Pensions Cautioned Against Trying to Beat the Market

Company bankruptcies, pension terminations and complex retirement benefit regulations force Bradley Belt, executive director of the Pension Benefit Guaranty Corp., to deal with arcane subjects and language.

    There’s one concept, though, that he believes is straightforward and that companies should heed as they manage pension funds: Be careful if you’re going to pursue alpha, or above-market return.

    Although some pension funds may be able to find market niches that allow them to earn more than beta–the market return–they may not last long because there is about $4 trillion in pension money looking for the same niches.

    “What makes me nervous is … that conventional wisdom is that we’re going to be in a low-return, low-interest-rate environment for a period of time,” Belt says. “Everybody’s saying, ‘Aha, we’re going to chase alpha.’ Well, this isn’t Lake Wobegon, and not everybody is above average.”

    That’s particularly true of pensions, Belt says. “In aggregate, pensions are the market,” he says. “Not everybody can achieve above-average returns. For every winner, there’s going to be a loser. There’s not enough alpha for everybody.”

    Part of the reason that defined-benefit plans are underfunded by about $450 billion is that companies counted on the bull market of the 1990s to bring in outsize returns to sustain their programs. The economic downturn that hit in 2000 resulted in huge funding gaps.

    “The problem is that companies aren’t willing to recognize that there is a trade-off between risk and return,” Belt says. “Each company is in the best position to determine its own appetite for risk. But to pretend the risk isn’t there is not the answer. What they want to be able to say is, ‘Let’s take the risk so that we can get the upside but the downside is shifted to third parties.’ I guess we would all like to have that: Heads I win, tails you lose.”

    The business community asserts that the pension changes the Bush administration has proposed will increase the volatility associated with defined-benefit plans and force companies to shut them down.

    “They expect to spend a lot of money on their plans,” American Benefits Council president James Klein says of sponsoring companies. “What they can’t justify is having unpredictability about their expense.”

    Belt argues that companies will have the ability to control risk and volatility under the Bush plan. “If what company sponsors are saying is, ’The only way we’ll stay in the system is if we can continue to have the flexibility to chronically underfund our pension plans’ … then I think we need to ask ourselves whether the cost is too high,” he says.

Workforce Management, September 2005, p. 14 —Subscribe Now!