Harrison Fiduciary

Asking the Right Questions — a Fiduciary Responsibility

Sovereign debt (Greek and others) continues to plague financial markets.  My last few posts have tried to illustrate that these are not abstract issues, but can have real impact on money market funds, securities lending and stable value programs.  Fiduciaries must understand these implications.

Today the NYTimes reports that many money market funds have been paring back their exposure to european bank debt.  Wary Investors Shun European Banks.  As explained in the article,  European Banks rely heavily on short term funding provided by U.S. money market funds.   And, let’s not forget that most US investors turn to money markets as safe investments.

Not surprising, there is a wide spectrum of investment views on european sovereign and bank debt.  The Times points out these different views and, these differing views make markets. Again, no surprises here.

When asked about money market funds’ exposure to european debt, Deborah Cunningham, a senior portfolio manager at Federated Investments commented, “We’re always rethinking it and assessing it, but we’ve not come up with a different answer,” she said. “We don’t feel there’s any jeopardy with regard to repayment.”

Similarly, a spokesman from Fidelity Invetments, Adam Banker explained, “We’re very comfortable with our money market funds’ European bank holdings, including French bank holdings.”

Both Federated and Fidelity are huge players in the 401(k) retirement arena.   The article reports that they manage $114 billion and $428 billion, respectively in money market funds (note, the article was explicit about the Federated money market assets under management, where as the Fidelity number was not specifically identified as money market assests. However, Fidelity reports that it currently manages $1.5 trillion of assets, so it is reasonable to assume that $428 billion is held by money market funds).

The real point is that Federated and Fidelity collectively manage more than $500 billion in money money market funds.  Thousands of plan participants are relying upon their judgment with respect to the safety and security of the participants retirement assets.

The volatility of financial markets these days is historically very high.  In large part due to questions raised by European Debt.

Fidelity and Federated must do better than “we’re very comfortable”  or “we don’t feel there’s any jeopardy … “.  Those are nice quotes for a NYT article.  But for fiduciaries these quotes should constitute red flags.  If we have learned nothing else from the financial crisis, bland statements issued by corporate spokespeople have the potential to hide serious issues.  According to the Times article, Federated has about 13 to 17 percent of assets … invested in French bank debt”.   That is not insubstantial.  It begs further explanation.

For any Plan Sponsor whose retirement plans offer Fidelity or Federated money market funds, pick up the phone today.  Just ask a few basic questions.  Remember, other smart investment professionals are not comfortable.  They in fact see potential jeopardy ahead. Fidelity and Federated must explain their positions.  Here’s a few questions for starters:

• Why are you comfortable?
• Why isn’t there any jeopardy?
• How did you analyze your investment positions to reach this conclusion?
• What assumptions did you make?
• What are the weakest points in your analysis.

As if often the case …. a few open ended questions can spark a very enlightening discussion.

Plan fiduciaries have an obligation to ask these questions and assess the reasonableness of the responses.

Rarely would I turn to Ronald Regan for wisdom, but here goes,  “Trust, but verify.”

Continue Reading

An Independent Fiduciary Can Be Your Best Friend (and Security Blanket)

No one has the right answer.  This weekend’s news papers and financial blogs are filled with every prediction imaginable (from economic disaster to boons) and financial advice to fit each prediction.

With the markets swinging 500 points in opposite directions, this is not the time to embark on market predictions and changes in investment strategies.

Steep, drastic price plunges are not fun.  Like the free-fall drop on a roller-coaster when your stomach does its own loop-de-loop, these prices plunges elicit a real and physical reaction.  Panic is scary.  A racing heart beat, cold sweats and sleepless nights are subjects of cliches.  But, when you are experiencing it yourself, it ain’t a cliche.  It is very real.

From the deepest wells of our very being, panic surges forward.  The visceral emotional response becomes its own reality.  Emotion as reality.  That is never a good place to be. And certainly, not a time to be making decisions.

