A better way to hedge
Your article, "UFCW hedges to lock in gains" (Dec. 8, page 3), brought to mind the famous retort of the Queen in Lewis Carroll's "Through the Looking-Glass."
"A slow sort of country you live in," said the Queen to Alice. "Now here you see it takes all the running you can do to keep in the same place."
In a defined benefit pension plan, it is somewhat erroneous to assess the worth of an investment strategy by comparing its return to the return on cash. The four-year zero-coupon bond/call option strategy described in the article will break even "in a cash sense" in a standstill environment. However, the pension liability should be implicitly growing at the actuarial assumed interest rate of the plan.
In four years, assuming a modest 6% interest assumption, this would imply, in a standstill investment environment, that the liabilities of the plan have grown in excess of 24% more than the assets, resulting in an underfunding of the pension plan.
The situation becomes far more significant and hazardous if a period of deflation is experienced in the next four years. Given the course of events in the Asian economies, such a scenario is more than remotely possible.
In a deflationary setting, the experience in the decade of the 1930s taught us, the stock and bond markets decouple. Long-term interest rates and stock prices decline at the same time. This is a disastrous scenario for the funding strategy described in the article.
True, the UFCW plan will get all its cash back when the four-year strips mature and the call options expire worthless. However, the decline in interest rates will imply the long duration liability of the defined benefit pension plan will grow enormously, resulting in a critical underfunding of the plan.
However, all is not lost since the strategy described in the article can be repaired to perform well in the context of the pension plan. The trustees of the UFCW should contact us. We will be glad to show them how to salvage this provocative situation they got themselves into.
Leonard H. Wissner
Ward & Wissner Capital Management
I found Kenneth Grossman's Jan. 26 article on the AIMR Performance Presentation Standards quite interesting, to say the least. It has stirred a great deal of attention.
As one who frequently consults, who has been responsible for three industry surveys, and who frequently speaks on the standards, I find much to comment on in Grossman's piece.
Five years after the standards went into effect, we find not only wide acceptance within the United States, but globally. A few countries have adopted the standards as written, while others have used them as the basis for their standards. The general acceptance of the AIMR-PPS has resulted in the formation of an international group that's working toward a set of standards, to ensure uniform presentations globally.
Although I believe the standards primarily were intended for the investment adviser market, we've found acceptance by mutual fund companies, insurance companies and banks. Even brokerage firms are adopting them.
Our surveys have consistently found more than 90% of the market either claims compliance or plans to comply. Mr. Grossman's point that we "need to garner the support of the investment community" is accurate; our latest survey found wide acceptance by investment consultants and plan sponsors.
This tremendous degree of acceptance surely confirms AIMR's success in achieving credibility.
Are all firms that claim compliance actually complying? No, and this is one of several reasons firms should undergo verification. The standards are not trivial and their application can result in errors being made. As more firms get verified or become further educated about the standards' nuances, we should expect the degree of actual compliance to increase.
While some consultants may not go beyond the "checked box" on the questionnaires, many do and more will. There are subtle ways to validate a firm's compliance, if the consultant feels it's necessary and appropriate.
AIMR is working diligently to eliminate the "gray areas" Mr. Grossman speaks of. Are the standards perfect? No, but given the complexity and dynamics of our industry, could we expect otherwise, especially after such a short time?
One of the major challenges of the standards is verification. There remains a great deal of confusion and AIMR is working toward rectifying the shortcomings that still exist.
My guess is the wide acceptance of the standards is much greater than AIMR expected five years ago. They don't have enforcement capabilities, and yet they've succeeded in not only changing the way U.S. managers report performance, but also have inspired managers from all areas of the globe to recognize the benefits of a standard for presenting their results.
Can the standards benefit from some "fixing"? Of course, and this will continue to be an ongoing process. But the industry should be grateful for the effort that's been expended by the individuals who have been involved in the standards design, implementation and maintenance. The standards are working, and we should expect greater acceptance over the next five years.
The Spaulding Group
University's pension fund
The University of Missouri System was not included in your Jan. 26 issue on the Top 1,000 pension funds.
As of Sept. 30, the market value of the system's retirement fund was $1.705 billion.
This would rank us No. 388 in your survey.
We look forward to participating in future surveys.
Shirley Shea DeJarnette
Assistant vice president,
investment and banking
University of Missouri System