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Public Sector Pensions Are Counting On Cryptocurrencies, Should You?

Gregory Eaden makes a big show about the water that runs from his faucet.

“Look at this stuff, should anyone even be allowed to drink this stuff? Is this even America?”

Eaden, like the other residents in Flint, Michigan, is of course complaining about what passes off as water in the once thriving industrial town in the heart of what was once America’s industrial heartland.

Like so many other towns that once represented the American dream, offshore manufacturing and globalization have taken their toll on the backbone of America’s industrial glory.

But Eaden has one feather in his cap, apart from his fellow Flint residents — he has a pension. Eaden used to work for the Ford Motor Company, where he worked the assembly line, rising to floor chief and retiring almost two decades ago.

For Eaden and thousands of other workers like Eaden, a pension provides for the fruits of their labors, a recompense for their dedicated years of service to a company, in return for a safety net at the end of their working years.

But increasingly, promising a pension is becoming a long term and expensive business — especially where pension payouts are linked to earnings.

Whether an employer is private or public, the costs one might be lead to assume, ought to be the same in the long run, as would be the investment approach.

And up until 2008, before the financial crisis, that was true for most American pension plans. Both private and public sector pension plans had more or less the same asset allocations, which sought to grow at a rate faster than inflation, whilst still preserving the overall value of their pensions.

Pension Plans Just Got Racy

But a report by Jean-Pierre Aubry and Caroline Crawford of the Center for Retirement Research (CRR) at Boston College shows that things may have changed quite dramatically for the once staid business of pension plan management.

For starters, quite apart from wealth preservation, the CRR report revealed that public pension plans have 72% of their portfolios in what are considered “risk” assets, including equities and alternative such as hedge funds, with private pension plans holding only 62% in similar assets.

As any seasoned investment manager worth their salt will tell you, the public sector pension allocation mix in “risk” assets is hardly a “preservative-biased” asset allocation plan. If nothing else, whether wittingly or unwittingly, such an asset allocation is “growth-biased.”

But because private pension plans generally have more members who are retired, they adopt a far less risky approach. Because private pension plans must focus on paying benefits immediately, rather than on the assumption of long-term growth, it is understandable that their approach is somewhat more conservative. Whereas public sector pension plans are not as hamstrung in their asset allocation.

Because the cost of paying any pension stretches far into the future, a 25-year-old today, could still be receiving an income in the 2080s. Which is why employers must discount future payments by some rate to calculate the current cost of running the pension.

And since a pension is in essence, a long-term liability or debt, a private pension plan must use a bond yield as the discount rate, or the risk-free rate of return as the discount rate, while a public sector pension plan has the privilege of using the expected rate of return on their investments — the higher the assumed return, the higher the discount rate and the lower the current cost appears.

Currently, public sector plans assume, on average a 7.4% rate of return — which is pretty optimistic considering that Ray Dalio’s Bridgewater Pure Alpha Fund returned 14.6% last year, one of the highest for a hedge fund. Pension plans are not hedge funds. There’s a reason why Dalio and friends were able to post those returns — more risk.

But it is because public sector pension plans can plot a far longer term return horizon that they tend to have riskier portfolios — and they must, in order to justify their return assumptions.

And while this may come as a surprise to some, is precisely the reason why some American public sector pension plans have catered an allocation for cryptocurrencies, specifically Bitcoin and Ethereum.

While during the early days of the cryptocurrency craze, public sector pensions did not even know about, let alone consider, cryptocurrencies, the relative cooling off of global interest and the rise of institutional grade custodial solutions for cryptocurrencies recently put them on pension plan manager’s radars.

Cryptocurrencies, specifically Bitcoin and Ethereum are considered speculative bets in the long term future of decentralized finance — similar in perhaps some aspects to public sector pension funds investing in venture capital. And with Bitcoin and Ethereum both riding relatively stable at around US$3,500 and US$100 respectively, they seem (to some), far less risky than perhaps a bet on an already over-priced stock.

Given the returns of public sector pensions over the past decade, an allocation in cryptocurrencies, regardless of how speculative, may be justifiable. According to CRR, the average public pension was only 72% funded as of 2017 — a result of an abysmal decade of returns since the financial crisis — and this is using the most optimistic accounting approach.

In contrast, in 2001, public sector pensions were fully funded. And dismal returns in 2018 in equities means that public sector pensions will likely be in even poorer shape moving into 2019.

It is against this backdrop, that it is understandable why public sector pension managers are looking elsewhere for gains.

With a red-hot stock market at eye-watering valuations, public sector pension managers are looking to emerging markets, venture capital and it seems, even cryptocurrencies, to cover the gaps of today, while perhaps providing that possible adrenaline shot for the future that will payoff the Millennials that are working in the public sector today.

Back in Flint, Eaden is driving his 2018 Ford F-150 to a nearby Walmart to get a new water filter, oblivious to the fact that the future of his pension may be as murky as the water in Flint.

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Patrick Tan

Written by

CEO of Novum Alpha, an all-weather digital asset trading firm that uses Deep Learning tools to deliver dollar-returns in all market conditions.

The Capital

A publishing platform for professionals in business, finance, and tech

Patrick Tan

Written by

CEO of Novum Alpha, an all-weather digital asset trading firm that uses Deep Learning tools to deliver dollar-returns in all market conditions.

The Capital

A publishing platform for professionals in business, finance, and tech

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