Harrison Fiduciary

No One Seems to Care about Conflicts

A member of the board of trustees of a NY City private school provides information to a prospective parent about the school.  Sounds simple enough, but then the parent pays the trustee for the information.  Say, what?

Apparently, there is a business in this.  The NY Times reports that Aristotle Circle provides these various contacts to otherwise unconnected NYC parents.  Let’s set aside for a moment, the hyper-aspirations of parents and the crazed environment for coveted spots in select pre-schools.  Instead, let’s focus for a moment on the trustee who provided these services.

Serving as a trustee on the board of a non-profit is a fiduciary position.  The trustee owes a fiduciary duty to the Board and the organization.  Receiving a fee from a third party for either access to the school or information about the school is a gross example of self-dealing.  This trustee should be thrown off the board, ASAP.

The bigger issue, however, is how come this trustee is so tone deaf to a blatant conflict of interest?  Did the trustee have any qualms about these actions?  Furthermore, how does Aristotle Circle build a business model on these fee for services, and introductions?

A few weeks ago, Berkshire Hathaway announced that David Sokol had made personal investments in a company in which he then encouraged Warren Buffet to buy.  Neither Buffet, nor his right hand man Charlie Munger, seemed to think that there was anything wrong with these actions.  Sokol tendered his resignation only after pressure was raised by outsiders.

Whether it is the heir apparent of Berkshire Hathaway or an ambitious NY city parent, no one seems to be bothered by these conflicts of interest.

Try as we may to overcome the financial crisis through new rules and regulations.  No meaningful progress can be made until we address this very simple business proposition.  People who hold positions of trust — in any organization — must avoid any appearance of a conflict of interest.

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A Never Ending Source of Fees for the Pension Industrial Complex

Roger Lowenstein refers to our public pension system as The Great American Ponzi Scheme.  While supportive of the policy needs to provide pensions to public workers, I suspect that he comes to his Ponzi Scheme conclusion because of the vast gaps in funding of many state and municipal plans. Many current retirees enjoy healthy payments, while the system remains significantly underfunded.  A little bit like the Madoff investors who took out big returns as other investors were making additional contributions.

With respect to the funding issues, Lowenstein is right on point.  And, the funding issue is probably the biggest challenge facing the public system.  However, Lowenstein overlooks another critical dynamic of the pension system; that is, the investment of retirement assets and the fees paid to all of the various vendors.  Again, in the aggregate, the funding issue looms larger.  But, every dollar paid to a vendor is one less retirement dollar paid to retirees.  Research shows that these fees have a significant impact on investment returns.

If the funding system is a ponzi scheme, then the investment process for public plans is also, in many cases, a sham of another sort.

Last spring I spoke about fiduciary matters at a conference sponsored at Harvard Law School for trustees of public pension plans. The vast majority of the participants were policeman, fireman, teachers and other public employees who serve as trustees for the their retirement plans.  After spending a day working in small workout groups with the conference participants, I was struck by two significant insights:  1) the vast majority of these trustees are earnest and take their responsibilities very seriously and 2) notwithstanding this earnestness, they are no match for Wall Street.

I suspect that for some of these trustees, their formal education may have stopped at high school.  And particularly for teachers, their college careers were directed to towards degrees in education.  In contrast, the investment management industry is filled with algorithm yielding MBA’s and finance PhD’s from Ivy League schools.  In fact, one session of the conference was devoted to a liability-matching strategy so loaded with math and investment jargon that I’m convinced that my CFA partners would have been challenged to translate the strategy so that I could digest it.

This is not the exception, but the rule.  Investment concepts and the intricacies of investment products have become so extraordinarily complicated that even the best intention plan trustee cannot understand the fundamentals.   And yet, public funds continue to direct assets to the latest hedge fund or strategy pumped out by the investment management industry.

Sanity must be injected into the system.  Not only are public pension funds under funded but,  their assets no doubt are invested in expensive products, the majority of which produce average returns.  The math is not good.   Average returns and high expenses mean overall lower returns for retirees.

