Valuing Public Pension Fund Liabilities

In 2006, I penned "Will the Real Pension Deficit Please Stand Up?" as a way to draw attention to the urgent need to understand what reported numbers mean. Ten years later, questions remain about how best to measure defined benefit plan obligations. This is not a good situation, especially now when more than a few retirement plans are struggling. Click to review's pension liability and funded status data for eighty plans.

Authors of a Citigroup paper entitled "The Coming Pensions Crisis" urge transparency regarding "the amount of underfunded governmental pension obligations." I concur but the challenge is knowing what information should be disclosed so that legislators, policy-makers, taxpayers and plan participants have confidence in what gets shared. I have often written that is hard to manage a problem if one cannot adequately measure the problem. 

In early July, Pensions & Investments' Hazel Bradford wrote about the Competitive Enterprise Institute's suggestion to use a "low-risk discount rate" tied to U.S. Treasury bond yields. Critics counter that this would grossly inflate the size of a deficit and perhaps lead to inappropriate actions. On August 3, it was reported that two actuarial groups disbanded a task force over the topic of how to best value public pension fund liabilities. (In terms of full disclosure, I co-authored a paper in 2008 with one of the groups mentioned, the Society of Actuaries. Click to read "Pension Risk Management: Derivatives, Fiduciary Duty and Process.")

As someone who has been trained as an appraiser, taught valuation principles and rendered opinions of value or reviewed those of others, I know firsthand that reasonable people can differ about inputs and assumptions. I likewise understand that snapshot pension debt levels do not necessarily convey a message about current or ongoing liquidity, debt capacity or the ability to tax. The goal is to reconcile differences so that anyone making decisions based on valuation numbers understands their strengths and weaknesses. 

Given the goal of this blog Pension Risk Matters to educate and share helpful information about the global retirement industry and investment risk governance, I welcome input from knowledgeable appraisers, accountants and actuaries. If you are interested in being interviewed or writing a guest blog post, please kindly email

Corporate Finance and Pension Restructuring

As I wrote in "Pension risk, governance and CFO liability" for the Journal of Corporate Treasury Management, "Unchecked pension problems are increasingly wreaking havoc with merger, acquisition or spin-off deals." This notion that corporate finance and human capital issues are intertwined shows up in many other situations as well. When part or all of a workforce is unionized, there is the added complexity of collective bargaining as a decision point and what this means for a sponsor seeking to restructure a benefit plan.

Pfizer Inc. (ticker PFE) is a recent example. Articles in FiercePharma and elsewhere describe how this jumbo pharmaceutical company is gradually phasing out its traditional pension plan in Ireland and offering a defined contribution plan in its stead. The trade union Siptu has taken legal action, refuting Pfizer's assertion that the defined benefit scheme is too expensive to sustain. Click to visit the website of the Services Industrial Professional and Technical Union to read its various press releases about Pfizer.

As with other disputes, facts and circumstances must be evaluated. Nevertheless, we are reminded once again that shareholders and pensioners are not always looking at things through the same lens.

Fiduciary Certification and Training

Last week, I had the pleasure of speaking to Dr. Anna Tilba with the Newcastle University Business School in the United Kingdom ("UK"). A mutual colleague had suggested we speak since we both work in the governance area. Dr. Tilba has studied the fiduciary practices of investment intermediaries. Her report fed into the UK's Law Commission publication about current fiduciary standards and areas for improvement.

One of the topics that arose during our conversation was the need for adequate fiduciary education and what she referred to as the professionalism of investment stewards. I agree that having experienced and knowledgeable individuals in place is critical. Even if the intent is to outsource certain services to others, investment committee members are tasked with making an informed decision about what to delegate and to whom.

Stateside, the U.S. Department of Labor ("DOL") continues its Fiduciary Education Campaign. Each seminar covers topics such as those listed below:

  • Comprehend the nature of each ERISA plan offered;
  • Apply rigor in selecting and monitoring service providers; and
  • Steering clear of prohibited transactions.

DOL website visitors can access something called the ERISA Fiduciary Advisor for information and answers to questions about duties. It's a tool that should help beginners although the DOL cautions that content is not "intended to be a substitute for the advice of a retirement plan professional."

So far, there is no uniform set of answers to questions such as the following:

  • How should in-house fiduciaries be selected?
  • How should in-house fiduciaries (individually and as a group) be assessed in terms of demonstrating procedural prudence?
  • Should in-house fiduciaries receive a bonus for achieving certain plan-specific goals?
  • Does everyone on an investment committee need to be equally proficient in a particular subject area or should someone serve as a Sarbanes-Oxley type of "financial expert?" 
  • Do in-house fiduciary term limits make sense?
  • How do variables such as plan design and characteristics of the workforce impact the kind of fiduciary education needed?
  • How should training differ for small to medium sized plans as addressed by the "Report of the Working Group on Fiduciary Education and Training?"

The good news is that data exists to benchmark myriad types of retirement plan decisions in terms of process and not just outcomes. Furthermore, there is a large array of training opportunities. Click here to download the "Retirement Plan Professional's Designation & Certification Guide" to learn about several dozen available offerings. Note that this document has a 401k focus. The bad news is that not all programs are created equal in terms of topic coverage. Even if they were sufficiently similar, facts and circumstances for a given retirement plan often dictate the need for specialized training not required elsewhere. 

Although fiduciary training is uneven across plans, sponsors and geographic location, I predict that lawmakers here and outside the United States will eventually impose universal certification requirements for retirement plan fiduciaries. I don't think a "one size fits all" approach to fiduciary training is ideal but political pressures will almost surely prevail. As the collective pension crisis worsens (and I acknowledge that lots of plans are in great shape), participants and taxpayers will want to know who was in charge of troubled schemes and how they made decisions. Proverbial heads tend to roll when voters' wallets shrink.

Not Everyone Gets a Pot of Gold at the End of the Rainbow

On March 17, the Irish and "Irish-at-heart" happily celebrate St. Patrick's Day, wear the green and look forward to a productive twelve months, after which the festivities can begin anew. Yet March 17 this year brought gloomy headlines for some individuals. In "New pension scheme will see teachers work to 68 in Northern Ireland," Belfast Telegraph journalist Rebecca Black writes that critics of a newly approved plan to increase employee contributions and push back when an educator can retire will make life difficult for new entrants to the job market. For the one out of five teacher graduates who are able to secure employment, they will be asked to pay "9.6%, well above the rate for a civil service pension, and with employer contributions of 13%, well below the rate for a civil service pension." Beyond changes to benefit terms, there are some who offer that teachers burn out by their late 50's and that's why "Most teachers retire by 60." Being asked to work for almost a decade more could be a real hardship.

In the United States, multiple public employee retirement plans have been or are in the process of being examined, restructured, reduced or otherwise reformed. Kentucky State legislators just voted to create a task force to investigate how best to close a funding deficit. As of mid-year, the gap "stood at $14 billion." This step came in the aftermath of a decision not to issue $3.3 billion in pension obligation bonds. See "Senate passes bill to study state's underfunded teacher pension plan" (KY Forward, March 11, 2015).

