Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

According to a September 25, 2007 press release for the President's Working Group on Financial Markets ("PWG"), pension funds are playing an active role in setting policy. Following on the heels of guidelines released in February 2007, one committee, headed by Eric Mindich, CEO of Eton Park Capital Management, seeks to provide the asset management perspective. A second committee, led by Russell Read, Chief Investment Officer of the California Public Employees Retirement System, will represent institutional investors such as pensions, endowments and foundations. Click here to read yesterday's press release.

Drawing on the "Agreement Among PWG and U.S. Agency Principals on Principles and Guidelines Regarding Private Pools of Capital," drafted earlier this year, committee members will consider fiduciary duties. Not surprisingly, decision-makers are asked to consider the adequacy of disclosure, risk and valuation policies. Excerpted text follows.

• 5.1 Fiduciaries should consider the suitability of an investment in a private pool within the context of the overall portfolio and in light of the investment objectives and risk tolerances. Fiduciary evaluation should include the investment objectives, strategies, risks, fees, liquidity, performance history, and other relevant characteristics of a private pool.
• 5.2 Fiduciaries should evaluate the pool’s manager and personnel, including background, experience, and disciplinary history. Fiduciaries also should assess the pool’s service providers and evaluate their independence from the pool’s managers. Fiduciaries should consider the private pool’s manager’s conflicts-of-interest and whether the manager has appropriate controls in place to manage those conflicts.
• 5.3 Fiduciaries should conduct the appropriate due diligence regarding valuation methodology and performance calculation processes and business and operational risk management systems employed by a private pool, including the extent of independent audit evaluation of such processes and systems.
• 5.4 Fiduciaries that determine to invest in a private pool of capital should ensure that the size of their investment is consistent with their investment objectives and the principle of portfolio diversification.

The guidelines merit more than a cursory review. One sentence in particular struck a chord. Citing the importance of news, institutional investors are urged to obtain and analyze data that is both frequent and "with sufficient detail that creditors, counterparties, and investors stay informed of strategies, the amount of risk being taken by the pool, and any material changes." As readers of this blog know, seeing is believing. More than a few asset managers may be unwilling to unlock the keys to the information gateway, citing economic hardship if forced to provide full disclosure. Just a few days ago, the SEC announced penalties for an asset manager who failed to file Form 13F, evidencing their exercise of "investment discretion over $100 million or more." (Note: There is no universal agreement that 13F filings permit "sufficient" information transparency. At least one court case asks whether an asset manager should be forced to file without recompense for the "taking" of added-value that results from "superior" analysis.)

Additionally, access to greater amounts of information does not necessarily beget better information. Even if available data is Goldilocks perfect ("just right"), what happens when pension investors are unable to process what has been received?

It will be informative to see what the two committees create in terms of operationalizing these fine, but arguably broad, guidelines.

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Have the last few months of negative headlines scared you yet? If not, don't be too complacent. According to a recent survey conducted by Greenwich Associates, institutional investors have grown weary of structured financial products and fixed income securities. According to a summary provided by CFO.com writer Stephen Taub, a worldwide credit crisis "has caused a nearly complete disruption in the trading and use of many fixed-income products." Even trading in ordinarily liquid corporate bond markets has reportedly been difficult, leaving many scratching their heads as to whether the credit crisis is a short-term blip or a long-lived problem. Taub adds that the survey predates the Fed's recent rate cut. (Click here to read "Liquidity Crunch: How Long Will it Last?")

In his September 20, 2007 testimony before the House Committe on Financial Services, U.S. Treasury Secretary Henry Paulson describes the "interconnectedness" of global capital markets and the fallout from concerns over sub-prime mortgages - reduced investor confidence, reassessment of risk, and temporary diminution of liquidity. Describing self-correction tendencies of financial markets, Paulson's more sanguine take can be accessed by clicking here.

