The risk-averse rich

By Felix Salmon
December 15, 2009
Suze Orman is invested only in wrapped munis.

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What’s the correlation between wealth and risk appetite? I suspect that it’s somewhat bell-shaped: when you’re very poor you can’t afford to take any risks, while if you’re entering the middle classes you often feel that you have to take risks, especially with your retirement assets, if you’re going to have a chance of maintaining your standard of living once you stop working. If you already have more money than you’ll ever spend, however, then you don’t need to take those kind of risks any more, and you start becoming much more conservative again — see for instance the way in which Suze Orman is invested only in wrapped munis.

This big picture can be blurred by the fact that many of the riskiest investments, like venture-capital funds or leveraged hedge funds, are invested in only by the wealthy. But look a bit closer and you’ll invariably find that the investors in those funds are careful to make sure they’re set for life before taking a small percentage of their wealth and investing it in high-risk assets.

But thanks to a new law, we can now see how senior executives invest their money. And it turns out that even diversified stock-market investments are too risky for them:

Top executives at Bank of New York Mellon Corp. could invest their savings in a fixed-income fund that had a 6.6% return in 2008; thanks to electing this fund, Steven Elliott, senior vice chairman, had earnings of $1.3 million on his account, according to filings.

Executives at Cummins Inc. could choose among three options: the return on the S&P 500, “the Lehman Bond Index, or 10 year Treasury Bill + 2%,” according to filings. The executives at the engine maker had a total of $1.4 million in gains on their accounts, suggesting that none of them elected the stock index.

Executives at Illinois Tool Works Inc., a maker of fasteners and adhesives, received returns of 6.1% to 8.4% in 2008, while investments in the employees’ 401(k) lost 25%. A spokeswoman says that so far this year, the average return of employees’ 401(k) plans has been 23%, while the interest credited to the executives’ deferred-compensation plan is just 5.6%.

The WSJ implies, and Ryan Chittum makes explicit, the concept that any executives seeing gains in their retirement accounts were somehow getting special treatment, compared to ordinary employees whose 401(k)s got destroyed. But the bigger point here is that the rich executives are simply availing themselves of the luxury of being able to afford very low risk, modest-return investments. (As ever, Comcast is the outlying villain, guaranteeing senior executives a 12% return on their savings. Yuck.)

I’d also be interested in finding out how much company-specific credit risk is involved in these schemes. A giveaway is the word “notional”:

These deferred-compensation plans generally provide notional investment elections that mirror the returns on mutual funds available in the employee 401(k) plan.

In other words, we’re not talking about actual returns on actual money, here, we’re talking about notional returns on notional money which is really just an unsecured liability of the company to the executive. If the company goes bust, the money disappears — and even if it doesn’t, the money might not ever arrive. Just ask Fred Goodwin and Dick Grasso whether promised retirement funds are certain to become real cash.

There’s something to like about the fact that senior executives have an enormous amount of their retirement assets tied up in unsecured obligations of their employer: it gives them a strong incentive to avoid the kind of fat-tailed risks which could really wipe them out. So I’m not as shocked by the WSJ story as Chittum is. Except for that Comcast factoid, of course.


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Felix, that’s very naive. What happens to those funds if something bad happens to the company? They either 1) are committed to an annuity purchased from a large, stable insurer just before the chapter 11 filing, or 2) they go into a retention bonus pool that the company commits to pay to those “irreplaceable members of the leadership team” as part of the re-organization.

Google it. You’ll see these things in every Chapter 11 in the last 20 years.

Posted by Dollared | Report as abusive

How many institutional managers have a bit of their portfolios in high-risk investments? I wouldn’t consider a union pension fund to be a “rich investor.”

Posted by Mega | Report as abusive

I think we already saw this risky schism of privilege between Rich People and Little People sufficiently illustrated at Enron and General Motors.

What amazes me is that some of the so-called “risk-averse” guys in $10,000 suits have yet to go to prison, while the people that worked for them literally get to starve on account of chronic 401k evaporation.

Posted by HBC | Report as abusive

Then again one has to consider the ‘absolute’ sophistication on the investor and the ‘understanding’ of risk.

Russian Oligarchs – and mini-Oligarchs – who leveraged their assets with borrowed money to invest in yet more risky assets, that were highly correlated with their underlying loan collateral, did well while markets were rising, but got punished hard during the 75-percent decline. Both in terms of margin calls, and being forceably closed-out of those leveraged bets as the price of the underlying collateral declined relative to the value of the debt they needed to repay, and losses in the value of their underlying assets.

They got killed by leverage because they misunderstood the risk they were taking and how soon market sentiment in a real crisis could turn against them. Billionaires became millionaires. Some millionaires lost ‘almost’ all their ‘financial’ assets.

Posted by MrBill | Report as abusive