I am pleased to announce that I will be speaking as part of an upcoming Strafford live webinar, “Alternative Investments in ERISA Retirement Plans: Mitigating Liability Risks for Hedge and Private Equity Funds and Pension Plan Fiduciaries” scheduled for Wednesday, May 24, 1:00pm-2:30pm EDT. I am given ten (10) guest passes. If you are interested, please let me know.

Once the ten guest passes are gone, you can still attend the webinar. By referencing my name, you can receive a fifty percent discount. As long as you use the link shown below, the offer will be reflected automatically in your cart.

Our panel will provide ERISA and asset management counsel with a review of effective due diligence practices for institutional investors from both a legal and economic perspective. The panel will offer risk mitigation best practices at a time of increased government scrutiny and lawsuits by plan participants.

After our presentations, we will engage in a live question and answer session with participants so we can answer your questions about these important issues directly.

I hope you’ll join us.

For more information or to register >

Or call 1-800-926-7926 ext. 10
Ask for Alternative Investments in ERISA Retirement Plans on 5/24/2017
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Sincerely,

Dr. Susan Mangiero, Managing Director
Fiduciary Leadership, LLC
Trumbull, Connecticut

 

Since I started this blog a decade ago, I’ve repeatedly lamented the unfortunate situations when investment decisions are determined by politics rather than based on prudent process. As I read "Teachers Union and Hedge Funds War Over Pension Billions" by Brody Mullins (Wall Street Journal, June 28, 2016), I can’t help wonder if pensions are once again being used as political ping pong balls.

Mind you, I am not advocating a particular strategy or asset class for any of the teacher funds mentioned in the article. One would have to examine relevant facts and circumstances, investment goals and risk tolerance, at a minimum. However, as a taxpayer and fiduciary expert, I am disturbed by the possibility that asset managers are being lopped off an approval list (or added as the case may be) on the basis of whether they disagree (or agree) with the views of the American Federation of Teachers ("AFT").

In 2015, multiple organizations (including the AFT) published "All That Glitters Is Not Gold," a thirty-nine page analysis of eleven U.S. public pension plans that invested in hedge funds. Authors of the study urge decision-makers to:

  • Carry out "an asset allocation review to examine less costly and more effective diversification approaches" and
  • Mandate "full and public fee disclosure from hedge fund managers and consultants" to include information about performance.

These recommendations seem to make sense and should be applied to all asset classes with two qualifiers. First, cost is not necessarily the sole determinant. Selection and monitoring should consider numerous factors such as how an asset manager mitigates risks, safeguards against rogue traders and ensures operational excellence. Second, performance numbers should be consistently measured across asset managers, go beyond historical numbers, be adjusted for risk-taking and much more.

My prediction is that we’ll have lots more news about politics and pensions. This could be a good thing if actions by lawmakers and public pension trustees evidence improved oversight and good governance. Otherwise, questions asked about dubious practices may get answers too late to effect meaningful change.

Note: In terms of full disclosure, I was part of the team that reviewed New York City Employee Retirement System ("NYCERS") operations. I was not involved with any discussions about changing asset allocations.

As I have pointed out on multiple occasions, valuation is an integral part of investment risk management for several reasons. First, fees paid to asset managers are frequently linked to performance and performance calculations depend on reported values. If values are artificially inflated, returns are likely to be inflated as well. Second, imprecise values can skew asset allocation decisions, lead to hedges being too big (or too small) and possibly cause an investor to breach trading limits that are part of an Investment Policy Statement. It’s no surprise then that valuation process questions about who does what, when and how continue to surface.

According to a May 9 Wall Street Journal article, the U.S. Securities and Exchange Commission ("SEC") is investigating "the way hedge funds value their thinly traded holdings and how they respond when investors ask for their money back." The SEC has been vocal about its concerns regarding asset valuations for awhile. In December 2012, Bruce Karpati, then Chief of the Asset Management Unit of the SEC Enforcement Division (and now in private industry), talked about a focus "on detecting fraudulent or weak valuation practices – including lax valuation committees and the use of side pockets to conceal losing illiquid positions – and the failure to follow a fund’s stated valuation procedures." Click to read "Enforcement Priorities in the Alternative Space." (As an aside, some hedge funds buy and sell actively traded securities for which there is a ready market and full price transparency.)

