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

According to GoEnglish.com, to "put your all your eggs in one basket" is "to risk losing all at one time." This notion is oft-touted in the mainstream press for the benefit of non-financial readers. Logically speaking, one would expect the maxim to resonate with investment banking staff who should, by the nature of their work, have a good command of diversification principles.

According to "Wall Street Lays Egg With Its Nest Eggs: Retirement Lessons of the Dumb Moves by 'Smart Money',"  it appears that the lessons of Enron and other costly examples of excess concentration have been lost on some. (Wall Street Journal, September 27, 2008). Pundit Jason Zweig regales readers with a litany of bad news bears, including the following:

• "At the end of 2006, Merrill employees had 27% of all of their retirement money in Merrill shares" with losses this year close to $400 million.
• Morgan Stanley employees have "lost some $500 million on their 401(k) holdings of company stock in 2007."
• "At Lehman Brothers Holdings, employees saving for retirement lost 'only' about $200 million on their shares" in the last 18 months.
• "Twelve out of every 100 people whose 401(k)s can hold company stock have at least 60% of their retirement money riding on it."

Generally speaking, employees should heed "excess" concentration that could take several forms, including, but not limited to:

• Company stock in 401(k) plan
• 401(k) company match in form of company stock
• Company stock as part of profit-sharing plan
• Company stock match as part of a dividend reinvestment plan ("DRIP")
• Company stock options
• Career risk tied to fortunes of employer
• Employee ownership via an ESOP
• Company stock in defined benefit plan ...

Wall Street firms are not alone in encouraging employee ownership and that is not necessarily bad, as long as everyone fully understands the risks.

According to the National Center for Employee Ownership, statistics updated in February 2008, suggest that:

• $1.5 million participants were tied to 748 401(k) plans that were "primarily invested in employer stock" with an estimated value of $133 billion
• 10,000 ESOPs and stock bonus and profit sharing plans were "primarily invested in employer stock," with an estimated value of plan assets exceeding $928 billion and impacting 11.2 million workers
• 3,000 broad-based stock option plans encompass 9 million participants
• 4,000 stock purchase plans cover 11 million workers.

What are you doing to track your diversification potential, or lack thereof, as relates to your current employment situation?

Omelette anyone?

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to a September 25, 2008 press release from the U.S. Securities and Exchange Commission ("SEC Seeks More Transparent Disclosure for Investors"), pundits will gather in Washington, D.C. on October 8 to wax poetic about transparency. Two panels will convene to address "data, technology, and processes that companies and other filers use in satisfying their SEC disclosure obligations" as well as "how the SEC could better organize and operate its disclosure system so that companies enjoy efficiencies and investors have better access to high-quality information."

While I am in favor of "sufficient" disclosure to inform shareholders, plan participants and other interested parties, a critical question remains. What exact type of disclosure can really make a difference? I vote for information about process and accountability. Otherwise, financial statement users end up with snapshot assessments of mandated metrics. While these numbers could be potentially helpful, they are made less so without an understanding as to how they are derived, why they change and the extent to which an organization is exposed to economic danger. A few of the countless questions on the minds of inquiring individuals are shown below. (This is by no means an exhaustive list.)

• Who has the authority to effect change for all things financial management?
• Who oversees authorized persons and the latitude they enjoy to make decisions?
• How are risk drivers identified, measured and managed on an ongoing basis?
• What creates "stop loss" threshholds?
• How are functional risk managers compensated?

As reported by CNN.com, JP Morgan Chase has just purchased $307 billion in assets from Washington Mutual (ticker symbol WM) in what is described as "the biggest bank failure in history." Serious stuff indeed but would more detailed financials have helped? We know that the large thrift ushered in a new chief risk officer ("WaMu replaces its chief risk officer," April 29, 2008) to "help steer the nation's largest savings and loan through the fallout of the mortgage and credit crises."

The 2007 Annual Report on Form 10-K/A for Washington Mutual, Inc. is rich with information about risk management, credit risk management, liquidity risk and capital management, market risk management, operational risk management and "Factors That May Affect Future Results." Page 5 of said document states that an evaluation of the Company's disclosure controls and procedures allows the "Company's Chief Executive Officer and Chief Financial Officer" to conclude that, "as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company..."

