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Cypen & Cypen
NEWSLETTER
for
January 24, 2013

Stephen H. Cypen, Esq., Editor

1.      GIGO ADDS TO PUBLIC PENSION WOES:  Garbage-in-Garbage-out is a well known concept. If a public or corporate official distributes false financial information that serves as the basis for unwarranted action by others, he is guilty of either fraud or negligence, depending on whether it was signed off on knowingly or carelessly. Why then are academics not held to the same level of accountability asks Keith Brainard in Pensions & Investments?  One example is a statement from finance professor Joshua Rauh and assistant finance professor Robert Novy-Marx:
 
In Rhode Island, an anticipated annual return of 8.25% in pension investment has for the past decade come    in at about one-third that rate, only 2.4%. This means that while the state's pension system already takes 10 cents out of every state tax dollar -- and yet remains deep in the red -- it is not nearly enough to pay off the           promises.
 
These academics are well credentialed and are on the staff of highly respected institutions of higher education (Stanford and Rochester, respectively). One would assume they are capable of basic research, and make their claims based on solid information. The natural reaction to this information would be to demand immediate action. There is only one thing: What they reported is false. In fact, Rhode Island’s investment return for the past decade, prepared by an independent consultant, shows the pension fund's annualized return for the 10-year period ended last Sept. 30, 2012 was 8.3%, not 2.4%. In addition, since 2010, the Rhode Island retirement plans have used an anticipated annual return of 7.5%, not the 8.25% rate claimed by the professors. Mr. Brainard, who is Research Director of the National Association of Retirement Administrators, adds that the incident is not isolated.  Mr. Rauh previously produced what he called “run-out dates” for public plans, which led readers to believe the dates listed were when the plans were expected to run out of money. (The Pew Center for the States reported it that way, and a congressman cited the information on his website as proof-positive of the need for the “reform” legislation he was proposing.)  Naturally, the run-out dates resulted in high degrees of anxiety among both plan participants and the sponsoring agencies, and no small effort was made to clarify and correct the record for policymakers and the media. More than a year after publication of Rauh report, the Government Accountability Office included the following in a footnote in a report of its own:
 
However, the Rauh study was based on the assumption that benefits earned to date would only be financed out of current plan assets and not from any future contributions. The projected exhaustion dates are thus not realistic estimates of when the funds might actually run out of money.
 
Naturally, by the time the GAO report was distributed, the damage already had been done, and as usual, its report garnered almost no public attention. Was the misinformation in the Rauh report on this subject a function of negligence or fraud? Although Brainard says he does not know the answer, it seems reasonable to limit the range of possibilities to those alternatives, and to hold academia to the same standards as a public or corporate official, given the products of their “academic research” are likely to influence the actions of others.  Well said. 
 
2.      BLS REVEALS DEFINED BENEFIT AND DEFINED CONTRIBUTION RETIREMENT PLAN COSTS:  Bureau of Labor Statistics data show private industry employers now spend more per employee hour worked for defined contribution retirement plans than for defined benefit retirement plans. March 2012 private industry employer costs for defined contribution plans were 60¢ per employee hour worker, compared to 43¢ for defined benefit plans. During the same period, more than twice as many private industry workers participated in a defined contribution plans (41 percent) compared with defined benefit retirement plans (17 percent). If worker participation costs are derived (taking the employer cost for employee compensation divided by the participation rate for the benefit for that time period), data show that private industry employer costs for defined benefit participants are more expensive than for defined contribution participants. This item comes from International Foundation of Employee Benefit Plans.
 
3.      “PENSION FUND TRUSTEES SHOOT THEMSELVES IN THE FOOT?”:  Sorrow and anger over the killings of students and teachers in Newtown, Conn., have provoked an understandable impulse by pension fund executives and other institutional investors to do something to help stop gun violence. One step, says Pension & Investments, they can take is to divest their funds of holdings in gun manufacturers. Presumably they hope such divestment would drive down the market values of those companies and possibly force them to end gun manufacture. Not likely, as gun sales have soared since gun control discussions have broadened, possibly increasing the companies' market values. By their reappraisal, pension funds suggest their holdings contribute to gun violence. Yet, there are plenty of other pension funds and institutional investors that have not invested in gun-makers.   Those investment policies did nothing to stop the shootings. Divesting is a misguided reaction: Pension fund trustees are fiduciaries; their plans are not agents of social change. The primary purpose of pension funds is to secure the retirement of plan participants. Divestment is a distraction that takes them away from their mission. It also distracts policymakers from focusing on useful public-policy solutions to gun violence.   Pension investments, have sometimes become sources of controversy as a result of the latest social or political movement. Pension funds, especially public funds, have come under pressure to divest in response to one cause or another, and sometimes have succumbed to such pressure. In recent years, for example, private equity holdings have become wrapped up in a furor about such investments destroying jobs and companies for short-term profit. Pension funds need to step up and communicate the value of investments to their portfolios, to reaching their objectives and to the larger economy. It is incumbent on pension funds to take up the challenges of explaining their exposure, and maintaining their commitment to meeting their objectives. They would perform greater service by steering proponents of particular causes into more effective means of influencing policymakers. Otherwise, pension funds are doing a disservice to those committed to such causes. New York State Common Retirement Fund recently announced a freeze on investments in publicly-traded commercial firearms manufacturers, affecting over 45,000 shares, valued at $2.2 million, in Sturm, Ruger & Co. (The move was, of course, accompanied by the obligatory news release, from New York State Comptroller Thomas DiNapoli.)  An external manager of the same fund sold its 166,000 shares, valued at $1.3 million, in Smith & Wesson Holding Corp. Chicago Mayor Rahm Emanuel “ordered” five city of Chicago pension funds to review holdings in their combined $13.5 billon in assets for any stakes in companies that manufacture or sell military-style guns.  These divestment activities reveal shortcomings as fiduciaries in portfolio oversight, as well as reconciling different investment objectives. Risk of liability is a legitimate concern for any pension investment, but how has that risk been assessed? Pension funds' sudden interest in their gun-maker and related retail holdings reveals a lack comprehension in building such exposure and ill preparation for any backlash or consequences. Why have not urban violence or other horrific crimes at Virginia Tech; Tucson, Ariz.; and Aurora, Colo.; among others, previously provoked such a concern for divestment? On what basis are the divestment decisions now being made? Where is the evidence that continuing to hold investments in such companies will harm the funds? Has anyone examined what will be lost by the divestment? What are the costs of the divestment?  Pension funds, as fiduciary assets, should not invest or divest to meet social objectives. Pension funds should avoid being drawn into a debate on the Second Amendment. Their mission is not to grapple with such constitutional issues. As fiduciaries, fund executives have to focus on investment and funding objectives, not social goals. Firearms just happen to be the latest flashpoint of controversy among pension investments. Because of the span of their investments, pension funds are open to the risk their holdings might offend some sensibilities. But pension fund executives should not try to influence or supplant policymakers in coming to grips with social challenges. They must stay focused on securing the highest risk-adjusted returns possible for their funds. They must keep in mind and communicate that meeting their retirement objectives is a worthy and challenging social goal, one that is not easily met and one that has led to the demise of some sponsors, to the financial harm of pension plan participants.  So, there.
 
