April 2, 2013
The Problem With Pensions
The Investment View from Prescott, Arizona
Respected financial newsletter writer John Mauldin, whom I first met when we both collaborated on a Y2K book in 1999, recently wrote about The Problem with Pensions. The gist of his article was how state and local pension obligations are underfunded by some $3 trillion.
And with investment returns over the past 13 years running well below what most pension funds planned for, the hole they are in just keeps getting deeper.
Some states have laws that will not allow for adjustments of pensions that lack funding. The taxpayers are completely on the hook and pensioners are protected.
Or are they?
I have written several times about the austerity measures imposed upon Greece and other countries that flounder financially. Part of that process is the government throwing up their hands and saying something to the effect of “we know we promised you all of those benefits, but we can’t come up with the money. Sorry.”
The bottom line is that in “austerity” pensioners, government employees and public unions get their pay checks slashed, and have no option but to accept that fact.
In reading Mauldin’s article I realized that the protections pensioners rely upon were greatly weakened by the government’s ham-handed takeover of General Motors a few years ago.
In that takeover, the administration unilaterally decided that the normal pecking order of payment of debts in a bankruptcy would be tossed out the window. Normally in bankruptcies, stock holders are wiped out and bondholders take over what remains of the company. In the GM case, the autoworkers’ under-funded pension plan was put ahead of the bond holders and given a large block of GM stock.
So, what might happen if a State declares bankruptcy? If the federal government can change bankruptcy laws that have been in effect for more than 100 years on a whim, why can’t they also tell the states that the laws protecting pensioners must be written off, too?
We are learning to look forward to the next rabbit the Federal Reserve will pull out of its financial hat to deal with the lingering economic problems, but we should not get too dependent on government fixes. We need to recognize that the folks who run the government are just people and are struggling for answers like the rest of us.
A government that passes a law protecting pensioners can also void that law. It is very risky to ever depend on the Government to take care of you or your problems.
A Slice of Life
There are few places in the Grand Canyon area where the Colorado River is more accessible than in the Black Canyon below Hoover Dam. This past weekend I put in just a few hundred yards below Hoover Dam in a river raft and floated 15 miles down the Colorado to the Willow Beach campground.
Maybe all the mechanics and heroics that went into building the Dam are a guy thing, but a water-level view of the Dam is something I never figured I’d have. It is truly spectacular. And everyone can enjoy the clear water, soaring cliffs and herds of mountain sheep in this vast and beautiful wilderness.
The half-day trips are run by Black Canyon River Adventures and are well worth the time and money if you get a chance to do it.
Scottsdale Office Date
If you would prefer to meet with Will in Scottsdale rather than Prescott, please call 928-778-4000 to set up an appointment.
Q: What is always coming but never arrives?
How’s the Market Doing?
The big financial news from the first quarter – aside from Russian mobsters getting taken to the cleaners by Cypriot bankers – is the strength of the US stock markets. As of this writing on March 31st, both the Dow Jones Industrial Average** and the S&P 500 Stock Index** are at new highs after spending 13 years “under-water”, to borrow a term from our real estate friends.
Is this a big deal? Not really. Taking losses too large that it takes 13 years just to break even is a better way to put it, and is really nothing to brag about. Index investors may have finally gotten their money back, but have still lost 13 years of savings power, time that they will never get back.
However, things could be a lot worse, and have been worse for stocks for much of the past 13 years, so we ought to be grateful for what we have.
And times are still difficult for much of the bond market. The Vanguard Total Bond Market Index fund (VBMFX) lost .45% for the quarter even after reinvesting dividends, and looking back even further VBMFX has been declining for over 8 months now. Fortunately our Flexible Income* strategy invests very differently from Vanguard, and we have had different results as you can see elsewhere in this newsletter.
Gold, while having declined for 20 months now, is showing signs of life once again by trying to mount a small uptrend. Just like we must respect all small declines because big declines all start out as small ones, we take interest in each small uptrend, because big uptrends all begin as small ones.
What’s Going On In Your Portfolio?
Both our Growth and Flexible Income model portfolios wrapped up the first quarter with nice gains.
I added gold to both the growth and income portfolios recently. Although gold’s bounce off its February 20th low has not been a strong one, the chart pattern shows this to be a low risk entry point, which is the way I prefer to buy investments.
Growth portfolios now hold a combination of stocks of companies in utilities, consumer products, health care, real estate and Australia as well as some diversified growth funds and gold.
Income portfolios continue to hold municipal, floating rate, high yield and diversified bond funds as well as some high yielding real estate investment trusts and gold, but no government bonds.
Our municipal accounts flattened out in March, but still had a good quarter due to profits made in January and February. Because this strategy has had a good run, one soft month is not really cause for concern.
Making Money at Different Times
We have been making money in all of our model strategies this year, but so has the stock market, some might say. The difference in my performance and the stock market is that we diversify by using many different types of investments. And with our added diversification comes an extra level of safety not available with something like a stock index fund.
Our portfolios tend to go up slower when the market is hot and sometimes are counter cyclical, going down when the market goes up. But we also tend to be much more stable in bad markets, and if you understand the math of gains and losses you’ll understand this lower volatility is a result of my lower risk approach to things. It is easier to make money if you don’t take big losses, so that is priority #1 at Hepburn Capital.
This is what I refer to with tongue in cheek, the Hepocratic Oath. “First, lose no money.”
My style outperforms over long periods, but makes money for you at different times than the stock market.
It is easy to be fooled by a rising market and think that everyone (especially you) should be making just as much as the market indexes are doing.
In fact it is smarter to make money when risk is low and move to a safe harbor when risk is high rather than blindly following the indexes and the headlines they generate.
With our Adaptive Growth Strategy we strive to provide high total return from a combination of investments from both the equity and income markets with the emphasis on equities.
Our proprietary Stock Market Exposure Indicator is used to determine a stock market exposure that adapts to the strength or weakness of the market, directing exposure in the HCM Long/Short Equity strategy to range from 0% to a maximum of 80% of account value. The balance, 20% to 100% is invested using the HCM Flexible Income strategy. The HCM Safety Net indicator is designed to warn of sudden potential declines in which case stock market exposure is quickly reduced.
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable; however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.