Glitz and Glam or "Stodgy" Fundamental Investing?

Posted on April 30, 2008 by Susan Mangiero

When I was a young MBA pup (New York University), an investment professor asked students to purchase "Security Analysis" by Benjamin Graham and David Dodd. Not an unusual choice until one noticed the 1940 copyright. My reaction at the time was to think that this scholar needs to retire soon if he can't find a more modern text. Alas, the marvels of youthful ignorance, heh?

This flashback came to mind in reading the flurry of newspaper articles about the intended $23 billion purchase of Wm. Wrigley Jr. & Co. by private candy giant Mars Inc. Helping to finance things is no other than Warren Buffett who negotiated an approximate 10 percent of the deal for Berkshire Hathaway. With a stake in Sees Candy and the Coca-Cola Company, this uber value investor is familiar with beverages, salty snacks and sweets. (Note that Thomson Financial News, via Forbes.com, reports that Moody's Investors Service has put some of the Chicago gum giant's debt ratings under review as a result of the proposed structure.)

According to "Mars to Buy Wrigley’s for $23 Billion" by New York Times reporter Andrew Ross Sorkin (April 28, 2008), Wrigley's sales revenue just topped $5 billion. The National Confectioners Association reports that "gum sales continue to surge growing 9.3% over the latest fifty-two weeks" with the "key growth engine" being "seasonal confectionary products."

This news item is interesting but even more so after reading "Inside Citi, a Hedge-Fund Push Blows Up" wherein Wall Street Journal reporter David Enrich describes sales enthusiasm gone amuck. Having sold interests in "safe" fixed income hedge funds Falcon and ASTA/MAT to retail clients, global wealth management staffers are wrestling with a lawsuit, unhappy brokers and disgruntled investors. The article continues that Citi sold "only to clients with large, diversified portfolios." As litigation ensues (assuming it does), more will be known about sales practices and representations made to clients, existing and prospective.

Will an ordinary stick of gum pave the way for riches and leave certain "exotic" alternatives in the dust? One wonders - shades of the tortoise versus the hare? What are the lessons for retirement plans as billions of dollars are making their way into non-traditional securities?

Editor's Note: Here are a few fun facts about the confectionary industry.

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Equity Bye Bye - Asset Allocations Are a Changin'

Posted on April 28, 2008 by Susan Mangiero

According to Financial Times reporter Deborah Brewster ("Investors pull out of mutual funds," April 27, 2008), nearly all U.S. mutual fund managers saw a drop in assets in Q1-2008. Sagging returns are a main driver on the retail side. Citing Strategic Insight, Brewster writes that individuals and institutions have pulled $100 billion from American, European and Japanese equity funds.

Money market funds, charging lower fees, seem to be picking up the slack. This suggests an inevitable decline in profitability for the asset management business. In "Has the Financial Industry's Heyday Come and Gone?" (April 28, 2008) Wall Street Journal reporter Justin Lahart writes that "the businesses of borrowing, lending, investing and all of the middlemen in between" are slowing and thereby creating ripples throughout the U.S. economy. With documented job cuts in the financial sector, new regulations and questions about "excess" risk, a discernible shift is underway. A shrinking financial sector and reduced availability of credit hits consumers and corporations hard.

In addition, defined benefit plans are moving assets away from equity to alternatives and fixed income. In "CalPERS to shift $44 billion" (December 24, 2007), Pensions & Investments reporter Raquel Pichardo describes the giant retirement plan's move into international equity, real estate, private equity and a "new inflation-linked asset class." On April 17, 2008, New York Times reporter Mary Williams Walsh offers insight into what some of American's biggest plan sponsors are doing to manage market volatility. Referring to a new study by Evaluation Associates in "Market Turmoil Has Taken a Toll on Big Pension Funds," Walsh writes that General Motors, Ford, Boeing and Deere are a few of the large plans to turn from equities.

The issue is important for many reasons, not the least of which is the impact on statutory funding requirements, cash flow and related share price. In March 2008, money manager Charles Gilbert spoke to a Society of Actuaries audience about the double whammy of falling interest rates (increases the defined benefit liabilty) and unhealthy stock returns (reduces portfolio value).

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Do You Have Your Own Fiduciary? If Not, Why Not?

Posted on April 27, 2008 by Susan Mangiero

 New York Times reporter Alina Tugend ("Pick a Planner Who Can Spell ‘Fiduciary’," April 26, 2008) writes about the importance of doing proper homework when it comes to selecting an investment advisor, stockbroker or financial planner (consultant). Her rule? Ask someone you are thinking of hiring - Are you willing to wear the hat of fiduciary? Since not everyone is required by law to embrace the fiduciary mantle, and some do so only in exchange for additional compensation, the question is far from trivial. She quotes Sheryl Garrett, author of Personal Finance Workbook for Dummies (John Wiley & Sons, 2007) as urging individuals to document agreed-upon terms, including those that relate to the discharging of fiduciary duties such as care and loyalty. Fees and conflicts of interest are other considerations. For example, a compensation structure that includes commissions may encourage the sale of unsuitable securities to small investors.

