What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed

Cambria Quantitative Research Monthly, Issue 2, June 2011

9 Pages Posted: 13 Jun 2011 Last revised: 20 Jun 2011

Meb Faber

Cambria Investment Management

Date Written: June 10, 2011

Abstract

It is well known that pension funds in the United States are underfunded even if they achieve their projected 8% rate of return. The scope of pension underfunding increases to an astonishing level when more probable future rates are employed. A reduction in the future rate of return from 8% to the more reasonable risk-free rate of approximately 4% causes the liabilities to explode by trillions of dollars. As bond yields declined over the past twenty years, pension funds moved toward more aggressive equity-based portfolios in an attempt to reach for this 8% return. By investing in a portfolio with uncertain outcomes, pension funds could experience increasingly volatile and even negative returns. Paradoxically, in an effort to chase the universal 8% rate, pension funds may be laying the groundwork for returns even lower than the risk free rate. In an effort to offer an empirical basis for this possibility, we conclude the paper with a relevant comparison - the return of a hypothetical Japanese pension for the past two decades. We believe that pension funds need to at least prepare for the unfathomable: 0% returns for 20 years. Most pension funds, regrettably, have not adequately stress tested their portfolios for these scenarios.

Keywords: pension funds, endowments, bonds, stocks, Yale, Harvard, commodities, real estate, Japan

Suggested Citation

Faber, Meb, What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed (June 10, 2011). Cambria Quantitative Research Monthly, Issue 2, June 2011. Available at SSRN: https://ssrn.com/abstract=1862355

Meb Faber (Contact Author)

Cambria Investment Management ( email )

2321 Rosecrans Ave
Suite 4270
El Segundo, CA 90245
United States

HOME PAGE: http://www.cambriainvestments.com

Paper statistics

Downloads
4,367
Rank
1,363
Abstract Views
18,134