March 19, 2011

Japan Earthquake and Market Volatility

One of my colleagues, Eddie Wilcox, wrote a post for our blog, The Rollins Financial Blog, yesterday, and I thought he did a very good job of discussing the current issues involving Japan. It is always important to remember that the long term effects can be vastly different than the short term.

Japan Earthquake and Market Volatility

The world equity markets have been rattled lately by the devastating earthquake in northeastern Japan. It’s not the earthquake itself that caused such an enormous disturbance. Rather, it was the tsunami that followed and its ensuing damage to the nuclear power facilities of the affected area. Headlines of possible meltdowns at those nuclear facilities have clearly spooked investors and some of the Japanese over the past week.

While the human impact on those in the region is permanently devastating for the families involved, the economic impact is probably less permanent. We have been closely monitoring the affected investments, especially those located in Asia and Japan. The uncertainty of the event is, in our view, causing the most impact on the markets. While the nuclear situation still does not appear to be completely under control, it does appear that the Japanese and the international community are devoting every possible resource to gaining control of the problem.

Natural disasters have been and will always be one of the risks to the economy. In almost every example, however, those risks are concentrated in the near term following the event. The economic disruption is definitely felt in the immediate aftermath, but in the long term, the rebuilding process can make up for – or even eclipse – much of the initial loss of economic activity. This seems likely this time also, as Japan has unleashed nearly unlimited resources to battle the situation.

Clearly, the near term impact will be felt by many Japanese and U.S. companies with a presence in Asia and Japan. Depending on how you look at the numbers, you could argue that the event may or may not have much of an impact on the world economy. Japan remains the third largest world economy at about $5 trillion in GDP and accounts for over 8% of the world economic activity, which is very significant. However, the affected area accounts for a rather small portion of Japan’s economy. Furthermore, Japan does not contribute to global economic growth as the Japanese economy has been stuck in the doldrums for over a decade.

Without a doubt, the financial markets have reflected the uncertainty in Japan. Social unrest in Libya and elsewhere in the Middle East have only added to the volatility as the Dow Industrial Average has frequently traded higher or lower by triple-digit margins on a daily basis. The major averages, including the S&P 500 Index, are currently trading just slightly positive for the year after starting out the year with gains of nearly 7% through late February. The markets would rather have quantifiable data to trade on; oftentimes the uncertainty causes more commotion than if there was a known negative impact.

The fundamentals of the U.S. economy continue to strengthen through all of these geo-political situations. Even the slow to recover job market is showing signs that some strengthening may be on the horizon. It’s our position that the global recovery remains intact. But, of course, that does not mean that occasionally the markets or world events will not cause us to question that thesis.

While we are mindful that the human tragedy is the greatest concern, we will continue to closely monitor the affected investments and our portfolios under management. As always, we are available to discuss our strategy during this time if you have any questions or concerns.

Eddie Wilcox

March 13, 2011

What People Are Saying...

I have received a number of emails over the past few weeks asking me to weigh in on the issues in Wisconsin because I "seem to be level-headed when it comes to politics..." Thank you for the compliment, and I certainly try to be open to all viewpoints (something I wish more people would be). The current issue is tough, but I do see the arguments from both sides.

Honestly, I am pro-worker but not always pro-union. This does not mean I am against the benefits that unions have fought for (quite the contrary), but when the union takes on a life of its own and vows simply to just protect itself and not the workers it is supposed to advocate for... I think that is a big problem. I am trying to skip the politics of unions altogether.

To let you see what others have said, I have gathered articles and editorials from various newspapers, and the first one is written by Wisconsin Governor Scott Walker.

March 11, 2011

How Well is Georgia's TRS Plan Funded?

“How safe are my retirement assets?”

This is a question that everyone ponders, but as an active or retired member of the Teachers Retirement System of Georgia, you should know that your future pension distributions are secure. Is that one line answer really enough though? Today’s post looks at how well the TRS plan is funded.

Honestly, I have been thinking about this one subject since the end of December. I had a few potential educator retirees that asked to meet with me individually around the end of 2010/beginning of 2011. In preparing for my meetings, I decided to review the latest financial report and actuarial report for the TRS plan. While not many items had changed, I had no idea of the coming issues in Wisconsin that would cause even more frequent questions on the subject.