As more employees migrate (by choice or force) to defined contribution plans, investment literacy is critical. Interested readers may want to check out the following resources:

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Corporate Fraud - FBI Speaks Out

Posted on April 23, 2008 by Susan Mangiero

In a recent speech, Federal Bureau of Investigation ("FBI") Director Robert S. Mueller, III, warns white collar criminals that agents are busy at work. Citing an alarming increase in fraud (up by "more than 80 percent since 2003"), Mueller provided some interesting facts to attendees of the American Bar Association, Litigation Section Annual Conference.

  • The FBI has nearly 2,000 agents working on almost 17,000 white collar cases, "from public corruption and financial fraud to health care and mortgage fraud."
  • The FBI has successfully prosecuted more than "490 corporate and securities fraud convictions in 2007" with more than 30 insider trading indictments affecting employees of at least four major banks.
  • The FBI is investigating in excess of 1,300 mortgage fraud incidents and has identified "19 corporate fraud matters related to the subprime lending crisis."
  • The FBI has its sights on "accounting fraud, insider trading, and deceptive sales practices."

Urging reform to protect shareholders and other relevant parties, this lead G man cites the need for independent (and arguably competent and objective) auditors, outside counsel and independent directors. Conflicts of interest remain a concern.

Click to read the full text of Director Mueller's speech.

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Pensions Go Green - Happy Earth Day!

Posted on April 22, 2008 by Susan Mangiero

According to "Fighting Climate Change, State by State" by Anne Moore Odell (February 27, 2008), local governments are investing in environmentally-friendly companies for the long-term. Various treasurers from California to Connecticut have collectively committed billions of dollars to clean technologies. Evidence that they mean business, nearly 500 institutions came together in New York on February 14, 2008 to address the "scale and urgency of climate change risks, as well as the economic opportunities of a global transition to a clean energy future."

Progress since the 2005 inception of the Investor Network on Climate Risk ("INCR") includes an agreement to verify if, and to what extent, fund managers and financial advisors have bettered their "capacity to assess climate risk." For mutual funds, this includes an annual scorecard that reflects how portfolio managers vote on various shareholder proposals relating to climate.

To learn more, click to read "Investor Progress on Climate Risks & Opportunities: Results Achieved Since the 2005 Investor Summit on Climate Risk at the United Nations," dated February 2008.

Given statehouse initiatives relating to (a) divestment of certain international holdings and (b) limits on sovereign wealth fund exposure, is the commitment to being a friend of the earth a harbinger of future asset allocation directives or good portfolio diversification?

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Excuse Me! Excuse Me! Pension Fiduciaries - Heed the Call

Posted on April 21, 2008 by Susan Mangiero

Several recent experiences inspire this post. On the positive side, two weeks ago, I had the pleasure of spending time with my step niece, a darling little girl of 3. After just 15 minutes, I realized that her favorite way of getting attention is to scream "excuse me" as many times as it takes until nearby adults acknowledge her. Cute at first, it annoys after a few shouts but Lilly certainly gets her way.

On the other end of the experiential spectrum, my Sunday foray to Starbuck's introduced me to "Miss Manners Not." Though I was first at the counter and obviously not yet finished paying for a handful of gift certificates, a lady customer thrice reached over me and then pushed me aside to order a cup of joe. Not being shy, I murmured "sorry to be in the way." To my shock, she replied "it's okay." Yes, my first response was to tilt my cup in her direction ("oops") but give me credit for being an adult who quickly cooed sotto voce, "let it go." (You've met folks like this gal, right? Gotta love 'em for their arrogance and cluelessness.)

Here's the connection to all things pension.

Everyday brings new headlines about the retirement crisis. Just a few days ago, New York Times reporter Mary Walsh cites a new study that shows that 2007 investment gains for America's giant pension funds are fast being erased by early 2008 market tumult. Likely to add to the funding gap and compelling a need for cash infusions is a strategic move away from equity. More disturbing is that jumbo plans, in distress, could "swamp the federal insurance system," already reeling from certain airline and manufacturing company woes. Piling on is the Fed's lowering of interest rates which pushes up the size of defined benefit plan liabilities, exacerbating things. Given tighter funding rules, courtesy of the Pension Protection Act of 2006, plan sponsors have much less latitude in riding out the storm, if even possible. (See "Market Turmoil Has Taken a Toll on Big Pension Funds" by Mary Walsh, April 17, 2008. Also read "2007 Gains Reversed in First Quarter of 2008" by John W. Ehrhardt and Paul C. Morgan, "Milliman 2008 Pension Funding Study," April 2008.)

