Pension Risk Matters

New Study Addresses Pension Risk Management Gaps

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 13 Oct 2008 00:20:48 -0500

At a time of great market turmoil, plan participants, shareholders and taxpayers want to know whether their retirement plans are in good hands. Risk is truly a four-letter word unless plan sponsors can demonstrate that a comprehensive pension risk management program is in place. Unfortunately, there is little information that details if, and to what extent, plan sponsors are doing a credible and pro-active job of identifying, measuring and mitigating a variety of risks. The risk alphabet includes, but is not limited to, asset, operational, fiduciary, legal, accounting, longevity and service provider uncertainties.

While no one could have predicted the extreme volatility that characterizes the current state of global capital markets, it has always been known that poor risk management can make the difference between economic survival and failure. Applied to pension schemes, ineffective risk management could prevent individuals from retiring at a certain age and/or leaving the work force with much less than anticipated. Others pay the price too. Taxpayers worry about rate hikes that may be inevitable for grossly underfunded public plans. Shareholders could find themselves on the hook for corporate promises or experience depressed stock prices due to post-employment benefit obligations.

In an attempt to shed some light on this critical topic area, Pension Governance, LLC is pleased to make available a new research report that explores current pension risk management practices. In what is believed to be a unique large-scale assessment of pension risk practices since the publication of a 1998 study by Levich et al, this survey of 162 U.S. and Canadian plan sponsors seeks to: (1) understand why and how pension plans employ derivative instruments, if they are used at all (2) identify what plan sponsors are doing to address investment risk in the context of fiduciary responsibilities and (3) assess if and how plan sponsors vet the way in which their external money managers handle investment risk, including the valuation of instruments which do not trade in a ready market. The report was written by Dr. Susan Mangiero, AIFA, AVA, CFA, FRM, with funding from the Society of Actuaries.

Each survey-taker was asked to self-identify as a USER if he/she works for a plan that trades derivatives in its own name. A NON-USER works for a plan that does not trade derivatives directly but may nevertheless be exposed indirectly if any of the plan's asset managers trade derivatives.

In answering broad questions, a large number of surveyed plan sponsors describe themselves as doing all the right things to manage investment, fiduciary and liability risks. However, answers to subsequent questions - those that query further about risk procedures and policies at a detailed level - do not support the notion that pension risk management is being addressed on a comprehensive basis by all plans represented in the survey sample.

Key findings include the following points:

Plan size seems to be one factor that distinguishes USERS from NON-USERS, with 39% of USERS managing plans in excess of $5 billion versus 14% of NON-USERS associated with plans larger than $5 billion.
Pension decision-making appears to vary considerably by job function, with 48% (37%) of USERS (NON-USERS) choosing "Other" rather than selecting from given titles such as Actuary, Benefits Committee Member, CFO or Human Resources Officer.
Time allocation varies considerably with 64% (40%) of USERS (NON-USERS) saying they devote 75 to 100 percent of their work week on pension issues. In contrast, 37% of NON-USERS say they spend 0 to 24% of their work week on pension issues.
A majority of USERS (64%) and NON-USERS (48%) have had discussions about the concept of a fiduciary duty to hedge asset-related risks. A smaller number say they have discussed the concept of a fiduciary duty to hedge liability-related risks.
Few plans currently embrace an enterprise risk management approach with 59% (57%) of USERS (NON-USERS) responding that their organization does not use a risk budget. When asked if their organization has or is planning to hire a Chief Risk Officer, 57% (64%) of USERS (NON-USERS) answered "No."
NON-USERS cite numerous reasons for not using derivatives directly, including, but not limited to, "Lack of Fiduciary Understanding" (25%), "Perception of Excess Risk" (31%), "Considered Too Complex" (23%), "Prohibition Against Possible Leverage" (19%) and/or "Defined Benefit Plan Risk Not Considered Significant" (28%).
A query about whether survey-takers review external money managers' risk management policies results in 70% (58%) of USERS (NON-USERS) responding "Yes." Fifty-two percent (57%) of USERS (NON-USERS) say they review external money managers' valuation policies. This survey did not drill down with respect to the rigor of questions being asked.
Survey respondents seem to rely mainly on elementary tools to measure risk. Eighty-three percent (64%) of USERS (NON-USERS) rank Standard Deviation first in importance. Seventy-nine percent (63%) of USERS (NON-USERS) rank Correlation second. Only one-third (38%) of NON-USERS cite Stress Testing (Simulation). Four out of 10 USERS cite Value at Risk in contrast to 23% of NON-USERS who do the same.
Survey respondents worry about the future with 58% (60%) of USERS (NON-USERS) ranking "Accounting Impact" as a concern. Other concerns were also noted to include "Regulation," "Longevity of Plan Participants" and "Fiduciary Pressure."

