Wednesday, December 7th, 2016

Will they cover the vig?

1

The state pension fund is borrowing to bet more at the blackjack table, but can they cover the vig?

We may be only looking at the beginning of the SWIB’s buying on margin. The SWIB had considered borrowing up to 200% for investing, but chose for now this smaller amount.

Steven J. Foresti, managing director and head of the investment research group of Wilshire Associates Inc., said to Pensions and Investments that this is the future of investing for pension funds, and is advising clients to adopt the strategy. “…if the idea is to use leverage to manage risk and maintain diversification and current expected return levels, that is a free lunch.”

He also said that if a pension fund was leveraging to pursue return, “that would be different.” But that’s clearly what the SWIB is trying to do. The stated purpose of leveraging to invest in the TIPS is to maintain the returns from the investment in equity. SWIB is clearly borrowing to gamble, even if the loan is for the house payment they’re skipping to play Bingo at the casino.

Is this a reduction in risk? As much as diversification is good for your portfolio. However, the risk of stocks is independent of the risk of TIPS. Whether stocks go up or down is independent of whether the value of TIPS will go down. They could both go down, exposing the state pension to even more losses.

To make matters worse, the TIPS not only have to perform positively, but to make them a worthwhile investment they have to do well enough to cover the interest paid on the loan. If the TIPS lose value, the loss is even more exaggerated by the maintenance cost of the loan.

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