Hedging Options

The question—debt or equity?—is rarely raised in North American corporate boardrooms. A good part of the blame rests with the fundamental structure of the financial marketplace: both the brokerage industry and the retail investor segment is governed, almost entirely, by the need to trade instruments (stocks) which inherently incorporate substantial short-term upside. But corporate managements must also be blamed for failing to substantiate business models capable of reasonable analytical scrutiny; after all, without a clear direction, it is impossible to draw any qualitative distinction between the respective roles of equity and debt in a corporation’s growth strategy.

The traditional argument against the applicability of debt for juniors is premised on the notion that, without hard asset security (perhaps in the form of proven reserves), a debt issue is not a viable proposition. That notion is seriously flawed. On the one hand, convertibility can take care of debt default in instances where the value drivers influencing strategic success are unable to take concrete shape within a pre-defined time-frame. On the other hand, debt is invariably a consequence of pricing; whereas a developed mining company may be able to issue loan paper at 300 basis points over a benchmark rate (e.g. US treasuries or LIBOR), a junior may have to pay 700 or 800 basis points.

That brings back to the “debt or equity” question. Is debt at 15 % per annum more expensive than equity raised at current market price levels? No. There are any numbers of examples of well-managed juniors achieving five- and ten-fold increases in share prices over an 18-24 month period. Therefore, in plain percentage terms, the balance between limited dilution via debt and excessive dilution via equity must weigh in favour of the former.

In addition to the rather simplistic percentage-per-annum relative comparisons, sophisticated mathematical assessments of cost of capital produce the same results: credible business models make their own case for debt in favour of equity until such time that market capitalizations reflect underlying value. Such results may not hold in an environment where applicable interest rates exceed 20-25 % per annum, or where a company’s market capitalization far exceeds management’s perception of corporate value. But, in general, the conclusions hold good today.

Which brings us to the second question: Is junior-issued debt saleable?

Most certainly so; at the end of the day, debt placement is a function of price. And price, in turn, is a function of structure. Does the debt instrument offer convertibility into common shares? Will those common shares be tradable upon conversion? Will the debt paper undergo enhancement, potentially, during its validity, as exploration programmes lead to probable or proven reserves? Is the debt secured by a specific resource?

The exercise is not as complicated as it may appear in the first instance. On the contrary, most of the answers to structuring-related questions can easily be found in a company’s business model. For example, pricing depends upon where a particular company figures on the exploration-to-resource cycle, which impacts upon quality of the security on offer. To take another related example, the number of issued and outstanding shares—calculated on a fully diluted basis—directly impacts upon the conversion options.

All that said, what a junior requires today, at the very outset, is an acceptance of the fact that the sub-prime crisis has forced a total revaluation of pricing parameters, be it debt or equity, right across the investment spectrum.

Thursday’s mini rally did a very poor job of papering over the cracks in the global economy. On Friday those cracks were wide open for all to see with housing and financial stocks hit the hardest. Barclays in particular was back to square one, erasing all gains from the start of the week, as investors took a second look at their fund raising plans in light of Goldman’s predictions of further write downs for major western banks. Citi Group was also floored on similar sentiment, falling to its lowest level since 1998.

The Dow Jones Industrial average ended the week down 4.2% and nearly 8% down over the last fortnight. The FTSE faired little better, falling 2.88% on the week and 6.26% over the fortnight. The twin evils of Gold and Oil were again the sectors in demand, as investors looked to profit from further economic turmoil, and hedge their bets against inflation. Oil refused to budge below $130 and set a new all time high of $143. $150 a barrel, scoffed at by some just a few months ago, is looking increasingly more likely and is surely now only a matter of time.

Some positive cheer came with US consumer spending rising as Bush’s stimulus cheques hit. While this lift at least created a pause from the continuous stream of bad news, market participants were wary of reading too much into what may be a short term patch for the US economy.

Despite a shortened trading week with Independence Day on Friday the 4th of July, it is a very busy week ahead. Currency markets will be eyeing Thursday’s ECB interest rate decision and accompanying statement. The European Central Bank is expected to raise rates by a quarter of a percent to 4.25%. With this starting to be priced in already, market participants will be more interested in the prospects of a string of inflation fighting rate rises from the ECB.

