Illinois pension funds desperately need higher annual investment income that is earned in a prudent way via “Investment Grade” quality rating limitations on corporate debt obligations.  Illinois has an aggregate under funded public pension obligation that is near $80 Billion on net assets needed now to be fully funded to 100%.  Increasing the annual interest income on the bond allocations in fund portfolios will greatly assist in closing the under funded pension gap.

Please see letter below that explains a proposition by my firm, Capital Management Associates, a Registered Investment Advisor to set in place appropriate guidelines for Illinois Public Pension Funds to utilize corporate debt obligation to 30% of pension fund assets:

April 2010

Dear Senator Lauzen and Senator Harmon,

There are a number of concerns, as noted below, that need to be addressed in the Article 3&4 pension Code Revision, the Bill, before it becomes a statute, in respect to allowing investments in corporate debt obligations via mutual funds, ETFs and portfolio accounts to a maximum of 30% of total pension fund assets.  Each of these concerns has to do with avoiding excessive risk from allowing corporate debt obligations as an alternate investment in Government guaranteed debt obligations:

Maturity…How long the debt obligation is outstanding until maturity, to its par value redemption.

1. Issuer Bond Weighting…The percent holding in any issuer to the total portfolio.
2. Sector Weighing…The percent of total issuers in the same industry sector (Global Industry Classification Standards or GICS) to the total portfolio.
3. Call Features…Having a debt obligation(s) called early before the full maturity is reached.
4. Deferrable Features…Is the issuer able to legally defer making regular interest payments.
5. Leverage…Does the mutual fund or ETF employ borrowing or debt leverage to increase its interest yield
6. Rating drop below investment grade…If/when a purchased debt obligation is downgraded to below Investment Grade…What is security exit plan?

 The following discussion covers the need to establish limitations on corporate bond investments to reduce financial risk to public fund assets.

 Maturity

Limiting the maturity of a debt obligation allows the fund to set a maturity period in years on debt obligation investments to cover a time period compliant to the pension liability payout period…approx 30 years maximum. We recommend a 30 year maximum maturity term. This term coincides with the current 30 year maturity allowed under the Code for U.S. Government debt obligations.

 Issuer Debt Obligation Weighting

Limiting the issuer debt obligation weighting to a maximum percent of portfolio assets helps to minimize company default risk on the fund portfolio.  We recommend no greater than an industry-normal diversification standard of 3% maximum allocation to any one corporate issuer.

Sector Weighting

Setting a percent limit on the maximum investment allocation of corporate issuers to any one industry sector GICS (Industrials, Financials, Information Technology, etc) in the economy is a mechanism to limit risk exposure that may disproportionately impact certain economic sectors during extreme macro economic adversity.  It would not be desirable allow a large percentage of corporate issuers in the bond portfolio to be invested in the financial industry sector that is systemically exposed to: higher interest rate risk, leverage and credit default risk, as an example. We recommend limiting Industry Sector allocations to a maximum15% in any one sector. This ensures that at least 7 sectors will be used creating broad economic diversification to the overall economy. The Global Industry Classification Standards or GICS should be used as this is a widely accepted benchmark. The 10 GICS sectors are Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecommunication Services and Utilities.

 Call Features

Callable debt obligations create a risk condition to the investor, whereby if a bond is called or redeemed well ahead of its stated maturity, that would exposes the fund to risk of having to reinvest assets at lower interest rates than what the original bond holding was issued at.  We recommend allowing a maximum of up to 25% of the overall corporate debt obligation portfolio to be in callable bonds.

 Deferrable Features

If a debt obligation is deferrable, it can legally suspend interest payments for many years. This would create an interest income cash flow shortage to a fund, jeopardizing its pension liability payouts. We recommend prohibiting deferrable corporate debt obligations.

 Leverage

 The use of debt leverage within bond mutual funds and ETFs to enhance overall interest yields is inherently dangerous.  If interest rates were to soar, the effect is to financially collapse the mutual fund or ETFs viability.   We recommend that no bond mutual fund, ETF or debt obligation portfolio account employ the use of debt leverage.

 Rating drop below investment grade

 The Standard and Poor’s (S&P) investment grade range for corporate bonds spans from AAA to BBB-. Pension funds could excessively weight BBB corporate debt obligations (for highest relative interest yields), but being in the lowest tier (BBB), these debt obligation have relatively high downside price risk if their rating falls to “below investment grade” (Junk).  We recommend that if a corporate debt obligation holding is downgraded to below Investment Grade by two rating agencies, then the fund can hold the investment for up to 12 months from date of downgrade in anticipation of a corrective rating upgrade. If an Investment Grade rating is not reset for the debt obligation holding, the security must be sold.

 Revision to ILL Code allowing corporate debt obligation investments.

Insert the following after Line 169 of the Revised Code

 “Limitations on corporate debt security investments: (i) corporate debt maturity is limited to a maximum of 30 years from date of new issuance or remaining life of the security, (ii) no greater than 3% of the pension fund’s allowable 30% allocation to corporate debt assets can be invested in a single corporate issuer, (iii) no greater than 15% of the fund’s assets can be invested into any one GICS classified sector, (iv) deferrable interest debt obligations are prohibited, (v) a maximum of 25% in callable corporate debt obligations are permitted, (vi) no debt leverage is permitted within any bond mutual fund, ETF, or individual corporate debt portfolio, and (vii) if the investment grade rating by one or more of  two standard credit rating services falls below investment grade, then the bond must be sold if it is still rated below investment grade by two credit rating services after a period of 12 months of the downgrade.

Sincerely,

Chuck Dushek

In today’s world, the “Big Trouble” is massive unfunded State and Municipal fiscal deficit spending…plus enormous underfunded public pension fund payout obligations…for retirement and healthcare benefits. They have outstripped State and Municipal tax revenues.

Some of these deficits are a result of the prolonged recession that began in 2008. Yet, much more is “endemic” in the financial business models of State and Municipal governments. These entities, via their politicians, have granted huge growth in spending for education, infrastructure, non-essential public employment, early retirement pension at age 50, retirement healthcare benefits from age-50 to age 65…until Medicare steps in and so one…over the past 10 years and longer.

These spending initiatives are completely out of step with today’s economics at State and Municipal governments. Tax collections from retail sales, real estate tax assessments, income taxes can’t keep up with the growth in current budget spending, and hardly scratch the surface of the funding needed to cover the public employee retirement and healthcare packages.

This “time bomb” is ticking louder by the month, and the “Wake Up” call from the clock is ready to ring, according the Governor Chris Christie and Meredith Whitney.

I invite you to listen to the 15 minute video that aired on 60 Minutes last Sunday night. It is an amazing “right out of the box” reality discussion of the problems in public finance that are largely being ignored by the general populace, and the offending governments themselves.

http://www.senseoncents.com/tag/meredith-whitney-60-minutes-december-19-2010/

Wall Street is ignoring the impending financial crisis in state finances….for good self-interest reasons to themselves…”They syndicate all the new muni bond issuance that gives them fee income”…again self-serving, like the past binge in sub-prime mortgage issuance.

