Pension Benefit Guaranty Corporation: Asset Management Needs Better Stewardship
Published: 2011-06-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Pension Benefit Guaranty Corporation's (PBGC) insures the pension benefits of more than 44 million people. Since its inception in 1974, PBGC's assets have grown from about $34 million to almost $80 billion in 2010, largely through assets received in plan terminations. Despite significant swings in PBGC's investment history, there has been little focus on the extent to which it has met its investment goals, the nature of its investment policies or how they compare with best practices in the industry. GAO examined (1) how PBGC's investment objectives have changed over time and the outcomes associated with those changes, (2) the performance of PBGC's investments, and (3) how well PBGC's investment policies and operations comport with best practices in the industry. To address these questions, GAO reviewed PBGC's investment policy statements and operational procedures; analyzed data on investments; and interviewed PBGC officials, officials from several state pension plans and foreign pension insurers, and other experts.
section_title: What GAO Found
paragraphs: PBGC's investment objectives and stated asset allocation targets have changed frequently in the last 8 years, alternating between more conservative and more aggressive approaches to investing. Yet these changes in stated objectives had only a moderate effect on PBGC's actual asset allocation because, for a variety of reasons, PBGC did not meet its targets. In our review of their investment history, we found that PBGC did not routinely monitor transaction costs related to its policy shifts and, at certain times, significant transaction costs were incurred. For example, we determined based on data obtained from PBGC's investment managers that nearly $75 million in transaction costs were incurred during the economic downturn which coincided with the period when the 2008 policy was being implemented and subsequently suspended. Using seven benchmarks, one of which was a Pension Protection Act benchmark that GAO constructed, GAO's analysis shows that PBGC's investments performed better than most benchmarks on an asset-only basis, but tended to underperform all seven of the benchmarks when returns were assessed together with the growth in liabilities. GAO notes that both analyses have limitations and can be seen by some experts as incomplete. However, GAO's method of analysis is consistent with how financial economics literature suggests investment performance analysis should be conducted. Finally, GAO's analysis found no apparent adverse effect on PBGC's investment performance as a result of changes in policy. PBGC's policy statements and operating procedures are incomplete and do not provide sufficient guidance to ensure sound implementation of its investment policies. The investment policies issued by PBGC's board for strategic guidance in the planning and execution of investments have generally lacked a number of provisions recommended by the Chartered Financial Analyst Institute; Independent Fiduciary Services; and other experts of sound investment management, such as the Government Finance Officers Association. Moreover, according to our review and based on interviews with PBGC staff, the policy statements have been insufficiently detailed to provide adequate guidance for staff. In addition, PBGC's Corporate Investments Department's staff have largely functioned without the benefit of fully-developed and documented operating procedures. Although PBGC has grown from a relatively small agency to one holding almost $80 billion in assets, its policies and procedures still reflect in many ways its small agency past. To ensure that PBGC can effectively and consistently meet its obligation to manage a fund of this size and its liabilities, PBGC's board and its management must enact better stewardship, standards, and procedures to ensure that PBGC can effectively and consistently meet its obligation to conduct the many investment related functions it performs.
section_title: What GAO Recommends
paragraphs: GAO recommends that the PBGC and its board of directors (1) develop and maintain comprehensive investment policy statements and (2) develop a complete set of operating procedures and guidelines for its investment activities. GAO received comments from the Department of Labor and the PBGC. They generally agreed with our recommendations.

section_title: Letter
paragraphs: The Pension Benefit Guaranty Corporation (PBGC) insures the pensions  of more than 44 million private sector workers and retirees who are  covered by more than 27,500 private defined benefit pension plans.  Created in 1974 as a federal guarantor of these plans, PBGC finances its  operations through insurance premiums paid by plan sponsors, funds  received from terminated pension plans, and money earned from the  investment of these funds. Despite PBGC’s financial holdings of almost  $80 billion, the agency currently faces a cumulative deficit of more than  $23 billion. Alternating between more conservative and more aggressive  investment strategies, PBGC has revised its investment policy several  times since its inception. You asked us to study:    how PBGC’s investment objectives have changed over time, whether  policy goals were met, and what impact have those changes had on  transaction costs;    how changes in investment policy have impacted investment returns; and    what methodology did PBGC use to execute investment policy changes  over the past 10 years and how well did PBGC comport with best practices  in the industry in terms of development, execution, and oversight of its  policies.
To answer these questions, we collected and analyzed information using  several methods. To identify changes to PBGC’s investment objectives,  policies, and associated costs, we examined the agency’s investment  policy statements, interviewed agency staff responsible for implementing  them, and obtained data on costs from staff and transition managers. Our  analysis did not include PBGC’s recently released investment policy  statement in late May 2011, since it was issued just after the completion of  our audit work.  To analyze the performance of PBGC’s investments, we  also obtained PBGC data on assets and liabilities and conducted a  portfolio performance evaluation of PBGC’s Single Employer Total Fund’s  monthly returns from October 1976 to December 2009. This analysis  compared the fund’s return performance to that of several benchmark  portfolios using a variety of portfolio performance statistics. To determine  how well PBGC comported with industry best practices regarding the  development, execution, and oversight of their policies, we reviewed  investment policy guidance from the Department of Labor, the Chartered  Financial Analyst Institute, and the Government Finance Officer’s  Association. We then compared policy elements from such guidance with  PBGC’s investment policies, and interviewed PBGC staff, a former PBGC  director, members of the Investment Advisory Committee, and board  representatives to obtain information about PBGC operations.  We also  interviewed and examined documents from domestic private and public  insurers, domestic pension plan sponsors, and foreign public insurers. For  additional discussion of our scope and methodology, see appendix I.
We conducted this performance audit from June 2009 through May 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: The Employee Retirement Income Security Act of 1974 (ERISA) created  PBGC as a government agency to help protect the retirement income of  U.S. workers with private-sector defined benefit plans by guaranteeing  their benefits up to certain legal limits. PBGC administers two separate  insurance programs for these plans: a single-employer program and a  multiemployer program. The single-employer program covers about 34  million participants in approximately 26,000 plans. The multiemployer  program covers 10 million participants in another 1,500 collectively  bargained plans that are maintained by two or more unrelated employers.  If a multiemployer pension plan is unable to pay guaranteed benefits when  due, PBGC will provide financial assistance to the plan, in the form of a  loan, so that benefits may continue to be made up to the guaranteed  benefit limits. However, if the sponsor of a single-employer plan is in  financial distress and does not have sufficient assets to pay guaranteed  promised benefits, the plan will be terminated and PBGC will likely  become the plan’s trustee, assuming responsibility for paying benefits to  participants as they become due, up to the guaranteed benefit limits. Most  of PBGC’s $102.5 billion in liabilities are due to future benefit payments  owed to participants of underfunded plans terminated under the single- employer insurance program.
To finance these liabilities, PBGC currently has approximately $80 billion  in assets. PBGC’s funds primarily come from three sources: insurance  premiums paid by sponsors of defined benefit plans, assets acquired from  terminated plans, and investment income earned on these assets. For  example, in 2010 all plans insured by PBGC paid a total of approximately  $2.3 billion in premiums. In addition, PBGC took over the assets from 147  defined benefit plans in fiscal year 2010, which totaled approximately $1.8  billion. Finally, over the course of the same year, PBGC recorded $7.8  billion in earnings from its investment portfolio, including interest,  dividends, and capital gains.
PBGC holds its assets in essentially two separate funds: the PBGC trust  fund and the PBGC revolving fund (see fig. 1). The PBGC Trust Fund  holds assets received from terminated plans and the return on investing  the assets held in the trust fund, while the PBGC Revolving Fund consists  of premium receipts and the return on investing the premium receipts.  Benefit payments and financial assistance are paid from the revolving  fund, and then the trust fund reimburses the revolving fund through a  proportional payment at least annually.
PBGC has grown significantly since the end of its first year of operation.  As of June 30, 1975, the agency had $34 million in assets and $1.2 million in  liabilities. At the end of fiscal year 2010, however, the trust and revolving  funds combined contained about $80 billion in assets (see fig. 2), to cover  total liabilities of $102.5 billion, leaving a deficit of approximately $23  billion.
PBGC is governed by a three-member board of directors, which consists of  the Secretary of Labor (Chair), the Secretary of the Treasury, and the  Secretary of Commerce. The board is responsible for policy direction and  oversight of PBGC’s finances and operations. The board of directors is  responsible for establishing and overseeing the policies of the corporation,  including the approval of the corporation’s investment policy statement.  Under its bylaws, the board is required to review the corporation’s  investment policy statement at least every two years and approve the  investment policy statement at least every four years. Each board member  must designate an official (not below the level of an assistant secretary) to  support the board’s oversight.  Board representatives are given the  authority to act for all purposes under the bylaws, subject to some  actions—such as approving the corporation’s investment policy  statement—being ratified by the board members. The board members  often rely on these department representatives to conduct much of their  PBGC related work on their behalf.
PBGC uses institutional investment management firms to invest its assets,  subject to the agency’s oversight and in accordance with the investment  policy statement as approved by its board and applicable legal  requirements. For example, ERISA provides different requirements  concerning how the assets held in the revolving fund and the trust fund can  be invested. ERISA requires the PBGC Revolving Fund to be, in part,  invested in U.S. obligations.  PBGC has more flexibility to invest trust fund  assets in other investments, and, along with revolving fund investments, the  corporation’s investment policy statement provides direction on how these  assets are to be invested. With respect to the trust fund, PBGC does not  determine the specific investments to be made, but instead relies on its  investment managers’ discretion to invest a portion of the funds consistent  with the benchmarks and risk criteria provided to each investment manager.  When PBGC receives assets from terminated plans, PBGC determines  whether the assets fit into the agency’s current investment policy objectives.  For incoming assets that do not fit with their current policy, PBGC uses  investment managers to liquidate them, as soon as practicable, and then  reinvests the proceeds into assets that do align with PBGC policy.