For the past 20 years the investment industry has fed at the trough of the $ trillions held by public pension plans.  The industry has profited beyond its wildest dreams.  Unfortunately, the retirees have not been so fortunate.

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David Sokol’s Resignation from Berkshire Hathaway Doesn’t Pass the Smell Test

Full disclosure:  I have been a long time shareholder of Berkshire Hathaway.  Therefore, I’m particularly disappointed with the current episode of bush league antics from corporate America.  I expected more from Berkshire, Warren Buffet and Charlie Munger.

I want to set aside the legal analysis of whether Sokol’s action constitute insider trading or a breach of a duty to the corporation, shareholders or anyone else.  No doubt, talented lawyers will line up arguing both sides of these issues.  Irrespective of the final legal assessment, these facts stink.

As reported in yesterday’s New York Times, by Reuters, Sokol learned about Lubrizol  because Citigroup had an investment banking assignment from Berkshire to bring potential acquisition targets to Berkshire’s attention.   In effect, Sokol learned about the Lubrizol opportunity in his capacity as an employee and officer of Berkshire.  He then took that information and used it for his own benefit.

This egregious behavior was then compounded by the fact that he turned around and pitched the Lubrizol deal to Buffet.  He also attended a meeting with Lubrizol’s CEO in the process — no doubt that he scored this meeting because of his position at Berkshire, it was not in his personal capacity as an investor of $10 million in Lubrizol’s stock.  (Although a lot of money, $10 million investments don’t typically afford an investor a one-on-one meeting with a CEO).

Simply put, Sokol abused a position of trust.  Buffet and Munger’s failure to call him out on it only exacerbates these inexcusable actions. In fact, Munger makes the tired excuse: “Few people understand how good he is, how really good he is”.  In other words, he’s so good that he is above the rules. The ultimate rationale of elitism; members of the club can’t possibly do anything wrong.

Corporate governance experts are explaining that Berkshire’s internal policies (Code of Conduct, Insider Trading Policy, Conflict of Interest Policy, etc) need to be reviewed and possibly re-vamped.  As a fiduciary, I am a huge proponent of rigorous policies and procedures.  However, policies and procedures are only as good as the judgment of the people who enforce them.  Nothing replaces strong business ethics.  And, as anyone who has worked at in a large organization knows — a culture of strong business ethics  starts at the top.

Buffet and Munger’s staunch support of Sokol sends a strong message not only through the capital markets, but also throughout the entire Berkshire entity.  Just possibly, there are two sets of rules:  one set for the rank and file and one set for those who are “really good”.  In large organizations everyone sniffs out these double standards and the integrity of the culture begins to erode.

Our financial system has survived a near death experience.  Congress attempted a legislative fix through Dodd-Frank which is now mired in a political and regulatory  morass.  As I have stated before, real reform will never occur until behavior is reformed. We need business leaders with the courage to proclaim that conflicts of interest are intolerable and unacceptable. Failure to do so undermines the integrity of our financial system.

Warren Buffet use to be such a leader.  For decades, he has only taken a minimal salary from Berkshire for the stated reason that he wanted his interests to be aligned with shareholder interests.  A noble and unique position in corporate America.   Somehow David Sokol missed this message.  Maybe he and Buffet should pull out some of the old Berkshire annual reports.  They provide an exemplary primer on corporate ethical behavior.

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What is the Future of Retirement Plans?

Felix Salmon, an insightful finance blogger for Reuters, writes in yesterday’s NYT about Wall Street’s Dead End. Salmon notes that the sale of the NY Stock Exchange to the Deutsche Bores combined with the significant decline of companies listed on major exchanges point to a future in which corporate wealth and control is pushed into the hands of a small financial elite.  For Salmon the very notion of shareholder democracy is at stake.

And yet, much more than shareholder democracy is at stake.  The retirement and pension plans of millions of retirees (many of whom are baby boomers about to tap into their nest eggs) are also at stake.

Our retirement system depends upon robust equity markets.  It was not always so.