In January 2008, the U.S. Government and Accountability Office ("GAO") released an alarm bell in the form of its report entitled "State and Local Government Retiree Benefits." They concluded that "58 percent of 65 large pension plans" had funding ratios of about 80 percent in 2006, a decline since 2000. By extension, this means that 42 percent are in bad shape. (There is continuing controversy over whether 80 percent is deemed "safe" or instead suggests a need to worry.)

For individuals, new research cites the need for a long-term, relatively stable mix of stocks and bonds. In "Hitting or Missing the Retirement Target: Comparing Contribution and Asset Allocation Schemes of Simulated Portfolios," Professors Harold J. Schleef and Robert M. Eisinger argue that the likelihood of having enough money to retire comfortably is depressingly low. As New York Times contributor and money talking head, Mark Hulbert, points out, life-cycle or "target date" maturity funds may not perform "in line with their long-term averages." (Read "The Odds for a Retirement Nest Egg, Recalculated," New York Times, April 20, 2008.)

Of course, if Louis Lowenstein, author of The Investor's Dilemma: How Mutual Funds Are Betraying Your Trust and What to Do About It is right, fees and revenue-sharing arrangements will continue to erode retirement savings (meager for most), making it tougher to reach even a low savings goal. While employers shed their traditional benefit plans, they nevertheless have a vested stake in wanting their employees to be self-sufficient. Happy workers are typically productive workers who spin gold for shareholders and performance-compensated executives.

For the still clueless pension decision-makers, oblivious to the merits of effective asset-liability management (the equivalent of my coffee shop lady), hopefully the onslaught of economic and regulatory indicators will create a stir. If not, perhaps my young niece will take her "excuse me, excuse me, pay attention" show on the road.

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Lowballing LIBOR May Cost Pensions Plenty

Posted on April 18, 2008 by Susan Mangiero

According to Wall Street Journal reporter Carrick Mollenkamp ("Libor Surges After Scrutiny Does, Too - April 18, 2008), the British Bankers' Association is moving ahead to investigate the veracity of self-reported cost-of-funds numbers. The fear is that banks are paying more to borrow in the short run than they want to admit. If peers discover the truth, bank borrowers may find themselves at a competitive disadvantage. Non-borrowers will feel the pinch too as will swap and over-the-counter fixed income option counterparties and those trading the Eurodollar futures contract. The London Interbank Offer Rate ("LIBOR") is a common base rate for most short-term loans and derivative instrument contracts.

American regulators are worried too as market pundits predict that U.S. dollar LIBOR rates are likely to spiral. Just last week, three-month LIBOR loan rates rose to 2.8175% per annum, up from 2.7335%, "the biggest increase since the three-month rate rose 0.12 percentage point on August 9" when BNP Paribas prevented investors from withdrawing money from several of their funds. The current level is reported at "its highest" since March 13 when news came out about Bear Stearns.

A rising LIBOR makes swap-driven Liability-Driven Investing ("LDI") strategies more expensive for Fixed Rate Receivors - Floating Rate Payors. In addition, if quarterly checks indeed differ from estimated projections, pensions may eschew LDI strategies as too difficult to evaluate for accounting or risk management purposes.

Interestingly, quotation problems seem to be contained to U.S. dollar LIBOR situations and not other currencies such as the Euro.

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Valuation - Getting on Track

Posted on April 17, 2008 by Susan Mangiero

As an Accredited Valuation Analyst and long-time advocate of the notion that effective risk management and valuation go hand in hand, the release of two reports that emphasize good process in these areas is welcome news. See "Principles and Best Practices for Hedge Fund Investors" and "Best Practices for the Hedge Fund Industry." Click to read "PWG Private-Sector Committees Release Best Practicies for Hedge Fund Participants" (April 15, 2008) where "PWG" stands for the President's Working Group.

While I agree with Peter Schwartz that self-regulation and market discipline is ideal, I'd like to think that calls for reform are positive reactions to problems rather than "desperate" pre-emptive strikes against statutory mandates. Is that naive? Perhaps but hope springs eternal. (Read "Valuation is the Heart of the Matter," reprinted in "Money House of Cards or Disciplined Approach?" - April 17, 2008)

Where I part company with my colleague is that I believe one can (absent a once in a lifetime event) value complex securities if they are equipped with an analytical toolbox. If we peek inside, "hammers and nails" would include: (a) reasonable assumptions (b) appropriate and tested models (c) understandable and available data (d) identification of relevant risk factors that drive value (e) methodology that can be explained to others and reflects relevant economic considerations (f) disciplined, systematic process and (g) common sense.

Ultimately, value equals price when a willing (and hopefully informed) buyer and seller agree on terms. Until then, should we surrender to what some deem as villainous fair value accounting rules or roll up our shirt sleeves and get to work, acknowledging that a calculated "value" may differ from an eventual price?