In its role as an insurer, PBGC’s responsibilities are similar to those of  other institutions that conduct such functions. However, the corporation  also faces structural challenges that are not shared by other insurers,  which gives the corporation less control over the terms by which it insures  pension plans and constrains its ability to manage its risk of loss (see table  1). For example, in contrast with information provided by pension insurers  in Canada and the Netherlands, PBGC tends to have less control over the  terms by which it insures pension plans. Only Congress, through  legislation, can change premiums or plan funding requirements for defined  benefit plans in the United States.
Beginning in 2003, recognizing PBGC’s long-term financial challenges, we  included PBGC’s single-employer insurance program on our list of “high- risk” programs needing attention and congressional action; in 2009, we  added PBGC’s multiemployer program as a program of concern. Both  programs remain on our high-risk list today.
section_title: Frequent Policy Changes Occurred, but Changes to Actual Asset Allocation Were Moderate
paragraphs: PBGC’s investment policy has changed frequently since 1990, alternating  between more conservative and more aggressive approaches to  investment. The frequent changes in policy have had a moderate impact on  PBGC’s actual allocation of assets since 1976 because there were no  allocation targets in place prior to 1990 and the policy targets after that time  were rarely ever met. Meanwhile, the transaction costs for the reinvestment  of assets during each policy period have fluctuated with shifts in the market.
subsections: section_title: PBGC’s Investment Objective Changes Have Had Moderate Effect on Actual Asset Allocations
paragraphs: Since 1990, PBGC has shifted its investment policy five times. The shifts in  investment policy that occurred in 1990 and 2004 were aimed at strategies  that immunized against interest rate exposure by increasing the allocation  of fixed-income securities.  PBGC’s investment policy was shifted in 2009 to  a more conservative strategy of taking on a higher allocation of fixed- income securities. In contrast, shifts in investment policy that occurred in  1994 and 2008 were aimed at strategies that maximized returns by  increasing the allocation of equities. Shifts in policy of this frequency are  thought to reflect an undisciplined approach to investing. Experts we  interviewed stated that a more disciplined approach would require that  PBGC change its investment policy no more than once every 5 to 7 years,  except to review the policy during unusual circumstances, such as the  recent market crash or when taking over the assets of a large terminated  plan. They noted that it can take up to 5 years for a policy to be fully  implemented and to have an impact that can be evaluated. Moreover, these  experts stated that a long-term and disciplined investment policy is needed  in order to minimize the costs associated with shifts in policy. Since 1990,  PBGC’s investment policy was in place for more than 5 years only once— during the period from 1994 to 2004. All other policies were in place for  shorter periods, generally about 2 to 4 years (see fig. 3).
PBGC’s actual allocation of its total assets (both revolving fund and trust  fund combined) reflects these changes in policy to some extent, but the  impact has been tempered by a number of factors. First, PBGC must  comply with certain statutory investment restrictions. Therefore, because  PBGC only invest the assets of its revolving fund in U.S. obligations which  are fixed-income securities, accomplishing its investment policy goal is, in  effect, limited to reallocating the assets of its trust fund —that is assets  acquired from terminated plans under PBGC trusteeship. Second, during  the period between 2004 and 2008, PBGC adopted the practice of using  only assets of newly terminated plans to move toward new allocation  targets, rather than reinvesting assets already in its trust fund. When in  place, this practice further limited the amount of assets PBGC could use to  meet its target allocations. Third, market conditions, at times, hindered  PBGC in reaching its allocation targets by reducing the overall value—and  as a result, the proportion—of assets invested in a particular sector.  Finally, the frequency with which allocation targets changed also affected  PBGC’s ability to make significant changes in its allocation. During each  period a policy was in place, PBGC made progress toward reaching new  allocation targets with varying success before a new policy was adopted.
In May 1990, PBGC adopted a new investment policy calling for a decrease  in the proportion of equities to no more than 35 percent of its portfolio.  This policy was initiated by PBGC’s then newly appointed executive  director in response to both an increase in unfunded liabilities and to the  results of a commissioned study that examined PBGC’s liabilities and  investment options. The study of PBGC’s trust and revolving funds  together recommended that PBGC reduce its equity exposure and increase  its allocation in long-duration fixed-income assets. Accordingly, PBGC  adopted a new investment policy that focused on matching its assets with  its liabilities and targeted an asset allocation of no more than 35 percent in  equities and no less than 65 percent in fixed income. In 4 months, PBGC  decreased its equity allocation from 43 percent to 33 percent and was able  to maintain this allocation range throughout the period for which the 1990  policy was in effect.
In October 1994, PBGC adopted a new investment policy that focused on  maximizing the return on its investments by investing more heavily in  equities in order to reduce the agency’s deficit by achieving higher rates of  return. Although no explicit asset allocation was specified in the  investment policy statement, PBGC’s 1994 annual report stated that, along  with the adoption of the new investment policy, the agency had raised its  ceiling for its equity allocation to 50 percent. The assets in PBGC’s  revolving fund is, pursuant partially to statute and partially to PBGC  policy, invested only in U.S obligations which are fixed-income assets,  hindering PBGC’s efforts to increase its overall equity allocation.  However, in the years that followed, the agency attempted to raise equity  levels by investing all its trust fund assets into equities. In this way, over  the course of fiscal year 1994, PBGC increased its actual equity allocation  from 17 percent to 30 percent. During the subsequent 7 years this policy  was in place, PBGC’s equity allocation peaked in 1999 at 44 percent, and  over the period, averaged about 35 percent according to data provided by  the agency.
In 2004, PBGC adopted a new investment policy that would, similar to the  1990 policy, match PBGC’s assets to its liabilities by emphasizing fixed- income investments and limiting exposure to market risk. The 2004 policy  reduced the allocation target for equities down to the 15 to 25 percent  range and raised the allocation target for fixed-income securities to 75 to  85 percent. To implement this policy, however, PBGC’s board directed  staff to use only assets acquired from newly terminated plans, rather than  to transition core trust fund assets already under management. As a result,  according to PBGC officials, the volume of assets available to transition  toward the target allocations was limited and the agency was not able to  lower its allocation of equities down to the target range during the time  this policy was in effect.
In 2006, PBGC adopted a new policy as a result of its biennial review  process. It allowed PBGC to invest in international securities, a departure  from the past. The agency’s overall investment policy, however, remained  the same, with equity allocation targets set at 15 to 25 percent and fixed- income allocation targets set at 75 to 85 percent. Despite this new policy,  once again, PBGC officials said that the agency did not receive enough in  newly trusteed assets to be able to shift its equity allocation down to this  target range. Also, during most of this period, the returns on PBGC’s equity  investments outpaced those of its fixed-income investments, further  hindering the agency’s attempt to reach this allocation target. Equities  were achieving returns of 11 to 17 percent in fiscal years 2006 and 2007,  while the returns of its fixed-income investments were around 1 to 3  percent annually. Hence, according to PBGC, the actual allocation hovered  between 27 to 32 percent in equities and 67 to 72 percent in fixed income  throughout this period.
PBGC changed its investment policy again in 2008 with the goal of seeking  to maximize returns on its investment. To this end, PBGC adopted an  investment policy with target asset allocations of 45 percent in equities; 45  percent in fixed income; and 10 percent in alternative investments, such as  real estate and private equity. In addition, the policy called for expansion  into two new subclasses of fixed-income securities: high yield and  emerging market debt. In February 2008, when the policy was adopted, 28  percent of PBGC’s assets were invested in equities. To move quickly  toward its newly adopted allocation targets, PBGC decided to abandon its  practice of relying only on newly acquired assets from terminated plans to  transitioning a portion of core trust fund assets as well. PBGC transitioned  nearly $5.7 billion from its existing trust fund investments in fixed-income  securities to equities. Despite these efforts, the financial crisis and a 35  percent decline in the New York Stock Exchange Composite Index  between early February 2008 and May 2009 caused PBGC’s actual equity  allocation to drop to as low as 23 percent during this period.
subsections: section_title: 2009 to Present
paragraphs: In May and June 2009, PBGC’s three board members issued a resolution  instructing staff to cease implementing the 2008 investment policy.  This  resolution was in response to an investigation, conducted by PBGC’s  Inspector General, concerning potential conflicts of interest involving  PBGC’s then Director with securing asset managers for the agency’s  portfolio. Transactions already initiated were allowed to proceed, but no  new transactions were permitted until the board representatives issued  investment policy guidance in July 2009, since the board had not also  issued a new investment policy statement after it ceased the 2008 policy.  Instead, this new interim policy called for a return to the actual portfolio  composition as it was on March 31, 2009, which was 26.5 percent in  equities and 73.5 percent in fixed income. This interim guidance served as  the official policy.  Since then, PBGC has transitioned its newly acquired  assets to fixed-income investments. Nevertheless, the performance of the  equities market improved enough that as of September 2010, equities made  up 31 percent of PBGC’s portfolio.
section_title: Transaction Costs Have Fluctuated with Shifts in the Market
paragraphs: While the actual distribution of PBGC assets has remained within a fairly  narrow range since 1990, the transaction costs incurred for the  reinvestment of assets during each period a policy was in place have  fluctuated with shifts in the market. Some transaction costs are always  incurred with the assumption of assets from newly terminated plans and  with the management of existing investments, but the magnitude of these  costs can vary dramatically depending on the volume and type of assets  being transitioned, the investment policy or goal in place, and the market  conditions during the transition period. PBGC does not have a routine  process for tracking the transaction costs associated with different  investment policies, and does not consider these costs when developing  new investment strategies.