In the not so distant past, most retirement plans were invested in bonds.  Pension plan liabilities were projected by the actuaries and bonds were purchased to meet those liabilities.

By the mid-to-late 1970s,  a confluence of events created the pension investment world as we now know it:  1) modern portfolio theory gained traction, 2) analysts began reporting that stocks generate higher returns than bonds, “over the long term”, 3)  ERISA codified the concept of diversification, and 4) the seeds were planted for the pervasive investment and business culture which bloomed in the 80’s and beyond.

Since pension costs are “real” costs, meaning that they are a hit to earnings, CFO’s and CEO’s were all too thrilled to adopt stragegies to reduce these costs.  With pension plans it became easy.

If equities generate higher returns than bonds, and riskier equities generate even higher returns (so says modern portfolio theory), then it is an easy logical progression to shift pension plans into riskier assets.  But, forget logic …. These were real dollars, real increases in earnings and therefore real increases in share prices.

The tsunami of pension assets flowed from fixed income, to domestic equities, then international equities, to emerging markets, along with real estate, joint venture, private equity.  Even in the fixed income arena, boring treasury and corporate bonds were jettisoned for international and emerging market bonds, and bonds backed by everything from mortgages, credit cards, car loans and now even life insurance.

And of course, the Holy Grail:  the Hedge Fund.  Managers given the unfettered discretion to zap investments around the globe in any asset class, at any time.  Whatever suits the fancy of the omniscient hedge fund manager.

While Salmon might decry the loss of shareholder democracy ….I’m a little bit more selfish and I’m thinking about my retirement, and our whole retirement system.   This system is critically dependent upon the very shrinking capital pool that Salmon has identified.

The issue goes far beyond even the shrinking pool because, in fact, the pool hasn’t shrunk. Instead, as Salmon implies, it has simply passed into the control of a small elite.  The thousands of well educated college students who marched through the top rated business and law schools over the past 3 decades who now populate the investment industry.

The critical problem, however, is that our retirement system requires access to these markets and securities.  In effect, the demand has remained constant but the financial elite now controls access.  Like the robber barrons of the 19^th century,  the financial elite are able to extract a high trarriff on the commodity they control.  This tariff takes the form of a “2 and 20 fee” — 2% management fee and 20% performance fee.  This entire structure (and the financial theories which underlying it) merely reinforces the control and wealth of the financial elite.

The robber barrons met their match in Teddy Roosevelt’s trust-busing zeal.  This current system is far more resilient.  In fact, a global financial crisis, a legislative overhaul of the financial system, and a joint congressional inquiry could not lay low the power of the investment industry.  Hedge Fund managers and their brethren still earn billions of dollars in a single year.

Rather than turn to our elected officials for a systemic change (remember, their campaigns all seek funding from the financial elite), I suspect that the solution lies in the streets of Tunis and Cairo.  Please bear with me.  This is not so farfetched.

Again, in yesterday’s Times, the lead article, Tunisian-Egyptian Link That Shook Arab History, explains that collaboration among educated professional young Tunisians and Egyptians, as facilitated by various forms of social networking, contributed enormously to the toppling of these regimes.

Collaboration by educated, well informed and connected people works.

While I do not want to suggest parity between the needless physical and emotional suffering of exploited populations and the inequities of our financial system.  I do think that the techniques of reforming entrenched power structures can be similar.

Our system has gotten to where it is, in part, because retirement plan decision makers –our financial stewards — have allowed it to develop.  They continue to pour money into hedge funds, private equity and other similar investment strategies.  The allure of these returns is too great.  Unfortunately, individual returns can fall far short of promised possibilities.  And, the huge fees remain.  And these managers remain empowered.

The solution? Retirement plan fiduciaries must, “Just Say No”.  No more to extravagant fees; no more excuses for underperformance; and no more allowing managers to avoid fiduciary responsibility.  Collectively and loudly they must object to this entrenched system.

Plan fiduciaries must demand that investment managers put client interests first.  Not simply as an advertising campaign, but as statements of their core values and business ethics.

