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The World Loses a Great Investor

By Morgan Housel - Feb 27, 2014 at 12:40PM

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Joseph Dear on investing and the economy.

A year ago, I traveled to California with colleagues Brian Richards and Rick Engdahl to interview some of the world's sharpest economic thinkers, including PIMCO CEO Mohamed El-Erian and former Mitt Romney adviser John Taylor of Stanford University. 

We stopped in Sacramento for what I can sheepishly admit was originally a plan to kill time, interviewing a man we knew little about: Joseph Dear, the chief investment officer of CalPERS, the nation's largest pension fund. We didn't think we'd get much good material out of Dear; we'd had poor success interviewing public officials in the past, as they offer dry, scripted answers. But Dear surprised us. He shocked us, actually. He was as funny as he was wise, as humble as he was brilliant. He ended up being our favorite interview of the trip. 

Dear was diagnosed with prostate cancer soon after our interview. He passed away yesterday, CalPERS confirmed. 

Here are a few highlights I pulled from the transcript of our interview with Dear. 

On politics affecting the economyI think it's important to realize that in democracies, decisions when the pie is growing and when the question is how to distribute an ever-expanding base of wealth are way easier when the pie is shrinking and the decision is to withdraw benefits or to increase costs or to do both. It's really tough for the system to be able to do that. So there's some patience required because it is tough. These decisions, however, if avoided, will result in the consequence of a market riot, which nobody wants to see. 

I'd say what you're looking for first of all is an ability of the political system to produce a compromise. And by its nature, a compromise leaves everybody somewhat dissatisfied. You didn't get everything you wanted; you had to give up stuff that was really precious to you.

On the other side of every one of these is somebody who's going to have something to gain and somebody's going to have something to lose. Those people are way more vocal than the general public who wants a stable political system and an economy which is growing as fast as it can reasonably grow, because growth is the best solution to all these problems. 

On pessimistic groupthink: Well, I think there's growing optimism. I'm not on the leading edge of this, but I still think the mindset is having been bruised so badly with losses and terrorized by fear of a real meltdown in the global economy, that pessimism reigns. 

There's a great quote by the economist A. C. Pigou that said the dying era of optimism gives birth to a new era: an era of pessimism, which is born not a baby, but a giant. And we are still working through that pessimism phase.

On risk and liquidity: Volatility is a form of risk, but it is by no means necessarily the most important. One of the things we learned in the financial crisis is liquidity is important and if you run short of cash in a period of distress, you end up with a set of options which are all terrible. And without going into all the detail, CalPERS found itself in a liquidity squeeze in the fall of '08, and to get ourselves out of it, we had to sell assets. Well, if you're in the midst of a panic and you're selling assets, what can you sell? You can only sell your best stuff. And when you sell into a panic like that, you're marking your portfolio with real losses. That was an extremely painful lesson for us, and obviously we've taken that to heart in a number of ways.

Asked if Calpers can realistically earn a 7.5% return on its assets when recent performance has been below that: I do, I do. Now, we point to the past and say it's over 8% for that time period and then the skeptics go, well, but you had this huge secular decline in interest rates, combined with in general over that long time period, pretty good equity performance. It's not been so great for the past 10 years, but even there, if you look at big cycles in investment and see 10-year returns from equities relatively low, what we've seen after that is a return to better returns after that or a reversion to the mean, so I think there is a reasonable basis to be confident.

Making the argument that pension liabilities are overstated: We determine our liabilities by applying a discount rate which is typically equal to or very close to our assumed rate of return. Now, there are critics who say that that's unreasonably high, that we should discount against a governmental borrowing rate or against some other lower rate. And when you reduce the discount rate on your liabilities, you greatly increase the size of those liabilities, so some people think that the liabilities of public pension plans are really understated, because in the United States, most funds use the rate of return as the discount rate. ... In a super-low rate environment like we have today, liabilities are definitely bigger. Are interest rates going to stay? Is the 10-year Treasury going to stay at 1.6% indefinitely? I doubt it. So it's going to go up, and the interest rates will go up, and even those who want to do the yield curve will see liabilities coming down. 

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