4.      NHLers ACHIEVE HAT TRICK WITH NEW PENSION PLAN: Players taking to the ice in a shortened National Hockey League season will have their own benefit plan, according to pionline.com.  The new plan was included in the 10-year collective bargaining agreement between the NHL and the National Hockey League Players' Association.  The season, which was originally slated to start in early October, began this month.  The league and NHLPA must now turn to dealing with the nuts and bolts of the new Taft-Hartley plan, to be administered by a benefits committee comprising three or four representatives of both the NHL and the players' association.  League players previously had two defined contribution plans, a 401(k) in the United States and a pension plan and trust in Canada.  The league's 30 teams will contribute to the plan, although total contributions will be based on the players' share of overall league revenue, so the amount will not always be the same depending on overall player salaries. What makes the issues so complex is that seven of those NHL clubs are in Canada, which has different tax and pension rules than the U.S.  The plan must adhere to tax rules in both countries, as well as U.S. and Canadian provincial pension rules.  Score!
 
5.      PARENTS PLAY AN IMPORTANT ROLE IN FINANCIAL EDUCATION:  A majority of retirement plan participants in a recent survey say that they learned about finances from their parents.  American United Life Insurance Company announced the results of its retirement participant survey, reporting that fifty-six percent of respondents learned about finances from their parents (choosing from a list that also included books, a teacher or other family members). Younger adults between the ages of 20 and 30 were even more likely (71 percent) to have learned from parents.  Parents should take these findings to heart, and understand the tremendous role they play in the financial literacy of their children.  They should understand how important it is that they, themselves, understand finances and the basics of retirement, knowing their children are learning from them.  These findings tell us that there’s opportunity for the industry to fill in knowledge gaps. 
 
6.      POTENTIAL MACROECONOMIC CONSEQUENCES OF AN AGING POPULATION WITH INSUFFICIENT SAVINGS:  How is that for a catchy title?  As part of its Outlook Series, Manning & Napier says today’s "risk on/risk off" world is dominated by short-term swings in sentiment influenced by the latest headlines hogging the spotlight, spanning from the Fiscal Cliff in the U.S. to the state of austerity plans in Greece. While these events have consumed the attention of many market observers, another longer-term issue has been forming for decades in the U.S.: aging of the Baby Boomer generation. Baby Boomers (defined as those born between 1946 and 1964) have played a dominant role in the demographic landscape of the U.S. since their birth early in the post-WWII era. This case remains true as the leading edge of the Baby Boomers began to reach full retirement age of 66 in 2012.  Aging of this generation will be a central issue over the next several decades as experts predict a doubling of the age 65 and older cohort between 2010 and 2050.  The new paper explores potential impacts of the aging population on both the economy and the financial markets over the coming years. It is important to understand both the prior contributions from demographics, as well as the likely future impact that these issues will have, at the asset class, industry and company level. Investors should account for the fact that certain industries/companies may be at risk of losing demographic tailwinds, and should adjust their forecasts accordingly. The combination of the under-saving, of the increased demand placed on government programs, and decreased growth in spending due to the demographic shift argues for a slower pace of economic growth (all else being equal). Fortunately, all is not equal, and birthrate is not the sole growth driver for the U.S.  Immigration and productivity growth have the potential to offset the economic drag created by the retiring Baby Boomers, as do a number of upside scenarios explored in earlier papers.  As with other issues, active management and investment flexibility will be the keys successfully to navigate the risks of an aging population. 
 
7.      DEFINITIONS:   BOSS: Someone who is early when you are late and late when you are early.
 
8.      QUOTE OF THE WEEK:   The secret of all success is to know how to deny yourself. Prove that you can control yourself, and you are an educated man; and without this all other education is good for nothing.  R. D. Hitchcock
 
9.      ON THIS DAY IN HISTORY:  In 1962, Jackie Robinson is first Black elected to Baseball Hall of Fame.
 
10.    KEEP THOSE CARDS AND LETTERS COMING:  Several readers regularly supply us with suggestions or tips for newsletter items.  Please feel free to send us or point us to matters you think would be of interest to our readers.  Subject to editorial discretion, we may print them.  Rest assured that we will not publish any names as referring sources. 
 
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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.


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