Can Pension Funds Forgive Hedge Fund Failures?

According to David Hammerstein of Yanni Partners, ("Fewer Second Chances For Failed Fundies" - Hedge Fund Daily, February 27, 2007), "There is an extra standard of caution and care that has to be demonstrated among institutional investors" when it comes to giving failed hedge funds another chance. Noting the significant amount of pension dollars going into alternatives, Hammerstein emphasizes the need to assess risk controls.

He's not alone. Next week, I will join other speakers at the 23rd Annual Risk Management Conference to wax and wane about all sorts of investment-related risks. Hosted by the Chicago Board Options Exchange, Chicago Board of Trade, Chicago Mercantile Exchange and OneChicago LLC, the conference brings together a variety of researchers, investors and consultants.

My presentation is entitled "What Every Institutional Investor Fiduciary Must Know About Derivatives" and will cover investment fiduciary practices related to risk control. (Click here to view the agenda.

Can the risk lion be tamed?

Absolutely - but only if one is willing to open the cage door and acknowledge its presence!

Labels: Hedge Funds, Risk

posted by Susan Mangiero at 2/28/2007 06:12:00 AM | 0 comments | links to this post   

Pensions, Hedge Funds and Risk

On February 22, 2007, the President's Working Group on Financial Markets (PWG) released a set of principles and guidelines concerning "private pools of capital, including hedge funds." In concert with various U.S. agencies, the PWG report urges investors, creditors, counterparties, pool managers and supervisors to identify and understand fund-specific risks or walk away.

For fiduciaries, the guidelines (some of which are excerpted below) are clear. Individuals who are unable to demonstrate that a rigorous investigation of risk has taken place, BEFORE investing, put themselves in the line of fire with respect to personal and professional liability.

<< 1. Fiduciaries should consider the suitability of an investment in a private pool within the context of the overall portfolio and in light of the investment objectives and risk tolerances.

2. Fiduciary evaluation should include the investment objectives, strategies, risks, fees, liquidity, performance history, and other relevant characteristics of a private pool.

3. Fiduciaries should evaluate the pool’s manager and personnel, including background, experience, and disciplinary history. Fiduciaries also should assess the pool’s service providers and evaluate their independence from the pool’s managers.

4. Fiduciaries should consider the private pool’s manager’s conflicts-of-interest and whether the manager has appropriate controls in place to manage those conflicts.

5. Fiduciaries should conduct the appropriate due diligence regarding valuation methodology and performance calculation processes and business and operational risk management systems employed by a private pool, including the extent of independent audit evaluation of such processes and systems. >>

It will be interesting to watch what happens. Will some pension decision-makers forego investing in alternatives because the risks are considered too difficult to understand, let alone accept? Who will embrace the challenge and recognize the reality that risk management is an integral part of investment management? You simply cannot select funds without understanding how managers address financial and operational risk. When a fund invests in less liquid and/or complex instruments, the plot thickens.

Click here to read Agreement Among PWG and U.S. Agency Principals on Principles and Guidelines Regarding Private Pools of Capital.

Labels: Fiduciary Responsibility, Hedge Funds, Risk

posted by Susan Mangiero at 2/24/2007 06:30:00 AM | 0 comments | links to this post   

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."

Labels: Asset Allocation, International

posted by Susan Mangiero at 2/18/2007 08:24:00 PM | 0 comments | links to this post   

Pension Valentine

How do we need you? Let us count the ways.
We need you from the depth and breadth and height
Our portfolio statements will allow
We need you to the level of everyday's
Most urgent wants, for food and shelter

With apologies to Elizabeth Barrett Browning, it's true that pension fiduciaries often stand between a comfortable retirement and a financial struggle. Their job, if done properly, can make a real difference in the lives of individuals, still working or now retired.

This blog primarily addresses pension financial risk issues from a fiduciary perspective. Yet we've received more than a few emails from persons seeking assistance to recover lost or diminished pensions. Descriptions of tough economic times are poignant. They serve as a constant reminder that what pension fiduciaries decide has consequences.

Happy Valentine's Day!

Labels: Holidays

posted by Susan Mangiero at 2/14/2007 12:02:00 AM | 0 comments | links to this post   

Is Your Pension Plan Operationally Sound?

If you don't have a stress ball on your desk, now might be the time to splurge. Pension fiduciaries have a lot on their plate and it seems that every day brings new challenges, operational risk management included. According to a recent Advanced Micro Devices (AMD) white paper, written in conjunction with Toomre Capital Markets, "internal processes, people and systems periodically fail" and could possibly threaten a firm's survival. The authors describe "fat finger loss" wherein "incorrect keys were pressed with no malicious intent" to illustrate the importance of controls. Being able to catch data errors before they get out of hand is the lifeblood of a well-run organization.

