JoI: How did the liquidity crunch impact interest rates and how did that impact pension plans as a result?

Mangiero: For a while, as the government kept trying to depress interest rates overall by adding liquidity to the market, reported pension liabilities increased. In the aftermath of the Pension Protection Act of 2006, this was a big deal for many companies that suddenly found themselves in a position of being statutorily underfunded.

As a result, more than a few employers found themselves having to accelerate cash payments to their pension plans to restore funding normalcy. Now there are quite a few U.S. corporations seeking relief from the Pension Protection Act, saying, “Our stock has been hit so hard, and we don’t want to spend billions of dollars to top off the pension plan because of short-term issues, and we’re fine in the long term.” Preceding the central banks’ intervention, crisis conditions meant a rise in LIBOR. This resulted in higher costs for pension plan swap floating-rate payors.

JoI: Does the surge in correlations among different asset classes during times of market crisis have any impact on long-term planning?

Mangiero: I think the answer would have to be yes. It just depends, in part, on how pension plans respond. If the immediate response is to sell positions as correlations start to converge, the pension plan manager could incur transaction costs and lock in losses. 401(k) plan participants encountered the same problem.

Then there is the issue of strategic asset allocation. If investors do change the short-run mix, how is that likely to impact long-term performance?

I don’t think most investors had anticipated the flight to quality that we experienced in the fall of 2008. For example, if a pension plan had allocated money—and here I’m talking more about a defined benefit plan—let’s say, to a hedge fund that was investing a lot in equity, and the pension plan also had X percent allocated to a long-only strategy, and the equity market tanked, then all of a sudden the defined benefit plan is going to see its total portfolio drop in value from, not only the long equity allocation, but also the hedge fund allocation. I think many investment decision makers were just not prepared for that. It was kind of like a doubling-up, or worse, of the exposure to some things that were not doing well.

It’s a very tough time for people. The good news is—and this is what we’ve been encouraging, urging pensions, endowments and foundations to do—that people can use this time as an opportunity to focus on risk management, learn lessons, ask lots of tough questions, make changes now and hopefully improve the process. There are some folks who are doing a great job already. But again, the best defense is a good offense—in terms of risk management, just getting a very robust process in place. We are seeing more pension plans starting to consider [using] or just outright hiring risk managers. And I think that’s a wonderful step in the right direction.

JoI: Can you talk about how you see benchmark risk, and what the most critical issues are for pensions to consider in that area?

Mangiero: That’s a great question. It’s also one that’s difficult to answer. For example, consider liability-driven investing, a hot topic in the pension community. I ask a lot of pension plans the question, “How are you benchmarking the LDI managers?” And the answer I usually get back is, “We’re not sure how to do it yet.” Some people are using a pension surplus-at-risk measure, as opposed to value at risk. And some people are looking at a deviation around a cash flow benchmark.

I think for those involved in indexing, there’s a great opportunity to help the retirement-plan decision makers with thinking through what the benchmarks should look like.

JoI: Final thoughts?

Mangiero: I think retirement-plan decision makers are faced with many challenges, whether you’re talking about defined contribution or defined benefits. There’s almost no relief. There’s not a one-size-fits-all solution to which everybody can gravitate and try to make up for losses, try to protect themselves from losses down the road. The best defense, we think, is just having a really good process in place, so that you can identify risk drivers or risk factors, maybe before things get out of hand.

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