Transaction costs for reinvestment of assets generally consist of  commissions, fees and certain taxes (referred to as explicit costs), and  opportunity costs, due to market changes during the transaction (referred  to as implicit costs). PBGC typically uses specialized transition  investment managers when transitioning large pools of assets to keep  explicit costs down through economies of scale and by taking advantage  of other services offered by these managers. However, opportunity costs  can vary widely based on market conditions, and can result in either a net  loss or a net gain. Taking both explicit and implicit costs together, when  transactions net an amount lower than the original value of the assets, a  loss occurs; when transactions net an amount greater than the original  value of the assets, a gain occurs. Although PBGC does not routinely track  and conduct analytics on the transaction costs associated with  implementing different investment policies, we were able to compile the  costs incurred during each period a policy was in place from 2004 forward  by obtaining records from PBGC officials as well as PBGC’s external  transition managers, as summarized in table 2.
From 2004 to 2008, PBGC’s investment policy remained primarily the  same: to transition assets from newly terminated plans to increase the  level of fixed-income investments. When the 2004 policy was being  implemented, assets valued at $8.8 billion were transitioned, and positive  market conditions helped PBGC realize a net gain of $40.5 million (or 46  basis points). When the 2006 policy was being implemented, assets of  about $2.6 billion were transitioned, but declining market conditions  towards the end of this period contributed to a loss of $7.6 million (or 30  basis points).
In 2008, PBGC’s investment policy shifted to increasing the level of equity  investments and certain subclasses of fixed-income securities and the  agency opted to use assets already in the trust fund, as well as newly  terminated plan assets, to accelerate implementation of the policy. In  total, assets of about $13 billion were transitioned while this investment  policy was in place, with $5.4 billion moving from fixed-income securities  to equities and $7.6 billion moving from one type of fixed-income  securities to others (specifically, from long-duration securities to high- yield and emerging market debt). These transactions were completed in  three phases. According to PBGC’s own records, phase one was  performed in an “ad hoc” manner and transaction costs were not tracked.  Assets transitioned during this phase totaled approximately $3.7 billion.  Phase two was more structured (referred to as “coordinated sales”), with  PBGC assigning each fixed-income investment manager an amount of trust  fund assets to sell over a 5-month period, allowing trades to be made on  favorable trading days at the discretion of the investment manager. About  $7.9 billion in assets were transitioned during this phase. During phase  three, termed the “runoff” phase, the 2008 policy had been suspended, but  PBGC officials told us they decided not to cancel the trades for about $1.4  billion in assets that their investment managers already had initiated. Due  in part to the market downturn during the period the 2008 policy was in  place, the transaction costs associated with asset trades of about $9.3  billion that were tracked during the last two phases of the transition  totaled nearly $74.6 million (or 80 basis points). According to one PBGC  investment manager, some trades related to the 2008 transition incurred  opportunity costs of 400 to 500 basis points.
In July 2009, a new interim directive was issued to decrease the level of  equity investments back to the asset distribution held as of March 31, 2009.  PBGC staff estimated that implementing this new policy could incur  transaction costs of as much as $52 million. In January 2011, PBGC  provided data indicating that between June 2009 and September 2010, $7.4  million in transaction costs had accrued since implementation of this 2009  directive.
section_title: PBGC’s Investment Performance Results Have Been Mixed
paragraphs: Our analysis of PBGC’s investment performance found that PBGC’s  investments performed better than most on an asset-only basis compared  with the seven benchmark portfolios (see table 3). However, PBGC’s  investment portfolio tended to underperform these benchmarks when  returns were assessed together with the liability return (or growth in  liabilities). Specifically, in the asset-only comparison, PBGC’s portfolio  achieved better risk-adjusted performance on its investments than that  achieved by six of the seven benchmark portfolios. When assessed with  liabilities, however, all seven benchmark portfolios performed better than  PBGC’s investment portfolio. This occurred for either one of two reasons:  either the benchmark had a mix of assets that were better correlated (that  is, moved more in tandem) with PBGC’s liability return (growth in  liability), or, when this was not the case, the benchmarks had returns  sufficient to compensate for the lower correlations for the period  examined. The best performing benchmark (the Pension Protection Act  benchmark) incorporated elements of both features, with a mix of  relatively high returns on assets and relatively high correlation of their  assets with PBGC’s liabilities.
Our analysis looks at the single historical period from 1976 to 2009, since  the purpose of the analysis is performance assessment, not asset  allocation recommendations. Typically, analyses for the purpose of asset  allocation would project forward over multiple potential future economic  scenarios in order to more fully assess potential risk and reward. The  various alternative static portfolios used in this report were analyzed for  the purpose of a “what-if” analysis—a historical comparison of alternative  investment strategies versus the fluctuating asset allocation that PBGC  actually employed—they were not for the purpose of recommending a  particular asset allocation going forward. Further, the fact that a particular  portfolio performed well over the 1976 to 2009 period in this particular  analysis does not necessarily mean that such a portfolio would be  appropriate for PBGC going forward.
We assessed performance by calculating risk-adjusted returns for PBGC’s  portfolio and for each benchmark, where higher returns improve  performance while higher volatility reduces performance. The  comparative benchmarks used for this analysis represent a range of equity  and fixed-income allocations. Six of the benchmarks are largely static  (fixed) allocations among asset classes; however, we also included one  Dynamic Benchmark that had allocations that varied among asset classes  over time.
subsections: section_title: PBGC’s Investments Outperformed Benchmark Portfolios on an Asset- Only Basis
paragraphs: Our analysis of PBGC’s investment returns for the period 1976 to  December 2009 found that, on an asset-only basis, PBGC’s portfolio  achieved better risk-adjusted performance on its investments than that  achieved by six of the seven benchmark portfolios. Specifically, our  analysis found that on an asset-only basis, PBGC’s portfolio outperformed  five of six fixed-allocation benchmarks, as well as the Dynamic  Benchmark. In each instance, the results were maintained regardless of  whether or not PBGC investment returns were net of investment  expenses. Within this framework, the PBGC and benchmark portfolios  were evaluated solely on how well the assets performed relative to the  risks taken. For details see appendix III.
section_title: PBGC Investments Underperformed Relative to Benchmark Portfolios When Returns Were Assessed with the Liability Return
paragraphs: When consideration of changes in liabilities was included in our analysis,  we found that PBGC’s investments did not perform as well as the seven  benchmark portfolios. PBGC must cover the liabilities from the  underfunded plans it trustees in order to pay benefits to participants and  beneficiaries. Other than the premiums assessed on plan sponsors that are  statutorily set, the only revenue that PBGC has to cover its liabilities is  the return on the assets it manages. Given this context, analyzing PBGC’s  investment performance in a framework that explicitly incorporates  liabilities provides useful information.
We found that PBGC’s investments underperformed all seven of the  benchmark portfolios on a risk-adjusted basis when the returns were  analyzed net of the liability return. In simple terms, this means that all  seven of the constructed benchmarks had a mix of assets with some  combination of risk, return, and correlation levels that made their  investment strategies achieve a higher level of risk-adjusted performance  than PBGC’s investment policy for the 1976 to 2009 period. This occurred  because either the benchmark portfolio had a mix of assets that had a  higher correlation with the liability return, or, in cases where the  correlations were lower, the benchmark portfolio had sufficient returns to  compensate for the lower correlations for the period we examined.  However, the dynamic portfolio, which maintains the same asset allocation  as the PBGC total fund, performed as well as the S&P 500 benchmark and  out performed the Barclays Capital and Post Fiscal Year 2002 benchmarks  as well as the PBGC portfolio—three portfolios that have significant  allocations to bonds. (For additional information, see app. III).
According to our analysis, the best performing portfolio for the 1976 to  2009 period was the PPA Benchmark Portfolio, with a mix of 40 percent  bonds and 60 percent equities. Because, this analysis is strictly based on  past performance, this result does not guarantee or imply that a PPA-like  portfolio will perform better than the current PBGC allocation going  forward. Moreover, the PPA benchmark and other portfolios with a  significant weighting toward equity would likely not perform as well if  incoming cash-flows from new plan terminations were included in the  analysis. Rather than determining a particular asset allocation, this  analysis highlights that an approach that was not only mindful of returns,  but also accounted for the correlation between asset returns and the  liability return, was more likely to result in an investment policy for PBGC  that achieved higher risk-adjusted performance for the 1976 to 2009  period.
section_title: No Clear Evidence that Fluctuation in the Allocation of Investments Had Adverse Effect on Performance
paragraphs: Our analysis found no link between the frequent changes in PBGC’s  investment policy since 1990 and the actual allocation between equity and  fixed-asset investments. This is because while the stated policy shifts were  significant, changes to the actual allocation were moderate. Hence,  changes remained within a narrow range of a portfolio mix between fixed- income and equity allocations. As a result, although some shifts in actual  allocations did occur, we found no conclusive evidence that fluctuations in  the proportional allocation between equity and fixed-income investments  had a notable adverse impact on PBGC returns. This was the case for both  types of analysis—asset-only and assets net the liability return.
Finally, in the assets net of liability context, our finding that PBGC’s  portfolio underperformed relative to the Dynamic Benchmark suggests  that factors other than asset allocation are causing the  underperformance—such factors could include the inflows of new assets,  timing of shifts to meet allocation goals and their associated costs, or  could reflect that there are no costs or fees in the Dynamic Benchmark.  However, detailed information would be required to determine the reasons  for the underperformance of the PBGC total fund relative to the Dynamic  Benchmark.
section_title: PBGC’s Policies and Procedures for Implementing Its Investment Policy Are Incomplete
paragraphs: In our review of PBGC’s internal documents, we found that the agency has  largely functioned without complete investment policy statements and  operating procedures. Compared to industry-recommended standards for  pension funds and insurance companies, PBGC’s investment policy  statements are missing important provisions that provide implementation  guidance. Further, PBGC staff have largely functioned without the benefit  of fully developed and documented operating procedures.
subsections: section_title: Investment Policy Statements Generally Lack Specifics in Key Areas
paragraphs: The investment policies issued by PBGC’s board for strategic guidance in  the planning and execution of investments have generally lacked a number  of provisions recommended for sound investment management or have  been insufficiently detailed to provide adequate guidance for staff  concerning certain investment objectives.
