At the heart of every financial transaction is risk. With few exceptions, the only way to increase what you have using investments is to shoulder some risk. This can work, growing your money and creating much more than if you had not done a thing. And if it doesn’t work, you could lose all of the money you invested or just a portion.
Even a grade school kid can understand that concept, albeit on a smaller scale, one akin to “if I give you my ball, will I get it back or will you lose it.” For the rest of their lives, they will always weigh those sorts of balances hovering between what could have happened had they taken the risk and what should have happened because they did not. Some of these kids grow up to be investors.
Investors should always have a clear understanding of what risk is and how to project its potential worth. Some do it better than others; some simply employ age-old techniques such as value investing or use extensive research and analytical tools to help offset what would otherwise be the gut instinct that almost all investors wished they had.
The best investors spurn these very human emotional impulses. These are not the ones who buy when the markets are on the way up and sell when they are on the way down but instead weigh the possibilities independent of what their gut suggests. They know that gut instinct is wholly unreliable over the long-term because risks can and almost always shift. Seasoned investors know this. Speculators thrive on it. Most folks get caught up in it and attempt to determine risks often with limited amounts of (much-needed) information.
Some investors should not take risks. By taking the low road so to speak and assuming no more risk than is absolutely necessary to protect the underlying investments and those they invest for, they are performing the job with fiduciary responsibility. But when they do not, no matter what they assume they can achieve of the skills they think they possess, they forget that risk exists.
Such is the new policy being hoisted on Congress by the PBGC. This new policy offered to Congress in lieu of a potential $14 billion deficit is expected to close that gap between solvency and trouble.
The previous investment policy invested in Treasuries and high yielding corporate bond. This now considered too conservative and over the long haul, will not close the gap. Only it wasn’t the old policy that was at fault.
If you are not aware how the PBGC operates, here is a brief explanation. It was created by the government just like Freddie Mac and Fannie Mae, and like those troubled companies it is not inherently a government run entity. The Pension Benefit Guaranty Corporation guarantees the promise of a pension made by certain companies to their workers mostly in the hope of garnering their long-term loyalty. Currently, pensions are only offered to about 21% of the workforce and by their nature, lack the portability that the wildly popular defined contribution plans have.
But as they became less profitable to these companies, because the stocks that the pension may have invested in have not performed as projected - that last phrase is key and worth remembering - they have begun to jettison these plans in a variety of ways. Sales, mergers, etc. have left pensioners and those who had been counting on these plans out in the cold as freezes, closures or defaults have increased over the last ten-years.
The PBGC essentially guarantees those pensions by collecting insurance premiums from companies who offer them. The $14 billion deficit is the direct result of these companies under-funding those promises, defaulting on their premiums and in the end, just turning over the poorly managed pension to the insurer.
Now the PBGC sees the way out using the stock market. If it “performs as projected” the deficit could be wiped out in a number of years, or as the new policy suggests, 20 years.
Ultimately, the goal is increase the profits of the portfolio without losing any money while doing so. Charles Millard, PBGC director is a former investment banker and Bush appointee who believes that turning to the stock market to erase the deficit between obligations the PBGC knows it has or will have in the future is sound management.
Do they really believe that they can gamble their way out of this mess? The author of the old plan, Zvi Bodie, a finance professor at Boston University doesn’t think so. Nor does he believe that the projections take into consideration the short-term movements of the stock market and the often sudden need to finance pensions that have defaulted.
Mr. Millard claims that too conservative of an investment model will ultimately put the taxpayer at risk. But there is growing concern that they are already at risk. While acknowledging that the plan to increase profits is not necessarily a bad one, the General Accounting Office or GAO, thinks that this is the wrong investor shouldering the risk.
One of the main concerns that the GAO has lies in the projections made by the risk assessment firm hired by the PBGC. In the new policy, the belief that if something hasn’t happened, it will not likely happen in the future does not sound as responsible as it should be. According to CFO.com, “The agency's investment targets now include 40 percent fixed-income, 39 percent equities, 10 percent real estate and private equity, 6 percent alternative equities, and 5 percent alternative fixed-income.”
Is this head-in-the-sand logic or perhaps just a way to shelve the problem for the next administration? It could be a response to the sudden swings in the number of fully funded pensions from $60 billion surplus just a year ago to a $110 billion shortfall this past July. While those companies react to these problems by shifting their investments from equities to much more conservative instruments to make up for those losses, Mr. Millard is taking his company in the opposite direction. While those of us who do not have a pension seem to care less, it will be all of us who eventually bear the burden should the new policy at the PBGC fail. Is there yet another bailout on the horizon?