Click to download the 69-page study, entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Susan Mangiero. Given the large file size, readers are encouraged to (a) first save the file (right mouse click) and then (b) open the file from wherever you have saved the file. Otherwise, you may receive an error message, depending on your computer configuration.

The study is also available by visiting www.pensiongovernance.com. Send an email to PG-Info@pensiongovernance.com if you experience any difficulty in downloading the pdf file and/or want to comment about the study.

Pensions to Hedge Funds: Lock Me Up

PG-Info@pensiongovernance.com (Susan Mangiero) — Sun, 12 Oct 2008 02:56:30 -0500

As markets tumble, hedge fund investors are asking for longer lock-up provisions in order to preserve their investment.

Say what?

The reasoning goes like this. If an investor can redeem, and does in fact ask to redeem, a hedge fund manager may be forced to sell assets to raise cash. More liquid assets are sold first, leaving behind less liquid assets that are arguably harder to value. Pre-mature sales, due to accelerated redemption requests, may even force a hedge fund to close and "give long-term investors their money back at a time when asset prices are low." By asking for longer lock-up periods, investors are seeking to forestall forced sales and thereby protect their original investment. See "Hedge investors ask for lock-ups to avoid closures" by Laurence Fletcher, Reuters UK, October 8, 2008.

We caught up with Mr. Edward Stavetski, Director of Investment Oversight, Wilmington Family Office, and asked him for his two cents. Here is what he has to say.

"This crush of cash outflows may be only one cause of fund closures at year end. Consider high water marks as we near the end of the calendar year. As news that some hedge funds are down 30 to 40 percent, it will become quite difficult for those fund managers to realize any earnings from their respective 20 percent performance clause. Most funds use management fees to keep the lights turned on but depend on the performance fee income to hire star traders or retain top talent. Without the near-term promise of a high performance payout, we could see a dramatic shift of key players in the hedge fund world. While people may rejoice that the 'nasty' hedge fund cult is finally getting its just desserts, the damage will reach far beyond the hedge fund community. The rush to buoy cash holdings will depress prices of stocks, bonds, mortgage-backed securities and other capital-raising mechanisms in the near-term. None of this is good news for investors, asset managers and/or consumers."

This blogger wonders if smart money will head towards or away from hedge funds. After all, if pensions and 401(k) plans are dumping stocks in record numbers, and U.S. treasuries (and international equivalents) return little, how else will plan sponsors and individuals "make up for losses?"

We'll watch and see.

New Study Suggests That Few Are Ready to Retire

PG-Info@pensiongovernance.com (Susan Mangiero) — Sun, 12 Oct 2008 02:44:02 -0500

According to a new study, retiring at age 67 may not be in the cards for many individuals, partly by choice. Tracking desires and expectations of American workers, a newly created Sun Life Financial Unretirement^SM Index suggests that 8 out of 10 persons want to continue working as a way to "stay mentally engaged." Other results are not surprising. Fewer than half of the respondents feel they can afford to stop working. One-third of survey-takers worry about the financial viability of Social Security. One coping mechanism, cited by 82 percent of the sample group, is to reduce their spending with about two-thirds of respondents saying they will lower their debt as a way to "improve retirement prospects" For more information about this attitudinal metric, click here.

Nice as it is to have choices about when to retire, the recent market rout makes it difficult at best for some to consider anything else but continued employment (assuming no layoffs by their employer). Yahoo! News references Congressional research that "Americans' retirement plans have lost as much as $2 trillion in the past 15 months." Making matters worse, economic conditions that result in lower wages make it difficult for some to keep saving for retirement, if they did so in the first place. Click to read "Retirement accounts have lost $2 trillion" by Julie Hirschfeld Davis, October 7, 2008.

In an interview with PBS, Peter Orszag, Director of the Congressional Budget Office, explains that "two-thirds of the assets that are in 401(k) plans are in stocks," exposing plan participants to fallout, just like institutional investors. He adds that economic problems are already impacting defined benefit plans. As the value of their asset portfolio drops, companies will need to "put in more money, and that will come out of either their shareholders, their workers, or they'll try to pass it along to their consumers." Click to read "Market Turmoil Puts Squeeze on Retirement Savings," October 9, 2008.

This blog has covered changing demographics and retirement angst for months. One can only hope that the current market malaise is short-lived and that individual savings goes up (or at least excess leverage goes down), to the extent that individuals can afford to put monies aside for post-employment consumption.

