The topic of the Congressional hearing I’m about to address may not resonate with many readers, but as someone who designs investment portfolios professionally, the potential recklessness of the politicians involved astounded me.
The House Education & Labor Committee grilled the head of the Pension Benefit & Guaranty Corporation, which is the backstop for U.S. company’s pensions. The PBGC takes over the administration and allocation of pension assets that corporate sponsors can no longer support. Like most pensions and other large institutional investors, it takes a quantitative and very analytical approach to its responsibilities including the design and implementation of an "investment policy".
An institutional investment policy is a document that estimates the future liabilities of an investment fund, and designs a portfolio allocation around them with various constraints. It is a basic requirement of sound long term investing. And the main objective of a policy allocation is to diversify risk and minimize volatility for the given level of returns required to satisfy those future obligations. According to the testimony, the PBGC has 70% of its assets in bonds, and 30% in risky assets, and the total portfolio declined in value by roughly 6% in the current crisis. Many investors would feel pretty good about that. And over long enough periods, a pension should be able to recover from a 6% loss in one year without too much trouble.
Here’s the problem — Committee Chairman George Miller of California, along with some of his fellow members, is up in arms about the fact that PBGC assets are at risk, and that the riskier part of the portfolio has lost 23% of its value during the market meltdown. First, what counts to the well being of the PBGC (and the pensioners who rely or will rely on it) is the overall portfolio performance, not what happens to one slice of it. And in risky assets, periods of poor performance should absolutely be expected — it’s WHY you diversify assets. Over the long run, a well designed portfolio gets you where you need to go with less overall risk. And yet Rep. Miller is addressing the PBGC like a hysterical client might address their stock broker. At a time when the PBGC should be focused on rebalancing to take advantage of depressed prices for risky assets, the folks on Education & Labor appear to want to pull the plug entirely! That would be a severe disservice to the people who rely on the future ability of the PBGC to pay benefits, but ironically, Miller et al claim to be acting in the interests of current and future pensioners. Hmmm…who would they rather have that additional 30% invested with? Oh, right, the U.S. Treasury…
The Representatives I heard, especially Miller (though he seems like a nice enough guy), were all over the map conceptually. That’s OK if you’re not an expert. But in that case, one ought to listen more than they tell — it is a hearing after all, not a lashing. Instead, he engaged in some bizarre, rambling, and preposterous observations, and many of the members implicitly threatened to impose drastic changes — to basically retreat from an approach that has been diligently developed and improved upon over five decades, and seen its share of Nobel Prizes. Examples of Miller’s nonsense include talking about the PBGC’s investment policy as though it’s some secretive document (it’s not, and policies are very generic documents); arguing that despite the witness’ solid defense of PBGC’s approach to allocation, Wall Street was "littered" with plans by the smartest folks in the room (displaying a profound ignorance of the difference between a conservatively managed pension fund and a highly levered investment bank, or market maker in an unregulated derivative); and claiming that the survival of BRIC countries ‘ economies (Brazil, Russia, India, and China) is now in doubt (!), despite them being investment "havens" not too long ago. Good grief! Emerging markets, like every other risky asset, are never considered a haven in investment policy design, even when they’re expected to appreciate dramatically. It’s frightening that people so ignorant of this area, and so anxious to "do something", have so much power over an institution as important as the PBGC.
Politically, given all of the economic and historical ignorance afoot, the vacuum of compelling economic leadership, and all of the uncertainty this creates, we’re sailing into some choppy waters. Most of the country will feel good in November about electing Sen. Obama, and he’ll have an enormous amount of political capital to work with as his Administration begins, as it should. But almost everything we’re seeing as far as policy direction parallels the 1976 ascendancy of President Carter. And those who were alive then (many of today’s voters were not) will also recall that those were a tough four years for the economy.