Systemic transformation does not come form a change in rules by those vested in the status quo.  That is a recipe merely for change at the margins.  True change comes when people tap a latent but unrecognized source of power. This power transforms behavior which in turn transforms systems and institutions.  Yes, the answers can be found in the streets of Cairo and Tunis.

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Beware Real Estate Hubris

In the late 1970’s/early 1980’s, AT&T unveiled an attention grabbing new corporate headquarters on Madison Avenue — complete with its chippendale crown.  On 1/1/84, however, AT&T was dismantled, broken up into its regional operating companies.  Twenty-five years later, Lehman brothers presented its sleak new global headquarters.  And, poof in September of 2009, Lehman was no more.

Remembering this architectural and corporate history, I read with great interest about 510 Madison Avenue — a fancy new “trophy” home for hedge funds.

Could this herald the beginning of the end of hedge funds?

The Times reported, last week, that 510 Madison suffered a significant detour (namely the ’08/’09 financial crisis) in its quest to capture $100/ft rents paid by ever-flush hedge fund managers.  Under new ownership and a brighter financial environment, however, high-end amenities are once again playing well to the Hedge Fund set.

Characterized as “more like country clubs, than workaday offices”, 510 Madison includes, a spacious lobby, restaurant, pool, and fortunately, a landscaped terrace.  I mean doesn’t everyone need a terrace to relieve the stress of managing $ billions of other people’s money.

And yet, here’s the problem …. It is other people’s money (OPM) as the cognoscenti well know.

While many hedge fund investors include high net worth and super high worth individuals — presumed to be sophisticated and capable of making their own investment decisions — most hedge fund managers also welcome the deluge of pension assets they have received over the past decade (as long as the pension assets don’t constitute more than 50% of the fund.)

It is not too hard to connect the dots and recognize that the hard earned pension assets of millions of workers are supporting the lavish work digs (not to mention the mansions, summer homes and private planes) of many hedge fund managers.

Sarcasm aside — plan fiduciaries must answer a pretty difficult question before investing assets in a hedge fund.  Are the “2 and 20” fees (2% management, 20% performance fees) justified?  Or, more appropriately are these fees “reasonable”.  Hedge fund managers can only afford their toys and lush office towers because fiduciaries sign-off on these fees.  And remember, ERISA requires that the fees be reasonable.

Last year the S&P 500 returned slight more than 15%, whereas the Barclay Hedge Fund Index returned 10.9% (other indices reported even lower performance). That is pretty expensive underperformance for 2010..   Of course, one year is not a fair comparison. However, before any fiduciary can justify investing in hedge funds, they need to examine, carefully, very carefully, the  3, 5 and 10 year performance returns.

Pension plans are under enormous pressure to generate competitive returns.  Unfunded pension liabilities are staggering.  However, reaching for the latest hedge fund du jour can lead to disappointing and mediocre investment results.

The beauty of the hedge fund business model, however is that even if performance remains mediocre, the managers remained ensconced in their fancy offices, sipping lattes on the landscaped terraces. Unfortuantely, the brunt of the pain is borne by the pension plan investors.

Certainly, ERISA didn’t contemplate these results.  And someday, fiduciaries are going to have to justify the reasonableness of their actions in authorizing these investments.

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Harrison Fiduciary Group — Our Pledge

As anticipated, the SEC issued it’s report, Study on Investment Advisers and Broker-Dealers, and recommends a new Unified Fiduciary Standard for broker/dealers and investment advisors.  Uniformity can be applauded, as well as a higher standard applicable to broker/dealers ….but, let’s not kid ourselves, as I discussed in my prior Post, it is a diluted fiduciary standard allowing for the payment of commissions, the sale of proprietary products and other accommodations to Wall Street.

At Harrison Fiduciary Group we will always rise above the morals of the market place and we pledge as follows:

1. We will not receive commission income;
2. No conflicts will be tolerated;
3. We will not promote proprietary products; and
4. All actions that we take, and decisions which we make, will be solely in the interests of participants and beneficiaries.