I opt for the latter because I believe action beats passivity (though some may say nein to investing in the first place). Indeed there are numerous occasions that require an opinion of value for "official" reasons (tax reporting, account redemption, fund creation, determination of hedge size and so on.) What worries me is when alternative fund managers adopt an arbitrary stance or embrace a philosophy that discourages attempts to apply reason, discipline and care.

  • Example One - Two or more appraisers may reasonably disagree on an exact identical DLOM ("discount for lack of marketability") for a particular economic interest. Yet a careful analysis of what contributes to a possible liquidity event is far superior to the X% times number of years formula in use by some alternative fund managers. 
  • Example Two - Appraisers cost a fund (or its investors, depending on which party pays) because they charge a fee to render independent, objective third party assessments.  Are pensions, endowments and foundations better off by blithely relying on marks provided by traders, knowing that they are often compensated based on reported performance (inducing an inherent conflict of interest as a result)?
  • Example Three - Should we accept that some instruments truly cannot be valued or instead identify economic and non-economic factors that impact the ability of an owner to eventually sell? Should we ignore emerging mechanisms that create markets in all sorts of "hard to value" business interests such as someone's client list or their employee stock options? 

Mr. Schwartz is certainly right to warn that some situations are challenging at best. As this blog has emphasized (perhaps ad nauseum), suitability assessment is a critical first step. It makes no sense to invest other people's money (plan participants) or encourage direct allocation (as with 401(k) plans) unless decision-makers truly understand risk drivers (qualitative, quantitative, economic, non-economic).

This blog will continue to address valuation issues. Your feedback is welcome. Drop us a line.

Editor's Note: Check out www.securitiesmosaic.com and the family of related websites. It's well worth your time. 

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Money House of Cards or Disciplined Approach?

Posted on April 17, 2008 by Susan Mangiero

Courtesy of fellow blogger and technology entrepreneur, I am reprinting "Valuation is the Heart of the Matter" by Peter Schwartz  (founder and president of Knowledge Mosaic).

<< Business and financial regulation in the United States builds upon two worthy traditions - self-regulation and self-disclosure. By design, these traditions preempt and represent lightweight alternatives to more heavy-handed and prescriptive direct regulation by government agencies. When the SEC deputizes private organizations such as the NYSE to police its members, it is adhering to the time-honored tradition of deputizing private citizens to maintain public order. When the SEC requires electronic disclosure, it respects the dependence upon, and responsiveness of, financial markets to the flow of information - to the idea that, indeed, markets are little more than the flow of information.

However, when industries themselves call for more self-regulation and more self-disclosure, it is always an act of desperation, not merely because they want to avoid direct government oversight, but because they are acknowledging that they can no longer survive without some measure of public accountability and public trust. They are acknowledging that the open markets to which they pay fealty now threaten to consume them.

In that spirit of desperation, today we are privileged to experience the much-anticipated release to the President's Working Group on Financial Markets of two private sector reports on hedge fund best practices - one from the hedge fund industry and one from institutional hedge fund investors (primarily pension funds, endowments, and foundations). These reports represent responses to the meltdown in the financial services industry that has led to the evaporation of more than $245 billion in asset write-downs and credit losses since the beginning of 2007, and to market instability that the hedge fund industry no longer trusts it can manage.

What strikes me in reading these reports, and observing the conversation about the recent financial crisis from a distance, is the centrality of the problem of valuation. Both reports combine reference to valuation with other key aspects of hedge fund management and investment - disclosure, risk management, taxation, accounting, liquidity, trading, and compliance. But there is a palpable sense that the other practices and conditions are secondary - that all would be well if we only knew how to value structured securities and derivatives.

The bottom line is that we don't. The credit rating agencies don't. The banks don't. The hedge funds don't. Institutional investors don't. And in the absence of robust valuation data, methods, and models, there is no floor to the risk that financial institutions face when they toy with structured securities and derivatives.

Both reports carve out special sections for the discussion of valuation challenges. The institutional hedge fund investors' report - which starts by affirming that "valuation is ultimately at the core of any investment" - is more discursive on this subject than the hedge fund industry report. This may be indicative of general differences in stylistic approaches to the subject matter. Or it may suggest an entirely different perspective on the depth of the issue, with anxiety about valuation reflecting investor concerns more than the concerns of asset managers.

While both reports focus on the need for better valuation methods, valuation policies, valuation committees, and valuation governance, neither really grapples with the core reality - which is that huge dollar volumes of assets simply cannot be valued. There is insufficient liquidity and inadequate data, and in their absence, values depend upon someone simply assigning a value that has no relation to anything except the interest in making a market out of vapor. Until the hedge fund industry, and government regulators and policymakers, acknowledge this deep emptiness at the heart of the financial industry, all the reports in the world will amount to nothing more than a rearrangement of the deck chairs on the Titanic. >>

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Pension Power in the Boardroom

