Pension Fund Leverage

Is it only me who cringes when pension funds issue debt or create "special purpose vehicles" (I know I date myself on that last one).
With respect to SPV's, the sense is that pension funds have tremendous internal investment expertise which they can share with the rest of the world. There are 2 issues:

1. Taking your eye away from your fiduciary duty to pensioners
2. The obligation to hold the equity piece

Yes, SPV's are a thing of the past, but pension funds issuing debt? And using derivatives to leverage their hedges? The bottom line is that leverage introduces risk and if one cannot justify leverage ex-ante or especially ex-post (after something blows up) then it may not be the right approach for a pension fund.

SEI Survey

A recent survey by SEI points to over 50% of pension funds moving to some form of Liability Driven Investing (LDI) mandate. Of course, defining that term is an imprecise science with plenty of debate. The range includes the hard-liners like Towers Perrin who advocate a 100% allocation to Fixed Income as part of its definition of LDI to softer versions with some allocation to equities.

To me, it is not about the actual asset allocation, but about education. It is about recognizing that risk emanates from the liability side of the balance sheet, not just the assets of a pension plan. It is about understanding that as a pension fund manager you are de facto short fixed income and likely inflation. These are not easy markets to navigate and the outlook is fairly bifurcated between doomsday prophets and cheerleaders of economic growth. And with respect to fixed income and inflation the picture is as murky as ever.

It is therefore imperative to understand, measure and interpret your risk based on an entire entity not single parts of that entity.

Bill Gross

Well, how do you like that - Bill Gross singing my tune

Time to take chips off the table

The panic of early 2009 has receded. Equities have rallied by 50% from the lows. Pension funding ratios are marginally better (corporate bond yields have decreased which means liability values have increased).

Markets feel a bit sluggish here. Some negative technicals have been cropping up.

Time to reduce equity exposure.

Liability driven investing (LDI) is being discussed, but it is not an all or nothing proposition. It is possible to transition to lower equity weights and now is the time to consider doing so.

Pension Risk

Interesting article on public pensions:

http://www.washingtonpost.com/wp-dyn/content/article/2009/10/10/AR2009101002360.html

I am not sure that ramping up risk is the right solution but it would be in line with the attitude of banks this past decade...if you need to keep up with peers (or in pension case, liabilities) just keep increasing leverage (risk) and if worst comes to worst (it did and likely will again in the case of pensions) government will be there to help out. Certainly with respect to public plans government backing is explicit; it was less so for the banking industry but that did not seem to stop them.

Nortel Pensions

And now this news piece to add to the murky waters of pensioners as company creditors. Not many employees consider the credit risk of their retirement funds when in a DB plan. A new regime has emerged. Pensioners need to be aware that the bankruptcy of their company may put their pension at risk.

Catch up Strategy

The gambling credo of doubling down may work for some but I remain fearful for the State of California and the PBGC. See here

Totally irresponsible if you ask me, but if you don't have to pay the price for failure, then what are you really risking? Like those who bought overpriced houses largely with banks money, it was the banks who ended up with the major losses. So too the State & Federal Government.