One expert we interviewed stated that while PBGC is unique and may not  be obligated to articulate the same policy provisions as other institutions  with similar responsibilities—such as foreign pension insurers, domestic  pension funds, and private insurance companies—the agency faces similar  investment problems, opportunities, and solutions as many investment  programs do. Hence, it is equally important for PBGC to have a well- developed investment policy statement as it is for these other institutions.  According to one expert, “an investment policy statement (IPS) is a  foundational document for a pension fund’s investment program. The  essential purposes of the IPS are to articulate the consensus view of the  board regarding the overall investment program and to document policies  and procedures regarding major issues.”
However, we found items included in the PBGC’s policy statements often  are insufficiently detailed to provide adequate guidance for staff  concerning certain investment objectives. For example, we found that  prior to 1990, PBGC operated without a formal investment policy  statement, and that the six different policy statements the PBGC board has  issued since then have been silent in many areas cited as important by  professional organizations such as the Chartered Financial Analyst  Institute, the Association of Public Pension Fund Auditors, and the  Foundation for Fiduciary Studies. We compiled a list of 25 items these  organizations recommended be included in an investment policy  statement in order to provide sound strategic guidance across the key  areas of governance, investment objectives, and risk management. We  then examined PBGC’s policy statements against these items and found  certain items were often missing (see table 4). The agency’s 2008 policy  statement has been the most thorough to date (including 15 of the items)  while PBGC’s most recent investment guidance, adopted by board  representatives in 2009, included the fewest to date (only 6 of the items).  Further, some of the provisions that were covered were, according to  some staff, insufficiently detailed to offer adequate guidance.
In the governance area, PBGC’s investment policy statements have not  assigned responsibility for managing, monitoring, and reporting on  portfolio risk. According to PBGC officials, those responsibilities were  either informally communicated to staff or staff assumed responsibility for  these activities on their own. Further, while most of PBGC’s statements  include a discussion of hiring and monitoring asset managers, they do not  assign responsibility for these tasks to a specific group. By contrast, the  investment policy statement of the United Kingdom’s pension insurer,  Pension Protection Fund, and most of the public pension plans that we  reviewed do assign responsibility for these tasks to specific groups, such  as the public plan’s investment advisory committee. Also, while PBGC’s  investment policy statements assign responsibility for the execution of the  investment program, they generally do not assign responsibility for  developing or monitoring the implementation of the policy.
According to statute, the PBGC board is responsible for establishing  policy. In addition, the board has an oversight responsibility to ensure that  PBGC is executing the board’s policy in appropriate ways. According to  PBGC staff, because of the lack of specific guidance in the policy  statements, there have been instances when staff have had to request  further policy guidance from PBGC’s board and the board had not always  been responsive. For example, in 2004, the board had instructed staff to  limit costs by using only incoming assets to transition to the new allocation  target. When adherence to this directive, together with a low level of liquid,  incoming assets caused the agency to miss its new allocation targets, staff  told us they asked for guidance but did not receive it. More recently, in May  and June 2009, the board members issued a resolution directing staff to  cease implementation of the 2008 investment policy, but did not approve a  new investment policy statement and did not provide further investment  guidance. In response, PBGC’s Corporate Investments Department’s (CID)  staff wrote a memo to PBGC’s acting director indicating that they were  concerned about the lack of a defined policy to provide direction to CID  staff with respect to asset allocation. Principal areas of concern outlined  were: (1) oversight and management, (2) investment of newly trusteed  assets, and (3) asset allocation risk. Subsequently, policy guidance was  provided by the board representatives until a new investment policy  statement was approved by the board.
In addition, while we have found that the board and board representatives  are meeting more frequently than in the past, we could find no formal  oversight or formal feedback mechanism in place for the board and board  representatives—a mechanism that is a necessary element for ensuring  that PBGC is executing the policy in appropriate ways. According to one  expert we interviewed, the inventory of critical subjects regarding an  investment program is extensive, and the board is ultimately responsible  for assessing and overseeing all of them. Some of the key elements the  expert noted that should require the board’s focus include clearly  articulated governance policies; a comprehensive, written investment  policy statement; a well thought out asset allocation process; clearly  defined and appropriate measures; monitoring processes; and monitoring  of investment costs. Although PBGC staff told us that these things were  accomplished below the level of the board members, we could find no  documentation that indicated that such a formal oversight mechanism was  in place. We reviewed decades of board meeting notes—up through the  most recent meetings—in search of such evidence, but could find none.
subsections: section_title: Investment Objectives
paragraphs: In the area of investment objectives, PBGC’s statements have remained  silent with respect to several items, such as return targets and statements  of risk tolerance. By comparison, the United Kingdom’s Pension  Protection Fund board, in its policy statement, has specifically set a long- term target investment return of 1.8 percent above liabilities and a risk  level equivalent to a tracking error of 4 percent against liabilities. The  Pension Protection Fund also identified nine risks that might affect its  investments and identified approaches to mitigate those risks. Six of the  eight public pension plans we reviewed also included a return target and a  risk tolerance in their investment policies. One expert stressed, in  particular, the importance of documenting tolerance for risk in the  investment policy cautioning that without such documentation, a firm  risks making changes at a bad time (selling at a deep discount) or in  response to political pressure. In order to keep the investment policy out  of the political realm, a well-documented, long-term, and disciplined view  with an effective governing board is necessary, while following a well  established allocation model that keeps long term perspective in mind.
section_title: Risk Management
paragraphs: In the area of risk management, although most items were covered in  PBGC’s policy statements, almost all lacked sufficient detail to provide  adequate guidance. For example, the cost management provision of  PBGC’s statements generally identified the types of investment expenses  involved and offered a low-cost policy for investing, but did not provide  guidance on how to monitor these costs. As noted by some experts,  ultimately, investing is not about seeking returns but about managing  risks, with well-grounded policies to ensure adequate monitoring of risks  over time.
Typically missing from PBGC’s investment policy statements has been the  practice of portfolio rebalancing. A provision for rebalancing was provided  for the first time in 2008. All of the public pension plans that we studied  included such tolerance ranges. Most also specified a time frame for  rebalancing or assigned responsibility for determining a course of action.
section_title: PBGC’s Staff Has Functioned without Formal Operating Procedures
paragraphs: The PBGC’s CID staff has largely operated without fully developed and  documented operating procedures, although it has recently begun to  create them. According to a PBGC staff member, the mission of the CID is  twofold: (1) to transition newly trusteed assets into PBGC’s investment  portfolio and (2) to manage PBGC assets. Further, to transition newly  trusteed assets into PBGC’s investment portfolio, CID staff are responsible  for transferring assets so that they are commingled in compliance with  PBGC policies, and are consistent with PBGC’s asset allocation. However,  the staff member also said that PBGC historically has not had formal  procedures for executing the investment policy and transitioning assets.  As a result, according to PBGC’s Inspector General, when the former  board established the 2008 investment policy, certain tasks were not  performed in the proper order by CID staff. For example, according to  PBGC’s Inspector General, PBGC had actually undergone several  transition related activities—such as the selection of three investment  management firms for strategic partnership contracts for managing $2.5  billion in PBGC assets—before risks and mitigating methods related to the  transition were even documented. In addition, CID staff provided a group  of documents covering a number of transition related activities that had  several notable weaknesses. For example, these documents indicated  timelines for implementation, but provided no risk analysis, accountability  measures to monitor progress, or a delineation of roles and corresponding  responsibilities related to the transition.
According to a PBGC staff member, to manage PBGC’s assets, at a high  level, CID staff are responsible for five operational tasks: (1) select, hire,  and terminate investment managers; (2) oversee managers: (3) oversee the  aggregate investment program: (4) implement board asset allocation and  any other board investment policy; and (5) oversee all aspects of the  PBGC investment programs including cash management and securities  lending. In 2010, CID staff began to draft more complete working  procedures for their investment operations, however, PBGC’s CID staff  and the Inspector General recently told us that this effort has been a slow  undertaking. PBGC’s CID staff stated that creating procedures takes away  from their ability to do their mission work and, thus far, they have only  been able to provide preliminary and incomplete drafts of some of the  needed procedures. However, while complete operational procedures are  lacking for most of the operational tasks under the purview of the CID,  PBGC’s CID staff have recently completed a draft compendium of formal  procedures that detail processes and procedures for managing their  securities lending program—the smallest program operated within the  CID.
According to one expert, well functioning operational policies and  procedures are an essential mechanism for ensuring linkages between a  fund’s governance structure, which includes policy making, and its  management systems. This expert wrote that with regard to operational  policies, directors should (1) identify and address aspects of the fund’s  investment operations, organization, and portfolio necessary to control  undue risk and expenses, minimize inefficiency, and achieve the desired  long-term return; (2) evaluate the fund’s organization and procedures  relative to those of its peers and industry best practices; and (3) find ways  to enhance public trust and confidence in the pension insurance system.  The board must oversee and approve such policies and procedures.
section_title: Conclusions
paragraphs: PBGC has grown from a relatively small agency with about $34 million in  assets in its first year after its establishment in 1974, to one with almost  $80 billion in assets in fiscal year 2010. As the agency has grown, so too  has the frequency of changes to its investment policies. The agency’s  policies and procedures for asset management still reflect its small agency  past. Indeed, there are few formally documented procedures and the  investment policy statements are insufficiently detailed for the agency to  manage its investments and apply the investment policy consistently  during a transition period and during times of political change. Without a  detailed investment policy and formal investment procedures, the agency  operates in an environment that is ripe for costly transactions and sub-par  returns. When factoring in the frequent changes to the investment policy  with the incomplete policies and procedures, a picture emerges that  suggests PBGC lacks a disciplined approach to investing—an unsettling  picture of an agency with responsibility for a large asset portfolio and a  challenging financial future.