Posted on April 17, 2008 by Susan Mangiero

On April 7, 2008, this blogger wrote about unhappy pension campers, seeking to rid troubled companies of certain board members. (See "Three Public Pension Plans Say No Thanks.") At the time, the general consensus seemed to be "good luck but don't count on being able to oust anyone" in part because experts suggest that boards may be limited in their oversight capabilities. In what appears to be a win for protesting pensions, director Mary Pugh has resigned from Washington Mutual. According to The Street.com, CtW Investment Group had asked shareholders to draw support for Pugh (chairwoman of the bank's finance committee) and a second director, James Stever (chairman of the human resources committee). In a slide presentation and on its website, CtW blames this duo for failing "to recognize and act in a timely manner on the risks to shareholder value presented by the housing bubble" and for not reducing executive bonuses as a result of "this risk management failure." Note that she was re-elected with "50.4 percent of the shareholder vote" according to the Associated Press ("WaMu directors narrowly re-elected in shareholder vote, April 16, 2007), notwithstanding a Q1-2008 reported loss of $1.1 billion.

Click to read "WaMu Director Resigns Under Pressure" by Laurie Kulikowski (TheStreet.com, April 15, 2008).

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Investment Consultants and Time Perspective

Posted on April 16, 2008 by Susan Mangiero

 

I'm a big believer that we can learn from a variety of decision-makers. So it is with appreciation (and the proverbial hat tip) to Robert Elder for pointing out comments made by Frederick "Shad" Rowe, chairman of the Texas Pension Review Board. Robert pens an interesting Texas-centric blog called "Public Capital" and draws attention to Rowe's April 11, 2008 criticism of investment time travel that emphasizes past performance.

Recounting a Wayne Gretzky quote that "he skated not to where the puck was, but where it was going to be," Rowe excoriates investment consultants who "lead their clients not to where the puck is going to be or even where it is now, but instead to where it was three years ago." A 35-year investment veteran, Rowe further suggests that pension trustees are unwise to eschew long-term oriented investing in favor of strategies du jour such as (his words) "so-called 'alternative' investments, including private equity, where investment consultants are attempting to reduce what they call 'risk' and patching together a crazy quilt of 'uncorrelated' assets." Regarding commodities, he offers that the markets are too small to absorb the billions of dollars being thrown their way. Not a fan of international currency plays, Rowe thinks that pressure on the U.S. dollar will likely worsen economic conditions stateside. He urges pensions to think twice before investing in activism strategies that ignore company fundamentals.

Click to read Rowe's comments in their entirety. (In the spirit of encouraging productive debate, this blog welcomes comments from investment consultants about time orientation.)

Editor's Note: According to their website, the Texas Pension Review Board is "mandated to oversee all Texas public retirement systems, both state and local, in regard to their actuarial soundness and compliance with state law." Interestingly, there is a section about how the board is appointed. Worth reading, it is a rare example of documented experiential requirements. In this case, three of nine board members must have "experience in the field of securities investment, pension administration, or pension law." The board must also consist of an actuary, someone with "experience in governmental finance" and "a contributing member of a public retirement system."

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Co-Founder of Defunct Hedge Fund Gets 20 Year Sentence

Posted on April 16, 2008 by Susan Mangiero

Bayou Group leader, Samuel Israel III, age 48, receives a sentence of 20 years for his part in handing a $400 million loss to investors. (He pled guilty to conspiracy and fraud in late 2005.) A shorter than 30 year sentence reflects his co-operation with the authorities. U.S. Districut Judge Colleen McMahon is quoted as rejecting leniency and instead chastising this hedge fund "mastermind" as a "career criminal" who "ruined lives." In what appears to be a sea change in sentiment towards financial fraudsters, Reuters cites Judge McMahon's upset, referring to white-collar crimes as "every bit as heinous as every other type of crime."

Click to read "Bayou co-founder sentenced to 20 years in prison" (Reuters - April 14, 2008).

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Heels Pinch the Feet - Lessons for Pension Funds

Posted on April 16, 2008 by Susan Mangiero

As a big advocate of yoga pants and sneakers, wearing high heels is typically a "must do" versus a "want to do" item. I imagine that most men feel the same way about wearing ties. A recent article caught my eye wherein Wall Street Journal reporter Christina Binkley writes that "high-heeled pumps are the feminine equivalent of wingtips." Does that mean that penny loafers and ballet shoes put one on the slow track for promotions? (See "High and Mighty: Seeking Comfort in the Power Heel," April 10, 2008.)

So what does this have to do with pension funds? Allow me to explain.

In a literal battle of the fashionistas versus the style-challenged, my keynote presentation at Pension Bridge was followed by a public plan trustee who urged service providers to clearly explain investment concepts. Getting the audience to laugh about asset allocation and risk control is no small feat but that's what he did with his "plain folks" request. To paraphrase, "We say 'get out' as opposed to waxing poetic about contagion and geometric drift and so on.