A company press release dated July 22, 2008 informs the public of actions taken by the Company to build up its reserves and mitigate risk. See "WaMu Reports Significant Build-Up of Reserves Contributing to Second Quarter Net Loss of $3.3 Billion." The bank's website provides a slide presentation about credit risk management also dated July 22, 2008. It details all sorts of information about the loan portfolio, including allowances for loan losses.

According to Wall Street Journal reporters Robin Sidel, David Enrich and Dan Fitzpatrick, a flood of deposit withdrawals forced the demise of this Seattle based financial house. (See "WaMu is Seized, Sold Off to J.P. Morgan In Largest Failure in U.S. Banking History," September 26, 2008).

Question of the Day: What disclosures could have helped shareholders (including pension plans) to know how bad it could get and in what time?

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

Imagine my surprise upon receiving the September 2008 newsletter from Big Speak and seeing that I am profiled on the same page as billionaire Donald Trump. Beyond the fact that we are each registered with this California-based speaker's bureau, I happen to agree with Mr. Trump's familiar bark. To executives who did less than their best work, with dire consequences for all, might it be time to say "You're Fired?"

Click to read my Big Speak overview. Forgive the shameless plug. I have reprinted the text below.

                                 Is Your Pension Safe? Bring Econ. 101 to Finance 911.

The times are turbulent, the titans are tumbling and once venerable financial institutions find themselves drowning in debt. As global economic turmoil seems to envelop every facet of our lives, numerous questions about the financial future and investment stability are at the forefront of both corporate and individual concern. BigSpeak represents a number of corporate and personal financial pros that can help you navigate today's (and tomorrow's) stormy seas. Susan M. Mangiero has more than 20 years of experience and is a leading authority in such areas as capital markets, asset-liability management, derivatives and financial risk control. Dr. Mangiero has worked at General Electric Co., PricewaterhouseCoopers, LLP and Bank of America.

As a speaker, she has made recent appearances before the Harvard Club, as well as testifying in front of the U.S. Department of Labor about valuation issues (hedge fund, private equity, derivatives, etc…) as pensions, endowments and foundations are allocating hundreds of billions into these investments. Taking into consideration asset allocation, risk management and public policy, among a bevy of related topics, she addresses key questions and potential pitfalls facing finacial professionals in these challenging times. Dr. Mangiero also tackles the fast changing operating environment for investment buyers and sellers alike. Important topics, including portfolio valuation and operational controls have become front and center as fund managers, institutional investors and their service providers deal with new rules and regulations and the continuing fallout of credit-related problems. Dr. Mangiero shares her insights about: regulatory enforcement hot buttons, valuation and risk management litigation trends, best practices for evaluating key risks and managing exposures and institutional investor impact as pensions/endowments/foundations allocate more money to alternatives and complex securities. You've got questions, we’ve got experts. So before you clear those accounts, melt down the jewelry or stuff that mattress, get the Big financial picture from BigSpeak.

Editor's Note: Click to access my one-page profile with testimonials and a sampling of where I've presented.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

I had the pleasure of speaking twice at the annual SIBOS conference last week in Austria. (The 2007 event was in Boston. The 2009 forum will be held in Hong Kong.) The first panel could not have been more timely, given the current regulatory frenzy underway. Sure to cause a stir on any day, you can imagine the lively banter as market prices tumbled. Here is a summary of what ensued. This article was first published in Sibos Issues, SWIFT's daily newspaper devoted to reporting the Sibos conference sessions. You can view more articles and download each issue from SWIFT's website.

                           Regulation that fails to keep up could damage the funds market

Panelists at Wednesday's session on whether regulation helps or hinders the investment funds industry claimed to see no threat from regulation as such but plenty from sledgehammer regulation that failed to keep up with the market.