The State of New Jersey had similarly set up a task force to provide insights into current funding woes and recommend how to move forward. In "A Roadmap to Resolution" (February 24, 2015), the New Jersey Pension and Health Benefit Study Commission urges the freezing of existing retirement plans, the creation of a cash balance plan instead and a unification of benefit plan management to encompass both state and local municipal obligations.

Accounting changes will likely accelerate a further in-depth examination of other retirement and health care plans. According to "Why Some Public Pensions Could Soon Look Much Worse" (Governing, March 17, 2015), recent accounting rule changes - promulgated by the Governmental Accounting Standards Board ("GASB") - force dozens of plans to report "dramatic changes" that reveal significantly larger deficits. Using 2013 and 2014 data, magazine researchers examined 80 public plans in an effort to quantify the impact of using GASB 25 versus GASB 67. The results are telling. Click here to see for yourself how much of a difference ensues due to the now prevailing reporting regime.

As state and municipal plans seek to close serious funding gaps, participants may gasp if they are asked to pay more or receive less or both, making the proverbial gold at the end of the retirement rainbow a challenge.

UK Survey Highlights Fiduciary Management Trend

According to a September 8, 2014 press release, a survey of 359 UK pension professionals by Aon Hewitt suggests that investment complexity and a busy schedule are driving the increase in demand for outside help. Notably, researchers found that strategies such as liability-driven investing require a lot of analysis and that "trustees are spending less time dealing with these decisions, with 73% of trustees devoting no more than five hours each quarter to investment issues, up from 67% in 2013." Other highlights include an observation that larger plans may opt for some help whereas smaller plans, i.e. those with assets of 500 million GBP or less "are the most likely to opt for full fiduciary management." See "Aon Hewitt Fiduciary Management Survey 2014 finds the majority of schemes opting for tailored measurement of provider performance."

The issue of time and a long list of tasks that must be carried out is not unique to the UK. In "Beyond the Beauty Contest" (June 2014), Russell Investments describes its Outsourced Chief Investment Officer ("OCIO") solution for a Canadian defined benefit plan committee that was "spending most of their time hiring and firing managers."

Acknowledging that firms with third party service offerings have a vested interest in being hired by overloaded pension executives (many of whom have full-time jobs on top of committee work), the issue as to how persons with fiduciary responsibilities spend their time is an important one to discuss.

In "The Investment Committee: Pitfalls to Avoid," the Association of Governing Boards recommends that there not be "too many" members and to adhere to an agenda. Group think is discouraged as it "can result in bad decisions that reflect the prevailing consensus of what has worked recently..." Organizations with strong support staff enjoy the advantage of having a lot of time-consuming analyses done ahead of oversight and strategy meetings. Creating and then following documents such as a clear Investment Policy Statement and Committee Charter likewise has value.

There never seems to be enough time for any investment professional. When billions of dollars are at stake, effective scheduling and use of available resources is critical.

Foreign Corrupt Practices Act and Implications for Institutional Investors

For those who don't know, I am the lead contributor to an investment compliance blog known as Good Risk Governance Pays. I created this second blog as a way to showcase investment issues that had a wider reach than just the pension fund community. While I strive to publish different education-focused analyses on each blog, sometimes there are topics that I believe would be of interest to both sets of readers. A recent article that I co-wrote is one example. Entitled "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel" (The Corporate Counselor, September 2014), Mr. H. David Kotz and Dr. Susan Mangiero explain the basics of the Foreign Corrupt Practice Act. Examples and links to reference materials are included, along with a discussion as to why this topic should be of critical importance to pension funds and other types of institutional investors. Click to download a text version of "Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel."

Benefits Accounting Legerdemain

Accounting has been on my mind a lot these last few days. A colleague recently asked me to review his pitch deck for a prospective attorney client. We ended up spending time in discussing a slide about pension accounting. I suggested that he move the focus away from accounting-driven balance sheet risk and instead discuss the economic implications of an underfunded plan. Let's leave aside for now that we could have a lengthy and complex discussion about how to properly measure a shortfall - whether for a defined benefit plan or a defined contribution plan. Instead, I would like to reiterate that economic numbers are seldom the same as accounting numbers.

Let me repeat.

Economic numbers are not necessarily the same as accounting numbers. That's not to say that one is bad and the other is good. So much depends on the objective at hand. If I am a risk manager and need to plan for adequate cash on hand, a historical accounting number is not sufficient. Furthermore, accounting numbers can be based on a set of rules or driven by a collection of principles.  I will likewise leave a discussion of the merits of Generally Accepted Accounting Principles ("GAAP"), non-GAAP reporting, international accounting standards and hybrid approaches for another day. Until then, interested readers can check out "Principles vs Objectives-Based Accounting Systems," excerpted from "2012 Current Developments Update: Accounting & Financial Reporting" by Steven C. Fustolo, In a similar vein, if you would like to get a snippet of the concept that actuarial numbers are not necessarily the same as economic numbers, you can read "Will the Real Pension Deficit Please Stand Up?" by Susan Mangiero (June 22, 2006). While written before the Pension Protection Act of 2006 was signed into law by President George W. Bush on August 17, 2006, the notion about actuarial representations versus economic reality remains valid today. Complicating things is that actuarial numbers themselves can vary by virtue of inputs and model selection but I digress.

The important message is that one needs to understand how numbers are assembled, what they represent and, just as critical for proper decision-making, what they do not include. Moreover, it is essential to understand that accounting numbers can vary across countries, across sectors such as private versus public and over time.

Consider a November 11, 2013 statement from Fitch Ratings, Ltd. that predicts a likely jump in reported defined benefit plan provisions for 2013 as the result of a revised standard known as International Accounting Standard ("IAS") 19 on Employee Benefits. Authors of "German Corporates Most Affected by Pension Accounting" - John Boulton, Alex Griffiths and Cynthia Chan - write that "as there would be no change to the economics of a company's pension obligation, the new rules should not change our analysis or ratings." However, if an investor is comparing financial statements for a German company with a non-German competitor that utilizes a different way to create year-end and quarterly data, it will be necessary to make adjustments. Otherwise, the financial statement user is unable to make an evaluation on an apples-to-apples basis. In addition, it is important that the accounting numbers be converted to metrics that allow the investor to evaluate required cash flow, anticipated impact on debt service and other types of economic risks that are associated with the sponsor's offering of a benefit plan(s).

Another recent example of allowable story-telling about benefits that merits further analysis comes courtesy of Gretchen Morgenson. In "Earnings, but Without the Bad Stuff" (November 9, 2013), this New York Times muckraker describes the use of Regulation G by Twitter to present a second set of operating results "through the eyes of management" by lopping off $79 million stock-based compensation expense for Q1 through Q3 2013. She cites Jack T. Ciesielski, publisher of The Analyst's Accounting Observer, as saying that 'When they back out stock-based compensation they're basically saying that management is working for free...And we know that's not the case." Click to download the final amendment to the Twitter prospectus and visit the section entitled "Reconciliation of Net Loss to Adjusted EBITDA." You will see that, for the first nine months of 2013, a net loss of roughly $133.852 million is the top line. Then $79.170 million is added back, along with $77.670 million for depreciation and amortization expense. Another $6.203 million is added back for interest and other expense. Adding back $1.494 million as a provision for income taxes results in an Adjusted EBITDA of $30.685 million.