Prudence on the other hand, provides the required antidote to panic.  In the perennial push and pull between heart and mind, prudence provides the counter-weight to panic. Defined as “care, caution and good judgment, as well as wisdom in looking ahead” (see, www.dictionary.com), prudence requires the mind to prevail over the heart.

The key to extracting oneself from the distorted reality of pure emotions, one needs a trigger, or a technique to break the panic spiral.  Within the world of managing and overseeing retirement assets, care, caution and good judgment can be supplied by an Independent Fiduciary who can review and assess your portfolios against the plan’s Investment Policy Statement (IPS).  Call her.  She is paid to be prudent.

Hopefully drafted with the assistance of professionals and during a period of lessened volatility and other external pressures, an IPS reflects the prudent judgment of plan fiduciaries.  The IPS, in effect, is the road map for wisdom in looking ahead.  An Independent Fiduciary should always have the IPS in hand.

Have the investment performance of each of the plans’s asset classes evaluated.  Determine if any portfolios need to be re-balanced in order to reflect the allocation among assets classes envisioned by the IPS.  Instruct your Independent Fiduciary to make certain recommendations and then implement them.

Taking specific prescribed actions can deflate the power and energy of panic.  The key is to make sure that these actions had been well thought through before the specter of panic arises on the horizon.  An Independent Fiduciary can help allay the fear and the imprudent actions which a volatile market environment can inspire.

Continue Reading

Is Anyone Paying Attention?

The debt-ceiling crisis has been momentarily addressed and the financial markets are continuing to tremble.  In my past few blogs, I’ve raised topics which Plan Sponsors should address with their various plan fiduciaries.   It’s all about being prudent.  Today, the focus is on Securities Lending.

In the 2008-2009 financial crisis, Securities Lending programs froze.  Collateral pools experienced huge liquidity issues and loans could not be unwound.  Pension plan portfolios suffered significant loses.

The last time around the culprits were mortgaged-backed securities and all the various related derivatives.  This time, it could be sovereign debt.  Today, the NYT reports Large Banks in Europe Struggle with Weak Bonds.  The main thrust of the article is that sovereign prices for certain European countries are weakening dramatically thereby affecting the capitalization of some large European banks.

However, tucked deep in the article are references to repo transactions and the posting of collateral.  Sovereign debt is often used in these trascations.   This is where Securities Lending (the “reverse” side of a repo transaction) comes into play, and where Plan Sponsors should be focusing their questions.

Plan Sponsors should examine two separate, but very closely related, potential risk related to European debt and the European banks:

Short-Term Bank Paper Held by Collateral Pools — Remember Lehman Bros?  It’s paper was held by many investors, including pension funds.  As the paper became worthless, securities lending collateral pools lost values.  Plan Sponsors are on the hook for the investment losses related to collateral pools.  Many plan sponsors were not happy.

Collateral Posted by Broker/Dealers — When broker/dealers borrow securities to facilitate short sales by their clients, the broker/dealer must post collateral.  Often, Sovereign Debt offered as collateral qualifies for better terms than other forms of collateral.  Therefore, there is a huge incentive for broker/dealers to offer Sovereign Debt for these purposes.  However, to the extent that debt from any of the troubled European countries was used as collateral, and as prices continue to deteriorate, the broker/dealers will have to post more collateral as the value of this debt deteriorates.  Watch the capitalizations of the broker/dealers.

Don’t dismiss the role of broker/dealers in the stability of our financial system.  As Lehman as entered in bankruptcy, all the others teetered on the edge of the abyss.

Few areas are more technical, “nichey”, or esoteric than Securities Lending.  If Plan Sponsors want to partake of the benefits of Securities Lending, then they must really understand the risk.  They must dive into the details which I outlined above.

If these questions are too “geeky” for Plan Sponsors to develop in-house expertise, then they should delegate oversight to true experts.  Ignoring complicated issues can never be prudent.

Continue Reading

Does Anyone Really Know?

Everyone takes money market funds for granted.  Don’t know where to invest idle cash?   Stick it in a money market fund, right?  Our entire financial system treats money market funds as safe and secure investments.

