November 2010

Kudos to the Stable Value Investment Association for encouraging several days of lively discussions about important topics such as asset allocation, behavioral investing and risk management.

In my comments about stable value risk management, I emphasized the importance of having robust policies and procedures in place across all providers. I likewise mentioned the need for plan sponsors to investigate the use of derivative instruments on the part of both the asset managers and the wrappers, adding that some stable value funds may pose valuation challenges. Given the approximate $700 billion size of the stable value market and the widespread use of these products in 401(k) plans, financial service organizations have a golden opportunity to differentiate themselves from competitors by making their risk stance transparent with investment committee member buyers. This is especially true at a time when plan sponsors are increasingly asked to justify their due diligence and oversight of service providers.

Click to read "Stable Value Risk Management – Remarks Made by Dr. Susan Mangiero Before the Stable Value Investment Association on November 19, 2010."

You might also want to check out "Fiduciary Alert: Stable Value," provided by the team at Harrison Fiduciary. In speaking to Attorney Mitch Shames the other day about stable value risk management, he concurred with many points I made in my speech and added a few of his own. See below for his comments.

"Most of the time stable value ("SV") products are sold by recordkeepers. Often plan fiduciaries simply sign-off, thinking that they are getting a turn-key "stable" product which provides "value".  Plan fiduciaries rarely understand that SV is a hybrid product,   with an investment component and an insurance component. For instance, ask a fiduciary about the crediting rate on the stable value vehicle and they may give you a blank stare. Ask them to identify the wrap provider and describe their crediting rating and they may be equally in the dark. Finally, fiduciaries are sometimes surprised when they find out that traditional HR issues can have an impact on the wrap contract. Most all wrap contracts provide that if the work force is reduced by a certain percentage, then the wrap provider is released from the wrap coverage. So, if a sponsor has a significant plan closing, this can give rise to problems under the SV Program. Similarly, there are often restrictions on the number of participants who can withdraw from an SV plan.  Imagine if participants get sick of low returns and start shifting assets out of the SV program into equities, emerging markets, etc. This can create huge problems for SV programs.The point is that SV is extremely complicated and the devil, as always, is in the details. All fiduciaries must be familiar with the terms of the wrap agreement."

Another noteworthy read is "Risk Controls and the Coming Stable Value Surge." According to the author, Robert Whiteford, Bank of America, "wrappers and asset managers have made great progress in reducing risk in a way that should allow the existing wrappers to increase capacity in the future," adding that "new investment guidelines have been constructed to more faithfully reflect the mission of stable value funds."

Like most industries, the stable value sector is confronted with challenges to be more transparent and thereby lessen the pain for their fiduciary buyers and plan participants.

As you ready for the holidays, full of hope and excitement, but perhaps stressed out over a growing "to do" list at work, enjoy this musical interlude. Shoppers in the City of Brotherly Love joined the Opera Company of Philadelphia for an uplifting rendition of Handel’s Messiah, Hallelujah Chorus. Whatever your beliefs, it is heart-warming to watch the crowd join in.

Click for some holiday cheer in the form of Handel’s Messiah, Hallelujah Chorus.

I was delighted to talk about stable value risk management as part of this year’s Stable Value Investment Association forum. Click to learn more about the Stable Value Investment Association 2010 Fall Forum and Annual Membership Meeting. An impressive array of experts comprise "Beyond the Headlines: What Regulatory Reform, Economic Stimulus and Fiscal Restraint Mean to Your Retirement Security" in Washington, D.C.

Source: National Park Service

I have the pleasure of addressing a sold-out Fall Forum, sponsored by the Stable Value Investment Association. My mandate is to discuss risk management at a time of continued macroeconomic uncertainty.

Click to learn more about the Stable Value Investment Association 2010 Fall Forum and Annual Membership Meeting. An impressive array of experts comprise "Beyond the Headlines: What Regulatory Reform, Economic Stimulus and Fiscal Restraint Mean to Your Retirement Security" in Washington, D.C.

