Are Pension Performance Numbers Upside Down?

In a recent interview with Pittsburgh Tribune-Review journalist Debra Erdley, I pointed out the folly of relying solely on point in time actuarial numbers. As I state (below), no single metric is a substitute for a robust risk management process.

Susan Mangiero, CEO of Investment Governance, Inc., a group that advises pensions on best practices and risk management, said pension reports can be misleading - even when numbers are quoted accurately. "A one-point-in-time number is not very helpful. It says nothing about the riskiness of the investment portfolio. It says nothing about whether there is good due diligence in place - the vetting of the consultants, asset managers and investment managers. and it says little about the plan's ability to write checks every month," she said, adding that a pension plan with a high funding ratio could be heavily loaded with assets that are hard to convert to cash."

Others in the article (entitled "Onorato's boast about pension fund solvency raises eyebrows" - April 6, 2010) impugn politicians for their knowledge (or lack thereof) of arcane actuarial methodologies. Ouch!

I'm reminded of my finance teaching days when students were asked to rank capital projects by Net Present Value, Internal Rate of Return, Payback Period and so on. Consider Investment A with a calculated IRR of 50% and a NPV of $1,000 versus Investment B with expectations of 25% per annum and a dollar reward of $500,000. I'd rather have the cash than the cold comfort of a number that doesn't mean much.

Cash is king which is why an ongoing holistic risk management process is EVERYTHING!

Team Risk and Venture Capital Investing

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this fourth question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about team risk. Click here to read Mr. Levensohn's impressive bio.

SUSAN: How do you manage risk when backing serial entrepreneurs?

PASCAL: When we back serial entrepreneurs, it is critical to assess where they are today in their lifetime achievement and performance potential curve.  By that, I am reminded of the fundamental risk in looking at track records—“past performance is not indicative of future returns.”  It amazes me how many investors chase performance and don’t pay attention to the current team composition at the VC manager, to the current dynamics of the partnership.  Ideally you want to back a proven winner who is still hungry enough to deserve a seat at the table.  Venture capital is totally a hits-driven business, but there are very few hitters, either VCs or entrepreneurs– who are able to hit multiple home runs.  When you look at VC’s, you want to find VC’s who are magnets for great entrepreneurs, whether they are first timers or veterans, and rely on the VCs’ pattern recognition ability to make that judgment call in picking a winner.  One way to mitigate risk is to assess how deep the team is in the VC organization—remember that you are making a 10 year bet on a team, and few teams stay together through an entire cycle.

Are Pension Fiduciaries Liable for How Much Others Make?

In a May 16 interview with investment banker John Whitehead, Bloomberg journalist Christine Harper clearly pushed a button when she asked about Wall Street compensation. Said the former chairman of Goldman Sachs "I am appalled" and then described current levels as "shocking." Click here to read the interview.

On May 3, EFinancialCareers.com summarized an Alpha Magazine piece about the top twenty-five beneficiaries of the hedge fund boom, noting that disproportionate goodies that accrue to the fund's leaders encourage turnover. Hedge fund analysts have little incentive to remain beyond a few years, driving up costs and creating a drag on performance. Click here to read "Hedge Fund Compensation: Too Top-Heavy?"

From the pension fiduciary perspective, how does this news square in Peoria? Are investment committee members, trustees and/or board members on the hook for having selected money managers who are deemed to make "too much?"

Let me quickly add that what constitutes "too much" requires a systematic and thorough analysis of benefits netted against costs and that performance-linked pay is far from a bad thing under certain circumstances. For those fund professionals who are delivering "excess" returns (and that evaluation likewise requires care and diligence), current compensation may look like a bargain.

What's important is the process in determining how managers' compensation reconciles with projected risk-adjusted performance, at the outset when a selection is made and on an regular basis thereafter.

As a plan sponsor (regardless of plan type), how much attention do you give to this issue and how comfortable are you in explaining your decisions to plan beneficiaries?