"We work in an industry that prefers light-touch regulation to black-letter rules," said moderator Bob Currie, editor of FSR. "It has good reason to." Overall, the question for panelists was not whether but how much and what kind. "Regulation creates trust and makes the system work. It's a fiduciary business with a risk asymmetry between investor and provider," EFAMA chairman Mattias Bauer pointed out. "But regulators need to ensure they create a level playing field between products, with no regulatory arbitrage."

In the UK, that's precisely what regulators had failed to do, claimed EU Consumer Representative Mick McAteer. By treating insurance products and mutual funds differently, he said, UK regulators had "failed to improve market conditions, increase confidence in the market, or create a level playing field for consumers."

A.P. Kurian, chairman of the Association of Mutual Funds of India, took a contrarian position, urging "regulatory activism" as an approach and posing as a metric for existing regulations, "whether it had survived the test of a crisis." He claimed "strict regulation and strict compliance" had helped the funds industry in his native India minimize the impact of current economic volatility.

In contrast, Pension Governance CEO Susan Mangiero warned that over-regulation counterproductively increased risk because it impeded the transfer of information between buyers and sellers. "When you have excess regulation, it becomes difficult to reward good people and penalize bad ones because everyone's concerned with compliance rather than best practice in risk management. The result is that they have no incentive to do what they should be doing," she said.

A compromise came from Jack Gaine of the Management Funds Association, who cited what he described as a "compact" between regulators and the US hedge fund industry whereby hedge funds exclusively target institutions and high net worth clients in return for a waiver on short-selling restrictions.

In any case, Mangiero suggested finally, the debate was most likely academic. "I advocate a free market approach but what I expect is more regulation," she said.

                                                                            * * * * * *

Editor's Note: While I realize that espousing capitalism during a horribly tough economic environment is inviting verbal tomatoes, it is critical to acknowledge both sides of the argument. Check out the video entitled "The Resurgence of Big Government" by Yaron Brook, September 18, 2008. Dr. Brook is the President of the Ayn Rand Institute and a former finance professor.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Thanks to financial planner David Boczar for sending along a thought-provoking quote from famed commodities trader Ed Seykota. Described as someone who turned $5,000 into $15 million over a dozen years, this uber trend follower Seykota cautions: "Surrender to the reality that volatility exists, or volatility will introduce you to the reality that surrender exists."

As I've written many times, risk management is not the same thing as risk minimization. Risk is neither inherently "good" or "bad" but rather a reality, with potentially crushing economic impact if ignored or given short shrift. As we've seen in recent days, some attempts to tame the risk lion have resulted in serious casualties.

It is no surprise then that pundits and reporters are asking about the whereabouts of risk managers, part of the frenzied blame game afoot. (Is there a "Where's Waldo" equivalent here?) New York Times blogger Saul Hansell pressed a lot of hot buttons with his September 18, 2008 post entitled "How Wall Street Lied to Its Competitors." My response, now one of more than 100 posted responses, is shown below.

<< I concur with much of this article. Effective risk management is much more than quantitative analysis. Many individuals are lulled into false security when given a bunch of computer printouts, accepting numbers as gospel truth. Like the fictional Detective Columbo, decision-makers must search for “hidden” information, not reflected in computer printouts. I recently testified before the ERISA Advisory Council about “hard to value” assets. Click here to read my comments. http://www.pensionriskmatters.com/2008/09/articles/valuation/testimony-of-dr-susan-mangiero-about-hard-to-value-assets/

P.S. Some of the quants sat on boards of financial institutions. It would be helpful to know more about their role as relates to oversight of risk management activities. >>

To my last point (above), it should be noted that litigation risk could be a deterrent for prospective directors with risk management experience. For example, Ms. Leslie Rahl (who is quoted in Hansell's blog post about the perils of underestimating risk of complex mortgage backed-securities) is, according to the Financial Post, named in a lawsuit filed against Canadian Imperial Bank of Commerce (CIBC), along with others such as the former Chief Risk Officer and the current Chief Risk Officer. Journalist Jim Middlemiss quotes the bank as denying allegations and expressing confidence that their conduct was appropriate. (See "CIBC hit by suit over subprime lending," July 24, 2008.) Additionally Rahl, a former Citibank derivatives division head, is listed on the Fannie Mae website as a "Fannie Mae director since February 2004."