After a recent bridge game, I had a chance to ask my friend, Dr. Lucjan Orlowski, for his view of the world around us. As Senior Fellow at the Center for European Integration Studies (ZEI) at the University of Bonn; a Senior Fellow at the Center for Economic and Social Research (CASE) in Warsaw; a Research Fellow at the William Davidson Institute (WDI) at the University of Michigan School of Business, and a Research Professor at the German Institute for Economic Research (DIW) in Berlin, Orlowski's opinion counts in more ways than one. His prognosis? Not very good - In fact, he was downright gloomy with respect to jobs growth and continued ill-effects of this summer's incorrect pricing of default risk. Click here to read Lucjan's impressive bio.

So what does all of this mean for pension funds? Let us count the ways.

1. Diminished liquidity could imperil a plan's ability to meet its short-term obligations. This is especially serious for mature plans or in situations where labor contracts offer few opportunties to revise cash outflows. How should strategic asset allocations change to reflect a sustained credit crunch (if you accept that premise)?

2. Fewer companies are making their way to capital markets. Will a reduction in fixed income security issuance and/or a widening bid-ask spread make it more difficult for pensions to execute any type of liability-driven investing tactic that involves bonds or bond derivatives?

3. Will a weakening U.S. dollar, likely to experience even more downward pressure as oil producers switch to Euro invoicing, compel plans to seek out international assets? Will plan sponsors need to ask external asset managers more questions about risk controls, notably currency hedging techniques, as a result?

4. Could lower U.S. interest rates push some plans over the edge in terms of funding status and inevitable financial consequences?

5. Will changing correlation patterns, and the related reduction of diversification potential, leave defined benefit plan sponsors in a position of having to take on more risk? In the event that FASB requires additional pension investment risk disclosure, will corporate plan sponsors begin to feel pressure from shareholders as market volatility is more explicitly embedded in financial statements?

These are but a few possibilities for those who see the glass half empty and draining fast.

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Investment risk disclosure continues to take center stage. In "Clearing the Financial Fog - Emily Barrett ponders the virtues of transparency" (Wall Street Journal, MarketBeat Blog, September 14, 2007, posted by Tim Annett), the point is made that full disclosure is fraught with problems.

"The trouble with transparency is, there’s just something terribly obscure about it."

"In some ways, banks are already engaged in the clarification process, as more are forced to take back on their books funds previously buried out of regulators’ reach. This includes loans lying around in banks’ warehouses waiting to be chopped up and sold to raise money for private-equity takeovers. A number of bank sponsors of hedge funds have also been forced either to cut credit lines, or, as in the case of Bear Stearns Asset Management, to commit financing to shore them up. But there are limits to how clear banks can be. The complexity of structured finance, which deals in layered bundles of debt, doesn’t lend itself to easy analysis."

“The problem is exposures get buried in different structures,” said Jim Caron, rates strategist at Morgan Stanley. “I don’t think it’s a lack of willingness to get things out to regulators, there’s just a natural lack of transparency in these structures.”

Click here to read the aforementioned post in full.

To be sure, deciding on what and how to provide information is not an easy task. Nevertheless, access to sufficient and meaninful information is vital to good decision-making on the part of institutional investors such as pension funds. Here is the comment I posted.

<< As I’ve written many times (www.pensionriskmatters.com), pension fiduciaries have an obligation to make informed investing decisions. Whether pensions are counterparties to a derivative-related trade (mostly with banks on the other side) or they invest in funds (mutual/hedge/etc) that invest in derivatives, the information they currently get from their trading partners is limited at best. A plan sponsor must understand enough about risk controls and risk drivers for a particular investment/counterparty/asset manager so the investment committee can answer a fundamental question - Are we likely assuming too much risk for the expected payout if we transact with this bank/asset manager? In my view, financial institutions have a golden opportunity to disclose meaningful information about their risk exposures with institutional investor clients, going beyond mandatory requirements. Besides building goodwill, they may be able to attract (and retain) additional assets to manage by fully acknowledging the pension plan’s pain points (need for solid risk information). This does not necessarily translate into providing more information but rather providing “better” information that directly addresses economic risk-taking, and related controls. A joint interview with the portfolio manager and risk manager is one option. Providing the pension plan investor with the bank or asset manager’s risk management policy or statement of risk-taking is another positive gesture. Working with an independent third party to vet risk management process on behalf of the pension plan investor is another possibility. Comment by Susan M. Mangiero - September 18, 2007 at 1:10 pm >>

