I have been studying the Maryland State Pension and Retirement Savings Plan just because I’m interested in how professionals go about investing $36 billion of assets. It’s difficult to evaluate the plan’s asset allocation without considering the investment time horizon that is used to evaluate success. As you might imagine, the plan seems completely uninterested in short-term returns if defined as periods of less than 5 years. In fact, the plan uses actuarial methods that smooth the plan’s returns for very long periods of time. For example, the plan’s unfunded liabilities are smoothed under an actuarial convention called the “corridor method” that amortizes the plan’s pre-2000 unfunded liabilities over 20 years and then each subsequent year liability over distinct 25 year periods. In addition, the value of plan assets is “capped” to be 20% above or below the plan’s target actuarial return of 7.75% and can be amortized over five years. As it says in the plan’s annual report, any one year’s investment performance can take up to 15 years to be fully recognized under current plan accounting conventions. Fifteen years is a long time to fully recognize capital gains and losses, and it provides a powerful incentive to not be overly worried about short-term investment performance. We certainly don’t have the same luxury at Pinnacle where we have to mark our client’s investment performance to the market every day.
The Maryland plan sets up a series of performance benchmarks that also promote very long-term thinking. For example, one benchmark is to outperform the 7.75% actuarial return assumption over time. Another is to outperform inflation by 4% over time. Another is for the plan to outperform “the plan’s” performance benchmarks, which careful reading reveals to be individual asset class benchmarks. If there is a single benchmark to evaluate the total portfolio I can’t find it. It is the latter benchmark that is potentially short-term in nature, but it doesn’t incentivize plan managers to be concerned about short-term absolute returns. For example, if the plan’s equities lose 35% and beat the equity benchmark by 3% then they will have accomplished the goal of outperforming, even though they lost 35% on the position. The plan is obviously tilted in every way to succeed over the very long-term and investors will not find any reason to be concerned about short-term performance either in the plan’s asset allocation or performance evaluation.
The question I have is, so what’s wrong with that? The investing we do for Pinnacle clients is also long-term in nature when stated from the perspective of matching investment strategy to our client’s objectives. Retirement planning is a decidedly long-term endeavor, and investing to meet retirement goals should require a long-term perspective as well. Yet Pinnacle clients have access to return information every week and every quarter, as well as every year. The investment team earns part of their bonus based on quarterly performance. We read daily and weekly research, trying to discern how and when trends may change in the very short term. I doubt that we will ever resolve the conundrum of investment time horizon to my satisfaction. Good consumers want performance information in “real time.” I can only be envious of pension plan managers who seem to totally ignore short term market volatility.