Pension assumptions hitting the wall
– James Saft is a Reuters columnist. The opinions expressed are his own –
That 8 percent annual return on investment you and your pension fund manager were banking on is now looking almost as optimistic as Madoff’s magic 12 percent, as deleveraging and deflation bite.
With extremely low or negative interest rates and everyone from consumers to banks trying to shed debt and assets at the same time, what seemed like reasonable projections for a mixed portfolio of stocks, bonds and other assets are now substantially too high.
The implications are a potentially huge hit to corporate earnings and the economy. Companies will be forced to pony up more to keep their pension funds adequately funded while even consumers not encumbered by lots of debt will be likely to raise their savings rate to compensate for lower returns, thus acting as a drag on consumption.
And, while higher savings rates are ultimately what the economy needs, most U.S. company pension plans that promise a payoff based on workers’ final salaries assume an overall return on assets of about 8 percent a year. Individuals and their investment counselors are often even more optimistic, penciling in 9 or 10 percent a year and often maximizing exposure to riskier assets to try and get there.
“The available return from markets has been for some time a lot lower than people have understood,” said Gary Dugan, chief investment officer at Merrill Lynch’s wealth management arm in London.
Returns have been flattered by debt; both that employed in investment strategies to magnify returns and that taken out by consumers and partly recycled into corporate profits. And remember too, if you are an investor who doesn’t leverage you are still affected, as those who did inflated valuations and will remain sellers.
Why did the SEC fail to spot the Madoff case?
– Mark T. Williams, a finance professor at the Boston University School of Management, is a risk-management expert and former Federal Reserve Bank examiner. The views expressed are his own. –
With Congress now probing the Bernard Madoff case, some claim the SEC missed the risk because of under staffing. Even if that’s an issue, one SEC enforcement officer using basic risk-management skills, asking probing questions, searching for clear answers, and exercising timely follow up could have helped in detecting this fraud before it grew to such a staggering size.
The central flaw at the SEC is that its current oversight approach is not sufficiently risk focused. Moreover, any changes in approach have tended to be in response to a specific event instead of incorporating an overall risk-based approach across all areas under their regulatory purview.
The SEC is responsible for overseeing registered broker-dealers, transfer agents, clearing agencies, investment companies and investment advisers, yet there is not a consistent risk approach used in all of these examinations. For example, in 2003, after widespread unlawful trading practices surfaced in the mutual fund industry, the SEC took steps to take a more risk-based approach.
Yet these higher examination standards were not viewed important enough to be applied to investment advisers such as Bernard Madoff. The weakness in the SEC’s existing examination approach can be best highlighted by the fact that, in the last 16 years, while Madoff’s firm was investigated 8 times, no fraudulent activities were ever uncovered.
As part of their broad regulatory mandate, the SEC is responsible for overseeing over 10,000 investment advisers. This agency needs to adopt a “where there is smoke there is fire” approach. The SEC must become risk focused in the scope and frequency of its monitoring and surveillance operations. Given the significant number of investment advisers, even if we assume that 99 percent are low risk, that still leaves 100 that need to be closely monitored and scrutinized.
The SEC should keep a detailed list of the top risky investment advisers and use it to prioritize and set review frequency. Currently, there is no clear indication that the SEC links review frequency or scope of exam with level of perceived riskiness. Former SEC Chairman Arthur Levitt recently indicated that only 10 percent of investment advisers are examined every three years. A wealth of new fraud can be dreamed up, hatched, and perpetrated at such firms in the interim.
Good work Mark. The SEC should never have let it get this far, if we had adopted a “where there’s smoke there’s fire” approach they might have been able to stop this from happening. I mean, if you are obviously making a substantial return that is significantly higher than everyone else supposedly in the same market as you, have done it consistently year after year, then something doesn’t add up. Don’t they have a team or teams risk management auditors that should have been able to pick this up? Also, what about the institutions and people that actually contributed millions of dollars through his feeder funds or directly, don’t they have a responsibility in researching where their money is going? I know, I myself, if I was investing 5 million to Madoff who supposedly told me he could earn a 12% return on my money, would want to know exactly how he was doing it, not that I could take my money and do it myself to avoid his fees but it just should have smelled fishy from the start. Hopefully we are on the right track now too safeguard these types of losses and schemes that these unethical businessmen are causing.
Managing nonprofits in an “age of hope”
– Prof. James Post, an authority on corporate governance, teaches “Strategies for Nonprofits” at the Boston University School of Management. The views expressed are his own. –
I am inclined to think the Bernard Madoff affair has blown the lid off the financial madness of this decade. We have been living in an age of fraud, and now must rethink the way we do business. As John Kennedy once appealed to the nation’s better angels to call us into public service, Barack Obama’s inaugural address should instruct us on our obligation to serve the greater good. It’s not just a moral concept; it’s good business. I offer a corollary as well: Without good business, how far will a moral concept take you?
The management cliché about nonprofits goes something like this: What they lack in business savvy or operating budgets they make up for in passion and vision. This notion was especially apt in an age of decreased governmental support. And there’s a private-industry parallel declaring that firms may have a wealth of professionally trained managers but run in the red when it comes to inspiration. Few organizations have it all, so private and public industry must continue to collaborate to serve the community.
If Obama can keep the lives of real Americans in his sights, despite the overwhelming urge to obsess over Wall Street and Baghdad, he can have a profound effect on reversing the destruction wrought by the age of fraud. He can strengthen the bond between public industry and the private sector in ways that benefit all of the stakeholders. In many ways, the time is ripe for nonprofits to set a new example, one that marries sound management and ethics, and proves they can stay together for the long haul.
How do nonprofits rise to that challenge?
For starters, Obama’s Social Entrepreneurship Agency for Nonprofits and Social Investment Fund Network purportedly will “build the capacity and effectiveness of the nonprofit sector.” Not exactly a trillion dollar cash infusion, but a seat at the policy table. That means better lobbying access, governmental R&D/capacity-building support, a streamlined grant-making process, more explicit encouragement of civic involvement, and greater accountability. More attention will be paid to the energy, education, and training sectors, meaning added incentive for people to get involved in these areas.
There is an international poverty industry that rose alongside the greed driven corporate culture on Wall Street and other financial centres to shamelessly hoover up any public money or funds available for the disabled and poor for themselves. These organisations systematically deflect money away from need to maintain for profit lifestyles and the excuse that their executives and bureaucrats could earn more in the private sector totally misses the point of the piece as high earnings have not reflected dedication to service or ability at all they have simply reflected a lax attitude to selfishness and fraud.
Many coprorate non profits have head offices in the swankiest parts of town and have basically cut their intended beneficiaries out of the loop and are almost indistinguishable from their Wall Street counterparts that produce nothing but hot air and lavish lifestyles for themselves. The blind trust we’ve had that these organisations mean well has just perpetuated the cruellest and most cynical fraud against people we claim to care for.
We need to direct more money towards the churches and organisations embedded within communities and ensure needs are met through increased monitoring and professional accountability not simply go on funding poverty industry parasites who didnt quite make it into the financial sector.
Saft’s comments are both accurate and misleading. Accurate in that attaining an 8% return in the next year or two will be challenging. Misleading for those with a longer horizon.
The 8% assumption was never meant to be an every year number but rather an average with some years doing much better and others doing much worse. For those who have a short-term horizon in terms of retirement, Saft’s point is correct and a problem.
For those with a reasonably long horizon it is still a reasonable benchmark. Despite the current market, the average annual compound return of the S&P 500 for the past 39 years remains in 10% range (about 8% capital increase + about 2% dividend return). Unless one believes the economy will never recover, the long term assumption of 8% remains reasonable.