A Hobson’s choice is a free choice in which only one option is offered. As a person may refuse to take that option, the choice is therefore between taking the option or not - i.e. “take it or leave it”. So how does this apply to pensions?

1. Agcapita Update
October 2011

2. Agcapita Update
A Hobson’s choice is a free choice in which only one option is
offered. As a person may refuse to take that option, the choice is
therefore between taking the option or not - i.e. “take it or leave it”.
So how does this apply to pensions?
None other than the august PIMCO, the worlds largest (US$ 1
trillion) bond manager and home to Bill Gross, has jumped on the
“pensions are in trouble” band wagon. A bit late but a welcome
addition in any event. In some recent analysis they echo what our
firm has been warning about since the inception of Zero Interest
Rate Policies (“ZIRP”) around the globe - that the value of pension
fund liabilities is growing while the returns necessary to fulfill them
are dwindling, leaving pension funds progressively more under-
funded with each passing moment.
As I have written many times in the past I believe we are seeing
just the very beginning of the problems we will have to face with
pension finances.
The particular area of concern is that a significant number of
pensions assume annual returns in the range of 8% when they
are planning how to meet their obligations. As a large portion
of pension portfolios are in fixed income securities that are now
yielding a fraction of that number, these return assumptions are
challenging to put it mildly. It turns out that the 8% return number
is just the beginning of the aggressive assumptions that pension
fund managers are building into their models in order to make
their plans seem whole. Pension fund managers are now implicitly
assuming 11% equity returns. It goes almost without saying that
this is at best wishful thinking. It seems unlikely indeed that pension
fund mangers will be able to generate consistent 11% equity
returns going forward when they rarely if ever generated such
returns in the past. Even less likely since recent research from the
Federal Reserve shows that due to baby boomer selling pressure
equity returns will be below long run averages over the next 2
decades and no where near 11%.
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3. Agcapita Update (continued)
Given the unreasonable return assumptions, ZIRP outside of the US pension sector as well. Do we truly
and ongoing market losses, just how serious is believe European, UK or Canadian pension plans are
the pension funding shortfall? A recent pair of US in any different condition from their US counterparts?
studies on municipal and state pension obligations
by the Kellogg School of Management found a total Of course, we can safely assume that retirees
funding shortfall at the municipal and state levels who have been promised benefits are going to
of around $3.5 trillion - more than the banking bail- exert powerful political pressure to be paid in full.
out to date. In addition, PIMCO estimates that the Unfortunately, even some simple analysis should
recent reduction in yields brought on by the Federal make it clear that there is unlikely to be enough cash
Reserve’s “Operation Twist” - yes that’s its real name in pension fund coffers to pay them and stay solvent.
- combined with equity market declines created
approximately $80 billion in new shortfalls for US Ultimately, benefits will have to be reduced and/
corporate pensions bringing the cumulative total to or large amounts of additional capital in the form of
over $400 billion. higher contributions or newly printed bail-out monies
will have to be collected. Barring this pensions may
I would argue that these issues of unrealistic return go bankrupt. Take it our leave it - Hobson’s Choice.
assumptions, ZIRP and funding shortfalls exist
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