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    Pension Investing: A Bird's Eye View, Part I

    Most retirement plan fiduciaries (either the trustees or the persons responsible for making plan investment decisions) get lost in a forest of competing investment choices, pursued by a pack of financial "advisors" who have the "best" way to invest retirement plan assets. Admittedly, there is no single "right" way to go about the daunting task of investing your company's retirement plan assets. You are much more likely, however, to achieve some degree of success in this endeavor if you:

    1. Step back and get a feel for the "lay of the land" before you charge forward;
    2. Understand the general financial and legal goals and constraints of pension investing;
    3. Develop a specific written plan of action, aka, an investment policy, to follow and measure your progress against; and
    4. Hire a professional money manager, or managers, to carry out your investment policy on a day-to-day basis and to insulate you from fiduciary liability.

    Getting A Feel For The Lay Of The Land

    The first task of gaining an overall perspective on pension investing is to figure out where you stand. Assess your situation and establish a starting point from which to pursue your investment goals. Typically, this involves asking yourself a few questions, such as:

    • What type of plan do you have? Is it a defined contribution plan? Is it a defined benefit pension plan? In the first, the participants generally suffer the risk of investment performance. In the second, the company generally suffers or benefits from the investment results since plan earnings are a factor in determining required company contributions.
    • Should investment goals be a function of actuarial assumptions, the owner's age, the average age of rank and file participants?
    • How much are you investing? If you are starting out at the edge of the forest with a new plan and a relatively small amount of money to invest, your options may be limited in terms of your ability to: diversify investments, gain access to certain investment vehicles or investment managers, or to obtain certain investment fee concessions. On the other hand, if you find yourself in charge of investing a relatively large pension fund, you may have to move quickly to develop an investment strategy.
    • What does your current portfolio consist of? Are there any constraints (i.e., minimum deposit terms, withdrawal penalties, market adjustment features) upon changing the asset mix?
    • Who, if anyone, is advising you? If you don't have an advisor, should you get professional advice? Do you have the knowledge, the ability, and, most importantly, the time to manage an investment portfolio?
    • Do you have articulated investment goals and objectives?
    • Do you have a written plan for achieving these goals?

    So far, so good. If you were able to answer most of these questions, you should have a pretty good idea of where you stand. Now all you have to do is figure out where you want to go, the best route, and the means by which to get there.

    Preparing For Your Journey

    Before you can identify your investment goals (your destination), and how to get there, you need to recognize that investing pension funds as an ERISA fiduciary is different than investing your own personal assets. For those not already familiar with the fiduciary duties of ERISA, and the consequences of breaching those duties, please see True Confessions: What It Means To Be An ERISA Fiduciary on our web site.

    Okay? Welcome back. If you are at all concerned with potential legal liability (and who isn't?), your review of ERISA rules for fiduciaries should have yielded (at least) two important lessons:

    Lesson 1: It doesn't matter as much whether your investment choices actually make or lose money as how you go about making your investment decisions. In other words, following the recipe is far more important (for liability purposes) than whether the cake turns out! This is known as the rule of "procedural prudence." The only way you can demonstrate that you were procedurally prudent is by having a written investment policy (a recipe) and by maintaining a record of the steps you take in following that recipe.

    Lesson 2: If you are going to be held to the standard of the prudent professional plan fiduciary (e.g., a bank trust department), you might as well manage your plan's investments in a similar fashion. That is, you are much less likely to be accused of acting imprudently if you can demonstrate that your plan's investments (in terms of asset types, asset mixes, and asset diversity) and the day-to-day responsibility for portfolio management (daily investment decisions) are handled by or with the assistance of qualified professional advisors who have agreed to become ERISA fiduciaries of the plan. If you can properly delegate the day-to-day investment of plan assets to an ERISA "investment manager" you will not be liable for the investment decisions of that manager. In other words, you can kill two birds with one stone by obtaining professional day-to-day management of your plan assets and at the same time relieve yourself of the legal responsibility for these day-to-day investment decisions.