As the guarantor of basic pension benefits for 44 million Americans, PBGC  must take a more disciplined and long-term approach to investment by  developing and adhering to a long-term comprehensive investment policy  and developing a complete compendium of operational policies and  procedures. Well-functioning operational policies and procedures are an  essential mechanism for ensuring linkages between pension funds’  governance structure and management systems. Current work under way  by PBGC’s CID staff to develop such policies and procedure is an  important first step, but greater commitment is needed from both the  PBGC board and its management to assure that PBGC can effectively and  consistently meet its obligation to conduct the many investment related  functions it performs.
section_title: Recommendations for Executive Action
paragraphs: We are making the following two recommendations:  1.  To ensure a disciplined and long-term approach to investment, we  recommend PBGC and its board of directors develop and maintain a  comprehensive investment policy statement that provides clear  organizational accountability, well-defined goals, and risk management  parameters.  2.  To ensure proper stewardship of PBGC’s assets and effective  implementation of its investment policy, we recommend that PBGC  develop a complete set of operating procedures and guidelines  consistent with recognized best practices in industry and government.
section_title: Agency Comments and Our Evaluation
paragraphs: We obtained written comments on a draft of this report from PBGC and  from the Department of Labor (Labor), which are reproduced in  appendixes IV and V, respectively. PBGC and Labor also provided  technical comments, which we incorporated into the report as  appropriate.
PBGC and Labor generally concurred with our recommendations and  outlined actions the agency has taken to address many of the concerns we  raised. For example, PBGC and its board recently issued a more  comprehensive investment policy statement that has incorporated many of  the policy items that we identified as missing from previously issued  policy statements. In addition, PBGC is in the process of developing a  complete set of operating procedures and guidelines. We are pleased to  learn of the steps already taken and those underway to address our  recommendations. In our view, these initial actions and continued efforts  to implement our recommendations fully can only strengthen the  stewardship of PBGC’s investments to better assure that PBGC can  effectively and consistently meet its obligation to conduct the many  investment-related functions it performs.
Underscoring its concern with the importance of PBGC’s mission, Labor  highlighted the increased oversight activity by the current board, its  representatives and their staffs. The Secretary noted that the board also  exercises its oversight responsibilities through monthly transition and  investment reports written documentation and other activities. We  acknowledge this increased oversight and appreciate the efforts by the  current board to play a greater role in monitoring the PBGC. The increased  oversight by the current board members and their representatives indeed  represents an improvement in the way policies and processes are adopted  and overseen at the PBGC, but we believe such improvements must be  documented and institutionalized to assure that such levels of effort are  sustained through subsequent boards. Our prior recommendations to  Congress to improve governance at the PBGC through an expanded and  restructured board continue to be needed to assure that such appropriate  and continuous oversight is carried out, not only today but in the future.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies of the report to the Secretary  of Labor, the Director of the PBGC, and other interested parties. We will  also make copies available to others on request. This report is also  available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions regarding this report, please  contact Barbara Bovbjerg at (202) 525-7215 or bovbergb@gao.gov. Contact  points for our Congressional Relations and Office of Public Affairs can be  found on the last page of this report. Key contributors are listed in  appendix VI.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine how Pension Benefit Guaranty Corporation’s (PBGC)  investment objectives have changed over time and whether policy goals  have been met, we collected and reviewed investment policies used by  PBGC from 1990 through the policy dated October 2009. We started our  review with PBGC’s 1990 investment policy because it was the first  investment policy that specified asset allocation targets, such as the  proportion of assets to be invested in fixed-income assets versus equities.  For each of these policies, we identified the overall objective, such as  whether the policy attempted to maximize earnings using a higher  proportion of equities or reduce risk by increasing the proportion of fixed- income securities matched to the duration of their liabilities. We also  identified the percentages of each type of asset required by the policy,  such as the percentage allocated to equities versus fixed-income  investments, and compared these target allocations to actual allocations as  stated in PBGC’s annual reports, internal trust and revolving fund data,  and other financial information received from PBGC officials. We then  looked at the conditions leading up to each change in policy, such as  changes in investment philosophy, incoming assets from terminated plans,  and changes in leadership at the executive director level. We obtained this  information through interviews with PBGC officials, and from other  information provided by the agency, including internal memos, e-mails,  inspector general audit reports, summary information prepared for board  and advisory committee members, asset and liability studies, and other  reports and memos prepared by various PBGC investment managers and  consultants. We also performed a detailed review of PBGC board and  advisory committee meeting minutes using NVivo content analysis  software. To identify and summarize discussions related to investment  policy development, review, and implementation, we reviewed investment  policy statements, related investment advisory committee meeting notes  and documentation, and board meeting notes when available. We obtained  and reviewed this information from PBGC’s inception in 1974 through the  current policy, but focused our analysis on the period between 1990 and  the 2009 policy because the policies in place during that period were the  focus of our review.
We also interviewed past PBGC directors, board representatives, advisory  committee members, and the PBGC Inspector General. We also reviewed  relevant federal laws and regulations. To determine how PBGC’s changes  in investment policy compared to other entities, we interviewed officials  from several pension consultants, investment and transition managers, life  and property and casualty insurers, and large state pension plans. We also  interviewed and reviewed investment policy-related information provided  by foreign pension insurers in Canada, the Netherlands, Switzerland, and  the United Kingdom. However, we did not conduct an independent legal  analysis to verify the information provided by state pension plans or  foreign pension insurers. Finally, we reviewed past our work on PBGC’s  investment policies and oversight structure.
To determine how PBGC transitions assets between investment policies  and the resulting costs, we interviewed PBGC officials responsible for  transitioning assets and reviewed transition related documentation  provided by PBGC officials, as available. For transitions where data was  not available from PBGC, we obtained this information directly from  PBGC’s transition managers and interviewed officials from those firms to  determine both implicit and explicit transaction costs associated with  changing investment policies. We also looked at the procedures and costs  associated with transitioning assets from terminated plans taken over by  PBGC to determine whether or not it was possible to separate these costs  from costs associated with changing policies.
We interviewed the PBGC Inspector General and past PBGC directors to  obtain additional information about PBGC’s transition related policies and  other adopted practices. In order to understand asset transitions more  generally, we interviewed transition and investment managers, financial  industry consultants, and officials at several large state pension plans. We  also looked at market conditions and returns on equity and fixed-income  investments during the periods in which PBGC was transitioning assets.  We limited our analysis of transaction costs to the policies in place from  2004 through 2009 because of the lack of detailed cost data available from  PBGC and their transition managers for transactions made prior to the  2004 policy.
To assess the performance of PBGC’s investments, we conducted a  portfolio performance evaluation of the agency’s Single-Employer Total  Fund monthly returns from the period October 1976 to December 2009.  This analysis focused on the single-employer program, which accounted  for 96 percent—or $21.08 billion—of the $21.95 billion total deficit from  the single-employer and multiemployer programs, as of September 30,  2009. For those portions of this analysis involving PBGC liabilities, we  used data on the liabilities associated with (terminated) trusteed plans  within the single-employer program. The Single-Employer Total Fund  represents the pool of trusteed assets that supports the liabilities  associated with terminated defined benefit plans that have been trusteed  by PBGC.
As part of the portfolio performance evaluation, we compared PBGC’s  Total Fund portfolio return performance to the returns on several well- diversified benchmark portfolios via a number of portfolio performance  statistics. We selected well-diversified benchmark portfolios for the  portfolio performance evaluation to ensure that the variability of the  benchmark portfolio returns almost exclusively represented systematic  risk and not the idiosyncratic risk associated with individual securities.  Also, the portfolios were selected such that they represented exposure to  the systematic risks that are reflected in the returns on several specific,  broad asset classes. The asset classes are the domestic equity asset class  (United States), the foreign equity asset class, the short maturity, risk-free  asset class, and the long maturity fixed-income asset class. These  particular asset classes were chosen because they are the ones  emphasized in asset allocation data provided by PBGC. The benchmark  portfolios used in this analysis are also distinguished by whether their  asset class composition varies dynamically over time (“dynamic”  composition portfolios) or is constant over time (“static” compositions  portfolios). The benchmark portfolios and their characteristics are as  follows:    S&P 500. Asset class composition: 100 percent equities. This is a static  composition portfolio that represents the equity asset class.
Wilshire 5000. Asset class composition: 100 percent equities. This is a  static composition portfolio. It represents the equity asset class with a  greater allocation to smaller capitalization stocks than the S&P 500.
Barclays Capital Long-Term Government Credit Index. Asset class  composition: 100 percent fixed income. This is a static composition  portfolio representing the fixed-income asset class, including both  corporate and U.S. government fixed-income asset classes.
Pension Protection Act Benchmark Portfolio. Asset class composition: 60  percent equities and 40 percent fixed income. This is a static composition  portfolio.
Life Insurance Benchmark. Asset class composition: 85 percent fixed  income and 15 percent equities. This is a static composition portfolio, and  is intended as a stylized representation of the asset portfolio typically held  by life insurance firms in their general accounts (with grouping mortgage  assets into the fixed-income category).
Post Fiscal Year 2002 Benchmark. Asset class composition: 30 percent  equities, 60 percent fixed income, and 10 percent cash. This is a static  composition portfolio, and is intended as a stylized representation of the  average asset allocation of the PBGC total fund during what is later termed  “asset allocation period 4.” This roughly corresponds to the period from  beginning of fiscal year 2002 to the present.
Dynamic Benchmark. Asset class composition: equivalent to the asset  class composition for the PBGC Total Fund. This is a dynamic  composition portfolio, where the asset allocation varies over time in such  a fashion so as to match that of the PBGC Total Fund for the broad asset  classes domestic equity, foreign equity, fixed income, and riskless short  maturity fixed-income assets (e.g., cash). The purpose of the Dynamic  Benchmark in the PBGC Total Fund portfolio performance evaluation is to  reflect the systematic risk exposure of the PBGC Total Fund as closely as  possible while at the same time abstracting from any active tactical asset  allocation undertaken by the PBGC Total Fund management, such as  tactical allocations in specific subsectors within an asset class or  investments in specific individual securities.
