Is Your Pension Fund "Going for Broke?"

From EWI
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Mutual fund cash levels have fallen to record lows in recent months. The one-word question is: Why?

The near-certain answer is this: money managers are incredibly optimistic about how they think risk assets will perform. Otherwise they would hold more cash, to defend against the future.

In the past, low levels of mutual fund cash often coincided with market tops. The opposite is also true, as you can see below (the recent 3.4 percent cash level noted in the chart is an all-time record low!):

With that record low 3.4 percent cash level in mind, now consider the cash levels of the nation's two biggest pension funds.

The California Public Employees Retirement System (CalPERS) recently had only 2 percent of its $230 billion allocated to cash or equivalents.

The California State Teachers' Retirement System (CalSTRS) recently had even less in cash or equivalents: just 1.4 percent of its $152.9 billion.

The investment officers who oversee those funds clearly are not afraid of risky investments. They've jumped into them with both feet. (In a recent interview with CNBC, the Chief Investment Officer of CalPERS said he's aiming for a 7.75 percent annual return, which would meet his pension promise.)

All is well when most financial markets are rising. But what if stocks and other risky assets tank again?

It may comfort CalPERS and CalSTRS shareholders to know that the funds are "diversified." CalPERS has 67.1 percent in global equity, 20 percent in global fixed income, and over 7 percent in real estate. CalSTRS has 54.1 percent in global equity, 17.5 percent in fixed income, and over 11 percent in real estate.

But does diversification necessarily protect a portfolio from substantial losses? Should you be comforted by a pension fund that's "spreading the risk?"

"Myth -- diversification protects investors from losses. EWI dispelled this myth long ago, but it took every bit of [the financial collapse], when nearly all markets were down 30%-50%, for the idea of diversification to finally come under scrutiny."

Elliott Wave Financial Forecast, February 2010

This "diversification" lesson comes from very recent financial history. Many markets can go down together.

Millions of households count on the financial health of pension funds. According to CNBC, the present shortfall is about $2 trillion. Pension fund officers are "going for broke" -- which, so far, has worked during the rally.

But what about the months and years ahead?