For all of the investors that include pension funds, endowments, foundations and family offices with allocations to organizations that are large shareholders of the now public 140-character communications company, they may want to ask about how different numbers were parsed. According to the Washington Post (November 6, 2013), Twitter's major shareholders include Benchmark Capital, JPMorgan and Rizvi Traverse.

Global Pension Assets: Another Tough Year

Hot off the press, the OECD's September 2012 issue of "Pension Markets In Focus" includes some notable statistics about pension schemes around the world. While aggregate assets increased to over $20 trillion (as of December 2011), post-fee real rates of return were miniscule at best. With an average annual rate of return of -1.7%, few winners bested the market at large. The award for the highest performing pension system went to Denmark with an annual return of 12.1% in 2011, followed by the Netherlands (8.2%), Australia (4.1%) and Iceland and New Zealand, each turning in a modest 2.3%. Turkey, Italy, Spain, Japan, the United Kingdom and the United States realized negative returns.

The news is not all grim.

According to André Laboul, OECD Head of the Financial Affairs Division Directorate for Financial and Enterprise Affairs, assessments of performance that consider many years show that the traditional 60% equity and 40% long-term sovereign bond mix have generated positive returns that range from 2.8% in Japan to 5.8% in the United Kingdom. Of course, many factors are at play, not the least of which is how much latitude an investment committee or policy-making body has to allocate monies locally versus internationally, the rate at which assets grow (and can be put to work) and the fees that are paid to various service providers.

Regarding asset class exposure, OECD researchers note that pension funds' allocation to "public equities declined significantly compared to past years." This trend is likewise noted in the "Global Pension Assets Study 2012." Published by Towers Watson in January, this compilation of interesting data points shows that the Netherlands and Japan have a "higher than average" allocation to bonds. In contrast, "in 2011, Australia, the UK and the US retained above average equity allocations." Apportioning more monies to alternatives is an undeniable reality for retirement plans in multiple countries

Since more than a few people posit that asset allocation decisions dominate portfolio returns, it is critical to track who is investing in what. Pension de-risking activity will likely have an impact on defined benefit plan portfolio mix going forward if, as experts suggest, more companies decide to exit or modify their exposure to the "pension business" by freezing a plan, using derivatives, offering lump sum payouts, entering into group annuities and so on.

Pension restructuring and adding more alternatives are factors that are changing the governance landscape in numerous ways. For one thing, the need for investigative due diligence and independent valuation services arguably becomes more acute. Second, the regulatory focus on holdings disclosure and compensation paid to service providers could inhibit the use of private funds at the same time that yield-seekers are writing checks.

The "push-pull" dynamic is holding everyone's attention since so much money is at stake.

Public Pension Investing in Europe

Market uncertainty typically paves the way for new investment strategies and what is happening abroad is no exception. In a recent article entitled "State pension eyes European chaos for opportunity," journalist Rob Varnon (Connecticut Post, May 23, 2012) writes that the State of Connecticut has soft circled $50 million to allocate to a so-called "opportunity fund" that has its eyes on "European distressed and defaulted debt."

I am quoted as saying that "Investing in Eurozone sovereign debt by institutional investors with a long-term focus may make sense" as long as a pension fund carefully weighs "the risks against the expected returns." I added that many of these opportunity funds are new which means that there is no track record available to review.

Besides liquidity risk, I cited the political will to adopt austerity measures as being variable across borders yet critically important to assess.

Finally, I emphasized the "we are one" aspect of global capital markets, namely that what happens in Europe is unlikely to stay in Europe. U.S. pension plans are almost sure to be impacted. For one thing, trading sentiment is seldom self-contained these days, a trend that is reflected in record high correlation coefficients for various equity and fixed income venues. Second, a pension plan could be already invested in U.S. multinational companies that heavily rely on European economic growth (or lack thereof) to generate sales and profitability. By investing further in European opportunity funds, a U.S. pension fund adds to that exposure and thereby lessens the extent to which it is diversifying geographically.

Continental Europe is not the only region beckoning to Yankee pension funds. According to "China may give foreign pension funds new investment opportunities" by Amy Li (Wall Street Journal, May 15, 2012), authorities are thinking about a mechanism to expand outside capital infusions. Other cited possibilities include the allowance of hedge funds to invest and for certain parties to be able to "open new yuan-denominated onshore bank accounts."

An important factor to consider, among many, is that "boots on the ground" can make an invaluable difference in helping pension fiduciaries to adequately vet non-U.S. partners. International investing has its own set of challenges and getting local help can make sense.

Old Age Can Be a Bonus With a Price Tag

Enjoy this interview about longevity and pension risk management with Dr. David Blake, Director of the Pensions Institute. Professor Blake explains why understanding life expectancy trends across age, gender and socioeconomic groupings is so critical. He comments on new valuation rules that relate to financial statement transparency and share prices of plan sponsors. He differentiates between pension buy outs from pension buy ins and offers reasons why longevity swaps can be beneficial.

Click here to read "Longevity and Pension Risk Management," an interview with Professor David Blake, May 2010.

For other articles about longevity and pension risk management, visit for a complimentary subscription to best practices website,

Risk Management, Leverage and Globalization

In "Risk Management Q&A: Risk is a four-letter word" (Perspectives, RBC Dexis Investor Services, April 2010), I talk about meaningful changes in terms of risk management as a result of the financial crisis. My comments about leverage in the same interview are nothing new. Leverage is not necessarily good or bad. Importantly, institutional investors must understand how to properly measure leverage and establish internal controls.

"All leverage is not created equal. A short position in an actively-traded instrument has a different risk-return profile than taking on debt or synthesizing exposure with puts or a combination of derivatives."

To read the full interview, go to page 10 of "The global power shift: New directions for the world economy". I am also quoted on page 8 in the article entitled "Reversal of Fortune: Regulators could push the consolidation trend back a few years" on the topic of reactionary regulation.

Bon Appetit or Indigestion As We Age?


Photo Source:

Having just returned from a showing of the new movie about Julie Child, several things struck me. First, I had no idea that she worked so tirelessly and persistently in order to publish her magnum opus entitled Mastering the Art of French Cooking. Second, I hadn't realized that she was a late bloomer and in fact started her culinary career with zest after 50. Third, if the movie is true to life, she seemed to enjoy a happy relationship with her diplomat spouse. 

Being of a certain age other than 21, stories of late bloomers are certainly inspiring and not a moment too soon. According to "Pension age 'could rise further'" (August 8, 2009), the BBC reports that UK pensioners may soon be forced to postpone retirement until age 68. David Norgrove, chair of the Pensions Regulator, thinks that number will eventually be exceeded.

I don't think this news is surprising one bit. Longer lifespans around the world leave governments little choice. After all, at a certain point, you can only tax citizens (those who are working) 100% of what they earn in order to support everyone else. 

Mark my words. We are going to be working until very late in life and no doubt be giving up much more of our disposable income to finance retirement. 

Julia Child is a good example of working late in life and having fun at the same time. As for the rest of us, saving can't start soon enough for our "second lifetime." Let's hope our meal is a culinary delight and not crackers and beans.

