Re: Wilshire memo warns on US LDI products

by Alex Beveridge 7 December 2007

US – An internal Wilshire memo sent to all its senior consultants has warned them of potential legal pitfalls for clients when advising on the suitability of liability driven investment (LDI) products in the US.

The concerns centred on an advisory opinion given by the Department of Labor (DOL) in October 2006.

It was sought by Donald Myers of ReedSmith on behalf of JPMorgan Chase Bank and asked for clarification on whether it was prudent for a fiduciary to consider LDI under the Employee Retirement Income Security Act (ERISA).

Under ERISA, investment strategies must primarily benefit the pension plan. As LDI strategies seek to reduce pension fund volatility, it could be argued they could also benefit plan sponsors by reducing volatility on their overall balance sheet.

The DOL advisory opinion subsequently approved the use of LDI as described in the request, however, the Wilshire memo raised concerns LDI marketers didn’t recognise the limits of the advisory opinion.

Dimitry Mindlin, managing director at Wilshire, told Global Pensions: “It bothered me a great deal when many LDI marketers told us at conferences and presentations that this advisory opinion was the final word. I read the opinion and I found it inconclusive. Although I am not an attorney, I believe that if this ever ended up in a court of law, they would not find it very helpful.”

One senior executive from an American asset manager, who asked not to be named, backed Mindlin. He noted: “The advisory opinion does not address the significant potential conflict between two goals – maximising the probability that the plan’s funding objective will be met by a particular investment strategy in the long run and reducing volatility of the plan’s funded status on an annual basis.”

He said the first goal was clearly prudent under section 404 of ERISA, but the second goal was problematic if it conflicted with the first goal. He suggested the argument the benefit to the plan sponsor was more than incidental could be applied if, in a bid to reduce annual volatility, it adopted a strategy that reduced the probability of funding the plan in the long run.

Marc Van Allen, a partner and member of the ERISA litigation group at law firm Jenner & Block, said: “From an ERISA fiduciary point of view, [when] looking to implement LDI, pension funds have to satisfy their twin duties; duty of loyalty and duty of care. The tricky part can be separating the benefits to the plan from the benefits to the plan sponsor’s balance sheet.”

He said the ERISA fiduciary needed to be able to demonstrate they were principally focusing on the benefits of the plan. “If there then turned out to be some sort of incidental benefit to the plan sponsor, then that’s OK,” he said.

To begin with, we had a problem in search of a solution, and now we also have a solution in search of a problem. Instead of meeting, they’re floating past each other like ships in the night.

Deutsche Bank told investors in its Rreef U.K. real estate funds, worth about 2.7 billion pounds, that they will have to wait for up to a year, the newspaper said. UBS’ 2.3 billion-pound Triton property unit trust is also invoking a 12-month waiting period for some investors, the FT said. Investors in Morley’s one billion pound pooled pension property fund have also been told of a wait of up to 12 months for redemption, the newspaper said. Aviva’s Norwich Union unit is also “preparing for every eventuality” for its commercial property fund, the U.K.’s largest, if investors keep leaving the industry, the FT said. The company said there was no immediate plan to suspend redemptions, the newspaper reported.

I also liked how Florida brought in Blackrock to help with bond illiquidity, while the conflict of interest question was ignored, in regard to Blackrock Florida pensions. One must realize that regulation is a non-issue in these matters and that collusion is everything! Go look at Florida pensions with blackrock!

I don’t see why they are looked at as the savior when they got themselves caught up in this mess too.
The conflicts seem very troubling to me.
Blackrock wants to save its own funds.
With their large Citi SIV holdings motivations are aligned with Citi.
And don’t forget that Merrill still owns most of Blackrock. After Citi, Merrill is clearly the most in need of SIV-type asset prices getting set artificially high.