State and Municipal new bond issuance is booming across the country. The Fed’s Zero interest rate policy “QE” is encouraging the average investor to “reach for yield”. That means there is a ready appetite for public debt if the interest rate and tax exemption is attractive…never mind the default risk factor.

Build America Bonds (BAB) represent a cheaper alternative for state and local governments to tap the capital markets through long-term bond borrowing. As part of the 2009 American Recovery & Reinvestment Act, these entities were allowed to sell the taxable debt for infrastructure purposes, receiving a 35% federal interest cost subsidy. Yet, even though the BAB looks to be a “healthy choice” to cover some state spending bills, it does nothing to cure the core problem of state financial infidelity of pursuing chronic deficit budget spending and growth in public employee entitlement benefits.

Yes Sir….“There is Big Trouble in River City”, and we believe it wise to listen a bit to Professor Harold Hill (aka Chris Christie and Meredith Whitney). Christmas benefit presents to public employees across the country are going to be a lot smaller in the years ahead, if not ending, if bond defaults begin to emerge.

Public pension fund Trustees have an obligation to help cure the unfunded pension deficits.  Their role is that of “pension fund investment management oversight”.  Most states are using a very outdated annual investment return assumption of 7.5% to 8%.  These annual returns have not been consistently attained for more than 10 years.  Trustees must revise their investing strategies to utilize high dividend yield common stocks, and cease their focus on “growth stock investing”.  See: www.CMAHighDividends.com  for portfolio strategy in high dividend common stocks.

Chuck Dushek, President

Capital Management Associates Inc.

801 Warrenville Road

Suite 195

Lisle, IL 60532

Phone: 630-963-4235 Ext 1

Fax: 630-963-4236

Email: ChuckDushek@CMAAdvisors.com

The economy and politics are at an important crossroads at this point in time.  There is no solid evidence of a sustainable economy recovery in place, and in November, the balance of political party power will shift from the election outcomes.  The public pension funding crisis is “coming front stage”.  Pew Center national pension fund underfunded estimates take the potential deficit to $3 Trillion, and that is assuming annual pension fund investment returns of 7-8% annually going forward.  The stock market has been flat in performance for 10 years running and the 10-year US Treasury bond yield is only 3% now…half the 6% interest rate in 1999.  All the points discussed below all correlate to a nationally “unmanageable” public pension liability condition in the years ahead.  Of particular note, see NJ Gov Christie statements about midway thru this report.

But first, let me start by summarizing a few of the most pivotal “points of interest” along our current journey along the highway of Uncertainty…Uncertainty felt by most people about there being a real upside turn on housing values, will there be growth in employment again, will there be an end to massive government deficit spending, and can stocks, after 10 years of flat line performance, rise again into a bull market?

The common thread of all these uncertainties is hinged to one critical factor of great importance to each American household.  People are most worried about their “personal financial condition”…can they be financially secure by retirement? Will the economy be supportive to sustain public pension liability payouts?  Financial security is the biggest worry facing households today.  The outcome of the elections in November and the course of the economy hold the key to household financial security.

For many months, and quarters, we have been advocating “income focused” investing strategy to build household financial security…building sufficient wealth to afford retirement.  All past history and logic that supported “growth investing” asset appreciation for wealth building is “out the window” today in this New Economy.  The New Economy is one that is prone to more frequent and progressively larger economic and financial market shocks.  These “shock” events of the past several years in particular have set the stage for a much slower economic growth trend in the years ahead.  The forward-looking business environment is less certain.  As people are now more fearful of stock market crashes and financial leverage-induced real estate value meltdowns…there is an exodus from appreciation-oriented risky investments.  Pension funds will need to employ more “income asset investments (corporate bonds)” or at least higher dividend equity investments to hit annual hurdle return rates.

The “New Economy” is a very sluggish growth economy, employment recovery will be slow, wage increases will be small, government deficits bigger, and private sector debt deleveraging will diminish consumer spending potential.  These are all things that are deflationary.  And, deflation means that asset valuations for real estate and stocks will be very slow to expand in the next 3-5 years.

Let’s now look at a series of predictions or projections that I can see as a result of current major conditions in the economy.  These are all conditions that have long multi-year cycles of boom-bust-recovery…”mega-cycle” conditions or events.    These conditions will inhibit any fast upturn in the economy and recovery in fixed asset and growth stock valuations.  Personal wealth growth from an asset appreciation cycle, cannot occur in a deflationary cycle setting.  Many of these deflationary conditions will need to run their course of correction and eventual recovery over a 3-5 year period…at least.  On the perspective of time for recovery, the Great Recession, which began about 2 years ago on September 15, 2008 when Lehman Brothers filed Chapter 11 bankruptcy, marked the onset of recession…the recession was supposed to have ended about this time last year, yet it still feels very much like we are still “in recession”…employment and GDP growth are stalling.

 CMA’s Forward Looking Predictions

 1.  Housing will continue to remain depressed as the sub-prime bubble created $1Trillion in defaulting mortgage debt.  This equals approximately 5 million sub-prime mortgaged homes that will continue going through repetitive foreclosure and short sale for the next 3-5 years, ending only when unemployment recedes to below 6%…3-5 years off.

 2.  Access to auto financing will stay depressed and annual sales will stay in 9-12 million range far below the 13-15 million unit pre-recession zero interest rate financed production/sales trend.  Employment will not grow in the all-important auto/light truck US production industry.  Imports continue to take market share.

 3. US government debt level has risen by about 40% over the past 3 years, where it will soon hit near 90% of annual US GDP, this will take 1% per year off the US potential annual GDP growth rate.

 4. Best guess for State and Municipal fiscal budget deficits for 2011 and 2012 is $300 Billion each year.  Spending reductions are needed because weak income tax revenues, sales and property tax collections have produced huge deficits…Illinois is $13 Billion deficit.  I estimate near $100 Billion in public sector job spending cuts.  At all-in employment cost of approx $70,000 salary/benefit per employee = 1,400,000 reduction in public sector State and Municipal employment work force during 2011 and 2012.

 5. Consumer household debt deleveraging.  In 1980s and 90s the Household Debt/Household Income percent ratio equaled near 80%, it peaked at 136% in 2007, and is currently near 120% of household income.  Consumer annual savings rate doubled to near 6% currently, should take 5 years to bring debt burden percent level back down to 90% range…near normal…weak future consumer spending as a result.

Read report by Baily & Lund:

www.international-economy.com/TIE_Su09_BailyLund.pdf

 6.  Federal Reserve Zero interest rate policy will stay intact for another two years.  This is a hardship penalty to retired population that “are not risk investors”.  CD rates at 1-2% will continue to retard retiree discretionary spending, which will continue to retard US economic growth from an expanding retiree population base.