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This blog's author recently had the pleasure of addressing an audience of hedge fund compliance officers and auditors about valuation issues - a topic near and dear to my heart. As an accredited appraiser, a certified financial risk manager and someone who has worked with models and trades, I am fully aware (and in fact often tout) the inextricable relationship between risk analysis and valuation. Simply put, effective financial risk management does not occur in a vacuum but rather depends on reliable valuation numbers. GIGO (Garbage In, Garbage Out). If a fund manager relies on faulty information, the inevitable result is flawed process, including (but not limited to) inaccurate hedge size (if hedging occurs), imprecise performance reports, possible asset allocation or portfolio re-balancing mistakes, trading limit utilization problems and so on. 

From the investors' perspective, the trickle down effect can be costly. Any "issues" at the asset manager level directly impact fees paid by pension funds, their own asset allocation decisions, not to mention cash flow and funding status breach as possible forms of "valuation fall-out." Valuation is the proverbial four-letter word in investment risk management. Cause for consternation, valuation issues are often complex and demand rigor with respect to policy creation, implementation and review.

Being somewhat impolitic, yet wanting to convey an important message to an important audience of hedge fund professionals, I cited chapter and verse about valuation pitfalls from a pension fiduciary's perspective. Including the need to get private placement memorandums that address what and how the fund manager intends to assess the portfolio on a regular basis, I explained the rationale for use of an independent third party to either render opinions of value, or at the very least, conduct a valuation process check. Even when a hedge fund does not exceed the twenty-five percent ERISA money limit (pursuant to the Pension Protection Act of 2006), best practices abound for both the fund manager and the pension investors alike. Interviewing traders, along with the asset manager's Chief Risk Officer, about valuation policies and procedures is another good idea. If a fund has no functional risk manager, ask why. Interestingly, one person responded to my comments by declaring success at drafting sufficiently obtuse documents that would likely keep investor accusations at bay.

In today's Wall Street Journal, reporter Eleanor Laise tells readers that it's not just hedge funds caught in the valuation cross-hairs. Mutual funds have their own issues. For example, when a security is not frequently traded, multiple methods might generate disparate "fair value" estimates. Quotation quality runs the gamut from the use of stale prices to "accommodation quotes" offered by "friendly brokers." Time-of-day selection is another conundrum, especially in the case of non-U.S. securities or instruments such as highly customized derivatives. Laise adds that "valuation policies can vary substantially from fund to fund." In some situations, an independent outside firm provides prices. Elsewhere, internal models or broker-dealer quotes are used. (See "Funds Struggle with Pricing Pitfalls," Wall Street Journal, September 17, 2007.)

As I've written (and presented) many times before, plan sponsors who sit silently by, without grilling asset managers about their valuation policies and procedures, are asking for trouble. Pension fiduciaries have a duty to oversee external fund manager performance as relates to the stated risk tolerance and return goals. This includes a weighty discussion about price quotes, marking to market (or model) and provider quality. (Not being an attorney, plan sponsors should seek counsel for a precise assessment of their responsibilities.)

With new accounting rules on their way and a variety of significant valuation unknowns, subprime loan-related losses may look like a walk in the park. What we don't know can hurt!

Editor's Note:

Pension Governance, LLC has partnered with the National Association of Certified Valuation Analysts to develop a technical workshop on hedge fund valuation. Click here for a course description. Other programs are in the works. Click here to read more about our June 28, 2007 webinar about hedge fund valuation. (The recording and program materials are available for a modest fee.) If you want additional information about valuation training for your board, risk analysis or process checks, click here to drop us a line.

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According to the Michael Page International Salary Survey 2007, "demand for risk professionals continues to grow with increasing focus on strong technical skills" at the same time that "packages have been upgraded as clients struggle to retain/attract the best people." According to their research, total compensation for directors in the market risk area ranges from $350,000 to $800,000 while directors in the quantitative areas enjoy $400,000 to $950,000 in salary and bonus.