And, they are safe.  Until they are not.

Today’s NYT, Hopeful, but Wary at Money Markets, prudently identifies the fault lines and risks associated with money market funds.   Fortunately, Edward Wyatt’s reporting is not a Chicken Little,  the-sky-is falling rendition of risks inherent in the financial markets.  [The press and blogosphere are filled with too many of these.]  Instead, Wyatt effectively outlines and explains the risks inherent in money market funds in the context of extreme volatility in treasury securities.

Money market funds exist solely by virtue of a vastly complicated regulatory structure.  Anyone interested in the risks associated with money market funds must be familiar both with the regulations as well as with the investment securities.  One without the other is simply half-the-story.

And, as the Wyatt’s article points out, money market funds are not free from risk.  During the financial crisis of ’08-’09 one of the largest money-market funds, Reserve Primary Money Market Fund, “broke the buck”.  That is, investors lost money.

Plan Sponsors often are not familiar with all of the intricacies surrounding money market funds.  As fiduciaries, however, they should understand the general parameters of the risks.  And, more importantly they should make sure that the experts they have hired are in fact experts on every intricacy and beyond.  The hired experts, however, do not take the plan fiduciaries off the hook.  Everyone needs to be doing their job.

Wyatt, quoting an executive from Fidelity Investments, reports that Fidelity, which manages $440 billion in money market assets, has had “a contingency team focused on this since the end of May.”  Fidelity recognizes that “we have to be prepared to respond to the unthinkable”.

In light of the Reserve Primary Fund’s experiences just a few short years ago, the previously unthinkable is not so unthinkable.

If Fidelity is engaged in contingency planning, prudent dictates that all plan fiduciaries should be engaged in similar contingency planning.  In the financial world, the unthinkable can happen.  Plan sponsors must plan accordingly.

Continue Reading

Confusing Times  — Simple Measures

The headlines may change, but the theme is the same — too much debt.

Weather it is the never-ending saga of European debt (Greece, Portugal, Spain), or the debt-ceiling gridlock here in the US, policy makers, politicians, economist, investors — everyone is trying to make sense of out the debt.

No one has any answers, just best guesses.  In the midst of all of this confusion, however, fiduciaries still must act prudently.  What’s the best course of action?

First, and foremost, fiduciaries do not need to be economic or investment experts or savants.  They do not need to look into their crystal balls and predict the outcome or even the best course of action.

Instead, they must act prudently.  The following actions will advance their fiduciary obligations:

1.  Review investment policy statements and investment accounts

Simply identify the investment accounts or strategies which might be effected by the debt issues.  One could say that all investment portfolios could be effected.  However, it would not be difficult to prioritize the accounts.  No doubt cash,  money market, stable value, and other fixed income portfolios should be at the top of the list.

2.  Meet with your consultants and advisors

Pick and the phone and request a meeting with your advisors — either in person or via teleconference.  Don’t worry if it isn’t time of a quarterly or half-yearly portfolio review.

3.  Obtain their analysis of the market environment and their recommendations

Remember, while a fiduciary does not have to be an expert on these issues, your investment advisors do.   They are paid to be experts.   Therefore, they should have cogent positions and explanations for the current market environment.

4. Question their assumptions

Don’t blindly accept their responses.  Questions their assumptions.  Explore alternative options in the event that their predictions don’t materialize.

5.  Inquire if they have conducted stress tests on the portfolio

Simulating various market conditions has become a standard tool for monitoring investment portfolios.  Require  your managers to provide you with the results of these various tests.  And, most importantly, determine if you are comfortable with the results.

6.  Get recommendations in writing

Don’t be bashful.  Ask your advisors for their advice in writing.  If they hesitate, explore their motivations.  But, continue to press.

7.  Document, Document, Document

Document your process.   This cannot be stressed enough.  Contemporaneous written records of your process and the results of the process are critical to fiduciary prudence.

The issues are daunting.  The landscape changes daily.  Nobel prizing winning economists line up on every side of the issue.

