According to studies by the Government Accountability Office (GAO), a growing number of DFP’s (Defined Benefit Plans, better known as pension plans) are funding their obligations by purchasing Hedge Funds and Private Equity Funds. While the prevalence of this usage funding is constituted in larger pension funds, their usage is not forbidden in smaller plans.
So, you might be thinking, “Thanks for the tidbit Kurt, who cares?” I’ll tell you exactly ‘who’: anyone. This affects any and every person who has a pension plan.
Hedge & Private Equity Funds
Stories of hedge fund disasters are regular features on the news, the most notable of which involved the former head of NASDAQ, Bernie Madoff. This is not to say that every Hedge Fund and Private Equity Fund are being run fraudulently, because the vast majority are ethical and well run. However, the valuation issues stemming from the lack of a regular market for these issues, combined with the challenge of transparency further magnifies their unpredictable nature.
Due to the rapid increase in the usage of these types of investments, (60% of large pension plans used hedge funds in 2010 compared to only 11% which used them in 2001), further scrutiny of their attributes is necessary. Private Equity Funds, which typically provide working capital for expansion, product development and restructuring to other entities, were utilized by 92% of large pension funds in 2010, up from 71% in 2001. This is a trend that shows no signs of reversing anytime soon.
Equally prevalent in the news these days are the horror stories regarding underfunded pension plans. Scads of separatist managed plans for fire, police and even now, teachers, are coming to light as being incapable of living up to the payout demands promised to their populations. And that is, scary – very scary.
The lack of transparency and illiquid nature makes overseeing these kinds of investments also more laborious (and perhaps neglected?) versus the management of stocks, bonds, cash and other easily valued asset portfolios in kind. Hedge Funds and Private Equity Funds often fly under the radar.
Diversify, Diversify, Diversify!
Today, perhaps more than ever before, alternative pension planning is imperative. We need to plan for the possibility that full pensions may not be received as expected whether due to fund performance, mismanagement or any other unforeseen factors. Alternatively, look to the following: 1) Additional funding to an IRA, Roth IRA, annuity or any other tax qualified product. 2) Investing additional funds in stocks, bonds, mutual funds, CD’s, etc.
There is safety in diversification. If you count on your pension 100% and it is no longer there or not to the extent expected, you will have serious problems. If, on the other hand, there are problems with your pension but you have done alternative planning with provisional investments in other asset classes, the impact will be lessened.
Kurt Rusch CLU, ChFC