Enron Redux? Pension Plans as Plaintiffs

According to the Stanford Law School Securities Class Action Clearinghouse, several cases against Washington Mutual, Inc. were consolidated in May 2008. Ontario Teachers' Pension Plan Board was designated lead plaintiff. The "complaint alleges that, during the Class Period, defendants issued materially false and misleading statements regarding the Company's business and financial results....On September 30, 2008, defendant Washington Mutual Inc. filed a notice of bankruptcy."

According to "Suing a Broken Bank" (CNN Money, March 30, 2009) and other sources, a motion to dismiss has since been filed.

Elsewhere in this video, I am asked by CNN Money anchor Poppy Harlow to comment on financial reporting as an element of risk management. (I agreed to discuss transparency in general but told producers upfront that I possessed no information about this particular case, other than what I had read as a member of the general public.) About allegations that material information was withheld from shareholders (whether this case or others), I stated that "It's essentially the same thing that we saw a couple years ago with Enron and WorldCom - Who knew what, when and on what basis and what was the obligation of senior management to disclose information to the shareholders?" Click to view "Suing a Broken Bank." In terms of full disclosure, I own 212 shares of Enron common (worth about a penny per share).

I wrote about Washington Mutual on September 26, 2008 when I posited whether better disclosure would have helped WaMu shareholders. At the time, the U.S. Securities Exchange Commission had just released a statement urging more "transparent disclosure for investors." I countered that "sufficient" news is always welcome but wondered (and still do) if numbers alone are meaningful. I think not. Let me repeat what I said then.

<< 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? >>

In addition to their already long "to do" list regarding asset allocation, plan design and so forth, countless pension fiduciaries are charged with corporate governance related duties such as monitoring. After all, they are frequently large shareholders in public companies stateside and abroad. It is interesting to note that most securities litigation leads are either public pension funds (U.S. and non-U.S.) or Taft-Hartley plans but not ERISA funds. Why this is true is one of the questions that will be discussed during our April 27, 2009 webinar entitled "Pension Plans as Plaintiffs - 800 Pound Gorilla of Litigation." Click here to register.

Pensions Query Private Equity and Venture Capital Funds

According to Wall Street Journal reporter Heidi N. Moore, investing in certain private equity funds may no longer be a walk on the beach. Not content to sit passively on the sidelines, "Pension Funds to Private Equity: ABCD. Always Be Closing Deals." (March 13, 2009) describes a desire to shift power to pensions, endowments and foundations, away from portfolio managers. Cited reforms include: (a) contracts that mandate the return of money to limited partners within a pre-specified period, thereby truncating fees earned by private equity funds (b) clawback arrangements that allow general and limited partners to equally participate in big wins and (c) detailed evidence that committed monies are being invested rather than left idle.

In a related article entitled "Venture Capitalists Chart a New Course" (March 13, 2009), Wall Street Journal reporter Pui-Wing Tam writes that some venture capitalists may be moving outside their comfort zone by investing in distressed assets and public companies via "registered directs" and private investments in public equities ("PIPES"). Brandon Park, a financial professional who invests in venture capital funds on behalf of institutional investors is quoted as saying that "many venture funds have charters that allow a certain percentage of assets -- typically 10% to 15% -- to be invested in assets other than private start-ups."

Indeed, there are many changes afoot in the private capital arena. They potentially impact if, and how much, pensions, endowments and foundations allocate to this asset class.

  • The credit crisis has made it difficult to do deals that depend on leverage.
  • The time period before which a company is likely to go public or be acquired has lengthened, often forcing a general partner to (a) hold onto a portfolio company for a relatively longer period of time and/or (b) possibly requiring additional cash infusions by that general partner as a result of a longer holding period.
  • Some private capital partnerships are not establishing new funds. As a result, their need to preserve cash (i.e. to keep existing companies afloat) may create even more friction for limited partners which want to see new investments being made.
  • If passed into law, a proposed rule to change the way carried interest is taxed for general partners could impact fees charged to limited partners.
  • FAS 157 applies to many alternative funds and remains a due diligence item for institutional decision-makers who must understand valuation policies and procedures for "hard to value" asset pools. 

A big plus is that some private equity and venture capital funds find themselves in an enviable position to pick and choose from a bevy of investments as entrepreneurs find more traditional funding paths closed to them. Ultimately, realized returns, ownership privileges and qualitative practices will influence how much money pensions, endowments and foundations continue to plow into non-public opportunities.

Editor's Note: Here are a few resources for interested readers.

Prince Charles Wants Pension Funds to Invest Green

According to Hugh Wheelan ("Prince Charles to propose 'pension plan for the planet'," Responsible Investor, November 17, 2008), England's Prince Charles is working hard to save the rain forests. Since late 2007, His Royal Highness is described as actively encouraging long-term investors such as insurance companies and retirement plan sponsors to buy 15-year bonds "with competitive returns." Issued by companies that are creating "sustainable energy solutions," proceeds of the bonds would likewise be used to make developing companies less dependent on income earned by chopping down trees. The P8, a consortium of 10 (not 8) interested pension funds, is said to include the (1) Universities Superannuation Scheme (2) Dutch giant ABP (3) CalPERS and (4) CalSTRS. (See "Prince Charles lead 'P8' pensions powerhouse finalises climate change report ," Responsible Investor, July 31, 2008.)

Richard Palmer, Daily Express blogger has a different take. In "Prince Charles Wants to Raise Your Taxes to Save Rainforests" (November 4, 2008), eco-friendly investing would get a boost, courtesy of the UK taxpayers as well. Not only would wealthier countries guarantee rain forest bonds, their citizens could pay a utility tax for the alleged benefits provided by tropical jungles - "global air conditioning system, storing its largest body of freshwater and providing a livelihood for more than a billion people."

With the current market situation, one wonders if initiatives such as these will fall by the wayside, for some time, at least. Leaders of developed countries have their hands full as they try to stimulate their beleaguered economies. At the same time, funding status for more than a few pension plans worsens, leaving them with fewer monies to allocate.

Cracks in the Pension Safety Net System?

According to two separate news accounts, cracks may be appearing in the pension back-up systems for the United States and UK, respectively. Already jittery taxpayers may look at these warnings with heightened alarm.

In "Pension Agency Sounds Alarm on Big Three," Wall Street Journal reporter John D. Stoll (November 28, 2008) writes that the Pension Benefit Guaranty Corporation ("PBGC") is worried that large automakers may offer early retirement or buyout deals to some plan participants, at the expense of those who remain. Stoll adds that a year-end accounting by General Motors ("GM") has its pension plans "overfunded by $18.8 billion," but recently reported that "its plan for hourly workers was underfunded by $500 million because of restructuring expenses." The Toronto Star suggests funding woes for GM's Canadian pension plan. (See "GM Canada's pension plan troubled before market collapse" by James Daw, November 15, 2008.)

In "Pension lifeboat may be sunk by wave of firms being liquidated" (November 28, 2008), Phillip Inman and Simon Bowers - reporters for The Guardian - write that "The Pension Protection Fund (PPF), which has already rescued more than 66 retirement schemes, may be forced to increase its levy on profitable companies to boost its finances or risk a government bail-out if more companies go bust." With the collapse of Woolworths and other troubled companies, this UK counterpart of sorts to the PBGC may find itself in a postion of having to pay out more each year than it takes in.