So how do pension professionals fare? In the Lonestar State, things aren't so bad. According to American-Statesman reporter Robert Elder, the Texas Retirement System board just approved a bonus plan that could mean $9 million in goodies for its investment staff. He adds, "The pension fund faces a shortfall of $12 billion between its assets and payout obligations, and retirees haven't had an increase in benefits in six years. It serves 1.2 million active and retired public school workers." (Click here to read "Bigger bonuses approved for Texas Retirement System investment staff" - September 14, 2007.)

From the outside looking in, it's impossible to know if Texas is on the right track or not. After all, Harvard Management Company lost "dozens of staffers" over compensation. While not a pension fund, the Boston experience is one of many where seemingly high pay packages are insufficient to keep talented risk professionals in place.

Expect plan sponsors to feel the pinch even more. According to its newly released "Strategic Plan FY 2008-2013," the Pension Benefit Guaranty Corporation announced plans to "improve risk monitoring and early warning activities and align resources to assure proper plan terminations." Of course, plan sponsors are likely to want their own team to tackle pension risk for a variety of reasons that go beyond regulatory inspection. This blog author's contention is that the investment management process is incomplete in the absence of a comprehensive risk management policy.

The bottom line is that risk managers don't come cheap. Plan sponsors (regardless of plan design - DB or DC) should factor in the costs of hiring skilled leaders in this area now, before demand skews in favor of the sellers even further.

Click here to read "Pension Risk Management: A New Paradigm" (Risk! - January 2007). Click here to request an email copy of "Life in Financial Risk Management: Shrinking Violets Need Not Apply" (AFP Exchange - July/August 2003). You may also want to click here to read our September 4, 2007 post on the topic of investment banking compensation.

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Love her or hate her (the woman), many feel that Ayn Rand's literacy legacy is beyond reproach. Author of best-selling books such as The Fountainhead, her main message is one of self-determinism and excellence of work. New York Times reporter describes the business glitterati who embrace her words to this day, including former Federal Reserve Chairman, Alan Greenspan, and a bevy of Fortune 500 CEOs. No wonder then that her books continue to sell. According to "Ayn Rand's Literature of Capitalism," Atlas Shrugged, published nearly fifty years ago, "is still drawing readers; it ranks 388th on Amazon.com’s best-seller list. 'Winning,' by John F. Welch Jr., at a breezy 384 pages, is No. 1,431."

So why does her work capture the hearts and minds of corporate scions and entrepreneurs alike and what could the pension world learn from Ms. Rand's work?

Addressing the first question, consider her many admirers who describe the inspiration they draw from reading this long (1,200+ pages) novel about the philosophical integrity and strength of characters such as Dagny Taggart (slated to be played by Angela Jolie in the Hollywood film version now underway), Hank Reardon and the all-time favorite, John Galt. Withstanding immense scrutiny and criticism from the entrenched bureaucracies, each fictional business persona fought steadfastly to create wealth by building a better mousetrap and to resist, at all costs, the temptation to be mediocre and do "just enough." 

Part of the book's appeal is its timelessness. As one Atlas Shrugged reviewer recently wrote, this 1957 book could just as easily have been written today. As Rand railed against excessive government regulation (influenced no doubt by her childhood experiences of living in Bolshevist Russia), contemporary critics decry the "excesses" of regulations such as SOX. Rand extolled the virtues (and urgent need) for bold leadership. She cautioned what would happen if the world fell from the shoulders of Atlas and the producers of high-quality products and services (without government help) left the "exploiters" to their own feeble devices. She impugned those who defrauded or otherwise took what did not belong to them. Her words resonate loud and clear in the aftermath of a wave of corporate fraud and scandals. She allowed only for strong property rights and proper commercial incentives (economic profit) to support a better quality of life for all in the form of unfettered markets. (How many innovations occur in the lands of despots and closed markets?) 

Should Atlas Shrugged be a guidebook for pension trustees? Asked in other ways, should benefit plan decision-makers focus on full transparency and accountability? Should fiduciaries bravely step up to the plate and make decisions that are in the interests of beneficiaries first and and always? Should plan sponsors map out a detailed plan (and follow it closely) to avoid conflicts of interest? Will plan sponsors adopt best practices that, in the short-run may cost more in terms of time and money, but in the long-run, create a better outcome for participants and shareholders alike? Should high-integrity fiduciaries be economically rewarded for their insight, commitment and diligence? Conversely, should those who accept sub-par quality of work be penalized?