    Of course, there are a few other bits of information you should arm yourself with before you are really ready to embark on this journey. These lessons on surviving in the investment jungle include:

    • The persons you are likely to run into along the way who may offer investment advice (or directions) for reaching your plan‘s investment goal.
    • The alternative modes of transportation available to you (i.e., investment vehicles) for making your journey.
    • Basic concepts, rules and terminology used in connection with portfolio management theory (i.e., the law of the jungle) that may help you to make some sense of the various claims of would-be advisors and the wide variety of investment choices. These lessons will be in Part II of this article.

    To Chart Your Own Course Or Pick Up A "Trip-Tick?"

    Once you are armed and equipped with all this invaluable (even if we do say so ourselves) advice concerning the road ahead, you are ready to select:
    • Your investment goal or destination;
    • Your route;
    • Your initial mode of transportation; and
    • Your guide, or guides.

    The process of analyzing investment goals, the means of achieving those goals and committing these decisions to writing is the process of developing a written investment policy. Although this critically important step of "mapping out" a strategy for your plan investments is often overlooked, it can be the most important step in fulfilling your duties as an ERISA fiduciary.

    By now you might be suffering from a migraine. Do you really have to reinvent the wheel or has this whole journey been navigated by others who may be willing to share their experience? Good news! You don't! Every day there are literally tens of thousands of retirement plans like yours engaged in all of the various stages of the journey described above. Unless you are a pioneer/survivalist/masochist, your main challenge is to identify and select a team of investment advisors with proven experience in assisting retirement plans and in whom you have the appropriate level of confidence. The "right" advisors can and should walk you through the steps of assessing your current situation; helping you to understand applicable financial and legal constraints, and analyzing your investment priorities with regard to risk and return, liquidity needs, investment horizons and the like.

    Although you may be tempted to adopt a "sample" written investment policy prepared for someone else, this probably won't do the trick. Having a written investment policy is less important than developing your own written investment policy. Even though your plan's investment policy may ultimately look suspiciously like thousands of other investment policies, it is important for you and your investment advisors to be able to demonstrate that you made the effort to analyze and consider the various factors which should go into a written investment policy.

    For starters, though, a typical investment policy might include:

    • The name and type of plan (defined benefit, defined contribution, profit sharing), the name of the fiduciary responsible for adopting the policy, and the date of the policy.
    • The history of the plan, including date of adoption, number of employees covered and current dollar value of assets.
    • The expectations as to projected cash inflows from contributions, as well as anticipated outflows from withdrawals or distributions over the next several years.
    • If the plan is a defined benefit plan, the accrued and projected liabilities of the plan, whether it is currently over or under-funded, and the plan's earnings assumptions for funding purposes.
    • If the plan is a defined contribution plan (e.g., profit sharing, 401(k) plan, money purchase pension), the average age of participants, the average number of years to retirement, and the anticipated turnover.
    • A general statement of the investment objectives for meeting funding objectives, as well as an overall return objective for plan assets (e.g., 3% over CPI).
    • The various asset classes (see Part II of this article) which are appropriate or inappropriate for the plan.
    • The plan's tolerance for volatility of returns based upon the plan's overall funding policy.
    • General guidelines indicating a range of desirable asset allocations that will yield the highest probability of meeting the plan's long-term investment objectives without exceeding the plan's tolerance for risk and volatility.
    • How investment decisions will be made. If money managers will be used, how they will be selected.
    • How the plan's overall performance will be monitored. How money managers, if selected, will be supervised and monitored. Here, it is useful to include a standard for measuring portfolio and/or the selected money managers performance (e.g., S&P 500 Index for Domestic Equity Managers).
    • Procedures for the periodic review of investment performance compared to the investment policy, as well as for the amendment of the policy, if necessary.

    What To Do?

    Remember, procedural prudence is the key. Therefore, you and your advisors must be able to demonstrate all of the significant steps you take in developing, implementing and monitoring your plan's investment strategy. If a proposed advisor does not seem to appreciate the importance of taking these steps, and documenting the steps taken, that advisor is not fully protecting you as an ERISA fiduciary. If nothing else, you should recognize that in order to survive and succeed in your quest to make sure that your plan's assets are properly managed and invested, there is no substitute for being well prepared (that is, educated), hiring knowledgeable and reliable guides (investment advisors) and choosing a safe route to follow (developing an investment policy).