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February 20, 1995 12:00 AM

PENSION FUNDS AND STRATEGIES FOR DERIVATIVES (PART 6 OF 6)

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    who is in my office and say, "Well, if that's where all the risks are, then that's where all the risks are," and I don't hire anybody else to take a look at it for me. I don't do the due diligence myself, and then I guess five years later I sue them if things didn't work out exactly the way they said. People don't take responsibility.

    Mr. Service: There is a lack of ability for service providers to the corporate pension fund area, particularly in the trustee arena, to accurately provide to the sponsor the information the sponsor needs to provide the check and the balance in the system.

    What Scott is pointing out is that there is an absence perhaps of check and balance in a lot of sponsor organizations.

    The other risk that I would point out as well is I guess what's termed "maverick risk" right now in the business. That is, as long as you've got the media blaming everything that goes wrong every place in the world on derivatives, there is certainly a risk in a pension fund establishing a position, even in the most mild-mannered derivatives program.

    Mr. Gurner: I don't think the technology is in place to completely control a futures program.

    Mr. Nederlof: The key point here is that very few systems and back offices are really very good at handling the full range of these instruments, and it kind of comes down to the ability to track them in real time - the FedEx commercial example is "real-time package tracking." Until the systems are able to handle the full range, the simpler answer would be nobody should accept any kind of widget that doesn't fit into their system and isn't completely disclosed.

    P&I: Are derivatives appropriate in 401(k) plans where participants direct investments?

    Mr. Shultz: I think it's entirely appropriate. To the extent that derivatives can be used to change the risk/return trade-off of 401(k) investments, I think it's a good idea. To the extent derivatives can be used to truncate the downside, create floors and such, I think there are many, many uses in 401(k) plans.

    Mr. Lummer: But clear disclosure is the key thing.

    Mr. Lummer: You can create some structures that would really induce investors who have never been in equities and only been in (guaranteed investment contracts), to get involved with equities, and if it's disclosed right, it can be great.

    Mr. Service: And while that's great in theory, I'm not certain how you are able to do that within the structure of a 401(k) that allows ready transfers on a daily basis from those funds right now, because I think what you are talking about really requires a horizon; and you are implying the person that's investing in that fund is going to need to read all the communications tools and understand if they pull out before the horizon is over that they indeed could suffer a loss. So I'm not quite certain, to be honest with you, how well that structure will fit in with a 401(k) plan.

    There are certain risk and return strategies that are perhaps inappropriate, because you cannot assume that all of your participants are going to read all of the communications materials.

    Mr. Baker: Are derivatives appropriate? I don't know. It's no different than if you walked up to me and asked me should I use a hammer. What are you trying to do? I don't know. I mean, if you're trying to build a house, yeah, I mean, you'll need a hammer, but if you're trying to settle an argument, ah, probably not an appropriate use.

    If you construct in a 401(k) a particular kind of strategy that's disclosed to them, this is exactly what we're going to do and the derivatives are used appropriately to achieve that objective, sure, they are appropriate.

    Mr. Shultz: That competes with the parsley, I think.

    Mr. Gurner: Most employees are trying to understand what an equity is.

    Mr. Shultz: They are probably going to send you copious amounts of parsley.

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