For interested readers who want to follow the mounting litigation related to sub-prime activities, check out attorney Kevin LaCroix's blog entitled The D&O Diary. Be forewarned that Kevin posts volumes about Director and Officer (D&O) liability. Should we be disturbed that he has so much news about which to write?

What does this mean for institutional shareholders? Run, don't walk, to the closest risk management analysts who can help you decipher whether a company is doing a "good" job of identifying, measuring and managing a panoply of financial and operational pain points. Send us an email if you want some help.

On the topic of models, my article entitled "Asset Valuation: Not a Trivial Pursuit" (FSA Times, The Institute of Internal Auditors, 2004) still rings true. Check out the 10 prescriptives discussed therein. (This is by no means an exhaustive list.)

1. Gain an intuitive understanding of the model.
2. Ask questions of the model builders.
3. Determine whether or not a model meets regulatory requirements.
4. Inquire whether or not different models are being used for tax reporting versus financial statement presentation.
5. Understand the data issues.
6. Ask about model access.
7. Evaluate the asset portfolio mix.
8. Ascertain the extent to which a model incorporates embedded derivatives.
9. Determine the simulation approach used to value path-dependent securities.
10. Enlist senior management to assign someone from the finance team to work closely with the auditing team.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

New York Times reporter Tara Siegel Bernard cautions that some money market funds do not represent a safe haven. Who would have thunk it? Several asset managers have now broken the buck, reporting Net Asset Values less than a dollar. See "Money Market Fund Enter a World of Risk" (September 17, 2008).

With everything else going on, perhaps it is no shock that the U.S. government has responded with a quick fix. In "Temporary Treasury Program to Support Money Market Funds," readers learn that this new measure seeks to "enable money market funds to maintain stable $1.00 net asset values." Click to access Notice 2008-81, effective September 22, 2008.

Details are still evolving though Deal Book adds that the U.S. Treasury Department will "use $50 billion to back money market mutual funds whose asset values fall below $1." Those who pay a fee are eligible to have their holdings insured. See "Treasury to Backstop Money Market Funds," September 19, 2008."

Federal insurance is likely to be good news for 401(k) plan participants who are busily shifting funds to what they hope are safer choices. The impact on taxpayers' wallets is yet to be determined.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to financial reporter Jennifer Levitz, a dismal trifecta accounts for recent retirement withdrawals. Rising unemployment, stricter credit conditions and a sagging equity market make defined contribution piggybanks a tempting target. Despite a 10 percent penalty for early withdrawals, participants are tapping into their post-employment savings to make ends meet. In addition, and not surprisingly, some employees are reallocating away from equities into money market funds.

Overall, "Investors Pull Money Out of Their 401(k)s" (Wall Street Journal, September 23, 2008) paints a gloomy picture of the retirement landscape. Keep in mind that traditional defined benefit plans are no longer a reality for countless individuals. A dwindling 401(k) plan balance spells real hardship since many participants will be unable to "make up" any monies taken out before they exit the workforce.

On the topic of 401(k) plans, ERISA attorney Stephen Rosenberg vents about poor plan governance as described in Fixing thte 401(k) by Joshua Itzoe (earlier reviewed by this blogger). Alleged excessive fees, poor investment choice selection and not controlling plan costs are a few of the ills he deems important yet beyond the reach of plan participants who "have neither the power, responsibility nor authority" to address fiduciary problems by themselves. Click to read the Boston ERISA & Insurance Litigation Blog.

• Email This
• Print
• Comments (1)
• Trackbacks (1)
• Share Link

At the invitation of the ERISA Advisory Council, I presented testimony about "Hard to Value Assets" on September 11, 2008 in Washington, D.C. Some of the questions I was asked to answer are listed below:

• Should valuation issues play a role in the selection of plan investments, and in achieving proper asset allocation and diversification?
• What, if any, modifications to plan investment policies and guidelines should plans consider when utilizing "hard to value assets?"
• As fiduciaries, what do you deem to be or what do you expect to be "hard to value assets?"
• Who can the fiduciary rely upon when ascertaining the value of "hard to value assets" when the fiduciary is incapable of valuing, in order to fulfill their fiduciary responsibility to plan participants?
• What valuation policies and procedures should a fiduciary adopt when holding "hard to value" assets?
• What disclosures and education measures are required or suggested for participants and fiduciaries with respect to plans which invest in "hard to value" assets?

