Future market action: We don’t know about future profits, how individual stocks or regions will perform, or about inflation and interest rates. Basically, anything that could occur in capital markets and the economy in the future is an unknown.
Political action: Pensions are funded via direct contributions by cities and states. We know many pension funds are underfunded; we have also seen resistance from municipalities to allocate enough money to cover pension obligations. Although some states have specific rules about minimum funding of pensions, not all do. There is a variable political component to this.
Performance (and fees): The performance of active managers cannot be known in advance. Yes, there are hopes and wishful thinking, but it is not the same as actual returns. And, for pensions that have sizable investments in alternatives, the performance portion of the fees are similarly unknown.
Last, many people seem to operate under a set of false beliefs that manifest themselves in the form of costly investment decisions. This is a challenge for both the future beneficiaries of any pension and the state that is obligated to fund them. Not coincidentally, lots of these costly errors are the result of doing business with individuals or firms with a vested interest in selling a product to the fund, or consulting on such products.
I believe pension funds should make the effort to have simpler, less expensive investments. Outperformance is hard to achieve, while holding down costs is something more attainable. But in the meantime, understanding what pensions do and don’t know is a great first step.
This column was provided by Bloomberg News.