As Pensions & Investments celebrates its 30th anniversary, pension plans today are pretty much in the same state they were in 1973. Or are they?
They experienced huge losses when the market plunged in 1973, just as they have in recent years.
Pension plans today are severely underfunded, as many were back then, especially those of automobile, steel and airline companies.
In the early 1970s, funding was of great concern after the collapse of the Studebaker Corp. pension plan in the 1960s, and that precipitated the enactment of the Employee Retirement Income Security Act of 1974.
Before ERISA, there was no guarantor of pension obligations beyond the financial resources of the plan sponsor, and when a company failed, employees often lost their pension benefits. While that is less likely today, the Pension Benefit Guaranty Corp. is saddled with such a large deficit for its single-employer insurance system — $8.8 billion — that the General Accounting Office placed it on a "high-risk" list of major federal programs that need urgent attention.
Geopolitically, the aftermath of a war entangles the United States, tension in the Middle East dominates the headlines today and oil is a hot issue. Thirty years ago there was a war in the Middle East that threatened to entangle the United States and, in its aftermath, an oil embargo that damaged the U.S. and world economies.
Pensions & Investments started in the infancy of the application of modern portfolio theory — an idea that would spawn Nobel prizes. From indexing to sophisticated asset allocation and mean-variance optimization, a new model for managing huge sums of money was developed, incorporating new investment instruments — including derivatives — that gave pension sponsors powerful tools for adding value and controlling risk.
Today's pension fund is the product of MPT, as well as investment consultants and independent money managers, all of which also grew up with P&I. But now the model is being questioned, from the investment style pigeonholing of managers to the use of relative-return performance measures. Fund sponsors are being pushed to hedge funds and other absolute-return strategies, or even to abandon equities altogether in favor of 100% bonds. This dissent leaves some wondering if again pension plans are without a model for managing huge sums of assets.
ERISA and modern portfolio management were supposed to diversify away the risk of an employee losing both his or her job and pension. But some 40 years after the Studebaker debacle, there is the collapse of Enron Corp., costing employees their jobs and pensions. In this case, however, it was a defined contribution plan, not the type backed by the PBGC. So the pension community has come full circle.
Still, there is more reason for optimism than for pessimism. William F. Wechsler, vice president, Greenwich Associates, points out the typical plan is 100% funded on a projected benefit obligation basis, save industries with huge legacy costs. Funding is down, he noted, from 120% a couple years earlier, because the markets have gone against the plans.
Mr. Wechsler believes the MPT model is still valuable. Like any model, it needs tweaking, but no other viable model has come along to supplant it. As evidence, he points to Japan, which is slowly adopting the U.S. pension management model. If the U.S. system had used the Japanese approach, its pension plans would be only 60% funded.
"For all the difficulties pension plans have had recently, if you told me you wanted to run a pension fund without the benefit of MPT and the protection of ERISA (including the PBGC), I would tell you to forget it."
The environment of recent years has been unusual, with incredibly poor equity markets for investments and unusually low interest rates for discounting liabilities. A change in public policy should not be based on such aberrations. Sure there are problems, such as better securing defined contribution plans, and issues such as corporate governance. But they aren't insurmountable.
Pension funds are long-term investments, currently facing difficult short-term troubles. Major changes to correct short-term problems could do more harm than good.