According to "DOL rule could raise pension funds’ costs: Proposed fiduciary requirement would hit appraisers of alternative investments" by Doug Halonen (Pensions & Investments, November 15, 2010), those who provide independent valuations could soon be declared fiduciaries. Remembering that there is no free lunch and that every new rule has unintended consequences, third party pricing experts are already running for cover. Some say they may exit the appraisal business at the same time that ERISA plans are enlarging their positions in alternatives and also being called upon to provide more information in their Form 5500 filings.

In case you missed it, click to access my comments on this topic, entitled "September 11, 2008 Testimony Presented by Dr. Susan Mangiero before the ERISA Advisory Council Working Group on Hard to Value ("HTV") Assets."

I had the pleasure of presenting on the same topic of risk management and valuation to the OECD and International Organization of Pension Supervisors in Paris in June 2010.

Clearly, pension plan decision-makers and their advisors, attorneys and consultants are going to be challenged to find the right balance between return and risk (with valuation questions being one type of risk). Not every alternative investment is "hard to value." Indeed, some mutual funds and other "traditional" choices have their own challenges in terms of pricing and liquidity.

Click to read "Hedge Fund Valuation: What Pension Fiduciaries Need to Know" by Susan Mangiero, Journal of Compensation and Benefits, July/August 2006.

According to up-to-the minute press accounts, some 100 magicians are stranded in the middle of the ocean on a cruise ship with a faulty engine. Expecting a few days of fun and legerdemain, these tricksters are awaiting rescue and forced to dine on cold goodies with no air conditioning. When a colleague brought this news to my attention tonight, my immediate query was why help was taking so long. In response, I was told that passengers had to wait for a tugboat that could transport over 3,000 people (magicians included). Help is expected in short order with a full refund and a free trip for those affected.

No doubt Jay Leno and others will get a few guffaws out of this unpleasant experience for the sailing "Houdinis" – something to the effect that magicians should be able to snap their way out of trouble. The reality is that bad things can happen, leaving one feel helpless and stressed out. Also true is that adversity should and can be anticipated. That’s why stress tests are so important as a way to model the unthinkable and plan accordingly. Maybe the cruise company in question did just that but, if so, why are paying customers forced to hang out for more than a few hours?

If we’ve learned anything from the financial market rollercoaster of late, it’s this. We can’t rely on sleight of hand to properly identify, measure and manage risks. Putting a contingency plan in place for any and all of the risk factors considered potentially material is good business sense. In pension land, failure to have tested the limits of a significant negative equity market has cost numerous sponsors big money. Other types of institutional investors and asset managers must heed this cautionary tale too.

Notably, in an in-depth survey conducted by MSCI Barra in 2009, "73% of pension plans and 26% of asset managers surveyed do not currently run stress tests, but cite this as a key focus going forward." This is encouraging. After all, ignoring the tail risk can lead to nasty consequences.

Other results that MSCI Barra uncovered are similar to what I found in a study of over 150 U.S. and Canadian pension plans, done in conjunction with the Society of Actuaries. Like MSCI Barra, few of our queried plan sponsors had Chief Risk Officers in place, considered retirement plan management as part of an enterprise-wide risk exercise and did not always pay close attention to risks such as liquidity. Click to access a full version of this 2008 study about the use of financial derivatives and fiduciary duty.

Pulling rabbits out of the hat is not as easy as it appears. Isn’t it better to depend on a systematic and disciplined approach to mitigating those things that have the potential to destroy, if left unchecked?

My jaunts to a local coffee house have given me food for thought about how people listen and respond to ordinary requests. Let me explain.

A regular treat for me is a double expresso and a glass of water with no ice. Since I had adult braces removed a few years ago, it’s tough to down frosty cold drinks so "straight from the freezer" is a no-no. Interestingly however, about ninety percent of the time, the person behind the counter hands me a tall H20 with (drumroll please) lots of ice. At first I thought it was carelessness on the part of one or two individuals but I started to notice that nearly everywhere I went, regardless of the type of dining venue, my pleas for room temperature liquid refreshment went unnoticed, unheeded or both. In the United States, drinking a cold beverage with lots of ice is standard fare. Maybe, as a result, servers are simply habituated to provide what they think most people want.

