The crypto industry is still reeling from last week’s shocking death spiral of digital currency exchange FTX. The company’s bankruptcy filing has left financial backers in the lurch — including the usual suspects in Silicon Valley, from Masayoshi Son’s SoftBank to VC firm Sequoia.
A few names on the list stand out, though. The Ontario Teachers Pension Plan was invested in the company. The Alaska Permanent Fund Corp, The Washington State Investment Board and others were indirect investors in FTX through Sequoia and other venture capital firms. While these funds say they had limited exposure to FTX, their inclusion points to a growing but alarming trend that could affect you even if you’re not a buyer of crypto yourself.
What’s happening: Pension funds are increasingly investing in alternative assets in search of bigger returns. Crypto is one example — and that could be risky for anyone invested in them.
In the United States, public pension funds are facing serious challenges that threaten the retirement plans of millions of state and local government employees.
The 100 largest public pension funds in the United States had been funded at just 69.3% of their total obligations at the close of the third quarter, down from 85.5% at the end of 2021 according to analysis by Milliman, an actuarial and consulting firm.
That means that these funds have a gap between the cash they’re holding and the cost of the benefits promised to both retired and soon-to-retire workers. In order to stay afloat, they have to make it up somehow. Raising taxes or re-balancing budgets pose political problems, and so many are instead attempting to juice returns by investing in riskier and more illiquid alternatives to stocks and bonds like cryptocurrency, private equity, and hedge funds.
“This really shines a bright light on what money managers are doing to try to achieve a higher rate of return. It’s not just about crypto as much as just their overall increased tolerance and appetite for these alternative asset classes,” said Matthew Eickman, national practice leader at Prime Capital Investments.
Riskier investments, bigger rewards? Of the roughly $4 trillion in assets managed by public pension funds in the United States, about one-quarter is allocated to risky alternative vehicles, including private equity, real estate, and hedge funds, according to the Boston College Center for Retirement Research. That’s up from 8% when they began measuring in 2001.
It’s not just a trend that’s happening in the United States. Pension assets allocated to real estate, private equity and infrastructure have increased from 7% to over 26% in the past two decades globally, according to Willis Towers Watson’s Thinking Ahead Institute.
But as the FTX debacle showed, risky investments can further erode the already damaged pension landscape. These alternative investments are often complicated, have high fees and are more volatile than stocks.
Portfolio managers are investing in “opaque investment strategies that we do not have sufficient understanding of that could create large problems in the future,” said Joe Brusuelas, chief economist at audit and tax and consulting firm RSM US. “My fear lies in these known unknowns.”
The silver lining: It’s been a tough year for markets, and a lot of pension funds are getting battered, which puts them in a position to look into increasing their stake in non-market investments, said Eickman.
But the recent events could prompt them to think twice. “What’s happened with FTX probably will introduce additional caution into those discussions,” he said.
The Fed delivers a confusing message
US markets snapped a two-day rally and closed lower on Monday after Fed governor Christopher Waller warned that the endpoint for rate hikes by the central bank is “still a ways out there.”
“We’re at a point where we can start thinking maybe of going at a slower pace,” Waller said at a conference organized by UBS in Australia. But he warned investors that the Fed was not softening its fight on inflation. “Quit paying attention to the pace and start paying attention to where the endpoint is going to be. Until we get inflation down, that endpoint is still a ways out there.”
The comments came after a report released last week showed that inflation in October was lower than expected. Investors seized onto the data as a sign that the Fed could soon pivot away from historically high rate hikes, and markets had their best day since the spring of 2020.
The CPI inflation report was “good news,” said Waller, but it’s “just one data point” and more readings are needed to convince policymakers that inflation rates are easing.
Mixed messaging: Stocks rebounded from session lows on Monday after another Fed official delivered a somewhat different message. Federal Reserve Vice Chair Lael Brainard indicated the central bank could soon slow the pace of its interest rate increases on Monday.
“I think it will probably be appropriate soon to move to a slower pace of rate increases,” she told Bloomberg News in a live interview. “We have raised rates very rapidly,” she said. “We’ve been reducing the balance sheet, and you can see that in financial conditions, you can see that in inflation expectations, which are quite well-anchored,” she said.
The bottom line: Markets could remain volatile until rate hikes end. Investors will search deeply for clues about future Fed policy in the Producer Price Index report on Tuesday, the retail sales report on Wednesday, and the Philly Fed manufacturing index on Thursday. But it’s best not to fight the Fed: When officials say one piece of data won’t sway their policy-making process, they mean it.
Biden and Xi meet during G20 summit
President Joe Biden held a three-hour talk Monday with his Chinese counterpart Xi Jinping, their first in-person encounter since Biden took office, report my colleagues Kevin Liptak and MJ Lee. The meeting comes at a time of deteriorating relations between China and the US.
Emerging afterward, Biden told reporters he was “open and candid” with Xi about the range of matters where Beijing and Washington disagree. “I’m not suggesting this is kumbaya,” Biden said at a news conference, “but I do not believe there’s a need for concern, as one of you raised a legitimate question [about] a new Cold War.”
Economic relations: Xi reportedly criticized the US for attempting to build “walls and barriers,” and pushing for “decoupling and severing supply chains,” during the meeting. “We oppose politicizing and weaponizing economic and trade ties as well as exchanges in science and technology,” he said.
A White House readout said that “(Biden) reiterated that (US-China) competition should not veer into conflict and underscored that the United States and China must manage the competition responsibly and maintain open lines of communication,” the statement said, adding that the leaders asked their teams to carry this work forward.
Markets encouraged: Stocks in mainland China and Hong Kong got a lift Tuesday, my colleague Laura He reports. Analysts said the unexpectedly constructive tone of the meeting boosted sentiment. The meeting had sent a positive message that the two sides would strive to find common ground, they added.
What’s next: The US will send Secretary of State Antony Blinken to visit China to follow up on their discussions, said the White House.