Congress could spoil a much-needed opportunity to modernize pension regulations that complicate hedge fund and other non-traditional investing.
It might ignore an opportunity to reform a prohibited transaction rule.
One proposal suggested to Congress would relax a prohibited transaction restriction that subjects hedge fund and other alternative investment managers to fiduciary requirements of the Employee Retirement Income Security Act of 1974 if they receive more than 25% of their assets from pension funds. That proposal would raise the limit to 50%.
That's important because the smaller ceiling keeps corporate and Taft-Hartley pension funds regulated by ERISA out of some prized hedge funds that don't want the hassles and liability of coming under fiduciary rules. Why take ERISA funds, and assume ERISA fiduciary regulation, when there are plenty of non-ERISA investors?
The rule needs to be modernized to keep up with the marketplace. Alternative investment management is proliferating, and ERISA-regulated pension funds face being shut out of a growing part of the investing universe. There are plenty of alternative managers, but the good ones often are more selective in their clientele.
This prohibited transaction rule impedes the ability of ERISA funds to expand their opportunity set of asset classes — including hedge funds — as part of a critical effort to better manage risk and improve returns and funding. With companies trying to improve funding of their plans, sponsors must have the best investment strategies available.
The prohibited transaction restriction doesn't apply to public pension funds or foreign-based pension funds, allowing them a better opportunity to get into the best-regarded hedge funds.
The Department of Labor can amend this particular prohibited transaction rule without congressional intervention. It knows the issues best and ought to take the lead in this effort to adapt the rule for the modern marketplace. So far, that hasn't happened. Congress should step into fill the void. The proposal ought to be part of the pension funding reform bill, or stand as a separate directive to the Labor Department.
And, corporate and Taft-Hartley plan sponsors ought to endorse efforts to ease the restriction. Even if they don't intend to invest in hedge funds, they still should want the latitude to move into this area in the future.
But the value of hedge funds and other alternative strategies is their assumption "of risks not generally borne by traditional asset managers," according to a statement by Michael C. Litt, partner and portfolio strategist, FrontPoint Partners LLC, Greenwich, Conn. "It is this assumption of differing risks that leads to diversification for the pension plan."
Corporate and Taft-Hartley pension funds — especially large ones — generally are sophisticated investors, capable of dealing with hedge fund and other alternative asset managers. They certainly should not invest without any restraints, but could develop investment parameters and transparency and liability and other appropriate safeguards. As an increasing amount of the investment market moves into hedge funds and other strategies restricted by the prohibited transaction rule, ERISA-regulated funds are at a disadvantage in the global investment market, raising pension funding cost for their sponsoring companies and making their business operations less competitive.