The comparisons allowed us to analyze various aspects of the PBGC Total  Fund’s risk-adjusted performance. Given that the primary function of  PBGC is to support its liabilities—the pension benefits associated with  terminated, trusteed plans—the portfolio performance evaluation was  conducted using asset-only returns and asset returns net of the liability  return.
To determine how well PBGC’s investment policies and operations  comport with best practices in the industry, we interviewed PBGC’s  Inspector General, current PBGC board member’s representatives, and  PBGC staff. We also reviewed relevant federal laws and regulations. To  evaluate PBGC’s operational guidelines and procedures, we obtained  procedures manuals and documents that PBGC’s staff uses to manage and  oversee their operations. To evaluate PBGC’s investment policy  statements against industry best practices, we obtained information and  documentation of actual practices used by industry experts, foreign  pension insurers in Canada, the Netherlands, Switzerland, and the United  Kingdom, investment committee documents from large state pension plan  providers, and a property and casualty insurance provider. To identify a  list of items that could be included in an investment policy we first  conducted a literature search for documents with guidance on investment  policy statements. We found documents from expert organizations which  provide standards that financial industry professionals follow to ensure  they are meeting the fiduciary requirements under relevant state and  federal laws. These organizations include the Chartered Financial Analyst  Institute, the Foundation for Fiduciary Studies, the Association of Pension  Plan Fund Auditors, the Government Finance Officers Association, and  Independent Fiduciary Services. We started with the Chartered Financial  Analyst Institute’s documents and listed elements of an investment policy  identified in a document created by the institute and then compared that  list to elements identified in the documents we reviewed created by other  organizations. We also considered the investment policy statements of  other entities and the elements that were frequently found in those  statements. In our list, we kept items that were mentioned in more than  one of the documents from the five expert organizations. We also added  one item, transition policy, which was not found in the documents we  used but we believe that it is specific and unique to the mission of PBGC  since the agency transitions assets and liabilities from the defined benefit  plans that are terminated. This list contains elements that multiple  industry organizations have identified as desirable elements of investment  policy statements, but, should not be considered an exhaustive,  customized checklist. While we believe that PBGC should have some of  the items contained in these lists, because every investor is unique, the  actual items that PBGC should include in its investment policy needs to be  tailored to their particular needs and situation.
section_title: Appendix II: Process for Transitioning Funds to Align with PBGC’s Investment Policy
paragraphs: Receipt of newly-terminated plan assets is a multi-step process. Assets are evaluated by an analyst  with PBGC’s Corporate Investment Department (CID).CID policy calls for various documents to be  compiled into a file (including, for example, a plan asset listing, investment statements, trusteeship  agreement, contact information), records receipt of the plan in CID’s plan tracking worksheet, and  assigns the plan to a CID analyst. The analyst then reviews the file and makes contact with the  party/parties that have custody of the assets (typically more than one) to initiate the transfer, and a  plan asset transfer methodology is determined. PBGC officials noted that it is CID priority to transfer  all assets in-kind, but that is not always permitted (per contractual agreements between the former  plan sponsor and the asset custodian and/or proprietary investment products) or optimal (for  example, with small dollar mutual funds). To transfer the assets, the analyst prepares a direction  letter that will include a copy of the trusteeship agreement and transfer instructions at a minimum.  This letter is signed by authorized PBGC personnel and sent to the asset custodian. The assets are  then transferred to PBGC’s asset custodian and placed in a holding account until liquidity is  determined and a certain dollar threshold is met.
Illiquid assets, such as real property, are generally transferred to PBGC's Special Situation manager,  where the manager seeks liquidation of the asset in a timely manner. Private equity (generally in the  form of limited partnerships) is transferred to one of PBGC's private market overseers.
section_title: Appendix III: Asset-Only and Net of Liability Analysis of Pension Benefit Guarantee Corporation’s Single-Employer Total Fund
paragraphs: We conducted a portfolio performance evaluation of the PBGC Single- Employer Total Fund monthly returns from the period October 1976 to  December 2009. This analysis focused on the single-employer program,  which accounted for 96 percent—or $21.08 billion—of the $21.95 billion  total deficit from the single-employer and multiemployer programs, as of  September 30, 2009. For those portions of this analysis involving PBGC  liabilities, we used data on the liabilities associated with (terminated)  trusteed plans within the single-employer program. The Single-Employer  Total Fund represents the pool of trusteed assets that supports the  liabilities associated with terminated defined benefit plans that have been  trusteed by PBGC.
As part of the portfolio performance evaluation, we compared PBGC’s  Total Fund portfolio return performance to the returns on several well- diversified benchmark portfolios via a number of portfolio performance  statistics. The comparisons allowed us to analyze various aspects of the  PBGC Total Fund’s risk-adjusted performance. Given that the primary  function of PBGC is to support its liabilities—the pension benefits  associated with terminated, trusteed plans—the portfolio performance  evaluation was conducted using asset-only returns and asset returns net of  the liability return. The liability return refers to the rate of growth in the  total value of the then-existing liabilities or terminated benefits, (i.e.,  exclusive of newly terminated plans). In computing the asset returns net of  the liability return, we use what we term the “scaled” liability return—the  product of the liability return and the inverse of the funding ratio (PBGC  Total Fund aggregate assets to PBGC total fund aggregate liabilities).
Our analysis also entailed examining patterns in the PBGC Total Fund’s  asset allocations (PBGC Total Fund portfolio “weights” across asset  classes) over time in order to assess the effect of fluctuations in the PBGC  Total Fund asset allocations on the performance of the PBGC Total Fund.  This analysis included characterizing the behavior of the PBGC Total Fund  portfolio weights and identifying asset allocation periods in the PBGC  Total Fund. The result of this analysis was used in selecting some of the  benchmark portfolios.
subsections: section_title: PBGC Single- Employer Total Fund Outperformed Most of Its Benchmarks on an Asset-Only Basis, and Fluctuations in Asset Allocations Did Not Adversely Impact Asset-Only Performance
paragraphs: The results immediately below provide a two-way comparison, on an  asset-only basis, of the PBGC Total Returns to the Dynamic Benchmark— the two dynamic portfolios among those included in our portfolio  performance evaluation analyses. Due to the design of the Dynamic  Benchmark, these results reflect PBGC Total Fund under- or over- performance linked to influences other than the asset class allocation,  such as asset allocations to specific subsectors within an asset class or  investments in specific securities. Then, in the following subsection, we  assess the effect of variation in the PBGC Total Fund’s asset allocation in  an asset-only context by comparing the performance of the Dynamic  Benchmark and the PBGC Total Fund against the static benchmark  portfolios. Special emphasis was placed on analyzing the differences in  performance between the portfolios that have particularly strong  performance and the two portfolios with dynamic asset allocations. This  special emphasis allows us to then assess whether the time variation in the  asset allocations associated with the PBGC Total Fund and the Dynamic  Benchmark appeared to hurt or help their risk-adjusted performance. Also,  we examine whether the data suggests other aspects of asset allocation  aside from variation in portfolio weights that might bolster or harm risk- adjusted return performance.
The performance statistics for this section are shown in table 6 unless  otherwise noted. The phrases “decade subperiods” and “decade” will be  used to denote the four subperiods—October 1976 through December  1979, 1980–1989, 1990–1999, and 2000–2009 for which statistical estimates  are shown in table 6.
subsections: section_title: Asset-Only Comparison of the PBGC Total Fund Return Performance to the Dynamic Benchmark Return Performance
paragraphs: The results summarized in table 6 indicate that, over the particular  historical period studied, the PBGC Total Fund outperformed the Dynamic  Benchmark on a risk-adjusted basis, where risk is measured in terms of  the volatility of month returns. In particular, all risk adjusted measures  (Sharpe, Adjusted Sharpe, Sortino, and Omega ratios) are slightly higher  for the PBGC Total Fund than for the Dynamic Benchmark for the overall  period. For those three decade subperiods where the Sharpe ratio is  positive for the PBGC Total Fund (1980–1989, 1990–1999, and 2000–2009)  the PBGC Total Fund outperformed the Dynamic Benchmark for two out  of the three subperiods (1990–1999, and 2000–2009). In the sub-period  where the Sharpe and Sortino ratios are negative, the Adjusted Sharpe  measure for the PBGC Total Fund is greater than that of the Dynamic  Benchmark, again indicating that the PBGC Total Fund outperformed the  Dynamic Benchmark in that period.
Disaggregation of the PBGC Total Fund’s return performance statistics  reveals that PBGC Total Fund returns tended to underperform the  Dynamic Benchmark returns on a risk-adjusted basis when the Total  Fund’s allocation to equities is higher, not lower. For instance, during  allocation period 1—when the PBGC Total Fund equity allocation had an  upward trend and the fixed-income allocation had a downward trend—the  PBGC Total Fund Sharpe ratio was below that of the Dynamic Benchmark.  In contrast, the PBGC Total Fund outperformed the Dynamic Benchmark  in terms of the Sharpe ratio in allocation period 2, when the total fund  equity allocation was falling. Also, the average allocation to equities was  lower in allocation regime 4 than it was in allocation period 3, and the  PBGC Total Fund outperformed the Dynamic Benchmark in allocation  period 4 but slightly underperformed the Dynamic Benchmark in  allocation period 3. The Sortino and Omega ratios show similar (and more  pronounced in the case of the Omega ratio) under- or over-performance  patterns across the weight regimes, thus corroborating and affirming the  Sharpe ratio results.