Thursday also sees the all important US Non Farm Payroll data brought forward a day because of the holiday on Friday. This more than anything could have the greatest impact on currency and equity markets for the new month of July. The UK certainly doesn’t escape without any top tier data with two lots of house price announcements. Nationwide release their data on Tuesday and The Halifax House Price index is tentatively planned for Thursday. The news is expected to be dire from both these announcements with Stephen Nickell, the head of the Prime Minister’s housing planning unit predicting that the UK housing market won’t boom again until 2015. To make matters worse, recent data shows that British households are more indebted than any other country in recorded history. 173% of household incomes are owed in debts. This is higher even than Japan’s peak in 1990 that preceded decades of deflation. Barclays added to the gloom by warning their clients to prepare for the financial storm ahead. While Thursday was an impressive sell off, doubts remain whether the ‘puking’ point has been reached just yet. Bottom feeders will start to become interested, but the VIX options volatility index is still some way off the January and March spikes. In addition we are not seeing the same flight to safe havens such as short term fixed income, that we saw in the first quarter. According to BetOnMarkets traders, with Gold bottoming around $860 and renewed concern over inflation, it is perhaps time for the precious metal to follow its evil twin, oil higher after a few months in the doldrums. A One Touch trade for Gold to hit $1000 again within the next two months could return 70%.

***

BetOnMarkets.com is the world’s leading Fixed Odds Financial Trading website. Fully licensed and regulated globally, BetOnMarkets.com handles around 18,000 trades a day, from over 130,000 registered clients. Over 15 million trades have been processed since inception in 2000. The multi-award winning BetOnMarkets.com allows traders to speculate on the movement of the worlds’ major financial markets, up down or sideways without actually owning the market, stock or currency you are buying.

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s)

1. how to maintain top quartile performance;

2. how to protect assets in times of economic uncertainty;

3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let’s examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It’s important that you do too.

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s)

1. how to maintain top quartile performance;

2. how to protect assets in times of economic uncertainty;

3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let’s examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It’s important that you do too.

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s)

1. how to maintain top quartile performance;

2. how to protect assets in times of economic uncertainty;

3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let’s examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It’s important that you do too.

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s)

1. how to maintain top quartile performance;

2. how to protect assets in times of economic uncertainty;

3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let’s examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It’s important that you do too.

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s)

1. how to maintain top quartile performance;

2. how to protect assets in times of economic uncertainty;

3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let’s examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It’s important that you do too.

The Ol’ Pension Blues

12/2/2009 By Fisher Investments Editorial Staff

http://www.marketminder.com/a/fisher-investments-the-ol-pension-blues/cbe61fa6-7302-4033-9368-1281867c171b.aspx?source=home

The ol’ pension blues are back—but they needn’t rob investors of holiday cheer.

Story Highlights:

> Corporate and public pensions are underfunded, a fallout from the market plunge and from under-contribution.

> The same pension worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now.

> Corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

> Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks.

________________________________________________________________________

The holidays are coming, and we can only guess what’s on corporate and public pensions’ wish lists: A big wad of cash. Pensions of all stripes are finding themselves underfunded—meaning liabilities (payment obligations to employees) are greater than what’s in the bank—a fallout from the market plunge and from under-contribution. The average public pension plan is 35% underfunded, and 92% of corporate pension plans were underfunded at the end of last year.

Solutions to the underfunding issues aren’t promising. Aside from Santa’s generosity, options include cutting back on benefits, contributing additional funds to retirement plans, or declaring bankruptcy and falling into the safety net provided by federal pension insurers, like the Pension Benefit Guaranty Corp. The recent market surge has helped some, but many pensions are still in the red.