Regulators and Congress may be compromised by political interests, but at HFG we are not subject to these pressures.  Instead, we are guided by our core corporate values which shall remain undiluted.  Our responsibility is to put the interests of plan participants ahead of our own.

Our flat fee schedule goes to the heart of our business model, and reflects our core fiduciary values.  For each assignment we will be paid a flat fee and not a basis point fee on the size of assets under management.  The “basis point” model has become endemic to the pension industrial complex.  Many service providers attempt to hitch their revenue streams to the ever growing pool of pension assets –investment managers, custodians, record-keepers and consultants.  We aim to break this link.

As a fiduciary we will be paid a fee in exchange for our fiduciary services.  This fee will reflect the fiduciary risk we assume, the complexity of an engagement and the amount of resources which will need to be devoted to the engagement.

Overseeing and managing the hard earned retirement assets of plan participants is a position of trust.  At Harrison Fiduciary Group we will earn and safeguard that trust zealously.

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Honest Talk about Fiduciaries

Next week, January 21, 2011, the SEC is due to deliver its report to Congress, as required by the Dodd-Frank Act, on the standards of conduct applicable to registered advisors and broker/dealers.  There is little doubt that this report will recommend a uniform standard — ostensibly, a fiduciary duty.  My greatest concern is that they will in fact adopt a unified standard and that they will trumpet fiduciary principles, but in reality it will amount to nothing more than a diluted version of fiduciary principles.

The lobbying by Wall Street has been intense.  Once the recommendations are made, the lobbying will get even more intense.  Wall Street’s business model is at stake.  This guarantees a watered down result.

In fact, the directives given by Congress to the SEC effectively preordained a diluted notion of fiduciary duty.  On the one hand Congress raises the prospect of a unified fiduciary standard, but on the other, also makes provisions for brokers to continue to sell propriety products provided there is sufficient disclosure of compesantion arrangements and conflicts of interest.   This is disappointing.

Simply put: commissions and disclosure are not consistent with fiduciary principles.

Fiduciaries are subject to a duty of loyalty.  This duty requires that a fiduciary put  client interests first, not engage in acts of self-dealing nor involving conflicts of interest.  Earning commission income from the sale of proprietary products clearly raises the potential of acts of self-dealing and conflicts of interest.  A fiduciary’s actions should never be clouded by acts of self-dealing.

Congress believes that disclosure will serve as the bulwark against acts of self-dealing.  In other words, if a broker discloses potential commissions, as well as how the commissions might impact his compensation, then the broker is “off the hook” from a fiduciary perspective.

Here, Congress is simply mistaken.  While disclosure is the corner stone of the securities laws, it does not hold the same weight as far as traditional fiduciary principles.   Under the securities laws, whether it is corporations or mutual funds, the underlying theory is that material facts need to be disclosed and investors can then exercise their own judgment based upon the facts.

For a fiduciary, however, the prohibition is fairly straight forward.  No acts of self-dealing.  A fiduciary cannot use its fiduciary discretion to engage in acts of self-dealing.   And, a fiduciary cannot disclose the potential self-dealing and obtain the client’s consent.

I focus on commissions and disclosure because it serves as a perfect example of how fiduciary principles will be watered down.  For those of us who believe that fiduciaries have a critical role to play in our financial system, this is a disappointment.  The marketing machine of Wall Street has the potential to dilute our commitment to longstanding principles.

At Harrison Fiduciary Group, we categorically reject efforts to masquerade self-dealing and conflicts of interest.  Our business model is structured on a fee for service basis.  Our fiduciary judgment will not be clouded by the potential to earn additional compensation.

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See No Evil, Hear No Evil, Speak No Evil

The Massachusetts Supreme Judicial Court handed trustee banks a disappointing decision on Friday; Massachusetts Ruling on Foreclosures Is A Warning to Banks.  Gretchen Morgenson of the NYTimes has been a prescient observer of, and commentator on, the subprime frenzy, subsequent collapse and its aftermath.  In today’s paper, she reports on the  court’s ruling that U.S. Bancorp and Wells Fargo did not have proper title to mortgages when they instituted foreclosure proceedings.

