Ted Ballantine | Pension360

Link Between Pension Trustee Composition And State Bond Ratings: Study

The composition of a pension system’s board of trustees is associated with that state’s bond rating, according to a working paper published by three researchers from Troy University and Rhodes College.

Specifically, elected board members are typically associated with lower bond ratings, while appointed and ex oficio board members are associated with higher state bond ratings.

Higher bond ratings imply better fiscal health — and better pension system management.

The paper explains:

Using data on state public pension systems and bond ratings for each state from each of the three major bond ratings agencies between 2001 and 2014, we find a positive relationship between outside board members and bond ratings. Having more outside members on a state pension board of trustees results in lower bond ratings and thus higher borrowing costs for the state. More specifically, we find that a 1 percent increase in the number of elected members on a pension system’s board of trustees decreases the state’s borrowing costs between $6.84 and $19.04 per $1 million in debt at a 5% interest rate.

[…]

These findings suggest that at least in the eyes of bond rating agencies, board composition does in fact matter due to spillover effects on a state’s fiscal health. Boards made up of inside members positively contribute to a state’s fiscal health. Importantly, this suggests that principal-agent problems may not be as particularly problematic as some research has suggested. Further, this may also be indicative of the prevalence of financial illiteracy that elected board members have been found to be associated with. Inside members may have stronger financial backgrounds, which does tend to be the case for both appointed and ex – officio members and appears to provide positive benefits

According to the researchers, pension systems with a board composed of a supermajority of insiders are linked to more economically and statistically sound results.

Study Finds Meager Median 401(k) Balances for Americans

A report from the Charitable Pew Trusts found that the average American has $72,383 in 401(k) balance, but the actual median for those surveyed is only $18,433.

The report compliments another recent study on retirement income disparity from the Employee Benefit Research Institute, which found 40% of 401(k) plan participants have less than $10,000 and 20% have more than $100,000 in their accounts.

The Motley Fool explored the possible reasons for this picture:

The average American has $72,383 stashed in a 401(k), which sounds encouraging.

However, the average can sometimes be misleading, because a large balance in a few 401(k)s can skew the result — after all, consider a hypothetical example of five people with a combined 401(k) savings of $500,000. The average is $100,000, which sounds pretty good until you discover that one person has $450,000, two people have $15,000, and the other two have $10,000 each in their 401(k)s.

[…]

Millions delay enrolling in 401(k)s — or don’t enroll at all. This is in large part because of status quo bias. The idea behind status quo bias is that people tend not to change things unless they see a clear need for change. (Ever put off doing paperwork because it wasn’t your top priority? Yeah, me too.) It’s one of the reasons why millions of Americans who have access to 401(k)s delay enrollment; it’s just one more piece of paperwork, and they have other things to do.

Workers simply aren’t saving enough. Many will simply enroll in their 401(k) at whatever the automatic rate is and ignore it after that. An analysis of Vanguard plans revealed that 65% of plans had an automatic rate of 3% or less — not nearly enough for most workers to build a sufficient nest egg.

The article went on to propose solutions for managing 401(k) retirements including automating enrollment, increasing the default contribution rate, incorporating automatic savings increases in the plans, and spreading out matching funds.

Call It A Trend: Lawyers Go After 401(k) Fees

Last week, Pension360 covered the lawsuit against the so-called “most expensive 401(k) plan in America.”

According to experts, there are more lawsuits where that came from as lawyers target out-of-control 401(k) fees.

From Bloomberg:

Lawsuits such as this one are just the beginning, said Marcia Wagner, a principal at the Wagner Law Group who represents plan sponsors and vendors under the Employment Retirement Income Security Act. The case follows a parade of high-profile suits filed by Jerome Schlichter, of the St. Louis law firm Schlichter Bogard & Denton, alleging breaches of fiduciary duty at some of the largest plans in the U.S. The mega-settlements Schlichter has won, along with a U.S. Supreme Court ruling last year that put plan fiduciaries on high(er) alert about the need to continuously monitor plan investments, has encouraged more law firms to develop and expand their fiduciary litigation practices.