For fiduciaries, be diligent about your process.  This will ensure that you are acting in the best interests of plan participants.

Continue Reading

Fiduciaries Really Need to be Experts

Plan sponsors need to re-calibrate their fiduciary obligations with respect to their retirement plans.  They have to ask hard questions. Do they have the relevant expertise to fulfill these roles?  Do they understand the “business” of maintaining and administering plans?  And, finally, do they want to devote time and resources to this responsibility?

In reality, most plan sponsors are too busy executing on their business strategy to worry about fiduciary matters. And, this is the way it should be.  Typically, HR and finance staff members oversee the plans and identify policies, procedures and vendors — all to be rubber-stamped by  high-level corporate committees.

This model is old-school, is broken, and must be fixed.  A recent appellate court case, in the 7^th Circuit, is bringing these issues into sharp focus.  Plan Sponsors need to pay attention.

The volume and sophistication of ERISA class action lawsuits has grown significantly over the past decade.  Until this April, however, plan sponsors and retirement plan service providers have largely successfully defended against this onslaught.  This has been good news for fiduciaries.

In April, however, the 7^th Circuit, previously a defendant-friendly court, handed plan sponsors and fiduciaries, a very serious set back.  In a class action suit against Kraft Foods, the court did not dismiss the case, but instead sent it back to the district court to determine whether the plan sponsor, Kraft, breached its fiduciary duty to the participants.

This holding is a nightmare for plans sponsors and corporate fiduciaries. No fiduciary wants a trial court to determine whether it’s acts or omissions satisfied the fiduciary standards of ERISA.  Likely the insurance companies will settle.

Nonetheless, this case goes to the heart of the critical importance of fiduciary processes.  With respect to a company stock fund, the court questioned whether the fiduciaries ever examined the operational structure of the fund and balanced the relative merits and drawbacks of different structures.  Furthermore, a question was raised as to whether Kraft ever reached an affirmative decision supporting one structure over another.  Surprisingly, no documentation was submitted which would support that a decision had, in fact, been made.

In addition, the court was not comfortable with Kraft’s 10 year relationship with its record-keeper.  Although consultants had advised that the recordkeeping fees were reasonable, the court was critical that third party bids were not obtained and used for comparison purposes.  Maybe the court just thought that the relationship was too cozy.

At a minimum, this case indicates that fiduciaries must develop a sophisticated understanding of the technical intricacies of the mutual fund, recordkeeping, and fund administration businesses.  Relying on consultants is not good enough.  Instead, fiduciaries must dig into the weeds, compare and assess the merits, deficiencies and costs of various service delivery models.

Plan Sponsors need to focus on capturing their own target markets, developing products, satisfying customer needs and growing their earnings. Why should they be bothered with this stuff?  It can be a nuisance.

As stated in the title of this posting, fiduciary oversight is not a part time job.  There is significant subject matter and procedural expertise required in discharging fiduciary responsibilities.  Plan Sponsors should recognize the professional skill set required to serve as a fiduciary, and acknowledge that it is not in their interest to develop or maintain this expertise in house.  Plan Sponsors, as well as participants and beneficiaries would be best served by hiring expert Independent fiduciaries to oversee the plans.

Continue Reading

It Could Be Money in Your Pocket

Well over a year ago I wrote about the impact of fees in accumulating assets in retirement plans.in , It’s the Fees Stupid. Every 12 months is not too frequent to remind ourselves of this critical point.

In today’s NY Times, Ron Leiber sets forth a compelling analysis of the impact of fees on retirement savings in a 401(k) accounts.  Leiber also reveals a sophisticated understanding of the business of providing and pricing 401(k) services.  Revealing Excessive 401(k) Fees.

With the advent of 401(k) plans, mutual fund houses like Fidelity (mentioned in the Leiber article) launched turn-key products for plan sponsors.  Known in the industry as “bundled services”, a plan sponsor could turn to a single firm for a complete $401(k) program — all in one, they would receive recordkeeping, administrative, investment and sometimes even shareholder support services.