If the answer to any or all of these questions is affirmative, the following quotes are for you.

"A creative man is motivated by the desire to achieve, not by the desire to beat others."

"Throughout the centuries there were men who took first steps, down new roads, armed with nothing but their own vision."

"The ladder of success is best climbed by stepping on the rungs of opportunity."

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While seen by some as a new-fangled name for an old concept ("keep your eye on the liability ball"), liability-driven investing ("LDI") is taking the defined benefit world by storm. Thought by some as a panacea for mismatched assets and liabilities, one type of LDI strategy entails the use of an interest rate swap (or a portfolio of swaps) whereby a plan sponsor receives a cash amount tied to a fixed rate (usually a specified treasury yield plus X basis points). Its obligation as a Floating Rate Payor is determined by the set level of a variable rate benchmark such as the six-month London Interbank Offered Rate ("LIBOR"). Like anything else, there is no free lunch. Besides the collateral a plan sponsor must pledge to the counterparty (such as a major bank), yield curve changes are another factor. Moreover, as LIBOR rises, the plan sponsor must pay more when swap settlement occurs. (This assumes the absence of an interest rate cap that could otherwise create a ceiling as short-term rates climb.) This is exactly what has been happening of late.

According to the Wall Street Journal, ("Libor Pops Up," September 6, 2007), LIBOR has steadily risen over the last few weeks. Even more troubling, its parallel moves with the Fed Funds Rate have been shattered by credit market turmoil. "In normal market conditions, Libor tracks the Federal Funds rate pretty closely, and as recently as July the two were just 13 basis points, or hundredths of a percent, apart. As of Wednesday's close, that gap had grown to nearly 50 basis points, or half a percent. With exposure to the U.S. mortgage market cropping up in seemingly unlikely places, such as banks around Europe, banks that lend at Libor are expressing concern, through the rising rates, that borrowers who appear safe may prove to have something ugly hiding on their balance sheets."

While the British Bankers' Association suggests stability as of September 7, 2007 (due to central bank intervention), one wonders if this can be sustained. After Friday's disappointing jobs number in the U.S. and statements from money folks worldwide ("The credit crunch is only just beginning."), plan sponsors may find themselves exchanging one problem (pension gap) for another (rising short-term rates that drive up swap floating obligations). 

Add market volatility and new regulatory mandates for disclosure to the mix and it's seat belt time for pension fiduciaries with financial decisions to make. Moreover, in "Why Libor Defies Gravity: Divergence of a Key Global Rate Points to Strain" (September 5, 2007), Wall Street Journal reporters Ian McDonald and Alistair MacDonald note that many other short-term rates are actually falling even as LIBOR and related financial instruments struggle. That's cold comfort if a corporate plan sponsor issues commercial paper or borrows via a short-term facility tied to LIBOR.

More to come about an increasingly important topic - LDI and pension financial management.

Editor's Note:

1. Click here to access LIBOR rates from the British Bankers' Association.

2. Click here to access H15 Selected Interest Rates from the Federal Reserve.

3. Click here to read derivative instrument FAQs, courtesy of the International Swaps and Derivatives Association, Inc.

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Voices of San Diego reporter Evan McLaughlin writes that the Fourth District Court of Appeal "upheld the district attorney's prosecution of six former pension board members." After several years of wending its way through the court system, allegations that trustees violated California's "conflict-of-interest law" will be heard. Charges emphasize "an agreement in 2002 that boosted the future pension pay of the defendants and thousands of other city employees in exchange for allowing the city to underfund the pension trust that year." Click here to read "DA's Pension Case Moves Forward" (September 7, 2007). Click here to read the ruling.

Regardless of the outcome, and acknowleging a presumption of innocence until proven guilty, a key take-away is that pension fiduciaries are absolutely on the hook. Not to be taken lightly, the job of retirement steward is a serious one. Civil and criminal penalties in the event of proven wrong-doing are possibilities. It's no surprise then that liability underwriters are fielding frequent calls for greater and more comprehensive coverage.