The U.S. Department of Labor ("DOL") regularly broadcasts its concerns about "hard to value" assets, including financially engineered products that show up in certain defined benefit and defined contribution retirement plans. In September of 2008, I spoke before the ERISA Advisory Council, by invitation, to address valuation issues from the perspective of a trained appraiser and fiduciary best practices expert. Click to read "Testimonial Remarks Presented by Dr. Susan Mangiero." I talked at length about valuation questions to ask of service providers and procedural prudence considerations for institutional investors.

A few weeks ago, senior attorney Fred Reish addressed monitoring and uncertainty in his April 19, 2016 newsletter. He directed readers to Fiduciary Rule preamble text that urges an advisor and his financial institution to install an adequate monitoring process before recommending "investments that possess unusual complexity and risk, and that are likely to require further guidance to protect the investor’s interests." Click to read "Interesting Angles on the DOL’s Fiduciary Rule #1." It doesn’t take a rocket scientist to conclude that a "complex" and "risky" investment could be hard to value and not particularly liquid. (I have purposely not defined the terms in quotes herein as they are often related to facts and circumstances for a particular investor.)

Expect to read more about this important topic of valuation, especially as applied to those investors in search of higher returns. In a "no free lunch" world, risk and return go hand in hand. It’s not necessarily a bad thing to take on greater risk as long as there is an understanding at the outset as to what gives rise to uncertainty and how risks are being mitigated.

Nine years today marked the debut of www.pensionriskmatters.com. Since then, I am proud to say that traffic has steadily grown, with continued feedback and suggestions about all sorts of topics. I am deeply grateful to visitors to this independent website for their time and encouragement. While the specific feedback tends to vary by issue or job function, a central theme is clear. Ongoing education about topics such as due diligence, fees, risk management, asset allocation, hedge funds, liquidity and valuation is both needed and desired. In 2015, this award-winning blog will continue its focus on providing objective and helpful information about important subjects that challenge investment stewards and their advisors, attorneys and regulators who oversee the management of more than $30 trillion.

As I point out in "Financial Expert Susan Mangiero Celebrates Ninth Year as Lead Contributor to Pension Risk Governance Blog" (Business Wire, March 25, 2015), "There is never a shortage of subjects to discuss, thanks to ongoing suggestions and contributions from readers and the significant realities of changing demographics, market volatility and new accounting rules."

To date, there are over 900 published analyses, research updates and guest interviews that can be readily accessed by category and keyword. Simply click on the Archives section of www.pensionriskmatters.com. For a complimentary subscription to this blog, as posts are published, click here to sign up. Click here to read our Privacy Policy. If you are interested in contributing an educational essay or letting us know about a relevant news item or rule change, please email contact@fiduciaryleadership.com.

Until the next blog post, thank you for your interest!

The prospect of being part of millions of retail retirement plans has some financial advisors and hedge fund managers giddy with excitement. The 401(k) market alone is huge. According to the Investment Company Institute, as of Q3-2012, these defined contribution plans held an estimated $3.5 trillion in assets. In 2011, over fifty million U.S. workers were "active 401(k) participants." This compares favorably to an approximate $2.66 trillion hedge fund market size in 2013, up from $2.3 trillion one year earlier. Private equity, real estate and infrastructure comprise the rest of the alternatives investment sector according to a press release issued by Preqin, a financial research company. See "Alternative Assets Industry Hits $6tn in AUM for First Time" (January 21, 2014).

CNBC contributor Shelly K. Schwartz explains that alternative investment strategies are appearing in the form of 400 plus mutual funds and exchange-traded funds ("ETFs") that employ "complex trading strategies" such as managed futures, long/short trading in stocks and multiple currency exposures. Allocating to leveraged loans, start-up ventures and global real estate are other ways that these relatively new funds seem to be mimicking the approach taken by hedge funds and private equity funds that traditionally have catered to institutional investors and high net worth individuals. Notwithstanding regulatory differences relating to diversification, percentage of "illiquid" investments, redemption, daily pricing and how much debt can be used to lever a portfolio, statistics suggest a growing interest on the part of smaller investors to get in on the action. See "Seeking safe havens? Analysts, advisors point to liquid alternative funds" (November 24, 2013). Also check out "Goldman pushes hedge funds for your 401(k)" (Fortune, May 22, 2013) in which reporter Stephen Gandel describes new funds being offered by various financial institutions, some of which invest in mutual funds that mimic hedge fund investing strategies and others that invest in hedge funds directly.

Not everyone is an ardent fan. In "FINRA warns investors on alternative mutual funds," Reuters reporter Trevor Hunnicutt (June 11, 2013) describes regulators’ concerns that "not all advisers and investors understand the risks involved," especially with respect to whether a retail-oriented fund is truly liquid. In its "Alternative Funds Are Not Your Typical Mutual Fund" publication, the Financial Industry Regulatory Authority ("FINRA") cautions investors to assess investment structure, strategy risk, investment objectives, operating expenses, the background of a particular fund manager and performance history.