Rogue trading likewise illustrates operations-related vulnerability. Think back ten years. Barings Bank, a venerable global financial institution, was literally driven out of business due to the actions of a single derivatives trader. Where was the proper oversight? It's an amazing story that some still find hard to believe.

I saw this firsthand while getting my Ph.D. and teaching finance. Not a fan of showing videos in class, I made an exception for the risk management students and asked them to view the HBO movie about Barings. At the end of the film, you could hear a pin drop. Finally, a student asked if I thought such a debacle could occur again. My response? Absolutely. Any time people are part of the process (and they always are), there is room for error. That's why effective operational risk management policies and procedures are so important.

Click here to read the AMD paper. It includes a nice summary of "Ten Sound Practices for the Management and Supervision of Operational Risk" as provided by the Bank for International Settlements (BIS). Click here to access the full version of the BIS document.

Technology is a critical component of operational risk. Without the ability to capture and analyze data, it is virtually impossible to create and monitor limits, check for odd exposures or even detect fraud. Even with a good system, it is far from easy.

Interested readers can click here to read "The Five Keys to Risk and Risk Management" or read the several chapters in my book about operational risk, technology and modeling.

Labels: Operational Risk

posted by Susan Mangiero at 2/12/2007 06:00:00 AM | 0 comments | links to this post   

Nutmeg State Seeks Pension Disclosure from Hedge Funds

According to reporter and financial professional Julie Fishman-Lapin, Connecticut could soon become less hedge-fund friendly if state legislators have their way.
In " State readies for a debate on regulation..." (Greenwich Times, February 9, 2007), Fishman-Lapin describes an initiative by Fairfield County Republican John E. Stripp that, if passed, would "require Connecticut-based hedge funds that receive more than $10 million from a pension fund to report the investment to the state banking commissioner within 30 days. The disclosure would include the name of the pension fund, the beneficiary organization and the address of the fund manager." Click here to read Proposed H.B. No. 5102, Session Year 2007 - An Act Concerning Hedge Fund Activity With Respect To Pension Funds.

Democratic state senator Bob Duff cites hedge fund disclosure requirements as part of his overall intent to focus on consumer protection. He will soon introduce a bill that likewise emphasizes disclosure. Click here to read his January 25, 2007 press release.

On December 5, 2006, addressing the U.S. Senate Committee on the Judiciary, CT Attorney General Richard Blumenthal urged federal regulators to increase penalties for fraud, raise the amount of money to qualify investors and adopt federal standards before states take matters into their own hands. Click here to read his remarks. Blumenthal is walking the walk, having formed the Hedge Fund Task Force last fall. The goal? To improve things and hopefully avoid an expensive Amaranth-type meltdown. (See "Hedge hunting season in Connecticut - In the wake of the Amaranth disaster, Connecticut Attorney General Richard Blumenthal seeks to reform the hedge fund industry" by Ellen Florian Kratz, Fortune, October 4, 2006.)

There is so much to write about the hedge fund - pension fund nexus. We will continue to focus on this important topic area. Until then, and in case you missed them, here are a few links to prior blog posts about hedge funds, along with links to some articles about hedge fund risk management and valuation.

Hedge Fund Notables for Pension Investors (December 29, 2006)

Hedge Fund Disclosure - Round Three (November 12, 2006)

Will Private Equity Stay Private? U.S. Dept. of Justice Makes Inquiries (November 5, 2006)

Pensions, Hedge Funds and Disclosure (October 27, 2006)

Legislative Matchmaker: Hedge Funds and ERISA (August 1, 2006)

Survey Shows That Institutional Investors Are Worried (July 28, 2006)

Will Hedge Funds Displace Pension Plans in Court? (July 9, 2006)

Hedge Fund Valuation: What Pension Fiduciaries Need to Know (Journal of Compensation and Benefits - July/August 2006)

Do You Know the True Cost of Your Retirement Plan? (May 14, 2006)

Hedge Fund Basics: Risk, Return and Reality (Family Foundation Advisor - January/February 2005)

Hedge Fund Imperatives (Hedge Fund Manager - December 2004)

Labels: Hedge Funds

posted by Susan Mangiero at 2/11/2007 12:20:00 AM | 0 comments | links to this post   

Retirement Planning for Career Builders

You can probably never start saving soon enough for retirement. Estimated longer lifespans and competition for scarce disposable dollars are critical factors. Making matters worse, countless "Career Builders," fresh from college, are deep in debt. According to the American Association of State Colleges and Universities, "the average borrower graduating from a public college owes $17,250 in debt" while "one in four finishes school owing at least $22,822. Particularly worrisome is that the number of college graduates with at least $40,000 in student loan debt has increased 10-fold in the past decade." The problem is worse for those who do not earn a degree.