The mutual fund houses, had one goal in mind:  get their mutual funds on the platform of investment options for plan participants.

This was a great business model, until the class action lawyers rounded up plaintiffs to challenge these arrangements.  Numerous cases have been filed around the country, and Leiber focuses on the Fidelity case.  While the allegations are complex and nuanced according to the facts of each case, the basic claim is that the fee structures for these products were excessive and unreasonable.  Part of arguments also include allegations that the fees structures are opaque and not fully disclosed, therefore no fiduciary or plan participant could make an assessment of the reasonableness of a fee.  If a fee is not properly disclosed, it can be assessed for reasonableness.

As Leiber notes, these cases have been winding their way through the court system and it is taking a long time for the issues to be resolved.  No doubt, if the initial proceedings do not go well for the mutual fund houses, the settlements with the insurance companies will be significant.

Theses cases caught the attention of the Department of Labor, and as Leiber noted, the Department has issued new regulators requiring fee disclosures.  However, disclosing the fees is only the first step.  Fiduciaries must understand the various fees and understand the price competitiveness of the fees.  Expert independent fiduciaries could extract significant savings on behalf of plan participants.

Why does all this matter?

Leiber puts in very real terms, “just a quarter of a percentage point in annual savings now can mean tens of thousands of dollars more come retirement time.”   Why should this money end up in the pocket of mutual fund execs or sales people.   Instead, it come be “between vacation each year or two at age 75, or one plan ticket, or serveral, for the grand children to come see you annually.”

The mutual fund execs and the investment managers are likely flying around in their private planes.  Better that retirees get to spend time with their families.

Fees matter. Fees add up over time.

Prediction:  Future ligitation will focus on another mutual fund industry product:   target date funds.   More on that in another Post.

Continue Reading

BlackRock Solutions Needs to Shed Light on Valuation Methods

Today’s Wall Street Journal, BlackRock’s “Geeky-Guys” Business, focuses a spot light on BlackRocks Solutions — a small business unit tucked away in the bowels of BlackRock, complete with its own elevator entrances, computers and separate office floors.  If nothing else, haven’t we learned from the ’08-’09 financial crisis, that “Geeky-Guys” hidden away from view have the potential to inflict great harm on our financial system.

Let’s give BlackRock Solutions (BRS) the benefit of the doubt — they have some really smart people who work really hard.  And, during the height of the financial crisis BRS assisted with the management of portfolios which held a lot of funky assets.  The system and US government (including the taxpayers) needed BRS.

As the WSJ reports, BRS provides various risk management services, including asset allocation, to major pension plans — both public and private.  As part of these services, BRS also values hard to value assets according to its own proprietary algorithms and processes.  These valuation process are secret — according to the WSJ.

While I obviously am not privy to the contracts between BRS and its clients, I have strong suspicions that BRS is hired as a fiduciary to provide these services.  Furthermore, the people at the pension plans who hire BRS are likely fiduciaries themselves.

Based upon these two assumptions, I have 2 simple questions:

1) If valuation processes are secret, how do the fiduciaries which hire BRS know that they are prudent processes?

2) Are the fees which BRS charge dependent upon these secret valuations?

These are not sophisticated questions.  But, the answers go to the heart of our pension system.

ERISA is very clear.   Plan fiduciaries are able to hire and delegate responsibilities to other fiduciaries.  If they do so, the decision to hire and delegate these responsibilities must be a prudent decision.  Furthermore, the plan fiduciaries must continue to monitor the hired fiduciaries.  How can the decision to hire BRS be prudent if the valuation methods are secret?  Furthermore, how can anyone monitor whether BRS is discharging its responsibilities in the face of secret valuation methods.

Finally, I also strongly suspect that BRS  charges a fee based upon the assets under management.  If this is the case, then the secret valuations placed upon the assets can directly effect BRS’s compensation.  This is a problem under ERISA.

Yes, the professionals at BRS are smart, and we should trust them.  But, that is besides the point.  Assuming that they are fiduciaries, secrets can’t be permitted.

