The pension funds have badly suffered because of the actual financial crisis. US pension funds have lost around 2000 billion Dollars. Other big institutional investors also have been forced to admit gigantic losses. The famous Harvard Endowment Funds has lost about 8 billion Dollars or 22% of its assets. The endowment has been a model for many other institutional investors or board members of big pension funds.
Exceeding liabilities as a dangerous loophole
There are two sides of the balance sheet of pension funds: the assets and the liabilities. A pension fund needs the assets in order to provide for the liabilities. The assets have been reduced substantially because of the financial crisis. Thus the liabilities of many pension funds exceed the assets as the result of the crisis. Matters get worse if the liabilities of corporate pension funds increase because the firms dismiss employees or have their employees sooner retired from work.
Many people might worry about their pensions as a consequence of the financial crisis. There are different alternatives. Either the stock markets experience a strong and sustaining recovery during the coming months and close the gap on the asset side or the pension funds have to take unpopular measures. The employers and the employees could be forced to contribute more money to the pension funds or the pensions for the coming generation of pensioners could be reduced.
Securities lending as a risk factor
Big pension funds can finance their administration costs with the earnings from securities lending. The bankruptcy of Lehman Brothers has demonstrated that the risks of securities lending may not be underestimated. Lent out securities to Lehman Brothers have vanished in the black hole of the bankruptcy. Prominent institutional investors struggle to recapture their lost securities.
How to avoid a gap on assets
I have attended boards of big pension funds. My most important rule of thumb is to provide for an enough big buffer of assets. The assets of a pension funds should exceed the liabilities at least for about 15%. This buffer should be accumulated during normal times. This is a minimal buffer. A 20 percent buffer would be better but much more difficult to achieve.
The board members or funds managers should not invest directly, but they should formulate the investment strategy and define the different asset classes to invest. It is furthermore their task to appoint the portfolio managers. Organising competition among different portfolio managers is a precondition in order to achieve a satisfactory performance. The board members should be independent and challenging personalities. They have to be dedicated to acquire and train the necessary skills in order to control the funds effectively.
A viable investment strategy, good governance and the comfort of a strong financial buffer on the asset side are the most important elements in order to lead pension funds successfully through serious economic crisis. More about such issues can be discussed at the forum of Make Money Tip.
Liliane Waldner is a business economist. She lives in Zurich. She has been in a member of the parliament of the State of Zurich during 17 years. She has attended the board of several public entities and companies, some of them dealing with the financial markets. Her website is: http://www.makemoneytip.com