Does this tendency to hear what we want to hear and respond accordingly prevail elsewhere? If so, and applied to institutional investors, how does meaningful change come about? How do old habits make way for new and improved practices? My having to wait for the cubes to melt is a trivial event. When billions of dollars are at stake and people don’t listen to reality or acknowledge what is needed, the consequences are material and potentially life-altering for plan participants who struggle financially because of bad fiduciary decisions.

I’ve noticed that discussions with some investors and asset managers since the recent market fallout bear bitter fruit. When asked if they are doing a great job addressing risk management, the answer is invariably "yes" but the reality is often quite different. Headlines aplenty in the last few years suggest that at least some decision-makers embrace the familiar (hear what they want to hear) by interpreting "risk" in the narrow context of standard deviation and correlations. Their take is that they are doing a top-notch job yet, in reality, have barely scratched the surface of what has to be done.

Investment professionals with fiduciary duties, functional or de facto, should understand that a new paradigm is upon us. As I wrote on January 1, 2009 in "History Repeating Itself or a New Start in 2009?" a "holistic risk management process must go well beyond benchmarking against point-in-time numbers alone." As I wrote in 2006, pension risks are both qualitative and quantitative in nature. Advisors, attorneys, asset managers and consultants can play a vital role in either perpetuating the myth that numbers tell the full story or bring fresh insights to the table with respect to a full and more complete assessment of where attention should be paid.

Imagine dressing up for a full course dinner and then being served a single stalk of celery. It’s the same thing when a pension, endowment or foundation investment committee asks for help and then gets handed a bunch of performance reports that leave operational and business risks in the corner, unattended.

As we head into a new year, let’s applaud the right-thinking investors who put risk management front and center.

Hot off the press, a study commissioned by the Securities Industry and Financial Markets Association ("SIFMA") questions whether a uniform fiduciary standard of care makes sense. Conducted by Oliver Wyman consultants, "Standard of Care Harmonization: Impact Assessment for SEC" (October 2010) suggests that a "one size fits all" approach for fee-based advisors and broker-dealers may force consumers to bear higher costs and/or limit their access to financial products that are distributed through broker-dealers and/or lower access "to the most affordable investment options." The authors assert that only one out of every twenty retail investors rely only on fee-based accounts. Their analysis considers three different types of investors to include "small," "affluent" and "high net worth." Researchers cite the regulatory burden on asset managers due to compliance with Europe’s Markets in Financial Instruments Directive as a harbinger of things to come in the United States.

Critics of the study have raised eyebrows about the type of data collected for examination. They add that the Dodd-Frank Act does not require all of a broker-dealer’s activities to be subject to an imposed fiduciary standard of care so the emphasis of this new research is misplaced. See "Advisory Industry: SIFMA Fiduciary Study Raises Lots of Questions" by Melanie Waddell, AdvisorOne, November 2, 2010.

At a time when numerous financial professionals are aggressively courting investors who seek to buoy their retirement nest eggs, how fiduciary standard of care rules are finalized will be important in numerous ways and to numerous individuals and organizations.

As Americans head for the polls today, pension reform is front and center for more than a few politicians in waiting. Unfortunately, the situation is far from trivial and transcends global borders. A trip around the world illustrates the potential perils:

I foresaw the tempest several years ago when I then described the inevitable "politicization" of employee benefit plan issues. On July 27, 2006, I wrote of a "tea party redux" with numerous state pensions in serious turmoil and the ill-effect on taxpayers who vote.

Alas, the problem has become much worse since then. According to "Pension Politics" by Girard Miller (Governing, July 22, 2010), the "blowout has not been capped." Material accounting changes are on their way, alongside significant economic devastation for states, cities and counties alike.

In the words of the former U.S. Speaker of the House, Tip O’Neill, "all politics is local." The problem is that our flat earth economy makes retirement plan reform a mandate for everyone, regardless of where you live. The longer the politicians wait to tackle the obvious need for change, the more acute the pain for us all.