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Little noticed inside the pension community is a provision of the Pension Protection Act of 2006 that directly impacts reporting by tax-exempt organizations. What's interesting is that required changes mandate important governance disclosures for churches and foundations and other non-profits. According to Guidestar.org, "Form 990-T was considered a tax return and was not open to public inspection. The Pension Protection Act of 2006, however, mandates that any IRS Form 990-T filed by a 501(c)(3) organization after August 17, 2006, is now a public document. The exception is a Form 990-T filed solely to request a refund of the telephone excise tax."

Too bad the same disclosures are out of reach for anyone interested in understanding the nature of fiduciary risk attached to pension plans. As we pointed out in "Searching for Hidden Treasure" (April 17, 2006), even seemingly "mundane" information such as who makes primary decisions about defined benefit and defined contribution plans is often out of reach. As I wrote then, other than the names of the plan sponsor and plan administrator (found on Form 5500), no one knows much about who is in charge. (Some databases provide this information for a fee and various plan sponsors voluntarily provide this information online or in writing.)

Wouldn't it be grand to know more about who is making critical decisions regarding the $10 trillion pension industry? After all, how can we reward "good players" and hold "bad" or "careless" fiduciaries accountable if they operate in the shadows?

At a time when the SEC is asking for additional information (executive compensation decisions, audit committees, etc) and FASB wants to know more (having just announced plans to promote pension investment risk disclosure) where is the upset about pension fiduciaries - who they are, how they are selected and whether they are qualified for the tasks put upon them?

Editor's Note:

Part III questions of the newly revised form 990 are shown below. The IRS website provides detailed instructions and commentary.

• Enter the number of members of the governing body
• Did the organization make any significant changes to its organizing or governing documents?
• Does the organization have a written conflict of interest policy?
• Does the organization have a written whistleblower policy?
• Does the organization contemporaneously document the meetings of the governing body and related committees through the preparation of minutes or other similar documentation?
• Enter the number of independent members of the governing body
• If “Yes,” how many transactions did the organization review under this policy and related
  procedures during the year?
• Does the organization have a written document retention and destruction policy?
• Does the organization have local chapters, branches or affiliates?
• If yes, does the organization have written policies and procedures governing the activities of such chapters, affiliates and branches to ensure their operations are consistent with the organization’s?
• Does an officer, director, trustee, employee or volunteer prepare the organization’s financial statements?
• Does the organization have an audit committee?
• How do you make the following available to the public?

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Do you feel comfortable about the amount of risk in your pension plan? Like the partially submerged truck, are you seeing only half the truth or are you completely unaware of investment risks lurking in your plan's portfolio?

If you're like the typical participant or shareholder (investing in a company with a defined benefit plan), the outlook is grim. A dearth of information makes it nearly impossible for an interested party to understand when a pension fund is taking on too much risk. That also means that one can never be quite sure about how a pension plan manages asset-liability risk, if at all. Scary stuff indeed!

FASB to the rescue? Perhaps.

At its August 29, 2007 meeting, the staff announced its plan to address three areas, including "disclosures about risks in plan assets, for example use of derivatives." The scuttlebutt is that disclosure about hedge fund investments and other alternatives may be a separate initiative.

This blog's author has long been an advocate of increased transparency, while noting that more disclosure does not necessarily mean better disclosure. Click here to read some past posts on this topic. Though no investment can be said to be absolutely "good" or "bad" (facts and circumstances are key), it is noteworthy that so little is known about such a large and important segment of the capital markets - the $10 trillion pension investor market.

When invited to speak with FASB pension team members on the topic of disclosure, I laid out what I thought would be "problem areas" in terms of disclosure and interpretation. Here are a few thoughts.

• There are multiple ways to measure leverage. Which one is best?
• How do you get people to look beyond traditional (and arguably limited-use) metrics?
• What rules discourage "gaming" of the system and instead focus attention on economic risk analysis (rather than accounting compliance)?
• Is there a chance of information misuse?
• Will periodic statements be sufficient to ward off potential problems (an oft-cited criticism of Form 5500 reports)?
• Could reporting requirements backfire and discourage plan sponsors to "play it too safe?" (Risk-taking is not necessarily a wrong move but certainly uninformed risk-taking spells trouble. Ditto for being "too" cautious if it means that a plan falls further behind in its ability to meet its obligations.)