 7.  As US government treasury securities interest rates will stay at half the interest rate level of 10 years ago, public pension funds will continue to become more underfunded due to low interest income returns…60% of pension assets are in US Treasury and Agency debt securities.  Pension payout benefits will eventually be reduced, as retiree pension incomes fall, and public sector retiree discretionary spending will fall.  Public pension system funds are near $3 Trillion underfunded today.  There is no quick fix…reduce payout benefits…or pension fund insolvency.  ( 9/15/10 NJ Gov. Chris Christie yesterday proposed a sweeping pension and health benefit reform package that would ultimately shift billions of dollars in costs from state and local budgets to current and retired teachers, police, firefighters and government workers.

While the Christie administration did not provide detailed numbers, the higher pension and benefit contributions proposed by Christie would be tantamount to a 7 percent pay cut for most teachers and government workers, and about a 4 percent reduction for police and firefighters phased in over the next three years, based on preliminary NJ Spotlight calculations.

The Christie plan also would significantly lower pension checks for future retirees by rolling back the 9 percent pension increase approved by a Republican governor and Legislature in 2001 and by eliminating all future cost-of-living increases for retirees.)

8. On global trade, the US dollar is staying artificially high due to its “reserve currency status” and US exports continue to be over-priced on comparative trade advantage with the rest of the world.  China, Japan, Western Europe all have undervalued currencies relative to the US dollar.   Japan’s yen looks “overvalued” according to the Japanese, yet they run a chronic “trade surplus” with US of about $80 Billion/year…Yen needs to higher to the dollar, not lower. US will continue to suffer a near $500 Billion annual trade deficit of goods and services (Primarily with China.) that equals 3-4% of US GDP.  More US manufacturing and services jobs will continue to leave the US…or, US unskilled wages will fall, that lowers household income and purchasing power.

 9.  Between now and November elections, most major business capex and hiring expansion plans are “on hold”.  Why?  If republicans have a winning streak in Senate and House,  a broadly “conservative political mentality” a majority, will curtail fiscal deficit stimulus spending going forward…and the potential for a stimulus-induced economic recovery in 2011 and 2012 will not exist.

 10. President Obama will continue to lose political popularity.  He has created inflated expectations that government stimulus programs can cure the extreme down business cycle correction of very high unemployment and an implosion in residential real estate valuations.  As it has been said:  “It’s the Economy stupid” that has traditionally influenced multi-term presidential popularity.  He will be a one-term president.  Unemployment will not see a meaningful decline until after 2012…too late in his game.

 All of you reading this are probably pretty depressed by now, maybe on your second martini.  Sorry…what I am predicting is not of my own unique fascinations…me looking through a depressing lens, not a rose colored one, to the future.  People much smarter and perceptive  than I: Nouriel Roubini, Pat Choate, Bill Gross, Mohammed Al-Arian see very similar visions of unfavorable reality ahead. It is all a part of the wonderful world of capitalism…boom and bust.

Governments cannot cure the “busts” or materially shorten the pain of a “bust”.  They only put “Band Aids” on them…soften the blow, push the real fixes off into the future…let the next generation or political administration worry about it.  I dwelled on that in one of my recent CMA Updates…”Fixing the Unfixables”.  Capitalism…The Best of the Worst economic systems on the planet.

Summary:  None of us can change or influence current ”uncertainty” or distressing economic conditions we face now and likely over the next 3-5 years.  I do highly encourage you, as investors and pension fund managers & trustees, to take heed and invest conservatively.  All of the CMA portfolio models on corporate bonds, preferreds, high dividend common stocks, MLPs and REITs are focused on one mission: preserve your wealth, pension asset values, and produce very predictable high annual investment income streams.  If you are not a client of CMA, I invite you in for an assessment of your financial objectives and to learn about the many CMA portfolio options available to you.  Take the time, make the effort, and assure your personal financial security and that of your pension fund.

Chuck Dushek

Illinois public pension funds have an estimated $60 Billion in unfunded pension liabilities.  Pension payouts are outstripping the degree that employers and employees can try and fund the deficit.  Lawmakers are not taking  enough steps to cure this matter..”The Ticking Pension $60 Billion Time Bomb”  They recently set a new retirement age and benefit payout for “new hires”.  Yet, any favorable impact from that will not appear until 25 years from now.  The pension funds are estimated to run out of cash by 2017…7 years from now.

So, here comes Senator Chris Lauzen and Capital Management Associates (CMA) to the rescue.  Senator Lauzen, a financially astute lawmaker, requested CMA to offer a solution towards increasing public pension fund annual income returns to help “plug the hole” in pension fund asset resources from unmanageable growing payout trends.

CMA proposed to Senator Lauzen that the Ill Legislature adopt an Amendment to the Ill Pension Code: 40 ILCS 5/1-113.1, Which will allow pension funds to invest up to 30% of  ”net assets” into corporate debt obligations.  This is long overdue in that the typical fixed income investment allowed for these funds is the 5 year Treasury Bond or Agency security that is currently paying only 1.5 to 3%.  The Code Amendment will allow pension funds to use corporate debt of the same and longer durations and earn near 7% interest returns.

The Code Amendment that Senator Lauzen has proposed for a Spring 2011 vote has many constructive safeguards proposed by CMA to include: Investment Grade debt, no issuer holding that exceeds 3% of assets, no more that 15% of assets in the same industry sector, no deferrable interest debt obligations, no more than 25% callable, no permitted debt leverage, and a kick-out provision if any debt security is marked down to below “Investment Grade”.

This Code change is very constructive for ILL Pension Funds to head off more serious underfunding in later years.

If you would like to learn more about the Corporate Debt Code change, as proposed, please contact Bill Tasker at CMA at email Bill@CMAAdvisors.com.  Bill can also send you a portfolio illustration of a “compliant corporate debt portfolio” for your Board or Investment consultant to review.

I strongly recommend that if you are a Trustee, Pension Board President, or Village Manager…please contact your Illinois lawmaker and ask them to support the passage of this Bill.

The employment report for May was quite telling, “the entire new job growth of 400,000 for May was from new part-time US Govt census workers”, with no job growth in the private non-govt sectors. The market was expecting about 400,000 “private sector” job expansion.  The stock market sold off over 300 DOW points on this major disappointment.

In the Illinois Public Pension area, we clearly see that investment returns per year are averaging far below the needed 8% “Hurdle Return Rates” to achieve just an even-keeling of pension fund asset levels.  The typical mix of equity investments to fixed income investments is 40% common stocks and 60% fixed income.  Common stocks, the low dividend types used in mutual funds by pension fund consultants and managers, have had a “negative return” for past 10 years.  The 5 year US Treasury bond, benchmark for pension fund fixed income, is only yielding 2% today and has averaged only 3.5% yield since 2000.  At this point in the economy, US Treasury interest rates will stay very low for 2010 and 2011.  The stock market is down 3% year to date in 2010.

In following the developments in public finance for State of Illinois, the State is in a huge intractable current year deficit of $13 Billion, and owes $5 Billion in unpaid bills.  The only money to fund the Illinois public pension deficit, which is estimated to be $60 to 80 Billion, is likely to come from a new $4 Billion borrowing by the State.

This puts the State even more at risk in the future for debt credit rating downgrades, and eventual fiscal insolvency. The current estimate of total Illinois public sector debt is $130 Billion.   The State has a 13 million population base.  So, Ill State debt equals $10,000 per resident.  The annual tax revenue income to the State is approx $30 Billion.  State insolvency or bankruptcy is a pressing reality.