Don't get me wrong. Math has its place for sure just as high heels add a note of perfection to that special outfit. However, do we want to start with number crunching and rocket science or focus first on fundamentals? I'd much rather start a discussion with plan sponsors that focuses on big picture risk drivers. Getting a feel for qualitatively what keeps people up at night is a great start to hunkering down to solve problems, improve practices and keep promises to participants.

What might service providers learn from Mr. Trustee's commentary? Here's a thought. Replace the fancy multi-colored slide decks (or at least augment) with some "101" conceptual illustrations BEFORE the quantitative heavy lifting begins. After all, if an investment decision-maker is uncomfortable with topics such as correlation, stochastic modeling and portable alpha, no sale is likely to occur and neither side brings closure to what could be a win-win.

There is a lot to be said for comfort and practicality some of the time.

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New York Pension Probe

Posted on April 16, 2008 by Susan Mangiero

According to State Editor Jay Jochnowitz for timesunion.com, Attorney General Andrew Cuomo is investigating "alleged abuses of the state pension fund" at school district, town and village levels. External contractors may be costing Empire State taxpayers a bundle in the form of "undeserved" retirement benefits. (See "Cuomo expanding pension probe," April 14, 2008.)

Not surprisingly (and assuming facts bear out the presence of fraud), folks are in a major huff. To read a few takes on the fast-changing situation, check out these items.

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Fair Disclosure for Retirement Security Act of 2007 Soon Up for a Vote

Posted on April 15, 2008 by Susan Mangiero

On April 16, 2008, members of the U.S. House Education and Labor Committee will mark up the proposed bill that, if adopted, will mandate additional disclosures as relates to retirement plan fees (1:00 p.m. in room 2175 Rayburn H.O.B.) As fee-related litigation soars (frequency and size of alleged economic damages) and individuals struggle to ready themselves for a long retirement haul (due to extended life spans), the import of any disclosure regulation is considerable.

To learn more, check out these resources. Note that the bill is renamed the "Fair Disclosure for Retirement Security Act of 2008."

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The "Terminator" Ends Bill to Nix Private Equity Restrictions

Posted on April 15, 2008 by Susan Mangiero

Governor Arnold Schwarnegger has put the kabosh on a state legislative attempt to prohibit the state's two largest public pension funds from allocating to certain money managers. Arguing that AB 1967 puts undue strain on the California Public Employees' Retirement System and the Calfornia State Teachers' Retirement System by prohibiting money managers who invest in countries with human-rights issues. If adopted, The Carlyle Group (owned in part by the United Arab Emirates) would be off limits and thereby shut off private equity deal flow. In his April 9, 2008 op-ed piece, published by the Los Angeles Times, Governor Schwarnegger writes that measure AB 1967 would "cause a deep wound to our retirement funds and government programs when we can least afford it." Though he earlier signed measures to divest from Sudan and ban investing in Iran, the state's head politico avers that this bill would (a) cost CALPERS and CalSTRS billions of dollars in lost opportunities over the next 5 to 10 years (b) do little to discourage sovereign wealth fund investing overall and (c) be a fig leaf with respect to boosting human rights. Click to read "California can't afford a symbolic divestment that won't affect human rights."

On April 10, 2007, Sacremento Bee reporter Dale Kasler writes that Assemblyman Alberto Torrico (D-Newark) is withdrawing Assembly Bill 1967 "for the time being. (See "Lawmaker pulls bill to set human-rights limits on public pension fund investments.")

Of course, this does not eliminate an obvious question. Should the state (in an editorial sense, not a particular geographic locale) direct public plan investing?

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Hourly Hyberbole - Beefing Up the Pension Payout

Posted on April 14, 2008 by Susan Mangiero



In what must be an amazing "way to go" moment for any journalist, Milwaukee Journal Sentinel reporter Dave Umhoefer earns the Pulitzer Prize for his detective-like reporting about pension trickery in Milwaukee County. According to "Pension investigation earns reporter Pulitzer: Umhoefer scoured county data for 6 months," Bill Glauber writes that privileged workers were allowed to buoy their benefits by purchasing "service time for seasonal and part-time jobs held decades ago" (Milkwaukee Journal Sentinel, April 7, 2008). Certainly novel, this form of back-dating is said to violate county and IRS rules galore. Congratulations to Mr. Umhoefer for bringing fraud to light on behalf of honest plan participants.

In "Buybacks may figure in pension lawsuit" (Milkwaukee Journal Sentinel, April 12, 2008), reporters Steve Schultze and John Diedrich write that legal documents have the county claiming that "its full costs of the '01 pension perks will reach in excess of $600 million." Alleging failure to give "adequate warning of the potentially steep costs of the lump-sum provision and related benefits while they were under consideration in 2000," the county seeks redress from defendant Mercer Co. The pension consulting firm counters that the county is "seeking to pass the buck for its own failings."