This day after American Thanksgiving, known as "Black Friday" for shopping jaunts, may be the day the bell tolled for two of the world's largest concentrations of private pension schemes.

Editor's Note: On November 17, 2008, a PBGC press release describes a reduction in its deficit as a snapshot number, influenced by events that may not repeat themselves.

<< The PBGC’s insurance program for single-employer pension plans reported a deficit of $10.7 billion, a $2.4 billion improvement over last year’s $13.1 billion shortfall. The deficit of the insurance program for multiemployer pension plans was cut in half to $473 million, a $482 million improvement from the $955 million deficit reported a year earlier. 'The PBGC’s lower deficit is good news, although it is important to remember that the deficit number is only a snapshot of where we stood on September 30,' said Director Charles E.F. Millard. 'Successful negotiations with companies in bankruptcy protected workers’ pensions and sliced hundreds of millions of dollars in liabilities off our books.  Favorable interest rate changes reduced liabilities, and our careful stewardship of the PBGC’s investments limited losses to 6.5 percent of assets. Although the current turbulence in our economy will mean a challenging environment in 2009, the PBGC has the resources to meet its commitments to America's retirees for many years to come.' The decline in the deficit in the single-employer program was primarily due to a $7.6 billion actuarial credit from a favorable change in interest factors, $1.4 billion in premium income, credits of $826 million from completed and probable terminations and $649 million in favorable actuarial adjustments. These amounts were offset by investment losses of $4.2 billion and a $3.4 billion actuarial charge due to passage of time. Total return on invested funds was -6.5 percent. > 

Pensions and Politics: Argentina Seeks to Nationalize Private Pensions

According to Wall Street Journal reporter Matt Moffett, Argentina's leader would like to nationalize the private pension system, allowing this South American country to "raid new pension contributions to cover short-term debts due in coming years." The picture appears bleak indeed. Trounced by lower commodity prices and rising IOUs, the $30 billion plan looks like a juicy target. (See "Argentina MakesGrab for Pensions Amid Crisis," October 22, 2008).

In "Argentina stocks, bonds plunge on pension reform plans" (October 21, 2008), Reuters reports that investors look unfavorably upon a takeover of the private retirement system. In "Argentina Pension Funds Attack Government Plan, Defend Result" by reporter Michael Casey (Dow Jones Newswires, October 21, 2008), a coalition of Argentinian private pension plans decry the need for a takeover. Asserting the need to review long-term performance, private pension leaders say "the reform project was founded on results incurred during the current financial market crisis."

This reminds one of the optical illusion that asks the viewer to recognize both a beautiful woman and an "old hag." Some see Argentina's pension reform as good news and others question the real motivation behind such a proposal.

Is this likely to become a trend around the world? We never thought global megabanks would be nationalized and now they are.

LIBOR Manipulation - Comments from the Author

Given its global prevalence as a performance benchmark, the ongoing scrutiny about the economic accuracy of the London Interbank Offered Rate ("LIBOR"), is not surprising. In the text that follows, one of the authors of a recent paper about LIBOR rate-setting adds a few comments.

"Thank you, Susan, for your October 15, 2008 coverage of our "Libor Manipulation?" research manuscript. As always, you succeeded in 'cutting to the heart' of a rather complex topic in your customarily succinct, yet engaging style. When your readers download and peruse our work, I would encourage them to focus on the manner in which we extend and elaborate on the analysis done by the Wall Street Journal. For instance, we were able to detect two specific dates in time that reflect structural 'breaks' in data patterns. One occurred shortly after (and doubtlessly occurred in response to) the publication of the Journal's announcement of its investigation. However, the other event occurred over eight months before the appearance of this announcement, and appeared to coincide with the publication of three relevant external news events that affected the industry. Your readers will find more information in our manuscript. We welcome readers' comments."

Submitted by Professor Michael Kraten, PhD, CPA, Sawyer Business School, Suffolk University

Laboring Over LIBOR

Long accepted as a key rate benchmark, the London Interbank Offer Rate ("LIBOR") may be replaced by something else if a current deal is a trendsetter. According to Bloomberg reporter Cecile Gutscher, Electricite de France SA will repay interest on an 11 billion pound sterling loan - used to finance the acquisition of British Energy Group Plc - by first computing "an average of funding rates supplied by BNP Paribas SA, Deutsche Bank AG, Royal Bank of Scotland Group Pld, Banco Santander SA and Societe Generale SA." (See "EDF to Use Alternative to Libor on 11 Billion-Pound Buyout Loan," October 14, 2008)

This rate at which banks lend to each other in the global capital markets has had its ups and downs lately. Volatility, due in large part to the credit crisis and the resulting financial services industry fallout, has taken its toll. Borrowers, hedge fund investors and fixed-LIBOR interest rate swap counterparties represent just a few of the many organizations that are impacted by gyrating LIBOR rates.

According to a new research study, directional moves may not be the only concern about LIBOR. Authors Rosa Abrantes-Metz, Michael Kraten, Albert Metz and Gim Seow examine LIBOR rates relative to other short-term borrowing costs, along with an assessment of the "individual bank quotes that were submitted to the British Bankers Association." Seeking to dispel or validate the notion that LIBOR levels are artificially low (alleging that quoting banks do not want to be seen as needing money and therefore cite low rates), the authors conclude that manipulation is unlikely, noting some irregularities in the data. For more information, click to read "Abrantes-Metz, Rosa M., Kraten, Michael, Metz, Albert D. and Seow, "Gim, "LIBOR Manipulation?" (August 4, 2008).

This pension blog includes several posts about LIBOR and its varied applications: (a) derivative instrument trades such as swaps-linked LDI strategies (b) asset management performance analyses and (c) borrowing arrangements. See "Are Pension Investments Too Complicated?" (September 5, 2008) or "Lowballing LIBOR May Cost Pensions Plenty" (April 18, 2008).

World Economic Forum Report - Demographic Gaia

According to Wikipedia, the Gaia Hypothesis refers to an ecology that inextricably ties together elements of Earth and the biosphere. With respect to world population trends, the World Economic Forum embraces the notion that "We Are in This Together" as one possible scenario. Other scenarios put forth include "The Winners and the Rest" and "You Are On Your Own."

 In its new report entitled "The Future of Pensions and Healthcare in a Rapidly Ageing World - Scenarios to 2030," authors cite UN projections that, by 2050, "one-third of the populations in developed countries and one-fifth of those in developing countries will be aged 60 or older." Authors Bernd Jan Sikken, Nicholas Davis, Chiemi Hayashi and Heli Olkkonen center on the likely outcomes associated with a radical increase in retirees. Why is this important? As more people leave the workforce, fewer wage-earners remain. This in turn means that fewer dollars (Euros, yen, etc) are deposited into the employee benefits pot to fund promises made to others.  

This blog has oft-commented on the potentially dire consequences of "out of control" obligations.  World Economic Forum researchers offer that population shifts will no doubt change the political and economic landscape in many countries. Their list of challenges includes, but is not limited to:

  • "Growing expectations that the private sector will come to the rescue"
  • Financial illiteracy on the part of individuals
  • Less than robust private-pension and health insurance mechanisms
  • Mounting pressures on "pay as you go" public safety net programs
  • Waning support from younger family members to care for elders
  • Shortage of skilled healthcare workers
  • No safety net programs for some 80% of those who live in less-developed countries.