“It started with Schlichter doing cases against very large corporations in America,” Wagner said. “And now it’s going to start to be a free-for-all.”

The focus of the suits is expanding as well, with a wider array of plan permutations and fees coming under scrutiny. “The pace of cases being filed has quickened, and the areas of challenge have broadened,” said Richard McHugh, a lawyer and vice president of Washington affairs for the Plan Sponsor Council of America, which represents defined contribution plans. Additionally, he thinks the U.S. Department of Labor’s new fiduciary rule will widen the number of defendants who are named in these lawsuits.

With more attorneys seeing an opportunity, smaller plans are starting to feel the heat. After launching four 401(k) lawsuits alleging breach of fiduciary duty late last year, Minneapolis-based Nichols Kaster has filed four more in 2016, most recently against Fujitsu and American Century’s $600 million plan. This year has even seen a 401(k) plan with less than $10 million in assets get hit with a lawsuit, a development that garnered the attention of many players in the small plan universe.

China Pension Prepares to Make $300 Billion Entrance to Stock Market

China’s local pension funds are collectively readying their entrance to the country’s domestic stock market, and they plan to make a splash to the tune of $300 billion.

China’s pension system has historically invested only in government bonds. But the low returns aren’t a good match for the country’s aging population, according to the pension system. So, it was decided last year that pension dollars be allocated to equities.

That process will begin soon.

World’s Third-Largest Pension Picks Grosvenor, Blackrock to Lead $1 Billion Hedge Fund Entrance

South Korea’s national pension fund – the third largest pension fund in the world with $415 billion in assets under management – will be investing for the first time in hedge funds later this year.

The fund has picked two investment firms to lead the foray into hedge funds: BlackRock and Grosvenor, who will each be in charge of $500 million.

Hedge Funds Worst-Performing Asset Class for Pension Funds; REITs Best: Study

A study by CEM Benchmarking found that hedge funds provide the lowest net annual returns to US pension funds among all asset classes. With an average compound return of 5 percent, only cash provided lower return figures.

[Read the full study here.]

Bloomberg summarizes the results:

Hedge funds provided lower average net annual returns to U.S. pension funds than any asset class except cash, according to a report analyzing $8.4 trillion in defined-benefit plans from 1998 through 2014.

“If cash is excluded as an asset class, then hedge funds must be considered the worst performing,” with an average compound return of about 5 percent, according to the study of retirement-plan assets by CEM Benchmarking, a Toronto-based consultant for institutional investors.

Pension funds from New York City to Orange County, California, are weighing exiting hedge fund investments. Vicki Fuller, chief investment officer of the New York State Common Retirement Fund, the country’s third-biggest pension fund, said in June that hedge funds should face performance hurdles to earn their traditional “2 and 20” fees, or 2 percent of assets and 20 percent of gains. The California Public Employees’ Retirement System, the largest U.S. pension fund, divested its $4 billion hedge fund portfolio in 2014, saying the asset class was too expensive and complex.

The same study found that publicly traded real estate investment trusts (REITs) and private equity produced the highest annual net returns for pension funds.

New Jersey Budget Allocates Big Bucks to Pension Funding; But Mixed Bag for Public Workers

New Jersey governor Chris Christie just signed into law the $34 billion state budget, which – among other things – will push the state’s pension contribution up to $1.86 billion dollars.

The payment is less than the actuarially required contribution, but is the highest single pension payment in state history.

NJ Spotlight elaborated on the win for retired public workers:

Much of the increased spending authorized by Christie for the 2017 fiscal year will be earmarked for the state’s grossly underfunded public-employee pension system, pushing the pension contribution up to $1.86 billion. That’s a record-setting amount. And though the figure is less than the full payment calculated by actuaries, Christie was able to keep the increased pension payment in the budget even after the state dealt with a $1 billion revenue shortfall in late May. That will make it harder for him to question the affordability of a proposed constitutional amendment calling for similar annual pension-contribution increases that’s likely to go before voters this fall.