Continue Reading

Outsourced Chief Investment Officer — More Questions Than Answers

Pension investment consultants have found their latest fad …..outsourced CIO services….otherwise known as OCIO.

From benchmarking, to style boxes, every couple of years the investment consultants cook up a new fad to sell to retirement plan fiduciaries.  As a business model, replenishing the product line has served the consulting industry very well.  The question, however, is “how well have the plans performed using their advice?”

And now, the industry is off on its newest fad:  OCIO.  While each firm might tailor their services in a unique manner, the general theme is the same. Rather than offering traditional consulting services, with an OCIO, a plan turns over its entire portfolio to the consultant to be managed.

Presto Change-o!!!!  The lowly consultant morphs into the coveted role of investment manager.  Rather than receiving a fee for consulting services they can now charge fees based upon the assets under management.  And, who knows? If they are lucky, they may even get a performance fee: the holy grail of asset management.

FundFire reports on this industry trend, Consultants Tweak Outsourced CIO Message.  As FundFire explains, however, there is a lot of confusion underlying the OCIO title and the services actually being provided.   This confusion requires the industry to “Tweak”  its message.  In fact, one public plan rejected the shift from traditional consulting to OCIO because of the lack of clarity surrounding these services and this role.

Two points in this article jumped out at me.

First, a critical term is missing. Neither the consultants, nor the article, mention the term “fiduciary”.  This entire model is presented as an asset gathering and fee generating exercise by the consultants.   But where is the fiduciary obligation to the plans and the participants?

Second, the article, in the opening paragraph, references potential “new conflicts of interest” presented by this new arrangement, but does not fully explore these conflicts.  Very often consultants provide multiple services to their clients.  Adding a OCIO role can add to these potential conflicts.

Furthermore, consultants also have significant relationships with other investment managers.   This side of the relationship equation is very murky.  How will the consultant  select managers for its OCIO services?   How will these services be priced?  These are just the start of the questions.

From the perspective of the consultant industry, it is completely understandable that they want to explore new ways to develop their services.  As Shale Lapping, president of IPEX, an independent consulting firm in Plymouth, MI states, “the ability to generate additional revenue is obviously an attractive position …. The margin has always been smaller for consultants (than for managers); that’s not secret in the industry. [Outsourcing] brings in higher margins and makes it easier to retain quality talent.”

This is well and good for the consulting industry.

At Harrison Fiduciary Group, we unequivocally and categorically reject this form of the  OCIO business model as embraced by many consultants.  While it might make sense for the consultants, it doesn’t necessarily makes sense for clients.

On one level, we do support the delegation of investment oversight, monitoring and management to outside, independent experts. In contrast, however, at HFG our business model starts and finishes with our role as a fiduciary for plan assets.  First, we provide a single service to plan sponsors — fiduciary services.  We don’t have multiple services to sell, or rather cross-sell, to a plan sponsor.  We have no ability to increase our fees with a client.  We also do not have affiliates such as broker/dealers which also can give rise to conflicts of interest.  Plain and simple, we pledge:  No Conflicts of Interest.

Importantly — and maybe even heretically in our business — we will charge a flat fee for our services.   We are not engaged in an asset gathering exercise and will not charge a basis point fee for assets under management.  Anwill bed, of course, we will never charge a performance fee. Instead, our flat fee is based upon (i) the complexity of an engagement, (ii) the resources needed to execute the project and (iii) the fiduciary risks which we assume.  Our fees will never increase simply because the value of a particular market increases.

To use a much over used expression; “we are thinking outside of the box”.  We present an alternative business model for the oversight, monitoring and management of retirement assets.  We are competing against traditional big players in our field.  However, we have a principled and new approach which puts the best interest of plan participants at the core of our business model.

We are not embracing a fad by serving as a fiduciary.  The duties of a fiduciary harken back to the 16^th century.  At Harrison Fiduciary Group we serve a time honored role.

Continue Reading

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.

Continue Reading