in more while they have to wait longer. Would anyone voluntarily sign up to that type of situation?

As I wrote on pensioners in Japan, the ramifications for people who discover the safety net they expected is not there, some choose to commit crime to spend life in prison as such a life is preferable to struggling on the outside on a pittance.

US public pension hole would swallow 100% of state taxes to fill

unfunded pensions

The beauty of pension accounting is that slight tweaks can make a large unfunded liability seemingly disappear. However if a pension fund plays the game of understating its risks for long enough then eventually it catches up with them. The risk of state and local (S&L)governments going bust is becoming a reality. I wrote on the S&L bankruptcies to date in the US last week. It is a nightmare for Main Street.

The US Federal Reserve has an interesting set of data on state and local pensions tucked away in its vaults. The unfunded pension liabilities as a % of GDP are truly worrying. As I pointed out with CalPERS, the generous return profile it states but isn’t achieving means its unfunded proportion is much higher in reality.

The Fed reported in 2013 that the State of California had an unfunded pension liability status equivalent to 43% of state revenue. However if marked-to-market with realistic discount rates we estimate that it is equivalent to 300% of state revenue or 7x as great. Going back to 2000, California had an unfunded liability less than 11% of tax collections. As a percent of GDP it has grown from 2% to 9.7%. If our estimate is correct, the mark-to market reality is that California’s unfunded state pension (i.e. for public servants only) is around 18% of state GDP!

unfunded pensions rev.png

The State of Illinois is even worse. The unfunded pension liability is around 24% of state GDP. In 2000 the unfunded gap to state revenue was 30% and in 2013 was 126% in 2013. Alaska is at 20% of GDP up from 0.27%.

On a gross country level, the US Fed reports that aggregated S&L unfunded pension amount of $1.35 trillion in 2013 from $94.8bn in 2000. As a percentage of GDP it has climbed from 0.9% of GDP to 8.19% over that same period. If the FT is right in assuming a $3.4tn pension funding gap today then the impact should be 2.5x higher or 20% of US GDP.

Putting unfunded liabilities as a % of state tax collections under that scenario and we would effectively see 100% of state budgets across America be required to close the gap. Of course the entire gap doesn’t require immediate action (because all retirees aren’t happening at once) to get it to zero but getting it to a point where it could safely cover future liabilities on realistic returns over the long run would still  require significant injections. Such injections would crimp S&L services causing retrenchment of staff, public services and so on.

Perhaps more alarming is that with asset prices so artificially inflated we must question the mark-to-market pension assumptions should equity and bond markets collapse, leaving even larger unfunded liabilities with the ensuing economic impacts crushing tax collection creating an even more vicious circle. As Caroline Burnham said on American Beauty, “You cannot count on anyone but yourself!”