On the disclosure front, reporter Diya Gullapalli writes that mutual fund managers are voluntarily providing information about their exposures, in hopes of minimizing investor angst. "Among the rare disclosures are precise percentages of mortgage-related holdings and lengthy explanations of losses." (See "Fund Firms Draw Back the Curtain, Wall Street Journal, September 6, 2007.)

Related to this notion of "need to know" is the SEC's announcement that three hunded letters are on their way to various companies, seeking details about executive compensation levels and the underlying rationale for alleged largesse.

A discernible trend towards increased disclosure is upon us. The critical question is whether the marketplace is ready. 

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According to "Pay at Investment Banks Eclipses All Private Jobs" (September 1, 2007), New York Times reporter David Cay Johnston tells the tale of two cities. There is Investment Banker Land where the typical weekly pay exceeds $8,300 and then there is Everyone Else Land. (In Fairfield County, Connecticut - home to many corporations and hedge funds -  the mean pay, as reported by the Bureau of Labor Statistics, was $23,846 a week.) Click here for a copy of this government report, with a breakdown in average pay by various geographic areas.

This blog's author is the first to say "hooray for capitalism." If financial institutions pay individuals the big bucks because they can spin flax into gold for shareholders, arguably a happy marriage between supply and demand has taken place. However, and notwithstanding the fact that we can vigorously debate the "reasonableness" of salaries all day long, plan sponsors face a dilemma.

1. How do pension fiduciaries deal with the gap between what they can afford to pay financial experts and what the big banks pay, especially at a time when skilled analysts and risk managers are desperately needed by pension plans, regardless of plan type?

2. If any particular fund manager is reporting losses or sub-par performance, how do pension fiduciaries justify a decision to retain a manager and/or investment bank that treats itself well in the compensation department? In other words, how does manager pay get factored into the short-term versus long-term retention decision?

3. How do pension fiduciaries assess "acceptable" compensation paid to asset managers and bankers? Do more complex strategies require the installation of smarter and more experienced personnel who should charge more as a result?

4. How much detail should be provided to plan beneficiaries with respect to compensation of asset managers and/or investment bankers who work with the  plan?

Rather than tell you what I think, email your feedback about investment banking and money management compensation. Let us know if we have permission to post your response.

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One of the original thirteen colonies of an infant America, Massachusetts has a special place in history books. In an about face with respect to economic freedom, lawmakers are making it difficult for state pension officials to do their job. According to The Boston Globe, attempts by both the state House and Sentate (and efforts by the governor) would force liquidation of investments in companies that do business with countries such as Sudan, Iran and North Korea. 

Journalist April Simpson quotes Michael Travaglini, as saying that $1.1 billion would be impacted, roughly two percent of total assets. Executive director of the Pension Reserves Investment Management Board, Travaglini adds that "The rule of thumb for investments is you sell the stocks that aren't performing well and run with the funds that are. This type of legislation runs counter to that. There's a very real potential to negatively impact the investment returns of the pension funds." Click here to read "Pension divestment effort gets complicated" (August 31, 2007).

As this blog's author pointed out just a few months ago on CNBC, there are potential fiduciary consequences. While no one in their right mind supports terrorism, fallout is inevitable.

"First, selling stocks because of statehouse mandates could cost taxpayers and plan participants in the form of "unexpected" transaction costs. This would in turn exacerbate funding problems for any states already in the red. Second, trustees would have to decide how to invest the proceeds of disposed equities, possibly earning less than before. Third, there could be a conflict for fiduciaries in terms of duty. Do they follow new rules that require divestiture, even if it forces them to violate state trust laws that demand careful analysis before deciding on an "appropriate" strategic asset allocation? Fourth, plan fiduciaries will likely need to spend considerable time and money in order to identify which companies offend, now and regularly thereafter." Click here to read the rest of "Is There Fiduciary Liability Attached to Divestment?" (June 15, 2007). 

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