For financial advisors, the challenge is significant. Busy with work and families, how do you get the attention of 25 to 34 year olds?

Enter the American Institute of Certified Public Accountants (AICPA)and state-level CPA societies. In partnership with the Ad Council, they have created a new website called Feed the Pig™, replete with videos that convey the importance of thrift. The main character, Benajmin Bankes, even has his own My Space page.

Labels: Savings

posted by Susan Mangiero at 2/08/2007 12:28:00 AM | 0 comments | links to this post   

Tontines - Way Out of a Pension Jam?

In a pension jam? Think tontines, not saltines, according to a newly published article about what to do as the benefits landscape quickly changes. Defined as a type of investment pool, tontines pay dividends only to survivors. Similar to an annuity "in that it provides a life income to a participant," a tontine could help millions of individuals who want retirement security without too much involvement (selecting and managing investments, forecasting post-employment spending and so on).

According to Ralph Goldsticker, author of "A Mutual Fund to Yield Annuity-Like Benefits" (Financial Analysts Journal, January/February 2007), making modern versions of the tontine a reality comes in the knick of time. Hundreds of companies are jettisoning traditional defined benefit plans as fast as you can say "senior citizen."

One version - a mutual fund/tontine hybrid - has the advantage of arguably lower default risk in contrast to a purchased annuity. Upon creation of an age- and gender-specific mutual fund/tontine structure, contributed monies are invested in a "diversified portfolio of high-grade fixed-income securities." A downside is the fact that heirs do not participate, forcing breadwinners to think about financial planning on a family-wide basis (not a bad thing to do anyhow).

Allegedly the brainchild of banker Lorenzo de Tonti, this 350-year old invention may deserve a fresh look.

Editor's Note:
Thanks to Hank Stern, Life Underwriter Training Council Fellow (LUTCF) and contributor to InsureBlog, for alerting me to the news about tontines. Winner of the 2005 Weblog Award, InsureBlog focuses on life and health insurance issues, with an emphasis on Consumer Driven Health Care.

Labels: Annuities, Financial Planning, Tontines

posted by Susan Mangiero at 2/06/2007 06:04:00 AM | 0 comments | links to this post   

Is Means Testing Mean?

If you think means testing of benefits is well, mean, then get ready to defend yourself, if you can. In the just released, long-awaited "best seller", Budget of the United States Government-Fiscal Year 2008, President Bush lays out his plan to tax the wealthy. Click here to download all or part of the budget.

According to Financial Times reporters Caroline Daniel and Krishna Guha ("Bush wants to means-test middle-class benefits," February 5, 2007), the $2.9 trillion budget "represents a challenge to parts of the system of entitlements enacted as part of the Great Society agenda of the 1960s."

Key questions arise, some of which are listed below.

1. What constitutes "wealthy" and how often will the definition change?

2. How will wealth be measured for purposes of means testing? Income? Property? Private Benefits? Gross? Net? Nominal? Real? Adjusted by Geographic Region or Household Size?

3. Is means testing really fair?

4. Would privatization of federal benefits empower more people financially by changing incentives to save?

5. What is the likely economic impact of means testing?

6. How will companies and municipalities be adversely affected by means testing of Social Security and Medicare or will they gain?

What a field day for the economists and politicians!

Editor's Note:
Check out the online U.S. debt clock. Hit the refresh button a few times for a real scare as estimated indebtedness increases by large amounts within a matter of seconds.

Labels: Economic Conditions, Social Security

posted by Susan Mangiero at 2/06/2007 05:40:00 AM | 0 comments | links to this post   

Big Apple Pension to Bite Apple Inc Over Options

Alleging questionable stock option practices at technology giant Apple Inc, the New York City Employees' Retirement System ("NYCERS") will serve as lead plaintiff in a lawsuit filed a few months ago. Citing the Private Securities Litigation Reform Act of 1995 ("PSLRA"), NYCERS claims the largest financial interest in the lawsuit. (Click here to read the original filing and here to read "Recent Developments Under the PSLRA.")

