As the creator of the research covered by Barry Burr's corporate pension fund performance article in the July 21 issue, I feel some commentary is due.
First and foremost, I congratulate Barry on achieving an accurate review of my research. I thank Barry for portraying the research with integrity.
However, my comments in the last paragraph of the article require clarification.
My concern is that an intelligent reader would conclude that the change in strategies that I propose amounts to eliminating active management and replacing it with indexed portfolios. Actually, the strategy that I propose is a review of asset/liability management.
The strategies used by most pension funds involve asset diversification for the sake of controlling the volatility of investment returns.
The result of this strategy has been tremendous volatility in the relationship of pension assets to pension liabilities; a standard deviation of about 15% per year. If we care to open our eyes and look, FAS 87 pension accounting shows this to us.
The second problem with the asset diversification strategy is that the diversification of equity investments pushes the funds into assets with high transaction, management and custodial costs and no obvious rationale for an inherent excess return. In fact, we can only demonstrate the higher costs.
A proper understanding of pension funds shows the asset allocation strategies currently recommended are wrong.
The only assets deserving of strategic consideration are large U.S. stocks and long U.S. bonds. All other assets are tactical assets. The sole reason for owning tactical assets is to add return.
U.S. pension funds have experienced the risks and the costs of tactical assets. They have not experienced the added value. The net result is that current strategies should be completely rebuilt.
Unfortunately, people are too focused on easy answers.
Indexing is an easy answer. Indexing is a poor answer where costs will be increased through index management. Indexing is also a poor answer where the strategy is bad. It can only guarantee achieve a bad result at a low cost.
The bottom line is there are no easy answers. Indexing does not relieve the sponsor from the burden of thinking. Indexing does not address returns. A poor strategy is a poor strategy whether indexed or not.
Finally, the only way to add value is through active management.
Pension funds blaming active management for poor results are looking in the wrong place.
I hope this letter clarifies a complicated discussion.
Stephen J. Church
Piscataqua Research Inc.
Advisers dropping clients
Please forgive a delayed response to your March 17 Editorial Page column on "Adviser risks 'suicide' to keep its style."
A manager resigning an account does not strike me as a particularly reckless or inappropriate step to take. If the manager and the client are not seeing eye to eye on the management of assets, it is probably a fiduciary duty to take precisely this action.
What I find surprising is (1) how rarely it happens, given that needs of sponsors will change over time and that a fiduciary obligation probably would dictate this step at least once in awhile, and (2) that the action of resigning an account is often seen as controversial, even dangerous.
First Quadrant has stepped down from a very small handful of accounts over the years, but has always taken great pains to do so discreetly and in careful cooperation with the client.We have never thought of these actions as rash or dangerous, but part of our fiduciary responsibility, in circumstances where a client's needs have changed or (rarely) where we have a different view on managing the money.
While I am puzzled that an issue of remaining "fully invested" would be a catalyst for a manager resignation, I commend Snyder Capital Management for having the common sense to take this step when they felt it to be a fiduciary obligation.
In my view, no manager should be punished for taking this step if they believed (1) it to be an appropriate action as a fiduciary and (2) they handled their resignation discreetly and carefully, with due respect for the long-term needs of the client. I question the consultant's annoyance or embarrassment at this action!
Robert D. Arnott
President and chief executive officer
An Aug. 4 editorial in Pensions & Investments calls for an end to sole trustees of pension and trust funds. We agree that a board is much less susceptible to corruption, although even some of the best boards are not immune from criticism.
The May 17 Sacramento Bee had an article about a questionable $100 million closed-door deal where the placement agent was a former board member. The California Public Employees' Retirement System has called for the individual accountability of directors for corporations.
We would take the P&I editorial one step further and call on all public pension funds to make all relevant closed-session meeting notes public, once the investments have been executed.
For hyperlinks to the Bee article and the CalPERS director policy, see our Internet site, www.corpgov.net/news.html.