Because money managers were at the scene of United Airlines Inc.'s pension plan wreckage, they must be implicated in the crash. And because money managers received their fees — a total of $126 million over a five-year period — the fees must be undeserved because the pension plan's crash will mean many participants won't receive their full pensions as promised. In short, that's the argument suggested in "How Wall Street Wrecked United's Pension," a story in the July 31 New York Times.
The story implies the United Airlines underfunding is due to the money managers employed by the pension plan. To be sure, the United plans might have been better off in government bonds during the past five years – a period that incorporated a deep bear market when bonds outperformed stocks.
But in the longer term money managers might well have played a big role in United's plans being as funded as they were. Would they have been as funded if they had been invested solely in unmanaged government bond portfolios over the past 30 years, for example? That's unlikely, given that long-term government bonds returned 9.5% compounded annually over that period compared with 13.7% for large company stocks and 19% for small company stocks.
The Times story made no attempt to provide a fair evaluation of the reason for nearly $10 billion in underfunding of UAL Corp.'s pension plans.
The story didn't provide information about the money managers beyond fees. While the company might not have been willing to share the performance of its managers, the average return of each manager (except for hedge funds and private equity managers) could be obtained, so an estimate of how the fund fared could be calculated.
There are many reasons a pension plan becomes underfunded, but the report doesn't discuss any of them. The underfunding could be due to a shortfall in corporate pension contributions, or a decline in the stock market, or a fall in interest rates, or any combination of these factors. In fact, adverse equity and fixed-income markets were predominant factors during the five-year period in question in the story, from 1999 to 2003. These factors affected all pension plans.
Poorly performing managers might have contributed to the shortfall, but by no stretch of the imagination could they have been responsible for more than a tiny fraction of a $10 billion underfunding. Then again, what of managers' positive contributions to funding levels?
Jacobs Levy Equity Management Inc., Florham Park, N.J., one of the 27 money manages listed with the story, was reported to have received $6.1 million in fees from United's pension plans during the 1999-2003 period.
According to Bruce I. Jacobs, president, Jacobs Levy produced a total income of $107 million for the plans in that five-year period. That total was $27.7 million gross of the return of its Russell 2500 benchmark.
Subtracting the $6.l million in fees, Jacobs Levy produced $21.6 million in income for the plans, net of fees, above its benchmark. For Jacobs Levy's entire tenure with United Airlines, from the inception of the relationship at the end of 1994 to June 30, the firm produced $249.3 million in total income for the plans. Broken down, that is $53.2 million above the benchmark, after subtracting the $11.3 million in fees.
So "for every dollar of fees the UAL plans paid, the portfolio earned $4.71 net of fees," Mr. Jacobs said. If that is a money manager wreck, most pension plans would want to join this type of crash.
The Aircraft Mechanics Fraternal Association has called for a forensic audit of the United plans to determine if there were any conflicting relationships that undermined performance, in light of a Securities and Exchange Commission report critical of investment consultants. A forensic audit should be undertaken.
Forensic audits ought to be used as a tool to identify the reasons for pension plans' underfunding, to determine if malfeasance or breach of fiduciary duty contributed to that underfunding, and if so, to bring consultants and managers responsible to account.
They also must place the blame on management and union officials who negotiated unaffordable pension benefits where that is applicable, as it no doubt was in the United case and others.