Yes, everywhere along the way in the securitization process, people and institutions were sloppy.  Why pay attention to detail when there was so much money to be made?

However, there is a critically important sub-text here, which has far greater impact on our financial well being than simply paying attention to details.  The real issue is that the role of serving as a trustee has been dumbed down over time so that trustees claim, “not my job”  when it comes to assuming responsibilities for their actions.

The securitization process is a lengthy one with many parties participating.  However, at the end of the day, there is a trustee of a trust, and the trust holds certain assets.  In this case, notes and mortgages.

Scrape away all of the financial engineering and mumbo jumbo.  At a very minimum, a trustee must know what assets it holds and is responsible for the management and disposition of the assets.  This is not a new concept based upon fancy algorithms or computer models.  To the contrary, it is a basic principle of trust law dating back to the development of the common law in England.

And yet, in defending it’s actions, a spokeswoman for Wells Fargo, Vickee J. Adams states, “As trustee of a securitized pool of loans, Wells Fargo expects the entities who services these loans to abide by all applicable state laws, including those laws that govern foreclosure sales.”

There you go ….it’s the other guy’s fault!   Great legal defense.

Unfortunately, as a fiduciary, it is not that simple.  Yes, trustees are often authorized to hire service providers.  And, yes, trustees can make reasonable assumptions about the service providers.  But, trustees have an obligation to conduct due diligence on the service providers they hire and they have an obligation to monitor these service providers as they perform their duties.  They simply cannot hire someone and then walk away from this responsibility.

Serving as a Trustee requires the exercise of judgment and discretion.  The privilege of holding assets in trust, on behalf of another party, carries with it the obligation to act prudently. There is no way to get around this.

The problem is that the role of the institutional trustee has been dumbed down over the past decades.  The large trust banks sell their trust services as if they are simply record-keeping services.  Both the banks and their customers discount the obligations and responsibilities of serving as a Trustee.

In fact, with the blessing of ERISA, a whole new role has developed known as the “directed trustee”.  These are trustee’s whose roles are so limited  that they simply follow the directions of other fiduciaries.  It is this directed trustee role which has greatly diluted the concept of the discretionary trustee.

And so, we have ended up with a network of institutions who at one time proudly served as fiduciaries and exercised discretion on behalf of their clients, but now do everything to limit their roles.  Therefore it is now easy to point the finger of blame at someone else.

Our financial system is deeply in need of responsible individuals and institutions ready to assume fiduciary roles and discharge those responsibilities prudently.

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Simple & Risk Free?  Hardly.

Plan participants have flocked to Stable Value programs to the tune of $700+ billion. As the name implies,  and most investors believe, these programs are touted as safe investment options for plan participants.  Maybe yes, maybe no.

Offering investment yields greater than money market funds, without the volatility of bond funds, Stable Value programs are hybrid investment and insurance products.  An investment manager manages the underlying cash portfolio, and an insurance company or bank then guarantees (or wraps) the book value of the program.  In essence, the value of the fund is not suppose to go below $1/share.

Hybrid products, however,  offer complexity, and complexity presents risks.

In the current low interest rate environment, unique risks confront plan fiduciaries.

To date, stable value plans have generated a higher investment return than money market funds because they can invest in securities with longer durations, paying higher interest rates.  When interest rates turn higher, however, this benefit becomes a drag.  Money market funds are more nimble and can take advantage of the higher rates in a rising rate environment.

Since most Stable Value funds are “marketed” as higher return investment options, plan participants will be very surprised to learn that their Stable Value options may be paying returns less than money market funds.  Employees must be educated on the true risks and mechanics of Stable Value Funds.  Failure to educate employees properly can bring sizable fiduciary risks on the plan sponsor.

With interest rates so low, Fiduciaries must not only monitor an upturn in rates, but they must also track withdrawals from Stable Value programs.   If interest rates do not increase, participants undoubtedly will begin switching into investment options generating higher returns.  Whether this makes investment sense is irrelevant.