Given the recent tumult in the global financial markets, it seems as if an eternity has passed since the September 11 hearing date. Valuation continues to be a hugely important topic. I hope that my comments are informative and helpful to readers. Let me know what you think. Click here to read "Testimonial Remarks Presented by Dr. Susan Mangiero." 

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

Thanks to our good friends at Knowledge Mosaic, a search of SEC filings suggests that at least several pension plans may still own stock in Lehman Brothers. While we do not have evidence that holdings were sold before Lehman filed for Chapter 11 protection, there is certainly that possibility. Numbers shown below may not reflect actual exposure as of the bankruptcy filing date and do not reflect a value at which stocks can be traded. Note that ASP refers to Average Share Price. Share counts are estimates only.

• Teacher Retirement System of Texas with 1.062 million shares and a $37.64 ASP
• NY State Common Retirement Fund with 4.195 million shares and a $19.81 ASP
• State Treasurer State of Michigan with 0.751 million shares and a $19.81 ASP
• Texas Permanent Schools Fund with 0.516 million shares and a $19.81 ASP
• NY State Teachers Retirement System with 2.141 million shars and a $19.81 ASP
• California Public Employees Retirement System with 1.786 million shares and a $19.81 ASP
• Public Employees Retirement System of Ohio with 0.89 million shares and a $19.81 ASP
• California State Teachers Retirement System with 0.940 million shares and a $19.81 ASP

In all cases cited above, the equity exposure to Lehman Brothers Holdings Inc. is reported as representing less than a fraction of one percent of respective plan assets. 

For an article on the giant Texas pension plan, click on "TRS takes a hit on Lehman Brother's stock holdings" by Robert Elder, September 16, 2008, Austin American-Statesman.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

One good thing about being an occasional night owl is that you get to blog about breaking news. Unfortunately, today's headlines are gloomy indeed. Here's a quick recap.

• According to a company press release (dated September 15, 2008), Lehman Brothers Holdings Inc. intends to file for Chapter 11 protection, seeking a reprieve from creditors. "None of the broker-dealer subsidiaries or other subsidiaries of LBHI will be included in the Chapter 11 filing and all of the broker-dealers will continue to operate...Neuberger Berman, LLC and Lehman Brothers Asset Management will continue to conduct business as usual..." Click to read the Lehman Brothers press release. Various stories describe a rejection by the U.S. government to bail out this venerable financial institution. In stark contrast to this news, Reuters reporters Christian Plumb and Dan Wilchins report that the bank had just reported "a record $4.2 billion" net profit. (See "Lehman CEO Fuld's hubris contributed to meltdown, September 14, 2008).
• New York Times reporter Edmund Andrews reports that the Federal Reserve has loosened collateral rules to allow investment banks to pledge "stocks and some debt that has junk-bond status." (Read "Federal Reserve Offers No Cash but Loosens Standards on Emergency Loans," September 15, 2008.)
• Merrill Lynch is selling itself to Bank of America and AIG is seeking billions of dollars to keep it afloat. (See "Bank of America to Buy Merrill" by Matthew Karnitschnig, Carrick Mollenkamp and Dan Fitzpatrick, Wall Street Journal, September 15, 2008 and "AIG Scrambles to Raise Cash, Talks to Fed" by Matthew Karnitschnig, Liam Pleven and Peter Lattman, Wall Street Journal, September 15, 2008.)
• According to Reuters ("Derivatives market trades on Sunday to cut Lehman risk, September 14, 2008), an emergency session commenced at 2 pm in New York, ran for two hours and was then extended for another two years, during which "trading involved credit, equity, rates, foreign exchange and commodity derivatives." Initiated at the request of the Federal Reserve, the goal was to net over-the-counter ("OTC") derivative instrument positions among major players in order to avoid a Lehman-related meltdown. (Lehman actively trades in the OTC derivatives markets.) Bond fund giant Bill Gross is quoted as saying that a "Lehman bankruptcy risks an 'immediate tsunami' because of the unwinding of derivative and credit swap-related positions worldwide in the dealer, hedge fund and buy side universe."
• Reuters also reports that UBS is expected to write down an additional $5 billion "on its risky investments in the second half of the year." (See "UBS to write down extra $5 billion in H2: report," September 14, 2008.)
• This collection of financial horribles follows quickly on the heels of a recent U.S. bailout of Fannie Mae and Freddie Mac. Click to access the website page for the U.S. Department of Treasury - "Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers."