On the topic of fraud, infamous rogue trader Nick Leeson (remember the sale of Barings Bank to ING for a nominal sum?) warns of a "black hole in some markets unless risk-management systems" catch up with the "sophistication of trading desks." Now a "been there, done that" luminary on the speakers' circuit, Leeson apparently corroborates the intended defense of Jerome Kerviel in Rogue Trader v. French Bank. In "Leeson warns of fraud 'black hole' in markets," Financial Times reporter Jeremy Grant (April 9, 2008) writes that corporate negligence will take the stand as Kerviel shouts "J'accuse" and ponders how his jumbo trading could go unchecked for so long.

If HBO found entertainment value in L'Affaire Leeson ("Rogue Trader" starring Ewan McGregor, 1998), can a french film version be too far behind? With so much real-life intrigue, Hollywood writers have little need to imagine.

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Are You Managing Your Investment Fiduciary Risk? Ten Things You Need to Know

Posted on April 8, 2008 by Susan Mangiero

This blog's author is off to San Francisco to keynote the 2nd day of the 2008 Pension Bridge conference. I'll be speaking about investment fiduciary risk and ten things one needs to know. The session description is shown below.

<< Fast changing rules and regulations, increased investment complexity, market volatility and changing demographics create new challenges for retirement plan decision-makers. Fiduciary accountability has taken on a new urgency as headlines about big losses motivate shareholders and taxpayers alike to demand reform. Integral to the process is the proper identification, measurement, and management of risk, including the selection and monitoring of consultants, money managers, actuaries and other key players. Join Dr. Susan M. Mangiero, CFA, FRM, AVA, for an update about performance pitfalls, sources of hidden risk, risk control gaps, pension litigation trends and valuation difficulties that directly impact defined benefit and 401(k) plan investment strategies. Learn ten things you can use to mitigate personal and professional liability. >>

Of course no one can summarize everything a fiduciary must know in ten steps or provide an exact recipe for staying out of trouble. (As I always remind, legal advice and interpretation is best left to attorneys and regulators.) The goal is to provoke thought about the investment process and related risk-taking. Interestingly, a recurring theme of the international regulatory pension conference (where I spoke on April 2, 2008) was a global emphasis on outcomes and not process. Imagine how different life would be in the U.S. if realizations trump decision-making.

Click to access the full agenda for Pension Bridge.

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New Research on 401(k) Plans and Amassing Wealth

Posted on April 7, 2008 by Susan Mangiero

As companies and government employers shed their traditional defined benefit ("DB") plan offerings, defined contribution schemes become absolutely and proportionally more important to individuals. In two new papers published by the National Bureau of Economic Research ("NEBR"), authors James Poterba, Steven Venti and David Wise conclude the following:

  • Self-directed retirement assets will outflank DB plans by 2010, "even though defined benefit plans remain the most important source of retirement assets for federal, state, and local employees."
  • The growth in self-directed retirement assets are influenced by a number of factors. These include (a) expected stock returns and bond yields (b) number of employees permitted to participate (not currently enrolled) and (c) asset allocation mix.

Citing data from the Survey of Income and Program Participation ("SIPP"), the research trio reveals that "only 5.8 percent of 44-yers old had 401(k)-type accounts" some 20 years ago. In 2003, that number had escalated to 44.3 percent. In 2000, per capita retirement assets for individuals about to exit the labor pool, and in their mid-60s, averaged nearly $30,000. A decade from now, available assets are projected to rise to $90,000 (in terms of year 2000 dollars). In 2040, the prediction is that nest eggs will topple $269,000.

Click here to order "Rise of 401(K) Plans, Lifetime Earnings, and Wealth at Retirement" (NBER Working Paper 13091) and "New Estimates of the Future Path of 401(K) Assets" (NBER Working Paper 13083).

Wall Street Journal reporter Jennifer Levitz offers a competing, albeit grim, reality. In "Americans Delay Retirement As Housing, Stocks Swoon," she writes that graying Americans favor longer work lives for a variety of reasons. Preservation of health benefits is one factor. Sagging equity returns in 2000-2002 didn't help, especially for those employees who had allocated a big chunk of their savings to stocks. Of course, no trend exists in isolation. A delay in retirement means younger workers will face more competition for promotions or even jobs though the impact is uneven across industries. Skilled workers are nearly always welcome, being indispensable for many knowledge-oriented businesses. Though written on April 1, her description of a brave new world is no April Fool's joke. Companies are fast being forced to reckon with changing demographics and altered employment patterns.

As a colleague aptly bemoans, the retirement trifecta (Social Security, juicy defined benefit plan payouts and hefty salaries, let alone a job) is a fantasy for most everyone still in the work force. For those who expect to live as well as your grandparents or parents, good luck. Start pinching those pennies hard and often.