Given the ongoing search for the next big thing, we are likely to see a lot more activity in the alternative investments marketplace – for both institutional and high net worth clients as well as for individuals with modest wealth levels. PensionRiskMatters.com will return to this topic in future posts. There is much to write about with respect to fiduciary implications, risk management and valuation.

In the meantime, I want to thank ERISA attorney David C. Olstein with Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates for apprising me of a 2012 U.S. Department of Labor grant of individual exemption for Renaissance Technologies, LLC ("Renaissance").  Described as a "private hedge fund investment company based in New York with over $15 billion under management" by HedgeCo.net (September 26, 2013), Renaissance holds a large number of equity positions in stocks issued by household name companies. Click to see a recent list of their transactions. The "Grant of Individual Exemption Involving Renaissance Technologies, LLC," published in the Federal Register on April 20, 2012 makes for interesting reading for several reasons. First, it describes policies relating to important topics such as valuation, redemption and disclosures for "privately offered collective investment vehicles managed by Renaissance, comprised almost exclusively of proprietary funds" and the impact on retirement accounts in the name of Renaissance employees, some of its owners and spouses of both employees and owners. Second, as far as I know, there are not a lot of publicly available documents about proprietary investment products that find their way into the retirement portfolios of asset management firm employees and shareholders. Third, as earlier described, there is evidence of a growing interest on the part of the financial community in bringing hedge funds or hedge fund "look alike" products to the retirement "masses."

Some pension funds invest in hedge funds. Some hedge funds invest in movie companies. That’s why pension fund fiduciaries may be interested in the recent comments made by Hollywood insider George Clooney. According to "George Clooney To Hedge Fund Honcho Daniel Loeb: Stop Spreading Fear At Sony" by Mike Fleming Jr. (Deadline, August 2, 2013), the actor and sometimes director and producer criticized activist hedge fund investor and head of Third Point LLC, Daniel Loeb, for what can be politely described as undue interference. The catalyst seems to be a May 14, 2013 letter written to the president and CEO of Sony, Kazuo Hirai, by Third Point’s CEO in which several recommendations are made, including the public sale of a minority stake in Sony Entertainment. Although Sony rejected the IPO, documenting the importance of the entertainment business as "fundamental to Sony’s success" in an August 6, 2013 letter to Third Point LLC, the conversations about company ownership and ways to enhance value are instructive.

Some of the numerous comments left on various publication websites refute the notion that a material investor has a right to make suggestions. This sentiment defies logic. For one thing, an investor (large or small) may have legitimate questions and suggestions that can potentially enhance the value of all shareholders. Second, an asset manager has a responsibility to its investors. Remaining silent about concerns could put the activist at risk for fiduciary breach. Third, an activist investor by definition has typically amassed "enough" money to transact. Unless we are talking about a jumbo lottery winner who wants a seat at the table, resources had to have come from somewhere, usually from other parties such as endowments, family offices, pensions and individuals who believe in the activist’s strategy. That’s not to say that an activist investor is always right or wrong but certainly deserves a hearing without impunity. For those companies that want to avoid short-term actions that they deem unattractive and antithetical to long-term performance, going private is one way to keep naysayers away from the door.

However, there are those who believe that squeaky wheels improve corporate governance and boost stock price. In "Activist investors find allies in mutual, pension funds" (Reuters, April 9, 2013), journalists Jessica Toonkel and Soyoung Kim attribute FactSet for statistics that show an increase in activist campaigns, from 187 in 2009 to 241 in 2012. They quote Hedge Fund Research as asserting that "Over the past three years, activist hedge funds have outperformed more traditional hedge funds." According to "Let’s do it my way" (The Economist, May 25, 2013), activists were once given short shrift but that is no longer the case. "Indeed, some American pension funds have even placed money with activists to keep companies on their toes."