Looking more closely at potential sources of the under- or over- performance of the PBGC Total Fund returns versus the Dynamic  Benchmark returns, a driver of the PBGC Total Fund’s under- or over- performance appears to be the mean of the returns, inasmuch as the  pattern of under- or over-performance in the risk-adjusted return metrics  across decades matches that of the pattern of under- or over-performance  in the mean. This holds whether one views the disaggregations by  “decade” or by allocation period.
section_title: Asset-Only Assessment of the Effect of Fluctuations in the PBGC Total Fund’s Asset Allocation upon PBGC Performance
paragraphs: According to our results, the Dynamic Benchmark outperformed every  static benchmark except the PPA and the Post Fiscal Year 2002  Benchmark—the benchmark portfolio with composition that roughly  reflects the PBGC Total Fund’s portfolio allocation during allocation  period 4—while the PBGC Total Fund outperformed all the same  benchmarks the Dynamic Benchmark did as well as the PPA. In addition,  another finding is that all of the static benchmarks that involve mixtures of  fixed income and equity securities outperform those benchmarks that  allocate all funds to either bonds or equities.
With regard to question of whether fluctuations in asset allocations had an  adverse impact on PBGC Total Fund returns, the variable nature of the  results precludes concluding that the time variation in asset allocations  necessarily adversely impacted the PBGC Total Fund return performance.  Both the PBGC Total Fund and the Dynamic Benchmark have fluctuating  asset allocations, yet both have higher values for the risk-adjusted  performance metrics—Sharpe, Adjusted Sharpe, Omega, and Sortino  ratios—than the majority of the fixed allocation portfolios. On the other  hand, there is one fixed-allocation benchmark—the Post Fiscal Year 2002  Benchmark portfolio—that, for the overall period, had risk-adjusted  performance metrics that were superior to both the PBGC Total Fund and  the Dynamic Benchmark. However, even this fixed allocation portfolio is  really based upon the PBGC Total Fund, for the portfolio weights for the  Post Fiscal Year 2002 Benchmark portfolio are a stylized representation of  the PBGC Total Fund weights over the course of allocation period 4. In  addition, note that, despite having fluctuating asset allocations, the PBGC  Total Fund has outperformed the Post Fiscal Year 2002 Benchmark—in  the sense of having higher risk-adjusted performance measure values— over significant subperiods of time in the past. For instance, the PBGC  Total Fund has performed better than the Post Fiscal Year 2002  Benchmark portfolio on a risk adjusted basis for two out of the four  “decade” subperiods—that is, the subperiods 1990–1999 and 2000–2009 for  a total of 20 years out of the 33 1/4 years from October 1976 to December  2009. Thus, when returns on assets are considered in isolation from the  growth in the liabilities, we did not find strong support in the data to  indicate that the variations in the PBGC asset allocations adversely  impacted the PBGC Total Funds’ performance.
Lack of diversification across asset classes appeared to have a more  adverse impact on risk-adjusted performance. Additionally, the portfolios  with 100 percent allocations to equities had some undesirable  characteristics. Notably, out of the eight portfolios considered in the  portfolio performance analysis, all the portfolios that represented a single  asset class were among the bottom half of the portfolios in terms of the  Sharpe ratio for the entire data sample, including the 100 percent fixed- income benchmark. The dominant contributing factor to their relatively  weak risk-adjusted return performance is risk—all three had among the  highest standard deviation and kurtosis scores for the entire historical  sample period. The two portfolios that were 100 percent equities—the S&P  500 and the Wilshire 5000—had an additional undesirable feature: negative  skewness. These two had the “most negative” skewness scores for the  total sample period out of the eight portfolios. The combination of  magnified negative skewness and kurtosis evident in the returns of the two  equity benchmark portfolios is undesirable because it implies that  investment in such portfolios has the potential to contribute of extreme  negative returns. Although both equity portfolios have the highest average  returns for the overall sample, the relatively low Sharpe ratio scores  associated with them imply that they do not offer enough reward per unit  of risk—that is, robust enough reward to risk trade-offs—to outperform  those portfolios, both static and dynamic, that contain a diversified mix of  both bonds and equities.
section_title: PBGC Single- Employer Total Fund Underperformed Benchmarks on an Asset-Liability Basis, and Fluctuations in Asset Allocations Did Not Adversely Impact Asset-Liability Performance
paragraphs: A two-way comparison of the PBGC Total Fund and the Dynamic  Benchmark enabled us to evaluate PBGC Total Fund under- or over- performance associated with factors other than the PBGC Total Fund  asset allocation. Next we examine the impact of fluctuations in the PBGC  Total Fund’s asset allocation in the asset-liability context.
subsections: section_title: Comparison of The PBGC Total Fund Return Performance to the Dynamic Benchmark Return Performance in the Asset-Liability Context
paragraphs: A comparison of the PBGC Total Fund net-of-liability return performance  to the net-of-liability return performance of the Dynamic Benchmark  indicates that the PBGC Total Fund portfolio underperforms the Dynamic  Benchmark in risk-adjusted terms on an asset-liability basis. In contrast to  the results for the asset-only analysis, the PBGC Total Fund had weaker  performance than the Dynamic Benchmark in that its Adjusted Sharpe  ratio was lower for the overall time period (October 1976 to December  2009). Despite the switch in the performance rankings of the PBGC Total  Fund and the Dynamic Benchmark, there are many similarities between  the asset-liability performance analysis results and the asset-only  performance analysis returns. The areas of similarity are as follows:  1.  Under- or over-performance pattern across “decade” and asset  allocation periods. The PBGC Total Fund underperformed the  Dynamic Benchmark for two out of the four decade subperiods and  two out of the four asset allocation regimes on a risk-adjusted, net-of- liability return basis, according to the Adjusted Sharpe ratio statistic  values.  2.  Lack of materiality of investment expenses. Deducting investment  expenses from the PBGC Total Fund returns in the asset-liability  context did not affect the performance ranking of the PBGC Total  Fund relative to the Dynamic Benchmark on an Adjusted Sharpe ratio  basis (in those periods for which investment expenses data were  available).  3.  Tendency to perform relatively worse in regimes where equity asset  allocation is greater or rising. The PBGC Total Fund’s relative  performance has tended to be worse in asset allocations periods where  there is an elevated or rising allocation to the equity asset class. For  example, as in the asset-only analysis, the PBGC Total Fund returns,  net of the liability returns, had an Adjusted Sharpe ratio below that of  the Dynamic Benchmark in allocation period 1 (which was  characterized by a rising allocations to the equity sector). Also, as in  the asset-only case, the PBGC Total Fund underperformed the  Dynamic Benchmark on a net of liability return basis in allocation  period 3, according to the Adjusted Sharpe ratio scores. In allocation  period 4, when the average allocation to equities in the PBGC Total  Fund portfolio was lower than in allocation regime 3, the PBGC Total  Fund had a higher Adjusted Sharpe ratio than the Dynamic Benchmark  did. However, unlike the asset-only case, the PBGC Total Fund  Adjusted Sharpe ratio was less than that of the Dynamic Benchmark in  allocation period 2, when the PBGC Total Fund allocation to equities  was falling and to bonds was rising. The similarity of the seemingly  inverse relation between the PBGC Total Fund Adjusted Sharpe ratio  value and the magnitude of the allocation to the equities asset class  reinforces the impression that elevated allocations of the PBGC Total  Fund to the equity asset class had adverse impact on PBGC Total Fund  returns net of the liability returns in an asset-liability context as well as  when the portfolio returns are considered in isolation from the liability  returns in an asset-only context. However the patterns in the equity  asset allocation and its relationship to performance should not be  viewed as implying causality.  4.  Mean excess return prominence as a driver of risk-adjusted  performance metric values across subperiods. In every sub-period and  asset allocation regime where the excess mean return (net of the  liability return) for the PBGC Total Fund exceeded the excess mean  return (net of the liability return) for the Dynamic Benchmark  portfolio, the Adjusted Sharpe ratio for the PBGC Total Fund exceeded  the Adjusted Sharpe ratio for the Dynamic Benchmark.
Given all of the similarities between the results of the performance  comparisons in the asset-liability and asset-only contexts, the reason for  the contrast between the PBGC Total Fund’s underperformance of the  Dynamic Benchmark in the asset-liability context and its outperformance  in the asset-only context appears to be risk. In the asset-only performance  comparison analysis, the PBGC Total Fund’s riskiness—as measured by  the standard deviation and semi-standard deviation of the returns—-was  lower than that of the Dynamic Benchmark portfolio. However, in the  asset-liability context, the results indicate that the PBGC Total Fund  returns have greater standard deviation and semi-standard deviation  values than the returns for the Dynamic Benchmark, suggesting that the  PBGC Total Fund returns (net of the liability returns) are riskier and more  volatile than the Dynamic Benchmark returns (net of the liability returns).  One factor that likely played a role in elevating the PBGC Total Fund’s  riskiness above that of the Dynamic Benchmark is the correlation of the  actual asset returns with the liability returns (not the correlation between  the liability returns and the asset returns net of the liability returns). For  the overall sample period, the PBGC Total Fund actual returns had lower  correlation with the liability returns —both scaled by the funding ratio and  unscaled—than the Dynamic Benchmark. Higher correlation makes it  more likely that movements in the liability return are accompanied by  movements in the asset portfolio return in the same direction and of  similar magnitude. Such co-movement of the actual asset returns and the  liability returns helps reduce the volatility of the asset returns net of the  liability returns.
Lower correlation has the opposite effect of higher correlation—lower  correlation reduces co-movement between asset returns and liability  returns and thus elevates the riskiness of asset returns net of the liability  returns. Thus, the extent to which the riskiness of the PBGC Total Fund  exceeds the riskiness of the Dynamic Benchmark on a net-of-liability  return basis probably reflects, at least in part, the extent to which the  liability returns are less correlated with the PBGC Total Fund’s actual  returns than with the Dynamic Benchmark actual returns. However, the  question of why the PBGC Total Fund would be less correlated with  liability returns than the Dynamic Benchmark would require a more  detailed investigation.
section_title: Assessment of the Effect of Fluctuations in the PBGC Total Fund’s Asset Allocation upon PBGC Performance in the Asset- Liability Context
paragraphs: The results of comparing the performance measures of the PBGC Total  Fund and the Dynamic Benchmark returns, net of the liability return, to  the performance measures of the static portfolios are that the Dynamic  Benchmark outperforms two out of the six static portfolios—the Post  Fiscal Year 2002 Benchmark and the Barclays Capital Long-Term  Government Credit Index—and is roughly tied in performance with the  S&P 500. However, the PBGC Total Fund did not outperform any of the  benchmarks. Moreover, two out of the three best-performing portfolios  have significant allocations to bonds and equities versus representing only  a single asset class.