According to Reuters (January 22, 2007), the NY fund's ownership stake is roughly one million shares or about $87 million in current value terms. Its 2006 Comprehensive Annual Financial Report shows $46.34177 billion as plan net assets as of June 30, 2006. While NYCERS equity exposure to Apple is large in absolute terms, it is small compared to the equity interests held by institutional investors such as Fidelity Management & Research (60,316,011 shares as of September 30, 2006) or AllianceBernstein L.P. (48,637,731 shares in second place). Click here to review ownership statistics, courtesy of Thomson Financial (and reprinted by the Wall Street Journal.)

The intent of this post is not to single out any one company nor to imply that the filing of a complaint supports any or all of the allegations. That's for the trier of fact to determine. What is important is to understand that executive compensation practices can (and often do) impact shareholder value. If the market interprets a particular practice as far removed from economic reality and/or regulators start sniffing around, defined benefit and defined contribution participants stand to lose a bundle. In order to reduce the likelihood of an adverse outcome due to investing in company stock, pension fiduciaries must carefully consider relevant risk factors. That includes the percentage of company stock already part of a particular plan (whether self-directed or not). See "Options, Pensions and the SEC" for additional comments about backdating and pension fiduciary duty.

With more than 120 companies being asked questions about their respective option practices, there is surely much more to say on this topic! posted by Susan Mangiero at 2/04/2007 07:03:00 AM | 0 comments | links to this post   

Options, Pensions and the SEC

It's hard to pick up a newspaper these days without reading some story about stock options - when they are granted, how often they are repriced, what portion of an executive's total compensation they represent and so on. What has authorities particularly busy is a fast-expanding review of practices such as option backdating and spring loading. As of December 31, 2006, the Wall Street Journal counts 120 companies on their option backdate list. Click here to view the options scorecard and learn about executive departures and various regulatory agency investigations.

The Free Dictionary defines backdating as "dating any document by a date earlier than the one on which the document was originally drawn up." Spring loading can mean either that "a company purposely schedules an option grant ahead of expected good news or delays it until after it discloses business setbacks likely to send shares lower." See "SEC eyes 'springloading'" as published by the New York State Society of Certified Public Accountants. In both cases, the idea is to inflate the value of the executive's stock option. (Experts remind that neither backdating nor spring loading is necessarily illegal per se, a conclusion that is best left to attorneys and regulators.)

These and other practices are important to pension fiduciaries and plan participants alike. Defined benefit plans sometimes invest in company stock. Defined contribution plan participants are often given a similar choice. Any problems with option grants, especially when they result in tax and/or accounting penalties, not to mention regulatory enforcement levies or litigation payouts, can do serious harm to an employee's retirement plan. From a fiduciary perspective, real questions could arise about the ex-ante assessment of company stock as a viable investment vehicle for a sponsored plan(s). Did an adequate due diligence review of risk factors that influence company stock price occur? Did pension fiduciaries sufficiently understand existing practices regarding executive compensation, including option awards? How often did pension fiduciaries assess option grant practices and/or inquire about industry norms, internal controls and likely impact on "shareholder" retirement plan participants?

For interested readers, the D&O Diary, authored by attorney Kevin LaCroix, has an excellent collection of articles about option backdating.

Option valuation is another topic with considerable import. Relatively new accounting rules in the form of FAS 123R set the stage for a vigorous debate about how to value employee and executive stock options (ESO's). Unlike shorter-term options that actively trade in ready markets, ESO's are more challenging to value for a host of reasons. Though a bit outdated with respect to regulations, readers may nevertheless find my article about option valuation of interest because it highlights the importance of having good inputs and an appropriate model. (Click here to read "Model Risk and Valuation," Valuation Strategies, March/April 2003.)

In a recent decision, the SEC notified Zions Bancorporation that its Employee Stock Option Appreciation Rights Securities (ESOARS) is "sufficiently designed to be used as a market-based approach for valuing employee stock option grants for accounting purposes under Financial Accounting Standards (FAS) No. 123R." According to Zion's press release, it is their intent to assist other public companies in valuing ESOs. I took a quick look at their site and plan to read more. Certainly a mechanism that facilitates marketability is a step in the right direction. After all, the coming together of willing buyers and sellers, under ideal circumstances, permits a flow of information that should result in the "right" price.

Editor's Note:
I am currently writing an article about option backdating as it relates to pension fiduciaries.

Labels: Fiduciary Responsibility, Options

posted by Susan Mangiero at 2/02/2007 12:02:00 AM | 0 comments | links to this post