And we thought we had pension problems

CalPERS stands for California Public Employees' Retirement System. It is, in a nutshell, a gigantic pension fund. For years, CalPERS had been a symbol of how an institutional investor should manage long-term savings.

The fund's investments were governed by clear policy and strategy, and its management was characterized by caring about the rights of investors. It was not exclusively conservative. Over the years it did not hesitate to place huge sums of money in relatively risky ventures such as venture capital funds, including some Israeli ones, private equity funds, real estate, and hedge funds.

It is interesting to take a closer look at this institution, which is the biggest pension fund in the U.S. No, I'm not trying to judge this great institution's performance or management. First of all, who is your humble author to do such a thing? Secondly, that will not teach anything to the reader in Israel. My aim is to describe the processes that happened in America's long-term savings sector, over a long time, and to use CalPERS as an example.

Let's look at some numbers. According to the 2008 report CalPERS filed, its assets at year-end were $183 billion, invested roughly as follows: 41% in American and other countries' shares, 13% in equity funds, 12% in real estate, 22% in American bonds, 2% in foreign bonds, 2% in financial instruments linked to the consumer price index, and 8% in cash.

By the way, its holdings in stock at year-end 2008 were historically low for a simple reason - during that year, stock markets plunged. In previous years, CalPERS had placed much more money in stocks.

If we look at that portfolio through Israeli eyes, we see it as dramatically different from the portfolios we know here. With 54% in stocks and equity funds, and only 2% in linked bonds that protect against inflation risks, you couldn't even begin to compare the risk level of the CalPERS portfolio to the average pension portfolio in Israel, be it the most aggressive in Tel Aviv town. The guys in California are a lot more aggressive than our investment managers.

Having peeked at the nature of the portfolio, let's peep at its past performance. Unsurprisingly, 2008 was a terrible year - the worst in the history presented on the CalPERS web site, which starts in 1984. The last 25 years didn't have any numbers even remotely as awful. The worst year before the last one had been 2002, with a loss of 9.5%.

In 2008, CalPERS lost 27% in nominal terms, or 30% in inflation-adjusted ones.

For the last three years, CalPERS presents an accrued negative return of 2.5%. Its accrued return for the last five years works out at 3%. But long-term savings mustn't be judged through the prism of a single year, certainly not a crash year like 2008. That is why I have appended some bar charts to this article, showing CalPERS over the last 25 years.

Let's start with average annual return. A $100 bill invested in CalPERS in 1983 was worth $975 in December 2008, representing nominal annual returns of 9.5%. Sounds pretty good, until you factor in a few other things.

Inflation reduced annual returns by about 3% a year, so the inflation-adjusted return is about 6.5%. Still sounds pretty good, but a lot less than 9.5%. Meanwhile, nominal returns on 25-year U.S. government bonds were higher than 10% in 1984. Buying and holding these bonds to maturity would have provided about the same yield as CalPERS over 25 years, with a lot less risk.

Now let's see who did well by CalPERS, and when. That is the main question when looking at returns over a long period of time. The bar chart showing the inflation-adjusted value of $100 invested in 1984 shows the answer clear as day. It shows the fund's performance can be divided into two periods - from 1984 to 1999, and from 2000 to date.

From 1984 to 1999, the inflation-adjusted value of that first $100 grew to $793, an annual return of 14% above inflation, which is terrific by any standard.

But from 2000 to date, that $793 increased to just $935, an annual rate of 1.8%.

As the bar chart showing the annual rate of return demonstrates, there were only two bad years between 1984 to 1999, and the drop was pretty small. But from 2000 to date, a far shorter period, there were four bad years, and some of them were truly terrible.

The reason for the difference between the two periods is that from 1982 to 2000, America experienced a bull market like never before. The yields on long-term bonds dropped from double digits to around 5% and the S&P-500 index surged from 120 points to 1,500.

But as the 1990s ended, the markets turned bearish and by December 2008, the S&P-500 index was down to 900 points (today, just two months later, it's at 735 points). True, in the bond market, yields continued to fall, dropping from 5% to 3%, but clearly there's a limit to future yields.

What conclusions can we reach from this short analysis? A few.

First of all, even with their very long-term view, CalPERS and funds like it couldn't achieve returns greater than 9% a year, as they did over the last 25 years. Long-term government bonds trading at a yield of 3% create too much of a burden on returns, which translate into excessively high expectations of the portfolio's stocks component.

We must conclude that the yield assumptions of all too many corporate pension funds are too optimistic, which means these funds will be a drag on the company's profits and shareholders equity.

Secondly, dropping yields on government bonds over time requires savers and public employers to increase their provision into savings, at the expense of consumption. That is the price of very low interest rates. In some cases, it can wind up depressing private and public consumption instead of stimulating them. We seem to have reached that point.

Third, from small to large, from hamlet to great city - all have a growing problem with pensions, and in many cases will find themselves required to pay huge amounts to make up for lost assets, creating a whole new macroeconomic problem in the future.

It seems that relative to the U.S., the situation of pension savings in Israel isn't that bad. It may be cold comfort, but at least it shows that it's okay not to emulate everything America has to offer.

The author is the chief executive of Compass Investments, a member of the Psagot group.