When Pension Funds Go Out on the Risk Curve... And a Desperate Move at Kellogg

There's a saying that I was thinking about the other day when I was reading a story in the Wall Street Journal... "Reaching for yield." That's when, for the sake of making even a little more on a supposedly conservative fixed- income investment, you buy something with a higher yield. But with higher yield comes […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] When Pension Funds Go Out on the Risk Curve... And a Desperate Move at Kellogg By Herb Greenberg --------------------------------------------------------------- [This could literally save your retirement]( The man CNBC called "The Prophet" says he'd put 50% of his kid's college fund in this stock. [He reveals the name and the ticker symbol here](... --------------------------------------------------------------- There's a saying that I was thinking about the other day when I was reading a story in the Wall Street Journal... "Reaching for yield." That's when, for the sake of making even a little more on a supposedly conservative fixed- income investment, you buy something with a higher yield. But with higher yield comes higher risk... There are plenty of examples of that strategy backfiring. The one that resonates most with me is the debacle surrounding what are known as auction-rate securities. Back in the mid-to-late 2000s, these were viewed as a virtually no-risk, slightly higher-yielding alternative to sleepy money market funds, U.S. Treasurys, and even commercial paper. They were also illiquid. Long story short, [as I wrote at the time]( they blew up... resulting in huge losses for a bunch of corporate treasurers and others who thought they knew what they were doing. I was reminded of this when I read that [Journal story]( which focused on how some public pension funds were starting to use leverage to juice their returns. That's right... as the markets are getting riskier, these pension funds are taking on more risk. More to the point, they're borrowing money to juice their returns. The goal is to make sure the funds have the money to pay retirees. Here's the problem, as the Journal explains... Even the longest equity bull market in history – a roughly 11-year run through early 2020 in which the S&P 500's 18% annual return more than tripled its historic average – didn't close the gap between pension funds' obligations and assets. In 2021, public pension plans had an average of just $0.75 for every dollar they expected to owe retirees in future benefits, according to data from the nonprofit Center for Retirement Research at Boston College. The funds can try to fill the gap by the politically difficult task of demanding more in yearly contributions from governments and from workers themselves, a move that often meets with pushback from public-employee unions. Or they can adopt a potentially higher-yielding – but riskier – investment strategy. That's where this gets dicey. Think about it... In the best bull market known to mankind, they didn't do well enough to fill that gap. In part, that's probably because by nature pension funds are – or should be – fairly conservative. So here we are, in as crazy and difficult and unpredictable a market as most of us have lived through, and we're seeing pension funds using leverage. Though to be fair, they started thinking about it and even doing it back in the good old days of a few years ago, when rates were rock bottom and stocks seemed like they were on a one-way trip to the moon... --------------------------------------------------------------- Recommended Link: [Why stocks could crash on July 19]( The number of Nasdaq stocks down 50% or more is at a near record. And on July 19, it could get worse – much worse. That day, one of America's most beloved firms will make an announcement that could send it plummeting... And take down hundreds of other stocks with it. [The man who called the 2020 crash is posting a new public warning here](. --------------------------------------------------------------- As the Journal points out, one of those funds – the Teacher Retirement System of Texas – started using leverage in 2019... A buddy forwarded over a slide deck from July 2019 that the fund's investment management committee used to justify the shift. In exchange for leverage, the plan called for it to get rid of such things as Treasury Inflation-Protected Securities ("TIPS"), exchange-traded futures, and directional hedge funds. Here's the best part: One slide specifically said that even with higher leverage, volatility would stay the same... but the fund would earn more. As my friend pointed out, "Of course, there was an advisor who helped them on the study." What's more, it was based on an assumption of 2.3% inflation. Going into 2022, according to the Journal, the ploy seemed to be working for Texas, with leverage helping add 1.43% to the fund's returns over two years. But that was before all hell broke loose in the markets – back when even some of the smartest investors lost sight of the underlying risk. As the Journal notes, it was just about then that CalPERS, the giant California retirement fund, was putting the final touches on its plan to start using leverage for the first time in 90 years. In fact, it was at a meeting of the CalPERS board in November of last year – just as the Nasdaq Composite Index was (surprise, surprise!) making its last stand – that managing investment director Sterling Gunn was telling his board... With the use of leverage, we can reduce the equity exposure just a smidge and increase the fixed-income exposure. It's that "just a smidge" that worries me. Just ask anybody who bought those auction-rate securities, when a smidge more risk resulted in mountains of losses. Moving on, consumer products giant Kellogg's (K) announcement last week that it's splitting itself apart doesn't come out of strength... The company had been trying for years to pull every lever internally to jump start profitability and growth as its cereal business got a bit too soggy. As part of the breakup, cereal will be spun into its own company, as will snacks and plant-based foods. This all comes after years of []Kellogg trying to keep investors engaged as it attempted to get from here to there. In fact, Kellogg had been so desperate to show growth that it resorted to clever accounting gimmicks. These helped make the company's cash flow look better than it really was... and revenue growth look stronger than it really was. All of this was happening as Kellogg was trying to convince investors that its attempted turnaround was gaining traction. That was on top of the company's broader efforts to cut its way to prosperity, with cost-cutting program after cost-cutting program... First there was K-Lean, followed by Project K – both against the backdrop of a move toward zero-base budgeting. The stated goal was to boost margins, but just the opposite happened... As you can see in the chart below, Kellogg's gross margins continued to slide... And earnings before interest, taxes, depreciation, and amortization ("EBITDA") margins slid as well... That's a ploy that can only go so far, especially for a company whose business model is broken. This split signals just how broken it is. As always, feel free to reach out via e-mail by [clicking here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Herb). And if you're on Twitter, feel free to follow me there at [@herbgreenberg](. My DMs are open. I look forward to hearing from you. Regards, Herb Greenberg June 28, 2022 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](