The fallout for pension plans is not going to be pretty if pundits are correct. Interest rates will fall, boosting defined benefit liabilities. Plummeting equity market prices (especially if contagion prevails) are going to hammer asset portfolios, especially those traditional benefit plans with big allocations to stocks. Funding status could worsen, creating its own set of adverse outcomes. Exposure to troubled banks potentially spills over to pensions if (a) they are the OTC derivative counterparty on the other side and/or (b) their external money managers find themselves in that unhappy position and/or (c) they own stock in any or all of the banks in question.

On the flip side, a sagging U.S. dollar could be a blessing for institutional investors with exposure to multinational companies that earn most of their net revenue offshore. Additionally, non-U.S. equities and bonds will likely rise in value. Unless regulators curtail trades, some parties will pocket dramatic gains from having taken a direct or synthetic short position in certain stocks and bonds. Commodities might turn out to be another bright spot for some. For those with cash, if this truly marks a bottom, as some suggest, bargain hunters may have reason to celebrate.

We are hard at work, chasing down the pension-centric facts. We predict there is going to be much more to say about risk management and valuation. Hang onto your hats! We are in for a bumpy ride.

Editor's Note: When testifying before the ERISA Advisory Council on September 11, 2008, I was asked to comment about the pervasiveness of "hard to value asset" issues. I said (and the inquiring Council member agreed) that: (a) defined contribution plan participants are not immune to potential valuation-related losses (b) "hard to value assets" might characterize some "traditional" mutual funds, separately managed accounts and money market funds and may or may not apply to alternative investments (depending on the strategy and other risk factors) and (c) the importance of the topic demands that considerably more attention be paid to model risk, independence of marking-to-model or marking-to-market and the extent to which an investor or trader integrates valuation with his or her risk management policies and procedures.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

I'll be blogging from Vienna, Austria shortly. I look forward to attending the SIBOS 2008 conference, billed as "the world's premier financial services event." I am honored to be speaking twice, once about regulation and a second time about pension issues. The theme is definitely global and the mood is serious. If you want more information, click here. The program is jam packed with terrific sessions and will no doubt offer interesting topics for www.pensionriskmatters.com.

I've included details about my participation below.

EVENT ONE: September 17 - "Will regulation help or hinder the investment funds industry?"

The funds industry is facing a tide of regulation, of which UCITS (Undertaking for Collective Investment in Transferable Securities) III and IV are the latest examples. In addition, the European regulator is demanding more transparency from the fund industry, especially around cross - border distribution (for example the Klinz report). How much impact will these initiatives have? What does the industry need to do to comply? Can initiatives such as the Fund Processing Passport provide an answer? And, most importantly, will the regulation help or hinder the industry going forward?

Speakers:

• Mattias Bauer, Chairman, EFAMA
• John G. (Jack) Gaine, Managed Funds Association
• A.P. Kurian, Chairman, Association of Mutual Funds in India
• Mick McAteer, EU Consumer Representative, Fin-Use
• Susan Mangiero, CEO, Pension Governance LLC

Moderator:

• Bob Currie, Editor, FSR Magazine

EVENT TWO: September 18 - "Where is my pension?"

The issue of pension shortfalls is a universal one, caused by a combination of longer life expectancy and inadequate planning. How does the financial services industry need to respond? In most markets, you need returns way above forecast beta. Does that mean that leveraged investment will become the norm? How should we fill the holes?