An added twist exists when activist investors gain exposure indirectly versus buying shares for cash. In "CSX Battles Hedge Funds – A Cautionary Tale for Pensions?" by Susan Mangiero (July 5, 2008), I wrote about a legal challenge to The Children’s Investment Management (UK) LLP by CSX Corporation over the hedge fund’s then prevailing cash-settled swap position as a way to gain equity exposure and a path to control. (The court ultimately decided not to opine on whether a total return swap holder is a beneficial owner. Click to access the July 18, 2011 CSX Corp. v. The Children’s Inv. Fund Mgmt. opinion issued by the United States Court of Appeals For the Second Circuit.") According to "Sony Holdings Blurred by Third Point Swaps, Goldman Bonds" (Bloomberg, June 11, 2013), Mariko Yasu and Takako Taniguchi suggest that Third Point’s direct equity stake could be less than five percent since it "doesn’t show up in regulatory filings" and "[s]hareholdings of more than 5 percent of a company have to be reported to Japan’s Ministry of Finance." Its "exposure" to an estimated 64 million Sony shares could be "clouded" due to its "use of cash-settled swaps and convertible bonds." A key question for investors in Third Point LLC and other activist hedge funds that use equity swaps is whether voting rights will be enhanced or impeded when derivatives are used.

Whatever you think about George Clooney or Daniel Loeb, the role of activists and the way they finance their positions is critically important to understand.

I am happy to announce that I will be joined by esteemed colleagues Howard Pianko, Esquire (Seyfarth Shaw) and Virginia Bartlett (Bartlett O’Neill Consulting) on September 10, 2013 from 1:00 to 2:30 pm EST to talk about QPAM and INHAM compliance audits. See below for more information. Click to register for this forthcoming educational event about ERISA requirements. (Note: I am given a few complimentary guest passes. Contact me if you are interested and they are still available.)

This CLE webinar will prepare counsel to advise asset manager clients regarding Qualified Professional Asset Manager (QPAM) and in-house asset manager (INHAM) audits as required by the Department of Labor. The panel will review the new exemption rules, who can conduct an audit, what the process entails, and how to showcase good practices with existing and prospective plan sponsors.

Continue Reading ERISA Assets: QPAM and INHAM Audit Legal Requirements and Best Practices

If you missed the Strafford CLE event on June 5, 2013 entitled "ERISA Pension Plans in 2013: Due Diligence for Hedge and Private Equity Funds: Avoiding the Pitfalls with Alternative Investments for Institutional Investors and Fund Managers," there is still an opportunity to purchase the recording. Click here for more information.

In the meantime, click to access the due diligence slides that were used by Dr. Susan Mangiero (Fiduciary Leadership, LLC), private fund attorney Rosemary Fanelli (CounselWorks) and ERISA attorney Tiffany Santos (Trucker Huss).

While we ran out of time with so much left to discuss beyond our assigned 90 minute slot, the two attorneys who spoke with me talked a lot about their perception of a changed environment. Their message was that institutional investors seem to be under a lot more pressure now to demonstrate that comprehensive due diligence activities have taken place. One attorney listener in the audience echoed this sentiment presented by the two legal speakers. He offered his opinion that an investment consultant or financial advisor should work closely with both an ERISA counsel as well as a fund attorney as part of the due diligence process.

I am delighted to have been invited to join the faculty of the Master’s Track at the annual fi360 investment fiduciary conference, held this year in Scottsdale, Arizona. Speakers include: (1) ERISA attorney Charles Humphrey (2) Edward Lynch, AIFA, RF, GFS with Fiduciary Plan Governance, LLC (3) Dr. Susan Mangiero, AIFA, CFA, FRM with Fiduciary Leadership, LLC and (4) pension auditor Michelle Sullivan, CPA with Freed Maxick CPAs

The fi360 Master’s Track offerings are created especially for those with a knowledge of fiduciary standards and how that standard applies to the topics being presented.

Our session is entitled "Due Diligence for Alternative Investments." Our panel will focus both on the legal issues and the internal control compliance issues that cannot be ignored by anyone with a fiduciary responsibility to prudently select and monitor. This session will describe the impact of Dodd-Frank on investing in alternatives, various court cases and regulatory enforcement actions as well as the DOL/IRS regulatory guidance on alternative investment allocations. Click to read more about this session and the other sessions to be presented at this conference of investment fiduciary professionals from April 17 to April 19.

I am delighted to announce our seventh year as an educational resource for the $30+ trillion global retirement plan industry. With over a million visitors to www.pensionriskmatters.com, I appreciate the ongoing feedback and encouragement from financial and legal readers. This blog began as a labor of love and continues to be personally rewarding as a way to help guide the discussions about pension risk, governance and fiduciary duties.

Here is a link to the March 25, 2013 Business Wire press release about www.pensionriskmatters.com, an educational pension risk governance blog for ERISA, public and non-U.S. pension plan trustees and their advisors.

As always, your input is important. Click to send an email with your comments and suggestions.

Thank you!