Debt Clock Runs Out of Numbers

PG-Info@pensiongovernance.com (Susan Mangiero) — Fri, 10 Oct 2008 00:18:28 -0500

According to the Telegraph.co.uk website, the U.S. National Debt Clock has too few digits to measure the current state of affairs. The clock's owner, the Durst Organization, is expected to add a pair of additional placeholders next year, making "it capable of recording a quadrillion dollars of debt." (See "Financial crisis: US debt clock runs out of numbers," October 9, 2008.)

I had to look it up but it turns out that a quadrillion is a thousand trillion or a million million million million (with "quad" referring to four). To put things in context, consider the following statistics:

The world population is currently estimated at 6.729 billion individuals.
The U.S. population is roughly 305 million persons.
As of fall 2007, Apple had sold more than 150 million iPods in countries around the world.
The CIA Factbook approximates a Gross World Product as equal to $65.61 trillion (as of 2007).
Up to Q4-2007, the over-the-counter derivatives market, measured in notional principal terms and reported by the Bank for International Settlements, totaled nearly $600 trillion.
As of June 2008 and reported by the Bank for International Settlements, outstanding futures contracts, in notional principal terms, exceeded $28.6 trillion. The size of the listed options market toppled $55.6 trillion.
The largest corporate bankruptcy to date, as reported by InfoPlease.com, is Lehman Brothers Holdings, Inc. with a bankruptcy date of 9/15/08 and total assets, pre-bankruptcy, equal to $691.063 billion.

As U.S. Senator Everett Dirksen is credited as saying, "A billion here, a billion there, pretty soon it adds up to real money." Imagine his posture today. (According to The Dirksen Center website, it is unclear as to whether the former lawmaker did in fact utter these exact words.)

Golden State Asks Public Pension Plan to Help

PG-Info@pensiongovernance.com (Susan Mangiero) — Sat, 04 Oct 2008 21:52:57 -0500

According to "California officials hope for easing of credit crunch" (October 4, 2008), Los Angeles Times reporters Marc Lifsher and Evan Halper paint a gloomy financial picture for this giant state. They explain that Governor Arnold Schwarzenegger may have no choice but to ask for help from Washington if short-term credit markets do not soon improve. An inability to issue Revenue Anticipation Notes with a face value of $7 billion will make it difficult to "get cash to pay for day-to-day operations, including paying workers, funding schools and feeding prisoners, between the end of October and the spring." Click to read the October 2, 2008 letter from the former action hero to The Honorable Henry M. Paulson, Jr.

Vox populi Jon Ortiz (aka Sacramento Bee reporter) and creator of The State Worker blog writes that State Treasurer Bill Lockyer may set his sights on the public workers' pension money pot, CalPERS. Author of an October 3, 2008 letter to The Honorable Bill Lockyer, State Senator Dean Florez writes that "the state should look to one of the world's largest investors, the California Public Employee Retirement System as a reasonable purchaser of short-term California state government debt."

In "Could CalPERS help with California's cash crunch? Maybe" (October 3, 2008), Ortiz posts a response from CalPERS spokeswoman Pat Macht who comments on process. "If we are approached, our investment staff would do their normal due diligence and make an objective evaluation of its merits, including returns as well as how it would fit within our asset allocation ranges and targets which guide our investment selections."

Editor's Questions: Will other cash-strapped states ask public and municipal pension plans to buy state debt? If so, how might this impact the funding status of those employee benefit schemes?

Reader's Comment About Retirement Fallout

PG-Info@pensiongovernance.com (Susan Mangiero) — Sat, 04 Oct 2008 21:23:20 -0500

In response to this blog's September 23, 2008 post entitled "Retirement Fallout - Breaking the Bank, Piggybank That Is," we received a link to an opinion piece, published in The Baltimore Examiner. Sent by editor Frank Keegan, the first part of the piece, entitled "Public pension panic," is shown below.

<< It’s pension panic time. Panic early. Panic often. Demand reform. Public employees must take control of their financial destinies. Politicians have made promises they never can keep. They and the union bosses who fleece workers don’t have to worry about it because they figured by the time the inexorable mill of reality turns up their deceit, it all will be somebody else’s problem. They counted on being long gone with millions – maybe billions. Well, the day of reckoning arrived a little earlier than they anticipated. >>

Reader's Comments about Demographics

PG-Info@pensiongovernance.com (Susan Mangiero) — Sat, 04 Oct 2008 20:28:13 -0500

Mr. Mark Steyn, author of the popular paperback book, America Alone, responds to the recent post about changing demographics. Read Mark's comments:

<< Sue, the problem isn't rapid aging, it is a rapid decline in fertility. Before the "smart" ideas of pensions (Bismarck, Germany, 1870) and Social Security (FDR), people's "pensions" were productive children. When the government tried to become the safety net, the incentive to build a flexible, productive, human pension withered. Now we try to shuffle financial assets around to plug the hole, when really what we need is more human ingenuity. So we're all in this together, against the government's unfulfilled and unfulfill-able promises that it will take care of us. >>

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Mr. Bob Mitchell echoes a similar sentiment that government largesse is unsustainable. Here is what he writes:

<< Full credit to Credence Clearwater Revival – “How much should we give? They only answer more! ‘more!’”

