Underfunded Defined Benefit Plans

[Ron Snyder]

As an actuary who has worked with DB plans for 39 years (yes I am old), I seldom had any input into clients investment choices. However, I noted that clients tended to either want stock market investments, fixed investments or real estate (less common the past couple of years) as their primary investment strategy.

It now seems that I am being bombarded with information about hedge funds. While hedge funds are no panacea, they offer the potential for investment returns not subject to stock market ups and downs.

I would like to know if your experience is similar. What percentage of your DB clients are considering such hedge fund investments?

[Andy the Actuary]

It is interesting: Awhile ago I attempted to seek a definition for "hedge fund" and found it not to be uniquely defined. So, please state the definition you had in mind.

[Ron Snyder]

Investopedia includes the following:

What Does Hedge Fund Mean?

An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).

Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year.

Investopedia explains Hedge Fund

For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.

It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.

[Andy the Actuary]

That explanation is an example of precisely why I dropped algebra in junior high.

[Belgarath]

"While hedge funds are no panacea, they offer the potential for investment returns not subject to stock market ups and downs."

And has that proven to be the case? Haven't a lot of them bombed?

At any rate, I'm no investment advisor, but our clients don't seem to go for them much, as we mostly do small plans.

Personally, I do tend to fall on the conservative end of the spectrum. A few of the old tried and true platitudes seem to work out over the long haul - "Don't put all your eggs in one basket" and "if it sounds too good to be true, it is" and the old Will Rogers "I'm more concerned with the return OF my money than I am with the return ON my money."

It does seem that for every success story (and there are a lot of them) there's another disaster. But I find that investing is totally stress free when all your money fits nicely in a piggy bank.

[AndyH]

I have a client who is a hedge fund manager. Funny they have never mentioned it in regard to their plan.

(As an aside, same for insurance people - never seen life insurance in any broker's own plans - ever - but I don't mean to suggest that the reasons are the same)