The wrap contracts (which guarantee the value of the stable value program) often contain covenants that require the Program to maintain a minimum number of participants or assets in the Program.  Falling below this threshold constitutes a breach of the wrap agreement, and would allow an insurance company to walk away from the guarantee.   This is a total disaster from the perspective of the plan fiduciaries.

The very name “Stable Value” lulls everyone — participants and fiduciaries, alike – into a false sense of security.   These are highly technical and complicated investment options that should be monitored, evaluated and negotiated by Stable Value experts.

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Credit-Related Strategies Warrant Heightened Scrutiny

It’s called the Great Liquidation.  As reported in today’s NYT, The Haggling for Troubled Assets Begins, “hundreds of billions of dollars of bad investments …are going up for sale”.  Fiduciaries must ensure that these bad investments do not end up in retirement plans.

Notwithstanding TARP, QE1 and QE2, financial institutions still hold impaired or “bad” assets.  This simply means that the assets are still held by institutions at values that are likely far in excess of their fair market value.

And so, the Great Liquidation begins.  The term — coined by Fortress Investment Group — refers to the prediction that “you’re going to see in the next five years, more financial asset liquidations than you’ve seen in the sum total of the past 100 hundred years.”  An exaggeration?  Ok, let’s assume it’s simply more than in the pat 50 years – that’s still a lot of assets being put up for sale.

If this appears daunting, don’t worry.   Fortress already has $12.7 billion of assets devoted to credit-related private equity and hedge funds.  No doubt the entire spectrum of the Wall Street herd — investment banks, commercial banks, hedge funds and private equity firms — will be bulking up in this area, if they haven’t already.

Just imagine a 2% management fee and 20% of profits on “hundreds of billions of dollars”.  Now that’s a nice bonus pool!

Before the Great Liquidation Orgy (my term) begins, however, Wall Street is going to need to raise money to indulge in this financial bacchanalia.  Certainly there will be private investors, wealthy individuals, sovereign wealth funds.  But the $16 trillion pool of pension assets is the granddaddy of all funding sources.

I can just see the entire pension investment consulting industry working itself into a frenzy cranking out their graphic laden presentations recommending Credit Related investment strategies and firms.  The graphs and the statistics, no doubt will be very impressive – worthy of PhDs.  But Beware.  “Its déjà vu all over again”.

Think back to the early 90’s.   Who had heard of hedge funds?   Private equity firms were still referred to as LBO firms.  In terms of financial markets and products it was a different era.  As the new century dawned, however, investment strategies and products exploded in complexity.  Simultaneously, in order to remain relevant, the pension consultants began touting these new products.

In time, consultants were recommending significant shifts in allocations to “Alternative Investment Classes”.  It was not surprising to see allocation recommendations of 8%, 10%, 15% or more to alternative asset classes.  In fact, in the summer of 2008, I had lunch with the Chief Investment Officer of a university endowment who said that they had allocated 45% of the endowment to hedge funds.

We all know the outcome of this story.  In the end, the investment returns of many plans were negatively affected by these allocations.  No one knows yet, if in the long run the plans were better off or worse for these significant allocations to Alternative Asset Classes.

We do know one thing, however.   Consultants merely make recommendations.  Plan fiduciaries hold the real power in making allocations to asset classes and to specific managers.

Without a doubt fortunes will be made in the course of the Great Liquidation.  The question is whether retirement plans need to venture into this arena.  Fiduciaries must invest assets prudently.   When a new asset class emerges, such as credit-related investments, how is a manager evaluated?  What’s the track record?  How is risk measured?  How are projected returns evaluated against the risks that are assumed?  What about due diligence on investments?

The list goes on and on.

The Media is going to feature the newly minted credit-related billionaires.  Investment returns may likely be huge.  The allure of jumping into these investments will be strong.  The consultants will be putting on a hard press.

Plan fiduciaries must be very wary.  For those who do decide to play in this game, make sure you do your homework.  Remember, you are investing other people’s hard earned retirement dollars.  Keep the financial debacle of 2007-2009 at the forefront of your mind.  And, tread carefully.

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