The report is chock full of graphs and statistics and includes a comprehensive bibliography. Case studies about China and Italy are worthwhile as their problems mirror those of other countries.

I personally am a believer in the "together" theory, no matter how much we save as individuals and irregardless of employer largesse (for whom that applies).

As we've seen in the last few weeks, global capital markets are kissing cousins. Someone sneezes in one country and we all get a cold. In a similar sense, increasing numbers of impoverished persons likely affect us all in the form of (a) increased taxes on working individuals (b) drag on economic growth as monies are diverted from the business sector to support government programs and the (c) human element of not wanting to see others suffer because they cannot afford everyday basics.

Email your thoughts. Do you think we are in this together as relates to a benefits crisis?

SIBOS 2008 in Vienna

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

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?


  • 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


  • 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?


  • 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

UK Pensions in the Red

According to "Red alert for pension plans," The Scotsman reporter Teresa Hunter enlightens readers about mammoth losses for pensions run by some of the UK's biggest 100 companies (August 10, 2008).  Describing the 41 billion pound sterling hit as "the largest downward swing since the dotcom bust six years ago," Hunter shocks by comparing the current status quo to a 12 billion GBP (Great British Pounds) surplus only 12 months ago. A collective infusion of 40 billion GBP and a reduction of "risk by cutting their exposure to the stock market from 59% to 53%" has done little to stem the tide. Recession, additional regulatory mandates, anemic stock market returns, new accounting rules (such as FRS 17 and/or IAS 19) and extended lifespans promise more pain.

Putting things in context, the reported loss is roughly 78 billion U.S. dollars (based on an August 8, 2008 GBP/USD exchange rate as reported by Some significant takeaways from the 2008 report, published by actuarial firm, Lane Clark & Peacock, are telling:

  • Like the United States experience, many British firms no longer offer traditional benefits to new employees.
  • The pension IOUs for some plan sponsors exceed their respective market capitalization. (British Airways, BT and British Energy Group are examples.)
  • Conflicts of interest arise between shareholders who seek improved pension plan expense managment versus plan participants who want more benefits (or at least do not want benefits to be cut).
  • Trustees take a longer-term perspective than shareholders, often putting them at odds with respect to risk-taking.
  • Accounting reports vary because of company-specific inputs that likewise vary such as discount rate, expected asset portfolio rate of return and longevity assumptions.
  • Some companies do not use derivatives to manage risk, hoping for an improved funding situation in "due course" and/or wanting to avoid negotiating asset allocation with trustees (who have "unilateral control").
  • "Most trustees are not investment experts" and require additional training before making a decision about swaps, pension buyouts and/or change in investment policy.

In the spirit of The World is Flat by Thomas L. Friedman, it is pretty clear that members of the global retirement fiduciary community share most of the same concerns and economic realities. There are few countries that are immune to the panopoly of factors that result in higher costs.

Editor's Notes:

Sturm und Drang in Europe Over Pension Cuts

According to "Europe Tries to Handle Political Fallout of Pension Cuts" by Carter Dougherty (New York Times, August 5, 2008), we learn that the "third rail of politics" is clearly a global pain point for legislators. Changes that include raising the retirement age (such as in Italy and Germany) or extending the service requirements for government workers (such as in France) could be figuratively lethal for those in power. Dougherty warns that European workers have cause to worry, stating that "Forty percent of Belgians over 75" will "live in poverty by 2016" according to official statistics.

The article describes the creation of the Pensioner Party by a disgruntled German retiree, now focused on electing candidates who will advocate for a "more generous pension system." Google lists a URL for "The Pensioners Party," a UK registered political party with stated objectives that include the removal of means testing, payment of higher benefits and various other assorted freebies. Milton Friedman is calling out to us - "There is no free lunch." National Public Radio reports that an Israeli Pensioners Party is "shaking up the balance of power after winning seven seats in the country's parliament." See "In Israel, Pensioners Party Surprises With Gains" by Eric Westervelt, April 2, 2006.

Unfortunately, the "graying" of global populations and financial reality make it extremely difficult to do anything but acknowledge that change is imminent. The recission of hard-fought reform to avoid public outcry and political fallout is only going to exacerbate an already serious situation. Numerous countries, especially those with entrenched state plans, are being squeezed due to dramatic demographic shifts and benefit largess. In response, countries such as Sweden and Poland are urging individuals to participate in employee-directed plans. Germany has offered a tax incentive for private savers. One would hope that retirees, counting on promises made and possibly facing limited work opportunities, will have "enough" to survive. 

The political ramifications, in Europe, the United States and elsewhere, are huge. Do not be surprised if older voters are soon fighting at the ballot box with younger workers who feel the crush of large retirement plan IOUs. The sad truth is that real people are going to get hurt. That is why the crisis must be recognized and managed, sooner than later. Time is a luxury that few countries can afford.

Editor's Note: The American Association of Retired Persons (AARP) presents detailed information about retirement plan issues in a variety of countries. Click to access any or all of these AARP research publications (free to the public).

Dutch and US Lawmakers React to Hedge Fund Activists

Far from the halcyon image of a young boy admiring Dutch tulips, hedge fund activism has some lawmakers seeing red.

In response to our July 5, 2008 post about CSX ("CSX Battles Hedge Funds - A Cautionary Tale for Pensions"), Peter at writes the following:

<< TCI also played a major role in the take over of ABNAMRO and benefited with an incredible return on investment (almost 100 percent). In the Netherlands legislation is being prepared to reduce impact of these activist inveztors that immediately profit by simply sending a warning letter to the board of a company. >>

Credit to Peter for directing us to the Governance Focus blog post entitled "Dutch taskforce wants to tighten corporate governance" (June 7, 2008). According to the cited June 5,2008 Reuters article with the same title, Dutch lawmakers seek to equalize what they perceive as an unlevel playing field across shareholders. In "Dutch corporate governance review mulls over M&A 'put up or shut up' clause" (Thomson Financial News, June 4, 2008), the head of the Corporate Governance Code Monitoring Commission, Mr. Jean Frijins, posits the need for more transparency as relates to corporate takeover attempts.

Stateside, reports on US Senator Chuck Schumer's letter to SEC Chairman Cox, asking why the court failed to penalize either The Children's Investment Fund or 3G Capital, having concluded that the "group" violated securities laws by not disclosing their partnership, pursuant to Schedule 13D rules.  Jurists did however allow TCI and 3G to vote their shares (direct and indirect via equity swaps). See "Schumer may propose bill concerning CSX ruling" by Ron Orol, June 18, 2008. Oral is the author of Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World (John Wiley & Sons, 2007).

As I wrote yesterday, this case is noteworthy for numerous reasons, not the least of which is the fact that derivatives (equity swaps here) are clearly changing the corporate governance landscape. Significant questions remain about what constitutes "appropriate" transparency (already a hot button issue for pensions, endowments and foundations that invest in hedge funds, not all of which provide "enough" detail about their holdings). Just as important, what is the proper role of activist money managers? Are they doing existing shareholders a favor by shaking up things, urging existing managers to improve performance (however "performance" is defined) or creating chaos? While each situation differs, their clout is far from non-trivial.