 How does that affect Illinois public pension fund resources?  There is not enough in “tax cash flow” to support the viability of the pension fund system.  As annual pension fund investment returns stay well below the 8% annual hurdle return rate, the State’s pension funding deficit gets bigger and bigger.   

Pension fund Trustee focus on pension fund investing must be to try and achieve hurdle return rates near 8%.  You can do this by using high dividend common stock portfolios…not growth stock portfolios as is being done now. 

Also, you need to contact your local State Senator and let him know you support a change in the Illinois Public Pension Code that would allow for the use of Investment Grade Corporate Debt in place of lower yielding US Government debt obligations.  This will allow Fire and Police pension funds to go from 2% interest returns on the fixed income allocation of 60% of assets in US Government debt securities to an approx 7% annual interest return in corporate debt obligations. 

 Send a brief email to Senator Chris Lauzen (chrislauzen@lauzen.com ) he is preparing a Bill to expand the use of Corporate Debt of Investment Grade Quality for Ill Pension Funds.

 What happens if  police and fire funds continue to have annual investment returns below the 8% hurdle rate? A) Your municipality will have to keep making larger annual employer contributions, which they cannot afford anyways;  B) More Police and Fire officers will be laid off, which adversely lowers the employee contributions to pension funds;  C) Your fund experiences an acceleration in the decline in its Net Assets towards Zero as annual pension payouts exceed the sum of employee, employer and investment return inflows, and D) If A, B and C prevail, then pension fund will likely be taken over by the State, which is already technically bankrupt under any normal credit evaluation technique.  Illinois is in a Zombie insolvent financial position.        

As a money manager, CMA is guiding pension Trustees on proper investments for the “reality” of the economy we are in.  If the US economy cannot have a normal recovery (and it is not showing one now), like it has enjoyed from past recession-recoveries…the “V” bottom, then the current recession we are in has low predictability towards an end.

 Owning and profiting from growth stocks and stock mutual funds for pension funds needs consistent GDP and job growth…not the case today.  Income investing, in stocks with high dividend yields (6-8%) is a better alternative for the times we are in.

 There is a “reality factor” in our face…with this recession.  It is likely the “Mother of All Bad Recessions”.  It did not materialize from the peaking out of a normal business cycle that overheated.  This recession was precipitated by a gigantic housing bubble bust, then a banking sector bust, now a commercial real estate market bust, now with the highest level of unemployment and household debt burdens since the Depression. 

 The Recession is rolling across multiple economic sectors with major force: housing, commercial real estate, banking, manufacturing, most small and midsize businesses (due to contraction of bank credit to them).  Europe’s current economic decline takes a “Big Engine of Growth” out of the global growth potential, and the Euro currency rate decline will weaken US GDP growth prospects by approx 1% per year in our estimation for 2010 and 2011.

Basically all of the economic expansion has occurred from massive government stimulus spending on roadway infrastructure improvements, cash grants to States to help offset some of their massive fiscal budget deficits, and extended unemployment benefits that run for “2 years” now.  None of this stimulus has lasting impact to “fundamentally” turn the US economy upwards out of recession, and create much progress in new “permanent private sector” jobs.

“Invest for Income Only”…This is a strategy of both “Offense and Defense” for pension funds.  For the last 10 years the US stock market has been sideways to down in major trend…a Lost Decade of stock value growth.  S&P 500 = 1500 in year 2000 and is 1073 Today.  The index has only a 2% dividend yield…same as most stock mutual funds, especially those in pension plans.  The net result for past 10 years…S&P 500 and most growth stock mutual funds have lost money.  Without steady and predictable GDP growth in the US economy…low dividend stocks falter in wealth creation. 

Perhaps the US economy is stalling out for a number of years to come before what is called “animal spirits”, the natural course of Capitalism…booms following busts…can take root and produce the beginnings of a natural recovery without massive Govt stimulation.  The evidence of this possibility, a naturally occurring economic recovery, is not apparent today.   

 “Invest for Income Only”…is the obvious Lifeboat for a pension fund to be floating in at this time.  Income is Defensivebecause corporate bonds, preferreds and high dividend common stocks are not dependant on US economic growth to create a return…they pay income of 7% or more.  They have lesser risk than common growth stocks that follow the business cycle for most of their returns.  Income is Offensive investing because at a 7% annual income return, annual compounding via reinvestment will double a pension fund’s assets in 10 years…it is a Lifeboat with a 7% propeller income engine, to get your pension fund to a safe and fully funded financial destination in the future.

 The Administration and Congress do not have the right answers to return the economy to the prosperity of just a few years ago.  They have lost their way.  They presided over the housing and banking collapse.  They (Presidents and Congress) are unlikely the ones to fix it.  Debt deleveraging across an economy may take the same amount of time to correct itself as it took build “the debt bubble” from 2001 thru 2007.  The same case is true for Illinois politics and responsible fiscal management.

 If you would like CMA to speak to your Pension Board or selected Trustees, please hit Reply and send me their names and email address and/or phone number….Thanks

 To learn more about high income investing…the strategy and illustrations, please click to www.CMAHighDividends.com

 Sincerely,

 Chuck Dushek

Granted, pension fund payout liabilities are growing unchecked.  Most of these pension benefit payout liabilities were put in place by legislators when investment returns were very high from 1982 through 2000.  Interest rates were higher during that period and the stock market went up 10-fold from 1982 thru 2000.

These benefits included retirement at young ages of 50 to 55, full 100% spousal survivorship pensions as lifetime longevity expands, 3% fixed COLA adjustments, and dollar pensions near 70% of highest jump-off salaries earned just prior to retirement.  In order to support this massive benefit load, the investment return on pension fund assets needs to be 8% annually(The Hurdle Return Rate), at a minimum, just to make Illinois pension funds near fully funded.

They are not though.  They are 40-60% under funded…Why?  Since, 2000 the stock market has delivered a Zero annual return from share price appreciation and dividend income combined (S&P 500 Index).  Pension funds invest about 40% of their assets in “growth-stock” type portfolios and stock mutual funds.  The remaining 60% of pension fund assets are typically invested in US Government guaranteed debt securities.  In 1999, the interest rate on the 5-year Treasury was over 6% and today is only 2.6%…for the past 10 years it has averaged 3.5%.  When combining the Zero return on stocks with 40% of fund assets and 3.5% return on Treasuries with 60% of fund assets, these pension funds are only earning 2% per year on 100% of their assets.  This equals a “below 8% target return” of minus 6% per year.  For the past 10 years, 6% underperformance per year equals the 60% under funded actuarial estimate of under funding.

Is this condition “fixable” by changing the pension fund investing strategy?  Yes, and it needs to be done quickly.  

