Remember the 2008 financial crisis? Of course you do as it crushed many individuals along with entities entrusted as fiduciary’s that were managing OPM or, other peoples money!
In the era leading-up to the implosion of the global financial markets, more than a few titans of finance from Wall Street to the streets of small school districts across America were duped into investing in highly complex financial products devised by quants out of schools like MIT.
These instruments that few outside of the ‘geniuses’ who created actually understood, went by names such as derivatives, credit default swaps (CDS), collateralized mortgage obligations (CMO), collateralized debt obligations (CDO) and Commercial mortgage-backed securities (CMBS) to name just a few.
These products in many cases were purchased without any real comprehension by the buyer of either the inherent risks or of the illiquidity of the investment were it ever necessary to sell them in the secondary market.
But, at the same time, these products had existed for many years and with the right participants on both sides of the trade, served a useful purpose. The problems arose when uninitiated and unsophisticated investors were sucked-in by the promises of outsized returns, explained to them by salesmen making outsized commissions!
And, as in all things, everything was okay until it wasn’t.
In 2017, Complex Investments and State Pension Funds
Now consider that in the post-financial crisis era of undersized bond yields, underfunded pension funds and pension fund annual return estimates that have not been significantly adjusted down, state and locally run retirement systems have once again turned to complex investments that they may not fully understand.
From The Pew Charitable Trusts, ‘State Public Pension Funds Increase Use of Complex Investments‘…
State and locally run retirement systems currently manage over $3.6 trillion in public pension fund investments, most of which are held by states. Broadly, half of these assets are invested in stocks; a quarter in bonds and cash; and another quarter in what are known as alternative investments, such as private equity, hedge funds, real estate, and commodities.
Although governments and employees contribute to pension funds, investment earnings on plan assets are expected to pay for about 60 percent of promised benefits. In a bid to boost investment returns and diversify investment portfolios, public pension plans in recent decades have shifted funds away from low-risk, fixedincome investments such as government and high-grade corporate bonds. During the 1980s and 1990s, plans significantly increased their reliance on stocks, also known as equities. And over the past decade, funds have increasingly turned to alternative investments to achieve investment return targets.
Greater investment in equities and alternatives can provide higher financial returns but also bring heightened volatility and risk of shortfalls…
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