There are worries the pressure to balance pension plans will hold back or even depress economic growth. When corporations shift funds to retirement plans, they do so at the expense of future profits and growth. Some corporations have reduced operations and expenses to maintain pension contribution levels. Employees at companies with underfunded pensions may feel uncertain about retirement benefits and perhaps cut back on spending and/or investing in stocks. Underfunded public pension plans are likewise a worry. Many public pensions are legally bound to provide stated benefits, meaning options to balance liabilities and assets are fewer. And a state or municipal bankruptcy would heavily weigh on taxpayers—not ideal given today’s weaker economic environment and high unemployment.

However, the ol’ pension blues aren’t new. The same worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now. Why? Many pension funds, corporate and public, invest in “alternative investments,” like hedge funds and private equity. Following bear markets, companies adjust downward their return expectations for the pension plans. (Similarly, expectations are generally adjusted upward during flush times, leading to under-contribution.) This downward adjustment increases the present value of future assets while the low interest rate environment increases the present value of liabilities, making pensions seem more underfunded than they really are otherwise. A function of accounting! Indeed, accounting for pension fund liabilities is complicated and highly subjective—it tends to extrapolate the most recent phenomena into the future, a common cognitive investing bias.

This isn’t to say the pension losses over the last year weren’t real. However, the overemphasis on the underfunding issue isn’t warranted. Even in 2006, before the recession and bear market, public pension plans were underfunded by $361 billion, and that didn’t hold back more growth, nor did it trigger economic or market collapse. Plus, corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks. More than a market-crushing event, this is likely one more brick in the wall of worry markets like to climb. Though pension plans’ balance sheets don’t look rosy, investors needn’t lose their holiday cheer.

Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by its author’s employer or performance of its clients. Such viewpoints may change at any time without notice. Nothing herein constitutes investment advice or a recommendation to buy or sell any security or that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

 

 

The Ol’ Pension Blues

12/2/2009 By Fisher Investments Editorial Staff

http://www.marketminder.com/a/fisher-investments-the-ol-pension-blues/cbe61fa6-7302-4033-9368-1281867c171b.aspx?source=home

The ol’ pension blues are back—but they needn’t rob investors of holiday cheer.

Story Highlights:

> Corporate and public pensions are underfunded, a fallout from the market plunge and from under-contribution.

> The same pension worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now.

> Corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

> Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks.

________________________________________________________________________

The holidays are coming, and we can only guess what’s on corporate and public pensions’ wish lists: A big wad of cash. Pensions of all stripes are finding themselves underfunded—meaning liabilities (payment obligations to employees) are greater than what’s in the bank—a fallout from the market plunge and from under-contribution. The average public pension plan is 35% underfunded, and 92% of corporate pension plans were underfunded at the end of last year.

Solutions to the underfunding issues aren’t promising. Aside from Santa’s generosity, options include cutting back on benefits, contributing additional funds to retirement plans, or declaring bankruptcy and falling into the safety net provided by federal pension insurers, like the Pension Benefit Guaranty Corp. The recent market surge has helped some, but many pensions are still in the red.

There are worries the pressure to balance pension plans will hold back or even depress economic growth. When corporations shift funds to retirement plans, they do so at the expense of future profits and growth. Some corporations have reduced operations and expenses to maintain pension contribution levels. Employees at companies with underfunded pensions may feel uncertain about retirement benefits and perhaps cut back on spending and/or investing in stocks. Underfunded public pension plans are likewise a worry. Many public pensions are legally bound to provide stated benefits, meaning options to balance liabilities and assets are fewer. And a state or municipal bankruptcy would heavily weigh on taxpayers—not ideal given today’s weaker economic environment and high unemployment.

However, the ol’ pension blues aren’t new. The same worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now. Why? Many pension funds, corporate and public, invest in “alternative investments,” like hedge funds and private equity. Following bear markets, companies adjust downward their return expectations for the pension plans. (Similarly, expectations are generally adjusted upward during flush times, leading to under-contribution.) This downward adjustment increases the present value of future assets while the low interest rate environment increases the present value of liabilities, making pensions seem more underfunded than they really are otherwise. A function of accounting! Indeed, accounting for pension fund liabilities is complicated and highly subjective—it tends to extrapolate the most recent phenomena into the future, a common cognitive investing bias.