For Illinois pension funds, there was a good article in Pension & Investments, the pension bible publication of the industry, where the author Joshua Rauh estimated that Illinois public pension funds will be “dry”…empty of funds by 2018, and in 2019 Illinois will need to pay out $14.5 billion a year to meet annual public pension payouts to public sector retirees.  That will be a great trick, in that this year Illinois has a $13 billion budget deficit, and owes $5 billion in unpaid bills.  In 2008, $14.5 billion would be 46% of that year’s total state tax revenues.   You can read the article by clicking to: http://www.pionline.com/article/20100326/DAILYREG/100329922

There is some movement within the Illinois legislature to allow public pension funds to invest up to 30% of fund assets into “investment grade” corporate debt obligations.  These currently pay about “3% more” in annual interest income to pension funds than US Treasury obligations.  I commend Senator Chris Lauzen for sponsoring this drastically needed change to the Illinois Public Pension Code. 

Further, most Illinois pension funds still continue to use a “growth strategy model” for their 40% of assets in equities.  These stock portfolios pay less than 2% in annual dividend flows.  Public funds can easily change to a high dividend equity investment  strategy (permitted investment under the Code) and safely earn between 6% and 8% in annual dividend yields.  These high dividend equities have dramatically outperformed the S&P 500 Index return by 3-fold in Total Return for the past 45 years.  (See www.tweedy.com/resources/whdyf/highdivresearch.pdf  )

Capital Management Associates, a Pension Fund Investment Advisor, is actively involved in changing the Illinois Code to allow higher interest yielding corporate debt to replace very low interest yielding US Government debt, and to promote the use of “high dividend equity portfolios”  (www.CMAHighDividends.com ) to greatly increase annual dividend income on 40% of pension fund investment assets.

Conclusion: The only meaningful change to fix the “investment strategy” process of public funds is to significantly increase annual income yields on the debt securities held by pension funds and increase the dividend yields on their equity holdings.  Without this change, public pension fund deficits will continue to get worse…until 2018, when Ill pension funds “are Dry”!

Capital Management Associates of Lisle offers a complimentary one-hour orientation presentation to any Trustees of Illinois Pension Funds interested in learning more about High Dividend Equity Investing for Public Funds and using Investment Grade Corporate Debt Obligations for Public Funds.  Email: Bill@CMAAdvisors.com for details.

In the face of these secular rising pension payout liabilities, the “investment returns on pension fund assets have declined dramatically” over the past 10 Years.  The 5-year US Treasury bond yield,  a mainstay investment of public pensions, was 6% interest 10 years ago and is 2.34% yield today.  Further, the S&P 500 index of common stocks, broadly used by public pension funds, is 22% lower now than 10 years ago, and stock mutual funds, used by public pension funds, are seeing not only capital losses on stock assets, but less than 2% annual stock dividend yields.

All this adds up to inferior investment returns that are imploding pension fund asset positions.  In this post, I wish to educate and inform pension fund trustees, adminsitrators, state lawmakers and voters…that now is a time to be changing pension investment practices to “increase” pension fund portfolio income.  This will reduce the gap between growing liability payouts and low fund investment income.

My investment company, Capital Management Assiciates, offers 6%, 7% and 8% dividend paying stock portfolios.  These  “high dividend stock portfolios” have overwhelming beat growth stocks and growth stock mutual funds for the past 10 years…and from the studies we have analyzed, have beaten growth investing for the past 100 years…Please read report at end:  “Understanding High Dividend Equities”.

 The S&P 500 Index, the investment performance benchmark of the financial industry, closed this past Friday at 1092, and 10 years ago on that date, it was priced at 1394.  That created a value loss of (1394 less 1092) down 22% over 10 years, but the S&P has about a 2% annual dividend income, so in spite of the share value loss, it generated a total of approx 20% in income to offset the 20% value loss…net,net No Change for 10 year’s investment.  This is a very bad outcome for typical pension funds that need a minimum accuarial hurdle return rate of near 7% per year.

On the CMA High Dividend Stock Portfolio, this is what separates its total return performance from the S&P 500, and many growth mutual funds that hold tech stocks, consumer growth stocks and cyclical stocks….at average dividend yields below that of the S&P’s 2% yield.

 In illustrating our 7% stock portfolio, we start with the 7% annual, straight line dividend yield…7% for 10 years on $1,000,000 is a $700,000 total income return.

 Next, these dividends are not static, statistically the dividend growth rate of the 90 -100 companies in our portfolio have registered an approx 8% annual average dividend growth rate, that includes 2008 and 2009 payouts…both recession years.  Beginning year One, the base dividend income is 7% and grows by the annual increases to 15% current yield after 10 years.  Hence the average annual dividend yield is not 7% but (7% + 15% divided by 2) = 11% effective average annual dividend income return over the 10 year period.

 Next, the companies CMA selected for the 7% portfolio are not “growth industry” companies such as: technology, highly cyclical industry companies, nor consumer discretionary companies…CMA company selections focus on secular slow-growth companies whose businesses are not expected to grow in revenues anymore than the growth rate of GDP across the US economy.  We target annual business growth at approximately 3%.  We project an average annual 3% share price rise from these industry stock holdings.  Further, these companies typically have “dividend payout percentage of earnings” significantly higher than the average of S&P 500 companies in order to pay high annual dividends.  Each year the portfolio is “re-balanced” back to original weightings.

 In conclusion, the beginning dividend yield of 7%, plus a dividend growth rate of 8%, plus 3% underlying annual share price appreciation estimate paralleling annual GDP growth, yields an average Total Return of approx 14% per year.  This creates a near 300% return over 10 years as was reported in the Morningstar analysis of our portfolio from 2000 thru 2010.

 The Morningstar portfolio analysis, available from CMA by emailing Bill@CMAAdvisors.com gives a complete breakdown of the portfolio including all its holdings.  Morningstar calculated its past 10-year annual return rate of 15.34% per year, and that compared to the S&P 500 10-year return rate of -.95% per year.  There are some variations in annual comparisons of return from changes in the Start Dates and Ending Dates when we run the Morningstar analysis once a quarter to “refresh” the 10-year statistical time frame.

 Today’s Post is not to market the CMA Portfolios, but rather to educate interested parties that a change in “pension fund stock investment strategy” can be very beneficial to Funds towards increasing investment results to meet pension fund payout liabilities.

Below is a study on High Dividend Equities to validate their importance with pension fund portfolios. 

“Understanding High Dividend Equities”

We ran across a very interesting report by Tweedy Browne, an 80 year old value investing firm that shares our mantra for high income stock investing and they have done very interesting research on it.  I am sharing it with you, but just the “nuggets of it” since it is long and detailed and can be read in its entirety at http://www.tweedy.com/resources/whdyf/highdivresearch.pdf ).  Their report demonstrates that high dividend common stocks are the best thing you can do for your investment portfolio or pension fund to build higher net asset values and enjoy high portfolio income that keeps pace with inflation adjusted life-style expenses or pension payouts. 

 Here are their observations on High Dividend Commons:

 The Tweedy Browne Report

 Tweedy… examines what some in our industry have referred to as the “yield effect”, i.e. the correlation of high dividend yields to market beating rates of return over long measurement periods.  Much has been written about dividends, and what is contained herein is not meant to be an exhaustive analysis, but rather a sampling of studies examining the impact of dividends on investment returns. We hope it will provide you with added insight and confidence, as it did us, in pursuing a yield-oriented investment strategy.