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Three Public Pension Plans Say "No Thanks"

Posted on April 7, 2008 by Susan Mangiero

Related to our April 6, 2008 post about risk management oversight (asking who is in charge is a logical query), Wall Street Journal reporter Jed Horowitz writes about unhappy pension campers.  Three plans are now on record as opposing the re-election of various Morgan Stanley directors, including Chairman and CEO John Mack. They include: (a) California State Teachers' Retirement System (b) State Universities Retirement System of Illinois and the State of Connecticut Retirement Plans & Trust Funds. Citing "failure to generate returns consistent with the broad stock market," inter alia, they decry an adverse impact of the company's risk-taking on the value of their Morgan Stanley shares. See "Morgan Stanley Board Feels Heat Over Loss" (April 7, 2008).

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Pension Funds Ask - "Who is Responsible for Risk Oversight?"

Posted on April 6, 2008 by Susan Mangiero

In "Bear's board was busy elsewhere," Financial News reporter Jeff Nash (March 31, 2008) writes that the investment bank's board has been busy, with three individuals doing work for "at least four other public companies" and two "of those three extremely busy directors" doing double duty as members of the risk committee. Corporate governance pundits add that outside distractions do little to help business fiduciaries carry out critical risk oversight duties.

Wall Street Journal reporter George Anders likewise addresses the question of where the buck stops, or if it arrived at all. In "Wall Street Housecleaning May Bypass Boardroom," the executive director of the $12 billion Illinois State Board of Investment, William R. Atwood puzzles over the involvement of directors as relates to sub-prime losses, wondering if "directors at big banks and Wall Street firms share some responsibility for what has gone wrong." Others quoted in the April 2, 2008 article counter that it may be ill-advised to unseat veteran directors. New appointees face a steep learning curve that exposes a company to risk of another kind.

The courts will surely play a prominent role in determining who pays (if at all) as shareholders and pension plan participants file lawsuits aplenty.

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Dr. Susan Mangiero Speaks at World Bank Pension Conference

Posted on April 2, 2008 by Susan Mangiero

Don't think there are no crocodiles because the water is calm.
...Malayan proverb

This blog's author (Dr. Susan Mangiero) joins internationally recognized leaders as part of the World Bank/IOPS 4th Contractual Saving Conference: Supervisory and Regulatory Issues in Private Pensions and Life Insurance. Nearly 200 regulators and practitioners convene in Washington, DC, hailing from countries such as the United States, Australia, Norway, Denmark, Mexico, Chile, Sweden and New Zealand.

Dr. Mangiero will address hidden risks from an implementation perspective. Other presentations similarly emphasize the message that risk mitigation is the sine qua non of modern asset-liability management. Without a dynamic and comprehensive process, fiduciaries leave themselves wide open to allegations of breach. Click to access the conference agenda.

Note: The International Organisation of Pension Supervisors (IOPS) is an "independent international body representing those involved in the supervision of private pension arrangements. The organisation currently has around 60 members and observers representing approximately 50 countries and territories worldwide."

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Hedge Funds - Boardroom Friends or Foe?

Posted on April 1, 2008 by Susan Mangiero

As hedge funds around the world take a seat in the boardroom, new rules of engagement apply. In response, the Conference Board Governance Center Research Working Group on Hedge Fund Activism issues draft guidelines for companies under attack from alternative capital pools.

According to its March 18, 2008 press release, the Conference Board prioritizes five areas, as excerpted below.

  • What corporations can do to better monitor securities holdings and learn about those accumulations of stock or extraordinary trading patterns that may reveal a hedge fund's activism tactic.
  • What measures corporations can adopt to avoid becoming a target.
  • How boards and senior executives can react to an activism campaign and how they should respond to requests for change made by hedge funds.
  • How companies and large institutional investors can ensure integrity of the voting process in those situations where hedge funds borrow shares for the sole purpose of influencing a shareholders' vote.
  • What considerations institutional investors should be mindful of when allocating some of their assets to hedge funds pursuing activism strategies.

Pension plan fiduciaries are urged to "pursue their beneficiaries' long-term interest" when allocating monies to hedge funds that are likely to buy shares in public companies. Does this imply that hedge fund activists may be motivated by short-term gains only? The authors provoke with an intriguing question. What are institutional investors obliged to do so as not to reduce "shareholder value for companies that may be held elsewhere in their portfolio?" This is a valid query for several reasons. First, a pension plan may be working against itself if it invests in both an activist hedge fund and a particular company, each with divergent interests. Second, a plan sponsor may think it is getting diversification when in fact it is doubling up (or more) on a particular equity issuer. The economic consequences could be profound.

Members of the public are invited to comment before April 30, 2008. A final report is planned for June 2008. Click to download "Report of the Conference Board Research Working Group on Hedge Fund Activism: Findings and Recommendations for Corporations and Investors."

Adopting a similar stance that hedge fund activism is a "must know" topic, the National Association of Corporate Directors hosts an afternoon program in New York City on April 17. Entitled "Activist Hedge Funds: What Public Company Directors Need to Know," the esteemed speakers will address the reality that "hedge funds now account for as much as 30% of total U.S. equity trading." Click here to register.

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