Safeguarding Pension Funds to Elude a Trillion Dollar Crisis

A recent study by Paul Ingrassia and Imogen Rose-Smith suggest the country’s pension system faces trillions of dollars in unfunded liabilities.

As a result, many states and other bodies of government are seeking higher returns for their pension funds to make up for ground lost in the last couple of years and to pay all the benefits promised to present and future retirees.  Higher returns come with more risk.

Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing.

The New York Times recently reported (March 9, 2010), “The Texas teachers’ pension fund recently paid Chicago to receive a stream of payments from the money going into the city’s parking meters in the coming years. The deal gave Chicago an upfront payment that it could use to help balance its budget.”

“Chicago did not have enough money to contribute to its own pension fund, which has been stung by real estate deals that fizzled when the city lost out in the bidding for the 2016 Olympics.”

Many public pension funds have been averaging a little more than 3 percent a year for the last decade, so they have fallen behind where their planning models say they should be.

In the late ’90s, the California Public Employees’ Retirement System, or CalPERS, was comfortably overfunded thanks to a booming stock market and the pension system’s annual investment returns as high as 20 percent.

Since then, public pension funds have witnessed some spectacular business failures due to corruption, accounting fraud and poor management.  A common theme of the past two financial crises appears to be the abuse of entrusted power for private gain.

Clearly, if pension funds except to achieve their projected rates of return, fund managers must take a more active role in safeguarding investments against corruption, fraud and poor management.

Investors become very upset and pay attention to corporate governance only when they’re losing money. After a bull market has been underway for some time investors become confident and complacent, until once again they are blind-sided by corruption, fraud and poor management.

After a second financial crisis in a decade, some shareholder advocates are now pressuring Corporate America to rein in hazardous pay practices, hold directors of corporate boards more accountable, and improve oversight of risk.

The key to their success will depend largely on improved internal transparency through an independent third party.

To investors, information is knowledge, and knowledge is power.  Improved internal transparency from an independent third party arms investors with comprehensive information about the quality of the business and strength of the management team.  This information will serve as a check and balance against the information provided by management as well as the auditors and outside consultants. 

Having access to information about the quality of the business and strength of the management team will give public pension funds access to a larger pool of investment opportunities; i.e., high quality, fast growing small and mid cap firms that lack adequate analyst coverage.

It’s time for public pension funds to draw the line with Corporate America. It’s not just enough to overhaul the regulatory architecture. Public pension funds need market-based discipline. To succeed, investors will need tools that hold corporate directors’ feet to the fire. That includes improved internal transparency from an independent third party to safeguard investments against corruption, fraud, and poor management.


About zethics
CEO and founder of zEthics, Inc. Thirty years of experience with finance and accounting background in public private sectors.

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