I did a double-take. I had not yet settled down with the paper, but merely glanced at the headline. Thinking to myself, “no this can’t be true”. I looked again, “Public Pension Funds Are Adding Risk to Raise Return”. Ditching my usual morning ritual, I sat down immediately in disbelief and read the lead article of the New York Times on March 8, 2010. The Article outlines that many state and other governmental pension funds are increasing their exposure to riskier asset classes with the expectation of earning higher investment returns and contrasts this approach with many corporate plans which are taking the opposite approach; that is, decreasing risk in their portfolios.
A former chairman of a state pension review board commented, “In effect, they are going to Las Vegas…..Double up to catch up.” In other words, if the economy and financial markets aren’t experiencing enough challenges, we now have to deal with high-roller state pension officials gambling with pension assets.
While academics, policy-makers and pundits alike continue to offer explanations into the causes and effects of the financial meltdown of 2007 & 2008, one overriding take-away from this experience is the recognition that financial risk is real. Yes, riskier assets can deliver higher returns, but they can also deliver bigger loses. I am not an investment professional, but merely a fiduciary lawyer, but even I know that there are two sides to the risk equation.
As a fiduciary matter, one can only wonder about the processes in place which gave rise to these decisions. Merely from reading the Article, however, one senses that there were no processes. Instead, confronted with the reality of investment returns not meeting projections and the potential to have to make increased contributions to the plans, it was simply easier to increase the risk profile of the portfolio. The fiduciary question is whether it is prudent to do so?
Possibly reasonable minds could come to opposite conclusions on the prudence of this strategy. But the real question is, on whose behalf are the fiduciaries making their decisions. Or, put another way, to whom do the investment fiduciaries owe a duty of loyalty? It appears that these decisions were made probably with the States and the taxpayer foremost in the fiduciaries minds; that is, if the over all goal is to decrease the contributions by the state, then dial-up the risk attributes of the portfolio. But, who is looking out for the best interests of the plan participants and retirees? I always thought that was the fiduciary’s obligation.
Here’s the nub of the issue: in times of limited resources it can be easy to lose sight of whose interests a fiduciary represents. Whether it is a state or a corporation which is funding pension obligations, it is always in the funder’s interest to increase the risk profile of the portfolio. But is it in the interest of the participants? There is a healthy tension in this equation.
Unfortunately, many times individuals who are plan fiduciaries are nonetheless beholden to the funder of the plan — whether this is a state employee or an employee of the plan sponsor. In these contexts, its easy to see how risks get shift onto the plans. Absent robust policies and transparent decision-making, serious conflicts of interest can arise. Fiduciaries must be sensitive to these conflicts, and avoid them at all costs.
Next week, “Ruth Madoff launches New Investment Fund”. Stay tuned.