This blogger does not have sufficient information to make a judgment about the CSX case. On a more general note, however, it would be enlightening to understand how pension plan fiduciaries (defined benefit or defined contribution) vet corporate governance risk before allocating monies to a particular stock, bond or hedge (private equity) fund. Unless the plan's corporate governance policies are made available (if they exist at all), we learn only from reading headlines and court filings, after the fact.

Wouldn't it better for investment fiduciaries to ex-ante publish how they monitor and manage "beneficial ownership" issues, especially in the event of a takeover?

Editor's Note: Click to read the "Final Judgment, CSX v. The Children's Investment Fund."

UK Pension Fund Goes Green

According to Institutional Investor ("Buying into Green Investing" by Henry Teitelbaum, June 2008), green is good for at least one large UK pension fund, the Universities Superannuation Scheme Limited ("USS"). Joined by three other organizations (Alliance Trust PLC, SNS REAAL N.V. and Mitsui & Co Ltd), this trustee company with 30+ billion GBP in assets is part of a 56 million GBP financing round for the Climate Change Capital Group, a London investment bank "dedicated to the low carbon economy." Teitelbaum adds that the USS is already sold on the commercial viability of environmentalism, demonstrated by its membership in the Enhanced Analytics Initiative. According to research done by this blogger, the USS is credited with taking "ethical, social and environmental considerations" into account when "assessing the merits of investment in a given company" as early as 2001. (See "Pension funds can get more from 'green investing' - SRI expert" by Nat Mankelow, bfinance, May 12, 2001.)

While few dispute the merits of considering a Socially Responsible Investing ("SRI") component for portfolio diversification purposes, it would be helpful to know how USS determines its strategic commitment to SRI economic interests as a separate asset class. Moreover, how does this pension giant consider "green" or "vice" factors before taking direct equity stakes in oil or tobacco companies? Top 100 USS equity holdings, as of March 31, 2008, include Royal Dutch Shell (position 1 with an estimated market value of 705.8 million GBP), BP (position 3 with an estimated market value of 625.2 million GBP) and British American Tobacco (position 14 with an estimated market value of 194 million GBP). This blogger is not maing a value judgment about investing in the stocks of these or other companies but rather simply thinking out loud about diversification analysis as it relates to SRI exposures.

Valuation is yet another consideration. As pension plans invest in environmental companies, how do (should) they properly determine the probability (and amounts) of revenue realization for start-ups and/or firms that depend on relatively new technologies to generate income? In the absence of accounting rules (across countries) or new regulations that mandate periodic assessments of value, the challenge is significant. Add the time pressures of compliance and these already important questions demand good answers.

Editor's Note: According to the EAI website, membership is "open to institutional investors and asset managers who commit to allocate individually at least 5% of their brokerage commissions to extra-financial research" or said, another way, the assessment of externalities on long-term investment performance. Most members are non-US organizations. The New York City Employees' Retirement System ("NYCERS") is a member.)

Aussie Seniors Unrobe to Protest Pension Problems

Derobing is certainly a novel way to draw attention to "anemic" benefits. According to "Seniors strip in pension protest" by Stacey Zenin (, May 16, 2008), several hundred retirees took off a few pieces of clothes to campaign for a "fair go for pensioners." Believing that the current federal budget does too little to add to post-employment financial security, seniors clamor for "between $70 and $100 extra per week in their pensions." Not unique to Down Under, the problem of financing retirement benefits is fast reaching crisis proportion for numerous governments. Balancing a budget is tough going without considering changes in tax policies and benefit levels.

For an interesting take on the Australian pension system, check out "Risk-Based Supervision of Pension Funds in Australia" by Graeme Thompson, February 1, 2008, World Bank Policy Research Working Paper No. 4539.

Editor's Notes:

1. This blogger had the pleasure of working with Mr. Graeme Thompson on a Chilean pension project, done in conjunction with Dr. Roberto Rochas of the World Bank.

2. Check out the pension risk management section of the Social Science Research Network.

Dr. Susan Mangiero Speaks at World Bank Pension Conference

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."

UK Pension Gains Wiped Out

Even British comic book hero Union Jack may not be able to save the day for some UK pension plans. According to data just released by the Pension Protection Fund, the net funding status for nearly 8,000 private defined benefit plans widened to 97.5 billion pound sterling. Worse than the 80.8 billion GBP gap reported for January 2008, this February 2008 number is deemed "highest since June 2003" and represents the fourth consecutive monthly gap. Another telling indicator of problems is the news that "In February 2008, the total surpluses of schemes in surplus fell to £32.6 billion from £37.3 billion1 at the end of January 2008." Twelve months ago, the "aggregate surplus of all schemes in surplus stood at £68.6 billion." Click to review the Pension Protection Fund data report.

Citing anemic equity performance and falling bond yields as the culprits, the report's authors add that lower bond yields resulted in a 8.1% rise in aggregate liabilities "while weaker equities have reduced assets by 1.5%." Noteworthy are the results of a survey commissioned by the PPF and carried out by KPMG that show that few respondents (defined benefit plans considered "large") employ liability hedging techniques. The chart that maps funding status to percent of liabilities seems to support a widely held belief that "where funding is severely low the schemes need to take a certain degree of investment risk to help get back to full funding, given the PPF is insuring a certain level of benefits."

Does this mean that regulatory subsidies discourage hedging? If so, the UK would not be unique in terms of a rational but perverse response to changed incentives. (The notion of unintended consequences is one of the free market economic arguments against regulation, especially when "innocents" end up paying the bill.)

Click to access the January 2008 survey entitled "Pension Protection Fund: Investment Strategy and LDI Survey."

On a related note, a survey of US and Canadian plan sponsors, focused on their pension risk management practices, is due out shortly. A collaborative effort on the part of the Society of Actuaries and Pension Governance, LLC, the results support those of the aforementioned UK survey with respect to lower than expected amount of hedging (of both assets and liabilities).

Pension World is Flat

Despite colorful tales of medieval historians disputing its shape, most people then and now realize that the earth is not flat. We won't get to the end and fall off. Indeed, we're arguably more interconnected than ever before. So it's not surprising that a galaxy of international speakers convened in Sydney with many of the same problems, challenges and concerns as US peers. A recurring theme emerged for everyone in attendance at the Asset Allocation Summit 2008 - Investment management is all about risk. Identification, measurement and control are important,. regardless of plan design and country of origin. In fact, the similarities as to what keeps folks up at night are eerily striking, whether voiced by a plan sponsor from Europe, Asia, Australia or North America. Here are a few concerns that resonated with all in attendance.

1. How can investment fiduciaries minimize their liability exposure, especially when investment strategies are becoming more complex and diverse?

2. What is the responsibility to defined contribution plan participants, knowing that many will retire without ample means to maintain a particular lifestyle?