 Stocks with high and apparent sustainable dividend yields that are competitive with high quality bond yields may be more resistant to a decline in price than lower-yielding securities because the stock is in effect “yield-supported”.   The reinvestment of dividends during stock market declines has also been shown to lessen the time necessary to recoup portfolio losses.

 Tweedy discovered that while year-to-year performance was driven by capital appreciation, long-term returns were largely driven by reinvested dividends. They showed the cumulative contribution to return of capital gains and dividends in both the U.S. and the U.K. from 1900 to 2000. Over 100 years, they found that a market-oriented portfolio which included reinvested dividends would have generated nearly 85 times the wealth generated by the same portfolio relying solely on capital gains.

 For the period 1802 to 2002, the total annualized return for the period of 7.9% consisted of a 5% return from dividends, a 1.4% return from inflation, a 0.6% return from rising valuation levels, and a 0.8% return from real growth in dividends. He concludes that “unless corporate managers can provide sharply higher real growth in earnings, dividends are the main source of the real return we expect from stocks”.

 Common stocks do not have to be exclusively of US companies.  In a study of global companies that pay dividends here are broader findings on the importance of dividend income:  A Global study indicated that the most profitable strategy was investment in the highest yield quartile (Top 25%). The compound annual investment return for the countries with the highest yielding stocks was 18.49% over the 20-year period, December 31, 1969 through December 31, 1989. The least profitable strategy was investment in the lowest yield quartile, which produced only a 5.74% compound annual return….A near 13% annual return difference.

 Another study on the DOW 30 concluded that: Over the 26-year period from 1973 to 1998, a portfolio consisting of the ten highest yielding securities in the Dow Jones Industrial Average produced a return of 17.9% annually, as compared to 13.0% for the DJIA (The DOW average.)

 In conclusion, in a more recent study, Jeremy Siegel, the noted finance professor at the University of Pennsylvania, examined the performance of S&P 500 component stocks ranked by dividend yield from 1957 to 2002.He calculated the returns of the stocks and quintiles (Top 20%…high yielders versus bottom 20%…pure growth stocks) over the near 50 year period. He found that better results were directly correlated with higher dividend yields. The highest yielding quintile (top 20% of S&P 500 based on yield) produced an annualized return of 14.27% versus an annualized return of 9.5% for the S&P 500’s lowest quintile of growth stocks, which resulted in over 7 times the wealth accumulation of the lower yielding growth stocks.

 CMA Conclusion:  High dividend yields really matter for you in meeting growing pension payout liabilities.  You need to be a part of this outstanding growth experience in high dividend common stocks.  CMA has established 3 High Dividend Portfolios that range from 6% to 8% annual dividend yields.  All stocks in the CMA portfolios are compliant with the Illinois Pension Code.

 The Tweedy Browne study has examined this investing strategy, and its conclusions, beyond any reasonable doubt, point the way to High Dividend Commons as a mainstay for pension fund portfolios.

 Chuck Dushek

With the economy in recession, the Federal Reserve has lowered short term interest rates to Zero, which has lowered 5 year Treasuries to 2% interest return.  Further, the benchmark of common stock mutual funds, the S&P 500, has been “flat in performance for 10 years”, and currently has only a 2.2% dividend yield.

Many municipal pension funds utilize an asset allocation mix of approximately 60% in US Government debt securities of 5 years or less duration.  At current 2% interest yields, these are providing very low returns, compared to 6% interest rates on these in 1999.  With many stock mutual funds used by public funds paying only 1-3% dividend yields, pension funds have low potential to achieve anywhere near the typically desired 7% annual hurdle rate of return on pension fund assets.

This Pension Fund Rescue blog posting discusses the current state of the US economy, fiscal and monetary policy actions in place, and an outlook of what investors and pension fund trustees should be considering in selecting higher income investments towards hitting hurdle rates of return.  Curing under funded pension fund deficits is of paramount concern to all fund trustees and investment managers.

There are important facts and ideas I want to discuss in this article.  Much confusion is in the financial markets now on the “State of the US Economy”, and how investors and pension fund managers should be focusing their investing dollars. 

Fed on the Gas/Banks on the Brakes…The economy is facing a uniquely diverse situation…The Federal Reserve has put short term interest rates down to Zero for near a year, whereas these super low rates are intended to stimulate borrowing by consumers and small businesses.  Yet, commercial banks “have the lending brakes on” with loan volumes and credit card limits contracting month after month.  Without loan growth, it’s difficult for the economy to grow.

We have witnessed: Japan, the second largest economy in GDP on earth has just completed its “second lost decade” of Zero growth in common stock values and interest rates below 1%…for 20 years!

What’s in store for the US?  First, the US economy is in a “Lame Growth Position”…it is stuck at or near the bottom of a recession.  There is no big catalyst to turn it upwards, other than Zero interest rates and massive fiscal stimulus, which is not working to turn the economy.  The 3rd quarter GDP up tick is a very small bounce from approximately 4 successive quarterly declines…and the initial 3.5% upswing was later revised back to just 2.8%….whereas unemployment still rose during that 3^rd quarter up tick.  The Feds are trying to give the economy gas, but falling bank lending is holding the economy back…We are in a Lame Position.

What is “not working” to turn up the economy, is the US Consumer.  With 10% unemployment, a record low 33 hour workweek…from fulltime employees put to part time, consumer spending is very weak on anything other that “staples”…necessities of life.  The point of this rather depressing outlook is not to deflate nice positive expectations…rather to understand the reality this country will face over the next 3-5 years.  There is little economic growth now, and not much acceleration ahead.

As was pointed out in the WSJ this week, consumer and small business lending continues to shrink at alarming rates from its July 2008 peak.  Banks, month after month, are contracting their consumer and small business loans.  Credit card companies continue to cut small biz and consumer credit limits.  It’s a vicious cycle of loan/lending contraction. 

This economy is powered 70% by consumer spending, and small businesses are the largest employers in the country,  and have the potential to create the most new “American-based” jobs.  Large public companies, that have very good access to bank and capital markets credit have a record of transferring jobs to lower labor foreign countries, and they cut hundreds of thousands of American jobs to-boot during this recession.

Small biz and consumers in the lending penalty box…The small business  sectors are the most “starved for credit” at this point in the economy.  Bank lending policy and CC limits…both in steady decline, are killing this vital area of the economy for future growth in new American jobs.

Over the past two years, bank lending contraction has cut $1.5 Trillion of lending from the economy to small biz and consumers…that equals about 12% of annual GDP.  Fed interest and bank lending policies are “working in reverse of desired goals”….low interest rates to large public companies that push jobs overseas, and a pull back on lending to small businesses that basically create the most American-based jobs. 

Why is debt contracting?…The consumer debt securitization industry for CC receivables, auto loans, and non-US Govt backed home mortgages is down nearly 40% since the peak of mid 2007.  Another factor that self-inflicts debt/credit reduction is the “voluntary efforts of consumers to lower their debt”.  25 years ago, household debt was about 60% of household income.  A few months ago that percentage peaked at 125% and now it stands just a little lower at 122%.  Many years of consumer debt deleveraging are ahead, and a lower percent of household income will go towards discretionary consumption spending. 