Speaker:

• Robert Brown, CEO, Ausmaq
• Glyn Edward, Funds, Custodian and Administrators, SWIFT
• Susan Mangiero, CEO, Pension Governance LLC
• Clive Witherington, Head of Business Development, Watson Wyatt

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Here is a link to a just-released report from the U.S. Accountability Office, entitled "Defined Benefit Plans: Guidance Needed to Better Inform Plans of the Challenges and Risks of Investing in Hedge Funds and Private Equity."

In terms of full disclosure, Pension Governance, LLC provided its authors with background information about risk management and valuation considerations. Having just received this now public document, I will read it more thoroughly at a later time and report back. It looks like a comprehensive analysis.

I am off to provide testimony as part of today's meeting about "Hard to Value Assets." The meeting is being held at the request of the ERISA Advisory Council. My submitted testimonial statement will be uploaded in the next few days.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Business Valuation Resources and Pension Governance, LLC just completed a joint survey on business valuation firms that currently provide valuation services to hedge fund clients. It appears that relatively few hedge funds are reaching out to the business valuation profession, despite regulatory and legal pressures to improve valuation practices. Some highlights are summarized below:

• Of the few survey respondents who currently provide services to hedge funds, appraisers say that 55% of their clients have a formal valuation process in place.
• Appraisers who took the survey say that almost half of their hedge fund clients generate valuation numbers internally. A quarter of their clients rely on third party administrators. Relatively few used certified business appraisers.
• Many reasons were given by appraisers as to why hedge funds procure a valuation. These include, but are not limited to: auditing (33% of respondents), asset allocation (27%) and performance reporting (24%), redemption (18%) and risk management (18%).
• Eight out of 10 appraisers with hedge fund clients say they’ve never been called in to assist their hedge fund clients with the development of a valuation policy.
• When asked about standards (guidelines), 48% of survey respondents claim their clients cite fair value accounting rules, 23% of respondents say their hedge fund clients use no standards and 23% of survey-takers cite the Private Equity Industry Group Guidelines (PEIGG) as a guide for their hedge fund clients.
• For those survey respondents who choose not to pursue hedge fund valuation work, appraiser liability is cited as the primary deterrent (77% of respondents), followed by 54% of survey-takers who say they are unfamiliar with the hedge fund industry.

Editor's Note: Thirty-nine persons answered the survey. Additional research is underway.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Wall Street Journal reporters describe a trend that some believe was once only urban legend, namely hedge fund managers cutting their fees. In "Hedge Funds' Capital Idea: Fee Cuts" (September 9, 2008), Jenny Strasburg and Craig Karmin describe a new balance of power in which investors are being courted to stay the course rather than pull out their money in search of greener pastures. Replete with examples, the article suggests that jittery institutions may get a big discount on fees if they agree to lock-up periods or give the fund managers ample time to recover losses or improve on sub-par performance.

This makes sense from the hedge fund managers' perspective, especially those who face unprecedented redemption requests. From the pension investors' vantage point, things are not so clear. Yes, it's great to be able to pay lower fees but if the price of doing so is the realization of a mediocre risk-adjusted return profile, plan sponsors may be better off rethinking their allocation to that fund. As with everything else, it's seldom so simple. Unwinding a position may be expensive in terms of transaction costs alone. Then there is the issue of what should replace the hedge fund, if jettisoned from the pension portfolio.

What will be interesting to watch is whether other hedge funds feel pressured to follow suit in terms of dropping fees.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In Fixing the 401(k): What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully, author Joshua P. Itzoe suggests that the 401(k) industry is broken and in bad need of repair. As many employers migrate away from defined benefit plans to defined contribution plans, it is critical to understand any weaknesses in the current system and work vigorously to correct them.

Chapter 1 states conflicts of interest and opaque fee disclosures as two of the biggest issues faced by the 401(k) industry. Chapter 3 explains basic fiduciary duties as codified by U.S. pension law in the form of ERISA, co-fiduciary liability and how fiduciary types differ from one another. Subsequent chapters are rich with descriptions of relevant industry players (and there are many of them), inherent conflicts of interest and the generally accepted compensation arrangement for each category of service provider. Though there is an entire chapter devoted to types of fees, it would have been nice to sink one's teeth into some meaty math examples, along with some empirical data about magnitude and dispersion of fees across plans. 