3. How can one avoid paying "excess fees" to managers?

4. What is the proper way to separate beta from alpha?

5. What is the role of infrastructure investing?

6. Should allocations to 130/30 strategies (and equivalents) come from equity or alternatives?

7. Will a recession be global in nature?

8. How much oversight is required by internal fiduciaries who delegate manager selection to consultants?

9. Is ESG (Environmental, Social, Corporate Governance) investing a plus or minus in terms of fiduciary duties?

10. How should derivatives be properly used and by whom (the plan, the money manager or both)?

Sound familiar? If so, perhaps we should be thinking about how to operate within a flat pension world. Credit Thomas Friedman for pointing out the oneness that pervades global thinking. In his best-selling "The World is Flat," he emphasizes the connections among seemingly disparate markets. Should we care about the governance of pension funds outside our borders? In a word, "yes." What is done elsewhere impacts an increasingly "flat" network of capital which in turn influences the investment opportunity set within our borders..

Isolationism is over for most everyone. What about you?

Chile Pension Reform Adds to Foreign Investments

In "Chile set to boost foreign investment," Financial News reporter Johanna Symmons (January 28, 2008) describes a proposed law that increases maximum international holdings from the current 40 percent to 80 percent. This means that the half dozen authorized private fund administration companies will have more latitude in how they manage the country's mandatory individual savings accounts. When approved, non-Chilean holdings could rise as much as USD 50 billion. In addition, reform will add to retirement plans of impoverished citizens, "funded by windfalls from copper production." Credit goes to President Michelle Bachelet who identified the need for change as "her administration's most important task."

This blogger is proud to say that she worked as a financial risk management expert on an official fact-finding team in early 2006. Led by Dr. Roberto Rocha (World Bank), colleagues and report co-authors included Mr. Graeme Thompson (former Australian regulatory chief and now pension consultant) and Dr. Eduardo Walker (Pontificia Universidad Catolica de Chile). If you are interested in learning more, know that pension professionals from around the world will be presenting at The 4th Contractual Savings Conference: Supervisory and Regulatory Issues In Private Pensions and Life Insurance. Hosted by the World Bank and occurring on April 2 through 4, 2008, the discussions will emphasize the "brave new world" of pension risk management. Yours truly is presenting a session entiled "Risk Management of Pension Funds: A Practitioners View."

If you are unable to join us in Washington, DC, I invite you to read about what other countries are doing in the area of pension reform for different types of plans. Chile is a particularly interesting case inasmuch as politicians and public policy leaders often reference this Latin American system as a noteworthy and innovative model. Think of it as a national 401(k) plan of sorts. While not perfect (no system is), many people like having their own account rather than being part of a "pay as you go" system. For more information, visit the site for the Superintendency of Pension Fund Administrators and click on the English overview.

Should Lawmakers Determine Pension Investment Policy?

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). 


Is There Fiduciary Liability Attached to Divestment?

According to Wall Street Journal reporter Craig Karmin, some legislators want public pension funds to shun companies that invest in terrorist countries such as Iran. Citing efforts by Missouri State Treasurer, Sarah Steelman, Karmin lays out the pros and cons of forced liquidation. (See "Missouri Treasurer's Demand: 'Terror-Free' Pension Funds," June 14, 2007.)

As part of a June 14 interview with CNBC's Maria Bartiromo, I offer four considerations (as much as I could say in a short on-air appearance). 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.

No one supports terrorism but this "solution" might invite more problems. There is never a free lunch. Someone, somewhere pays.

Green is Good

With all due respect to Gordon Gekko, replace the "d" (as in "Greed") with an "n" (as in "Green") and we end up with a way to both belately celebrate Earth Day and acknowlege an emerging trend in pension funds' allocation to Socially Responsible Investments (SRI).

Click here to access a nice primer from the UK. Checklists and case studies make it useful to anyone interested in knowing more about the topic. 

Stateside, Mercer Consulting's survey of U.S. pension funds about SRI suggests continued growth. Click here to access the survey.

By the way, it's not just Ayn Rand who rejects altruism. Institutional investors say that opportunities to reduce risk, enhance returns or better align economic interests with socially-oriented values are key drivers behind their decision to invest in SRI funds.

Chinese New Year Ushers in Pension Reform

February 18, 2007 marks the Chinese New Year (the Year of the Boar). Also known as the Spring Festival or Lunar New Year, it is the "most important of the traditional Chinese holidays." Interestingly, Chinese New Year's Eve is known as the eve of change and indeed, China is on the verge of significant change.

According to a new study, co-authored by Reuters and KMPG, the demographics are compelling. "By 2050 the number of people aged 60 or over is expected to rise to more than 430 million, or 31 percent of the population, from just 147.8 million, or 11 percent today. This would put it well above the projected world average. More worryingly, the percentage of China’s population that is working is expected to peak in 2010, with the ratio of workers to retirees declining from six to one in 2000 to two to one by 2040." Click here for a copy of the study.

"The heavenly mandate: Winning a piece of China’s pensions market" describes a 401(k) look-alike known as enterprise annuities. Fixed fees and a local investment requirement are two notable features. Asset allocation constraints are another. Equity investments are limited to no more than 30 percent of assets under management, 20 percent in money market instruments, and up to one half to be invested in fixed-income securities "but at least 20 percent must be kept in government bonds."

Asset allocation is touted by many experts as THE most important of all investment decisions, leading one to ponder. Will an arguably "conservative" mix require yet additional change? People can't pay bills with rates of returns and depend instead on having sufficient cash on hand. What happens if (when) people come up short?

From the "glass is half full" camp, reform comes none too soon. As an anonymous Chinese sage suggests: "Do not fear going forward slowly; fear only to stand still."

Pensions, Foreign Owners and the Power of the Investor

In response to "Retirement for Three Hundred People", a colleague wrote the following. I publish it here because it is (a) thought-provoking and (b) reminds us that global integration of capital is here to stay.

<< The interesting thing will be the cross-border wealth transfer. As we in the US begin to liquidate investments after retirement, there will be an upsurge in demand from India and China, where the general level of wealth is rising rapidly and the population is growing. Combine that with a probable higher marginal propensity to save and you will see more and more US companies taken over by Chinese and Indian companies. >>

What happens in one country necessarily influences what occurs elsewhere. Migration of capital across borders is a snap in an era of lightning speed information transmission, consolidation of global exchanges and continued deregulation of financial rules.

In the spirit of this notion about one global marketplace, a 2006 book entitled The New Capitalists: How Citizen Investors Are Reshaping the Corporate Agenda makes a compelling case for the power of the institutional investor. Authors Stephen Davis, Jon Lukomnik and David Pitt-Watson chronicle "milestones in the owner revolution", in the United States and abroad. While they concede that shares alone do not guarantee a particular outcome, the trend is unmistakable. Investor clout is on the rise.

Consider these examples.

1. "In 2002 three U.S. state pension funds took steps to squeeze conflicts and misalignments out of the investment chain. The 'Investment Protection Principles' commit funds to require money managers to report on conflicts, how they pay their portfolio managers, and what they do to act as real owners of citizen capital."

2. "In October 2004 a group of big European funds founded the Enhanced Analytics Initiative (EAI), which commits each member to steer 5 percent of broker commission fees to stock research firms that analyze extra-financial factors affecting corporations."

3. "Coalitions of funds are forming within and across national frontiers to address overlooked long-term investment risks. Forums in the United Kingdom, North America, Australia, and New Zealand now focus on climate change as a portfolio issue."

Spending and saving patterns around the world influence what goes on in corporate boardrooms. Regardless of your view about nationalism versus globalization, one fact is undeniable.

Investors reign supreme.