Academic journal article Journal of Accountancy

Revisiting Corporate Pension Fund Allocation

Academic journal article Journal of Accountancy

Revisiting Corporate Pension Fund Allocation

Article excerpt

Make calm, defensible strategy decisions--even when markets are stormy.

The party ended with a bang last summer. Financial executives in charge of corporate pension plans had looked like heroes without much effort for several years. But after three consecutive years in which even the S&P 500 index registered 20%-plus returns, the index dropped 10% in third-quarter 1998, with the trough almost 20% below peak. The market falloff signaled a need to look at corporate-level financial planning. Other market indices, especially foreign markets, fared worse than the S&P index, casting doubt on the conventional wisdom that diversification offers a safe harbor in troubled markets. Nor did the indices fully reflect the breadth and depth of the damage. Over 75% of NASDAQ-traded stocks fell more than 30% from their highs for the year. At times only long-term U.S. Treasury bills offered any shelter, and even their yields dipped below 5%. For many pension plan sponsors and their management committees, the 1998 third quarter could not end too soon.

Pension plan sponsors and others with fiduciary responsibility for corporate pension money now need to consider their investment strategies with extra care. Don Trone, president of the Investment Management Council (IMC) in Lafayette, California, a consultant to investment advisers, is coauthor of the best-seller The Management of Investment Decisions. He suggests that investment committees follow a well-defined sequence whether they are starting new plans or managing existing ones (see exhibit 1, page 41) and that they stick to their written policy. The Big 5 accounting firms have made use of this sequence and have used other components of IMC's services in their investment consulting practices, Trone says.

Exhibit 1: Steps in the Investment MAnagement Process

1. Analyze the current position.

2. Design optimal portfolio.

3. Formulate investment policy.

4. Implement policy.

5. Monitor and supervise.

Source: Adapted from materials issued by the Investment Management Council, Lafayette, California. Copyright [C] 1993; printed with permission.


Investment committee members should look into all aspects of the plan, covering its investment strategies, current holdings, the company's anticipated contributions and the plan's disbursements. Because each plan has a unique set of participants, the most appropriate investment strategy may vary widely between plans. Trone cites the example of a company where most employees are relatively young. Because the pension plan at a young company will not incur large distributions for many years, the committee can prudently consider less-liquid, long-term investments. In contrast, a mature company's plan faces more constraints. "At a steel mill, where the likelihood is that you have more money going out of the plan than coming in because your workers are older and many may already be retired, you clearly have a time horizon of less than five years," Trone says. "Your choice of asset classes will be significantly hamstrung. The most appropriate classes will be fixed income and cash."

At this point, the investment committee can compare the plan's existing investment allocations with projections appropriate for its requirements. If the steel mill's pension funds are entirely invested in technology stocks, or the funds from a high-tech start-up with no participants over 30 are entirely in Treasury bills, a fiduciary has a responsibility to act.

Once the investment committee has identified the appropriate asset classes, it should determine allocations among those classes. In this stage, actuarial assumptions and projected investment results all but determine the investment mix that the fund managers must adhere to.

Actuarial reviews are available from several sources. The larger consulting firms advising investment committees frequently "bundle" actuarial and other services (investment consulting, record keeping, etc. …

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