Written for 401(k) fiduciaries, the basic nature of the book is both refreshing but worrisome. If current plan fiduciaries (the target market for the book) are unaware of their core duties, how have they been getting along so far? Far from being pedantic, Mr. Itzoe includes several chapters with concrete advice for improving 401(k) fiduciary practices. His provision of important questions at the end of each chapter is a nice touch, along with some helpful appendices such as a "Sample Fiduciary Audit File," "20 Steps to 404(c) Compliance" and a relatively long glossary. There is no index but a short bibliography is provided for interested readers.

For more information, check out http://www.fixingthe401k.com/. Click to read the author's bio. At $13 and change, I recommend this primer. Kudos to Mr. Itzoe, CFP and Accredited Investment Fiduciary, for putting forth a solid book on an important topic.

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

According to Wall Street Journal reporter Mark Cobley ("Crunch hits complex pension investments," September 4, 2008), Liability-Driven Investing ("LDI") strategies may be creating some unexpected pain for pension funds. Touted as a way to mitigate risk, LDI depends on relatively stable market conditions. Recent volatility has upset the apple cart.

In some cases, a defined benefit plan enters into an interest rate swap as what is referred to as a Fixed Rate Receiver, Floating Rate Payer. Structured properly, this effectively creates a hedge against adverse interest rate moves. When interest rates fall, a defined benefit plan liability goes up but is meant to be offset by a floating rate swap obligation that goes down. (This is a gross simplication, ignoring yield curve differentials and shape, along with multiple factors that influence the size and timing of pension payouts. Additionally, a swap is usually structured to have the underlying pension liability "cash flow matched" so that the fixed rate swap receipts cover the pension IOUs.)

Unfortunately for some, worsening credit problems have led to higher LIBOR (London Interbank Offer Rate) rates, a standard floating rate swap benchmark and one gauge of the rate at which banks borrow and lend money to each other. As LIBOR goes up, floating rate swap outlays rise, negating part or all of the inherent benefits of having entered into the interest rate swap in the first place.

Another variation of LDI (and there are many) requires a pension fund to add "portable alpha," usually in the form of a hedge fund or "equitized" or "enhanced" money management fund. Essentially this is done to lower the opportunity loss when an asset allocation mix veers towards fixed income, away from equity. (This assume a positive equity risk premium whereby equities return more on average than "comparable" risk fixed income securities.) Quoting a Schroders LDI expert, Mr. Andrew Connell, increased LIBOR rates cause "the value of the assets drop and it becomes very difficult to meet benchmarks in the short term."

One solution discussed in the article is for pension plans to invest in offerings that guarantee a rate, tied to LIBOR plus a basis point spread. While it sounds good on the surface, it means that "the pension scheme invests in a portfolio of assets currently held on the bank's balance sheet, such as leveraged loans or asset-backed paper." Since we all know that nothing is free, the question becomes - What risks does a pension investor assume if this revised strategy is adopted?

On top of everything else, investment fiduciaries must properly benchmark their chosen LDI strategy, something that is easier said than done. For example, does one track the difference between required cash flows (owed to plan participants) and LDI "net" cash flows? Life remains a challenge for those now contemplating (or already taking the plunge) whether "to LDI or not to LDI."

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

According to the U.S. Department of Labor website, Labor Day occurs on the first day of every September and is "dedicated to the social and economic achievements of American workers." Over 100 years old, the holiday was first celebrated on September 5, 1882 in New York City, due to efforts of several labor unions.

Editor's Notes: Here are a few information sources about labor in the U.S. and elsewhere.

• "100 Years of Struggle and Success," AFLCIO
• U.S. Wage Statistics, Bureau of Labor Statistics
• Global Labor Statistics, International Labor Organization
• Global Labor Statistics, Global Policy Network

• Email This
• Print
• Comments
• Trackbacks
• Share Link