It’s not all good for public employees. Although their pension system will get an incremental funding boost, they will have to make healthcare-related concessions. NJ Spotlight:

The budget as enacted also banks on $250 million in undefined savings from employee healthcare plans that now have to be worked out between union officials and the administration. To add pressure, Christie says he will hold back funding for distressed cities and legislative add-ons until the savings materialize. Also, a proposed sales-tax cut that the Assembly passed last week in a broader plan to replenish the state’s Transportation Trust Fund with a 23-cent gas-tax hike should give public workers more cause for concern. The sales-tax cut could take away so much revenue from the budget in coming years that more drastic healthcare changes may become inevitable.

World’s Largest Pension Suffers $50 Billion Investment Loss in FY 15-16: Report

An anonymous source claiming direct knowledge of the matter told Reuters that Japan’s Government Pension Investment Fund suffered more than a $50 billion dollar portfolio loss in the last fiscal year (15-16), owing to the surge of the yen as Tokyo stocks crashed.

Reuters, via CNBC, elaborates:

Portfolio losses for the Government Pension Investment Fund for the 12 months through March were between 5 trillion and 5.5 trillion yen, the person told Reuters on Friday, speaking on condition of anonymity as the results are not public.

The $1.4 trillion GPIF has taken a more aggressive investment stance in recent years, shifting towards stocks and away from low-yielding Japanese government bonds, in line with Prime Minister Shinzo Abe’s push to deploy more of Japan’s huge financial assets in riskier investments and boost economic activity.

These results will reportedly be made public on July 29, 19 days after the country’s national election.

ERISA Class Action Suit Targets “Most Expensive” 401k Plan in America

An ERISA class action suit has been filed against Fujitsu Technology & Business of America Inc.’s 401k plan, describing it as the “most expensive plan” of its kind during 2013 to 2014.

Bloomberg BNA elaborates:

Fujitsu’s failure to monitor the plan administrative fees resulted in millions of dollars charged to participants, according to the complaint, filed June 30 in the U.S. District Court for the Northern District of California. The proposed class also alleges that the plan fiduciaries imprudently designed and implemented the plan’s target-date funds feature in violation of the Employee Retirement Income Security Act.

Nichols Kaster PLLP filed the complaint on behalf of eight plan participants. The law firm has recently filed similar complaints against M&T Bank Corp., American Airlines, Inc., and Deutsche Bank Americas Holding Corp.

According to the complaint, had Fujiitsu limited its expenses according to the percentage for similarly-sized plans, participants would have saved around $8 million in fees.

The class action suit is said to comprise between 9,800 to 14,000 participants.

Study Challenges Assertion That Performance-Based Fees Lead to Disproportionate Risk-Taking in Israel Pension Industry

With a recent paper, four researchers from Hebrew University in Israel are challenging the assertion of many regulators around the world that performance-based fees encourage dangerous risk-taking.

The crux of the researchers’ argument is that high levels of investment in alternative assets like private equity – seen by many observers as posing liquidity risk and providing insufficient risk premiums – aren’t as risky as commonly believed when taking into account other measures of risk, like return volatility.

It’s an interesting thesis, although it does fly in the face of other research.

From the paper:

While most regulators worldwide take the view that profit-based fees are risky and should be prohibited in pension fund management, our results cast doubt on the validity of this view: funds with performance-based fees are associated with more risk-taking in comparison with AUM-based funds only if risk is measured in terms of investment in illiquid and presumably risky “alternative assets.”

Comparisons based on other measures of risk, such as return volatility, are not highly consistent with the regulatory view. By contrast, funds with performance-based fees are clearly associated with high-quality investment management. Stated differently, even if funds with performance-based fees can be regarded as riskier than other funds, there seems to be a tradeoff whereby this higher risk is accompanied also by better investment management. We also find, within the limitations of our sample, that incentives (profit based fees) seem to be more effective than competition in inducing in inducing high-quality fund management; competition however, leads to lower fees for investors.

The researchers also recommended a revamp of current regulatory policies to better manage risk-taking by fund managers, as well as relax the restrictions on performance-based fees. Instead, they can turn to other measures including imposing fiduciary limits on specific types of risky investments. They, however, clarify that these recommendations should be adopted only as they apply.

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