Who’s hurting with low interest rates?…The FED is on the Gas with Zero percent short term interest rates to stimulate the economy, while Banks and CC companies are going the opposite direction and lowering lending limits to consumers and small biz.  It’s like a driver standing on the Gas and the Brake…a lot of Revs, but no forward movement.  There are bad unintended consequences to the FED’s Zero rate policy…savers and those scarred to invest in financial markets are getting Zero interest rate income return on a record $4 Trillion in money market funds today.   Its crushing the senior age retiree community…throttling back their spending, even without them using any credit.  Pension funds are receiving substantially lower interest returns of government and agency debt securities.

What are some of the best strategists saying about investing?  (This does not include self-serving Wall Street.)  They are saying that we will have a “New Normal” of 1-3% annual growth in GDP, not 3-5%% prior to the financial meltdown and recession; plus low inflation; and near Zero interest rates on money funds, CDs, and savings accounts for a while.  Companies that sell goods and services to traditional pre-recession growth industry settings, will have a lower GDP growth rate to deal with.  Growth stocks will languish in price, like they have already for the past 10 years.  Some are looking for a “second lost decade” in stock market valuation growth. 

This low-growth outlook, which I share, is “bitter sweet”.  Low growth in the economy will keep inflation tame.  Yet, low growth will prevent an emergence of P/E (share price earnings multiple) expansion…more likely a reversion to P/E multiple “contraction” in 2010.  As an equity investor, you need to make the right choices between cash-like investments paying Zero, Treasuries at 2% yields, and positioning pension fund assets to some tolerable degree of risk to avoid the Zeros on return.  Some investment strategists are avoiding “growth-focused” investing in growth stocks, speculative commodities, junk bonds, and avoiding highly cyclical or growth industry settings for their investments.  They are focusing their investment dollars on high dividend yield equity investments, at yields of 4% and higher.

What’s available that speaks to the reality of the future economic course? . 

 As an illustration, the top 100 dividend paying stocks in the S&P 500 index have an average dividend yield of 5% today.  This is much higher than most growth mutual funds used by public funds that pay just 1-3% dividend yields.  Pension fund trustees and investment managers need to consider “focused-investing” in the stocks of the higher dividend sectors of the major stock indexes. 

It is relatively easy to create portfolios of high dividend stocks from just the S&P 500, as an example, and earn dividend income rates of 6 and 7%…plus annual growth rates on these dividends of 5 or more percent per year.

 Of the top dividend payers in the S&P, here are examples of prominant companies and their dividend payout amounts in percent:  Frountier Communications (FTR) 14%, Centurytel(CTL) 8.4%, Altria (MO) 7.4%, Nisource (NI) 7%, Verizon (VZ) 6.5%, HCP (HCP) 6.5%, Lilly (LLY) 5.8%, Pitney Bowes (PBI) 5.8%. 

Also in expanding the stock universe to include the many MLPs (NYSE traded Master Limited Partnerships…common equities) in energy and basic materials in stockland, there are dozens that pay dividends from 5 to 10%.  Creating 6 or 7% dividend portfolios with stocks that are compliant with state pension codes is relatively easy.  This is a very powerful way to cure underfunded pension fund deficits.

Chuck Dushek

On Nov. 12 the Pew Center on the States, a venerable public issues think tank, pronounced Illinois as one of the nation’s 10 most “financially troubled” state governments.  With $11.5 billion current year budget deficit, not enough cash on hand to pay its bills, and massively underfunded pension funds…nearing a $50 billion unfunded deficit… Illinois is financially troubled in the same sense that the Titanic was structurally troubled by icebergs.

The State just can’t seem to get out of the way of its own fiscal mismanagement.  Illinois is not the US Government….It cannot print money, nor pile on new debt to cure the effect of unbridled overspending and an ill-fated Illinois Public Pension Fund Investment Code.  Change needs to take place, as discussed below.

State spending outlays have to shrink in line with the decline of the overall economy.  The recession has created large declines in State revenue collections…this year, and into the next two years…at least.

The Wall Street Journal disclosed this week: “Tax collections tumbled 11% across 44 states in the 3^rd Quarter 2009 versus collections in 3^rd Quarter 2008.” Every major source of state tax revenue…sales, corporate and personal – income taxes fell in that Quarter.  Roughly 80% of states’ total tax collections come from sales and personal income taxes.  With unemployment over 10%, this is an intractable hardship condition on both personal income tax collections and sales tax collections, especially from a huge falloff in consumer discretionary goods purchases due to high unemployment…these have the highest sales taxes.

WJS added further: “State tax revenues will remain fragile and gloomy at least throughout fiscal years 2010 and 2011 say the Rockefeller Institute”.

On Illinois public pension funds, this means that municipalities around the state will not be seeing any up ticks in sales tax revenue, new construction fees, nor rising property tax collections for several years.  None of these entities can afford an increase in contributions to police, fire, or municipal pension funds.

Mr. Bill Tasker, Financial Advisor and Chartered Financial Analyst CFA of Capital Management Associates states on Illinois Pension Fund deficits:

“For years, Illinois Article 3 & 4 police and fire pension fund assets have been invested to maximize returns. For the equity (stock) allocation of the pension funds, we have been conditioned to look for the best performing “growth mutual funds” that have traditionally paid little or no dividends. This philosophy/strategy worked well from 1982 to 2000 when the stock market performed above trend on growth at 15% per year and interest rates were higher than they are today.”

“It was relatively easy to achieve the 7% actuarial return many plans used as their minimum target, when the stock market was averaging “15% gains per year”. The pension assets, however, were not managed to a “predictable fixed income” 7% actuarial rate. They were managed to maximize the “potential appreciation growth” of the assets.  The last 10 years have presented a new problem, given that the stock market has been flat on share price appreciation performance and government security interest rates have been incredibly low having fallen from 6% in 1999 to 2% in 2009.”

“Since the typical growth mutual fund used in pension funds pays little or no average dividend yield, very few pensions have benefited on net return (dividends and share price appreciation) from their equity allocations since 2000.”

“Pension funds are faced with a dilemma: If pensions are obligated to maximizing their asset returns to meet a 7% annual hurdle rate, how do you do this in a flat-trend equity market and with Government debt securities paying only 2%?   Logically, the funds cannot, by using growth stock funds and low interest paying government securities.”

“The needed “change-up” in both the Illinois Public Pension Investment Code and pension fund management strategy should be to meet the 7% hurdle rate with “higher predictable return investments”. It is this goal of meeting the “pension payout liability” that needs to be addressed.”