There is no “fair amount” of minimum benefit that we need to provide, beyond possibly food to survive.
Whatever level you provide, you are too stingy for those who want more. So they will keep pushing.
People don’t have a right to live in a particular area that they cannot afford.
People don’t have a right to high paying jobs nor pensions.
People don’t have a right to unlimited free health care.
Some things have to be earned.
US standards of poverty exceed the average income of much of the world population.
You are on your own But if you work it right, you can join a group (lobbying, union, church, insurance plan, fraternity, etc.,) where someone will look out for you in exchange for your involvement. But don’t expect it to come for no cost.

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Editor's Notes: Click to read the original post entitled "World Economic Forum Report - Demographic Gaia" (October 2, 2008). Click to access the lyrics and music to "Fortunate Son" by Credence Clearwater Revival.

If you concur or have a different point of view, drop us a line.

World Economic Forum Report - Demographic Gaia

PG-Info@pensiongovernance.com (Susan Mangiero) — Thu, 02 Oct 2008 00:54:32 -0500

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?

Risk Oversight and the Boardroom

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 01 Oct 2008 08:19:32 -0500

Ms. Alexandra Reed Lajoux, with the National Association of Corporate Directors ("NACD"), responds to "Pension Funds Ask - "Who is Responsible for Risk Oversight? " as follows:

"New appointees face a steep learning curve that exposes a company to risk of another kind. Excellent point, well made. Director education is the key!"

I will be speaking at the 2008 NACD Corporate Governance Conference in just a few weeks. The panel is entitled "What Directors Must Know About the Company's Pension Plan." A session description follows.

"In light of the unanimous U.S. Supreme Court LaRue decisions, panelists look at the board's oversight responsibilities of ERISA plans to assure they are well managed. Historically, many boards have been uninvolved in the plans and have not exercised adequate oversight. From a governance and risk management perspective, we look at salient issues and core elements of oversight that should be addressed at the board level."

Click to read more about the 2008 NACD Corporate Governance Conference.

Reader's Comment About Transparency

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 01 Oct 2008 07:54:30 -0500

Wendy Fried writes the following in response to the September 26, 2008 post entitled "Would Better Disclosure Have Helped WaMu Shareholders?"

"It's pretty hard to say without knowing what really pushed WaMu over the edge. If it was a run on the bank by ordinary depositors acting out of fear, as has been reported, it's hard to see how more disclosure would have helped. More likely, what was called for was was smarter regulatory oversight and less faith in self-serving risk models."

Wendy is creator of an interesting and colorful blog called Proxyland.

Wall Street Retirement Nest Eggs - Splat

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 29 Sep 2008 00:11:24 -0500

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?

Would Better Disclosure Have Helped WaMu Shareholders?

PG-Info@pensiongovernance.com (Susan Mangiero) — Fri, 26 Sep 2008 01:22:29 -0500

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?

Me and Donald Trump

PG-Info@pensiongovernance.com (Susan Mangiero) — Fri, 26 Sep 2008 00:46:40 -0500

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.

Low-touch regulation, not black letter rules

PG-Info@pensiongovernance.com (Susan Mangiero) — Fri, 26 Sep 2008 00:06:54 -0500

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.

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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.

Risk Management Adventures

PG-Info@pensiongovernance.com (Susan Mangiero) — Thu, 25 Sep 2008 07:30:53 -0500

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.)

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

Treasury Program to Buoy Money Market Funds

PG-Info@pensiongovernance.com (Susan Mangiero) — Tue, 23 Sep 2008 01:42:40 -0500

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.

Retirement Fallout - Breaking the Bank, Piggybank That Is

PG-Info@pensiongovernance.com (Susan Mangiero) — Tue, 23 Sep 2008 00:58:24 -0500

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.

Testimony of Dr. Susan Mangiero About "Hard to Value" Assets

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 22 Sep 2008 00:14:24 -0500

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." Click here to send an email.

Lehman and Pensions

PG-Info@pensiongovernance.com (Susan Mangiero) — Thu, 18 Sep 2008 00:12:02 -0500

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.

How Much More Will Pensions Lose in Financials?

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 15 Sep 2008 02:22:18 -0500

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.