Russell: Pensions Still Reeling from 2008

Record-low interest rates have wiped out any gains from asset price recovery, writes Chief Research Strategist Bob Collie.

US pension plans still haven’t recovered from the 2008 financial crisis—and low interest rates may be to blame, according to Russell’s Bob Collie.

“It’s been the liability side of the balance sheet—not the asset side—that has hindered the recovery.”Pension funding levels remain “stubbornly poor” more than seven years after the peak of the crisis due to liability increases, not falling asset values, the chief research strategist explained in a blog post.

“At its low in March, 2009, typical funded status (on a fully marked-to-market basis) had fallen by some 30%,” Collie wrote. “That was mainly the result of a sharp fall in asset values.”

But while asset values have since recovered, funding levels have not, he continued.

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“Falling asset values dragged funding down, but it’s falling interest rates that have kept it down,” Collie argued. “It’s been the liability side of the balance sheet—not the asset side—that has hindered the recovery.”

Had interest rates remained unchanged, Collie said funded status would have fully recovered to pre-crisis levels by 2014 based purely on the impact of investment returns. Even given the decline in funding levels in the last two years, the average pension would still be roughly 90% funded today.

Instead, funded status for US pensions today is under 70%, showing little improvement since hitting 60% in 2009.

“The fall in the discount rate has prevented the recovery in funded status that would have otherwise occurred,” he argued.

And UK pensions are facing a similar issue: Across the pond, pension liabilities are priced relative to bond yields, which are at record lows following Brexit and the Bank of England’s August interest rate cut.

Consultant JLT Employee Benefits estimated that the aggregate deficit of UK private sector pensions had risen to a record high of £390 billion ($513 billion) at the end of July.

Persistently poor funding levels, Collie concluded, proved that investment returns alone were not enough.

“This highlights just how important it is for the two sides of the pension plan balance sheet to be managed together,” he said.

russell pension funded status Source: Russell’s Fiduciary Matters Blog

Home > News > Manager Selection > LPs Not Fooled by Inflated PE Valuations

Manager Selection August 11, 2016

LPs Not Fooled by Inflated PE Valuations

Underperforming private equity firms often overstate portfolio values when launching new funds, a study has found—but investors don’t fall for it.

To any private equity firms thinking of exaggerating their performance to better raise a new fund: Don’t bother.

“Sophisticated LPs are, on average, unlikely to misallocate capital.”While portfolio net asset values (NAVs) are easy to distort due to their subjective nature, limited partners (LPs) are not easily tricked by valuation manipulations, according to a study by the National Bureau of Economic Research (NBER).

Underperforming managers often boosted reported returns when attempting to raise money for new funds, reported finance professors Gregory Brown, Oleg Gredil, and Steven Kaplan. However, these managers were unlikely to succeed in launching a new product.

“Investors see through much of the manipulation,” they wrote. “Overstating interim returns has not been a winning strategy for GPs on average.”

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For the study, the NBER researchers used private equity transactional and valuation history for over 200 LPs from private capital data provider Burgiss. This information, combined with Stepstone’s SPI database of fund sequences and start dates, allowed the authors to determine when general partners (GPs) distorted NAVs—and how these distortions affected fundraising.

They found that exaggerated portfolio values were associated with lower probability of raising follow-up funds. Furthermore, conservative reporting had stronger positive effects on fundraising than market-adjusted performance.

In particular, top-performing GPs were shown to underreport NAVs in order to safeguard their reputation from negative shocks.

“GPs who are not underperforming should have an incentive to be truthful, or even conservative, with their unrealized investment valuations,” the authors wrote.

But whether GPs over- or understated performance, Brown, Oleg, and Kaplan found that LPs did not take interim performance reports at face value. Instead, investors appeared to prefer performance signals in the form of cash distributions following successful divestments by funds.

“Sophisticated LPs are, on average, unlikely to misallocate capital,” they concluded.

Read the full report, “Do Private Equity Funds Manipulate Reported Returns?”

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