This isn’t to say the pension losses over the last year weren’t real. However, the overemphasis on the underfunding issue isn’t warranted. Even in 2006, before the recession and bear market, public pension plans were underfunded by $361 billion, and that didn’t hold back more growth, nor did it trigger economic or market collapse. Plus, corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks. More than a market-crushing event, this is likely one more brick in the wall of worry markets like to climb. Though pension plans’ balance sheets don’t look rosy, investors needn’t lose their holiday cheer.

Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by its author’s employer or performance of its clients. Such viewpoints may change at any time without notice. Nothing herein constitutes investment advice or a recommendation to buy or sell any security or that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

 

 

The Ol’ Pension Blues

12/2/2009 By Fisher Investments Editorial Staff

http://www.marketminder.com/a/fisher-investments-the-ol-pension-blues/cbe61fa6-7302-4033-9368-1281867c171b.aspx?source=home

The ol’ pension blues are back—but they needn’t rob investors of holiday cheer.

Story Highlights:

> Corporate and public pensions are underfunded, a fallout from the market plunge and from under-contribution.

> The same pension worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now.

> Corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

> Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks.

________________________________________________________________________

The holidays are coming, and we can only guess what’s on corporate and public pensions’ wish lists: A big wad of cash. Pensions of all stripes are finding themselves underfunded—meaning liabilities (payment obligations to employees) are greater than what’s in the bank—a fallout from the market plunge and from under-contribution. The average public pension plan is 35% underfunded, and 92% of corporate pension plans were underfunded at the end of last year.

Solutions to the underfunding issues aren’t promising. Aside from Santa’s generosity, options include cutting back on benefits, contributing additional funds to retirement plans, or declaring bankruptcy and falling into the safety net provided by federal pension insurers, like the Pension Benefit Guaranty Corp. The recent market surge has helped some, but many pensions are still in the red.

There are worries the pressure to balance pension plans will hold back or even depress economic growth. When corporations shift funds to retirement plans, they do so at the expense of future profits and growth. Some corporations have reduced operations and expenses to maintain pension contribution levels. Employees at companies with underfunded pensions may feel uncertain about retirement benefits and perhaps cut back on spending and/or investing in stocks. Underfunded public pension plans are likewise a worry. Many public pensions are legally bound to provide stated benefits, meaning options to balance liabilities and assets are fewer. And a state or municipal bankruptcy would heavily weigh on taxpayers—not ideal given today’s weaker economic environment and high unemployment.

However, the ol’ pension blues aren’t new. The same worries surfaced in the late 1980s and in 2002, and it turned out underfunding fears then were greatly overstated, as they likely are now. Why? Many pension funds, corporate and public, invest in “alternative investments,” like hedge funds and private equity. Following bear markets, companies adjust downward their return expectations for the pension plans. (Similarly, expectations are generally adjusted upward during flush times, leading to under-contribution.) This downward adjustment increases the present value of future assets while the low interest rate environment increases the present value of liabilities, making pensions seem more underfunded than they really are otherwise. A function of accounting! Indeed, accounting for pension fund liabilities is complicated and highly subjective—it tends to extrapolate the most recent phenomena into the future, a common cognitive investing bias.

This isn’t to say the pension losses over the last year weren’t real. However, the overemphasis on the underfunding issue isn’t warranted. Even in 2006, before the recession and bear market, public pension plans were underfunded by $361 billion, and that didn’t hold back more growth, nor did it trigger economic or market collapse. Plus, corporations contributing more funds to pension plans could be a positive for markets if the extra funds find themselves into stocks, as they did in 2003.

Underfunded pensions are a widely known phenomenon—meaning the negative impact is likely already largely priced into stocks. More than a market-crushing event, this is likely one more brick in the wall of worry markets like to climb. Though pension plans’ balance sheets don’t look rosy, investors needn’t lose their holiday cheer.

Disclaimer: This article reflects personal viewpoints of the author and is not a description of advisory services by its author’s employer or performance of its clients. Such viewpoints may change at any time without notice. Nothing herein constitutes investment advice or a recommendation to buy or sell any security or that any security, portfolio, transaction or strategy is suitable for any specific person. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.