First, all of the information that I reviewed came directly from the TRS website (, and other than my comments regarding the information, anyone can easily find and review the information themselves in the Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2010. This is a “short” 62 page PDF that really can be informative if you want to get down to the details of the plan. The plan itself is audited annually (year end is June 30) by KPMG LLP with actuarial reviews by Cavanaugh Macdonald Consulting LLC that lag by one fiscal year (FY). Thus the report above covers the June 30, 2010 audit and the actuarial review of June 30, 2009.

In short, the plan is very strong with $45.989 billion in assets as of June 30, 2010 and an actuarial funding ratio of 87.2% through June 30, 2009. This is down from the June 30, 2008 actuarial ratio of 91.4%, but the decline in the equity markets through March 2009 was expected to hurt the ratio. Comparatively speaking, Georgia’s ERS and TRS plans are near the top of the nationwide averages of actuarial funding as of June 30, 2008 coming in at #9 overall with the average plan being funded at 80.5% (Standard & Poor’s - Pension Funding And Policy Challenges Loom For U.S. States – July 8, 2010). Performance wise, the TRS fund grew +11.1% in FY2010 versus losses of -13.1% and -3.4% respectively in FY2009 and FY2008, and over the past five years, the annualized return of the fund was +2.6%. Now that you have the basics, let’s start examining the details of the plan.

“How is the fund invested?” For the most part, the TRS fund follows a traditional 60/40 model. This means that 60% of the assets are in equities and 40% are in fixed income. This “balanced” approach tries to allow for capital appreciation in the stock market as equities grow, but with the safety of fixed income investments during tougher economic times. The fund will never keep pace with the S&P 500 as it moves up, but it should also not be as hurt as it drops. This 60/40 ratio is the “target” allocation, so since FY2005, equities have ranged from 55.2-61.8% and fixed income from 32.1-41.9% (there is also an “other” category that includes cash and receivables that will be the difference) of the total assets.

One of the questions that I am frequently asked is what stocks does the fund own. As of June 30, 2010, the fund’s top twenty holdings (ranked by allocation) were: Apple, Exxon Mobil, Microsoft, Johnson & Johnson, IBM, Procter & Gamble, JP Morgan Chase, Bank of America, Hewlett-Packard, Chevron, General Electric, Wells Fargo, Google, AT&T, Wal-Mart, Cisco Systems, Pfizer, Coca-Cola, Berkshire Hathaway, and PepsiCo. Obviously, these are all very large companies with some paying dividends, so the fund has tried to balance the growth stocks (Apple, Google, Cisco, etc.) with the value stocks (Johnson & Johnson, Procter & Gamble, Coca-Cola, etc.).

Contribution Rates - A piece of the puzzle that has been frequently overlooked until recently is the contribution rates of the employees and employers. This is a very important part of the puzzle as these contributions fund the plan for the current retirees and build a foundation for your own pension. Your TRS statement will never show the employer’s portion of contributions made for you, but this does not mean that it is not there.

Currently in Georgia, the employees (educators) contribute 5.53% for FY2011. Employers in Georgia currently contribute 10.28% for FY2011. (Note: The preceding contribution rates were corrected from the original post of 5.25% and 9.74% respectively). These figures are calculated based on actuarial tables, and they are reflective of the assumptions made by the actuaries for growth in the plan, salary changes, COLAs, retirees, etc.

The way I view the contributions are simple… if you want to receive your pension benefits later, it is better to make the small contributions now that will supply those. Comparatively speaking, my own 401k (not a pension) contributions are made by my employer and me, but are vastly different from the TRS contributions. I contribute 10% of my salary, and my employer “matches” the first 8% at a rate of 50% (4% max), so my total contribution is 14% with the lion’s share coming from me. Granted I have control of my 401k if I leave, but there is no defined benefit waiting for me when I retire…

In the end, what I hope you to take from this post is that the TRS plan is on good financial ground with annual audits to insure the plan is continuing on its current path. The employees and employers are continuing to make contributions to make up for the current unfunded actuarial liabilities (spreading the burden over years and years not at any one time). The fund invests in a good mix of equities and fixed income securities, and it is not simply doing nothing or gambling. None of this means that everything is perfect, but the overall fundamentals of the plan are a good guide for a long prosperous future.