“The Illinois Public Pension Fund Code needs to be revised to allow for the use of Investment Grade Corporate Debt Securities in replacement or alternative to just US Government and Agency and State guaranteed securities.  Corporate sector debt securities have interest payment levels that are currently 3% or more above government debt securities. These are from premium corporate issues such as: Boeing, Comcast, Verizon, Bristol-Myers, Fed Express, Kraft, Disney, IBM, JP Morgan, Time Warner, DOW Chemical, Cummins Engine, Goodrich and many others…debt from the same companies that are “permitted investments” via their common stock ( a junior class security) held in many common stock mutual funds used by public pension funds.  This needed access to using higher interest rate securities of companies versus government securities could assure pension funds of hitting 7% annual hurdle rates on their fixed income investment allocations.”

Mr. Tasker says: “There is another asset allocation area….equities….that would benefit if public funds utilized a “Liability Driven Investment Strategy”. This strategy must seek a total return of: 1) High dividend income, 2) Growth in dividend income, and 3) Appreciation potential of share values.  This matches to the normal objectives of public pension payout liabilities: 1) 7% per year fund income to meet pension payouts…holding equities that pay an average 7% dividend income flow, 2) A COLA rise of 3% per year….rising dividend income, and 3) New pensioners coming into the system requiring a progressively rising fund core asset base…rising equity values grow fund asset size.”

“High dividend equity portfolios offer 3 distinct benefits:

1. Stable, consistent, cash dividend payments to meet annual pension payouts.
2. Growth of dividends to offset COLA adjustments.
3. Potential of stock price increases over time to increase fund asset valuations.

“Doesn’t it make sense to utilize strategies that incorporate tangible cash income payments objectives to meet the liability driven hurdle return rate?”  Mr. Tasker definitely thinks so!

To learn more about the use of a high dividend equity strategy, go to WWW.CMAHighDividends.com

A Typical recovery from a recession takes, on average, 2 years to restore full employment, and consumer spending back to normal levels.  This paradigm on recovery time is true under “normal” business cycle swings.  We are not in the Typical business cycle recession.

State and municipalities are caught in a vicious cycle of falling income tax revenues, lower sales tax collections, and falling property values that lower assessed valuations.  Cash flow is shrinking at public entities causing huge budget deficits.

Cities and municipalities cannot afford rising public pension fund contributions.  On the surface, pension deficits look intractable…lower pension fund investment returns, unaffordable municipal contributions, and rising pension payout liabilities…Something has gotta give!

The current business cycle decline  results from the breaking of a giant leveraged financial bubble…larger than any other since the Great Depression.  One of the largest sectors of the economy, residential construction, went from a 2 million new home construction rate to less than 500,000 per year.  Plus, commercial construction of: new shopping centers, office buildings, condos, hotels, transit & distribution centers and municipal buildings that were drawn along with the housing boom, has come to a STOP.

At this point, infrastructure spending, other than what the Government has directly stimulated, is just the runoff or completion of past projects started.  The building sector of the US economy is at a STOP…no new demand, huge over supply, and more office vacancy than ever.  Further, commercial mortgage lending has stopped due to default risk from weak cash flows and high vacancy on commercial real estate.  The economics of states and municipalities thrive during construction booms from fee revenue…now it is fee-famine.

Consumer spending makes up approx 70% of GDP spending.  Both unemployment and underemployment are at the highest rate seen in 30 years.  The 10% unemployment rate is only part of the story.  There are 130 million workers in the US that a few years ago had a 38 hour average work week…now it is only 33 hours for those employed.  That reduced work time is equal to approx 15 million jobs lost.  This is a huge “take-away” on consumer  spending…it is of depression-era proportion on discretionary spending activity for all goods and service, other than staples.  Sales tax revenues to state and municipal bodies are shrinking, as overall consumer spending falls.  “Entertainment tax revenues” have been crushed from a dramatic falloff in restaurant and hotel spending. 

Past recessions have had much shallower declines in employment, ones that we could recover from in a couple of years.  This recession is the “Mother of All Recessions”….7 million full time jobs lost and a 13% reduction in the average work week.  A recovering economy, in a normal recovery creates about 150,000 new jobs per month or 1.8 million per year…”after job losses stop”.  We have not stopped seeing job losses as yet, unemployment and underemployment are still rising.  

Consumer debt burden (inclusive of mortgage debt) is currently the highest it has ever been at 125% of household income.  The norm for this debt burden is 80-90% of income.  High unemployment keeps aggravating this debt burden because household income is not rising now, it is still contracting as un- and under- employment grows.  Consumers are paying debt off, and this household deleveraging means no or little discretionary spending.  Sales tax growth is an illusion to municipalities for at least a year or two.

State and municipal finances are in an intractable weak position.  These entities have no capacity to stimulate: Consumer spending to increase sales tax revenues, Nor create incentives for new commercial or residential construction. Nor increase jobs to increase income tax collections.  These entities are hamstrung to do anything that can “move the needle up” on tax or fee revenue growth.

If public sector pension fund deficits are to be mitigated or cured, the solution is not going to come from “increasing contributions” from Cities and States.  That option is unaffordable.

Much progress can be made on increasing investment returns on pension fund assets.  Funds typically need a minimum 7% per year return on assets, just to “maintain” the drastically underfunded position they are in. 

Here is a basic cure to the “annual investment return” problem many funds face.  By and large, public funds invest their “Equity Allocations” in growth stocks for potential appreciation…these have very little dividend income.  Fund equity allocations need to be focused in “high dividend” equities…not growth stock portfolios.

Jeremy Siegel, noted University of Penn professor, did a study that clearly proved that the “Highest dividend paying stocks in the S&P 500 generated a total investment return that was 7 times the return of the lowest dividend yielding stocks in the S&P over the past 45 years, ended 2002.  This is phenomenal, and read below for more detail on this.  If public pension funds focused more on high dividend equity selections, funding deficits would recede from the benefit of higher annual cash flow investment returns.

Growth stock investments need economic growth to sustain long term share price appreciation trends.  If you looked at the critical evidence that could support an economic recovery, it would be tantamount to having a table stand without any legs.  Current economic statistics do not show any positive upturn in the financial status of the American household, at best it is “treading water”, at a high level of financial stress.  Without growth in consumer spending that drives 70% of US growth, we just stay in recession or experience a very low future economic growth rate.

In summary, the purpose of this analysis is to focus concern on how we should be investing the public pension funds we have.  Since there is low or no opportunity for “growth investments”, then the alternative is “income investments”.  The class of investments, in combination, that yield the best income, and growth of income to meet pension payout liabilities are: Corporate Bonds, Preferred stocks, and High Dividend Common stocks.

If a pension fund is a committed common stock investor, then consider this: Within the S&P 500 index of the largest companies the average dividend yield on the highest dividend paying 100 stocks is 5% in a range of 4% to 14%.  The dividend range in the 100 lowest yielding S&P stocks is 0.0% to .80% with average at .23%.  To get the best predictable annual income from stocks….use the top 100 payers in the Index. 

Goto: www.CMAHighDividends.com for High Dividend Equity Portfolios that use these stocks, and None of the 100 lowest paying stocks.  Growth mutual funds typically go the exact opposite allocation and hold mainly the lowest yielding Growth Stocks.  Pension plans need to “cut loose of” common growth stocks and traditional growth stock mutual funds.