Following the
market declines of 2001-2002, many defined benefit pension plans have become
underfunded. Some are responding by embracing hedge funds and other
"absolute return" strategies. My fear is that, in five years, those ambitious
pension funds will find themselves even more underfunded. Whatever the truth may
be, such matters are of profound importance, not only for the sponsoring
corporations, but society as a whole. With this book, Bernd Scherer challenges
conventional wisdom about pension fund management, proposing that funds not only
avoid sexy alternative investments but that they also forgo plain old equity
investments.
Scherer is a smart
and articulate author who wrote an excellent (2002)
text on risk budgeting. With this book, he wades into that great divide that
exists between financial engineering and actuarial science—and he stumbles.
Suggesting that methods of actuarial valuation are flawed, he proposes that
pension obligations should be marked to market as fixed streams of cash flows
and hedged with cash-matched or duration-convexity matched fixed income
portfolios. His arguments are sophisticated and very informative. While I
disagree with almost everything he says, I must admit that I learned much.
Contents
1. Actuarial Foundations
2. Valuation of Pension Claims
3. Hedging Corporate Liabilities
4. Liabilities and Portfolio Theory
5. Theory of the Firm vs. Portfolio Theory
6. External Asset Allocation in a Contingent Claims Framework
As is common when
individuals approach this debate from the financial engineering perspective,
Scherer profoundly underestimates the actuarial challenges involved. However, the
financial tools he brings to bear, including risk neutral valuation and
Modigliani-Miller theory are impressive. Scherer always thinks outside the box.
His writing is lively, with references to Adam & Eve and Oscar Wilde. He even
throws in a really bad actuary joke. The provocative questions he raises, and
the unique perspectives he offers, make the book worth reading. I had to think
long and hard to figure out exactly why I differ with him, and the exercise was
rewarding. If you are a sophisticated professional or theorist with some understanding of
pension liabilities, I think you will find this book just as rewarding. [11/27/05]
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