In order to detect potential sources of underperformance, as measured by  the Adjusted Sharpe measure, in the PBGC Total Fund and the Dynamic  Benchmark, we conducted a detailed comparison of various performance  metrics for these two portfolios to performance metrics for the PPA  benchmark portfolio—the portfolio that had the highest Adjusted Sharpe  measure for the overall October 1976 through December 2009 sample  period and, by that measure, the best risk-adjusted performance. This  detailed comparison suggests that a major source of the  underperformance of the PBGC Total Fund and the Dynamic Benchmark  relative to the PPA benchmark portfolio was weakness in the mean excess  return, for both portfolios had lower mean excess returns for the overall  sample period the mean excess return of the PPA benchmark portfolio.  However, both the PBGC Total Fund and the Dynamic Benchmark  portfolios appeared to be less risky than the PPA portfolio inasmuch as  the returns on both portfolios had lower standard deviation and semi- standard deviation than the returns on the PPA portfolio. Thus, the  primary immediate reason both portfolios have lower Adjusted Sharpe  ratios than the PPA benchmark is that their returns (net of the liability  return) had lower mean excess returns than the PPA benchmark return  (net of the liability return) not because they were more risky than the PPA  benchmark. One other feature of the results that underscores the extent to  which both portfolios were less risky than the PPA benchmark on an  asset-liability basis is that the returns (net of the liability return) for both  portfolios had lower standard deviations than the return (net of the  liability return) for the PPA benchmark for every decade sub-period in the  case of the Dynamic Benchmark and for three out of the four decade  subperiods in the case of the PBGC Total Fund.
Although the statistics clearly suggest that weakness in the mean excess  return played a role in lowering the risk-adjusted performance of both the  PBGC Total Fund and the Dynamic Benchmark portfolios, the evidence  provided by the performance measures about whether the variation over  time in asset allocations associated with both portfolios necessarily  lowered the risk-adjusted performance of their returns on a net-of-liability  basis is less clear. For example, on the one hand, the Dynamic Benchmark  has a lower Adjusted Sharpe ratio for the overall sample period—and by  that metric, weaker risk-adjusted performance—than several static  portfolios; however, on the other hand, it also outperforms other fixed  allocation portfolios on an Adjusted Sharpe ratio basis, which suggests  that fluctuations in asset allocations alone do not immediately imply  underperformance on a risk-adjusted basis.
In general, the evidence from the performance metrics is too ambiguous to  support the conclusion that the variation in the asset allocations inherent  in the PBGC Total Fund and the Dynamic Benchmark portfolio necessarily  lowered the risk-adjusted performance of the returns of both portfolios  within the asset-liability analysis. Furthermore, there are subperiods  where the returns (net of the liability returns) for both dynamic portfolios  have higher Adjusted Sharpe ratios than the PPA benchmark, even though  this portfolio had the highest Adjusted Sharpe ratio for the overall sample  period. In particular, both the PBGC Total Fund and the Dynamic  Benchmark have higher Adjusted Sharpe ratios than the PPA benchmark  for two out of the four decade subperiods; also, the Adjusted Sharpe ratios  for both portfolios exceed that of the PPA benchmark for one of the four  asset allocation regimes, a period of 8 years. The lengths of time over  which the PBGC Total Fund and the Dynamic Benchmark outperform, on  a risk-adjusted basis, the best static portfolio over significant subperiods  of the overall sample period does not indicate that the fluctuations in the  asset allocations for the PBGC Total Fund and the Dynamic Benchmark  alone are a preeminent source of weakness in the risk-adjusted  performance of the returns for both portfolios in the asset-liability context.
This analysis has primarily (although not exclusively) focused on the  comparison of the risk-adjusted performance of the two dynamic  portfolios to the performance of the PPA benchmark, the static portfolio  which had the strongest risk-adjusted performance. However, if the focus  is expanded to include comparisons across all of the static and dynamic  portfolios, another feature of the results emerges. That is, the influence of  the correlation between the portfolio returns and the liability return on the  riskiness and the risk-adjusted performance of the portfolio returns net of  the liability return. This influence is emphasized in the results for the best  three performing portfolios over the period studied—the PPA benchmark,  the Wilshire 5000, and the Life Insurance Benchmark portfolio  performance results. The PPA benchmark and the Life Insurance  Benchmark both have adjusted Sharpe ratios that equal or exceed that of  the Wilshire 5000 for the overall sample period even though the mean  excess return of the Wilshire 5000 for the overall sample period is 49  percent greater than that of the Life Insurance Benchmark and 31 percent  greater than that of the PPA benchmark. Because both the PPA and the  Life Insurance Benchmark have lower mean excess returns than the  Wilshire 5000, the source of their strong adjusted Sharpe ratio  performance in comparison to the Wilshire 5000 rests in the riskiness of  the returns for those two portfolios (in comparison to the Wilshire 5000).  As shown in table 7, both portfolios have distinctly lower standard  deviations and semi-standard deviations—two measures of riskiness— than the Wilshire 5000. Specifically, the annualized standard deviation of  the Life Insurance Benchmark returns is 49 percent less than that of the  Wilshire 5000 returns, and the semi-standard deviation of the Life  Insurance Benchmark portfolio returns is 46 percent less than the semi- standard deviation of the Wilshire 5000 returns. Similarly, the annualized  standard deviation of the PPA benchmark returns is 32 percent less than  the annualized standard deviation of the Wilshire 5000 returns, and the  annualized semi-standard deviation of the PPA benchmark returns is 30  percent less than the semi-standard deviation of the Wilshire 5000 returns.
By examining the correlation of the PPA benchmark, the Life Insurance  Benchmark, and the Wilshire 5000 returns with the liability return in  conjunction with the standard deviation values for the returns on those  three portfolios, one can observe the potential role of the correlation in  reducing the riskiness of the PPA and Life Insurance Benchmark return  (net of the liability returns). In particular, the correlation of the returns on  both the PPA and Life Insurance Benchmark portfolios with the liability  return are distinctly higher than the correlation of the return on the  Wilshire 5000 with the liability return. As shown in table 7, the correlation  of the Wilshire 5000 return with the scaled liability return is 0.29, but the  analogous correlation statistic for the PPA benchmark return is 0.51 (76  percent higher than the Wilshire 5000 correlation statistic) and for the Life  Insurance Benchmark portfolio is 0.74 (155 percent higher than the  Wilshire 5000 correlation statistic). Furthermore, it appears that, the  higher the correlation, the lower the risk, since the benchmark portfolio  that has returns with the highest correlation with the liability return—the  Life Insurance Benchmark—has the least risk. When considering all eight  portfolios being studied (instead of only the three portfolios with the  strongest risk-adjusted performance), the four portfolios with the highest  correlations with the liability return have the four lowest standard  deviations, and the four portfolios with the lowest correlations have the  four highest standard deviation estimates. Also, with the exception of the  two portfolios with the highest correlation scores and lowest standard  deviation values, the rankings of the standard deviation values matches  the rankings of the correlation estimates (in ascending order by standard  deviation and descending order by correlation). The strong relation  between extent of correlation with the liability return and risk highlights  how the relatively strong correlation of the PPA and the Life Insurance  Benchmark returns with the liability return seems to contribute to  lowering the riskiness of the returns (net of the liability return) of these  two portfolios, enhancing their Adjusted Sharpe ratio values and risk- adjusted performance (according to the Adjusted Sharpe ratio statistic).
The apparent linkage between the risk-adjusted performance metric and  the correlation between the actual portfolio return and the liability return  is most likely a reflection of the effect of the correlation between the  actual portfolio returns and the liability returns on the volatility of the  portfolio returns net of the liability return. As was discussed in the  comparison between the performance of the PBGC Total Fund and the  Dynamic Benchmark, higher correlation between the (actual) portfolio  returns and the liability returns implies a greater degree of co-movement  between the asset returns and the liability returns, and greater co- movement between the asset returns and the liability returns weakens or  lowers the volatility of the portfolio returns net of the liability return. One  reflection of the lowered volatility for the portfolio returns net of the  liability return is a lowered standard deviation value, and a lower standard  deviation value helps elevate the Adjusted Sharpe ratio value, implying  stronger risk-adjusted performance.
The strong relation between the correlation statistic and the Adjusted  Sharpe measure values provide at least a partial explanation of why two  out of the three portfolios that have the best risk-adjusted performance (as  indicated by their Adjusted Sharpe ratio scores) all have allocations to the  bond asset class sector of 40 percent or more. The portfolio of the  liabilities consists mostly of annuities and annuity-like instruments, all of  which are obligations of the PBGC. To the extent that annuities are fixed- income contracts, the portfolio of liabilities is essentially bond-like in  nature. Hence, the fact that the asset portfolios that have a significant  allocation to bonds have return behavior that is more similar to, and thus  would have higher correlation with, the liability returns is not surprising.
Among the three portfolios that have the returns with the strongest risk- adjusted performance, the returns for the two portfolios that have the  highest allocation to bonds (the PPA benchmark and the Life Insurance  Benchmark) also have other desirable characteristics. For instance, these  two portfolios (as opposed to the Wilshire 5000) have returns which, net of  the liability return, have higher skewness for the overall sample than the  Wilshire 5000. The higher skewness of the returns for the PPA benchmark  and the Life Insurance Benchmark portfolios suggests that those portfolios  are less likely to have months where the return on the asset portfolio falls  extremely short of the growth in the PBGC liabilities than the Wilshire  5000. Minimization of the instances where the asset returns fall extremely  short of the liability returns would help prevent further growth of the  already sizeable PBGC funding deficit.
The desirable implications of the higher skewness can be seen through  other statistics. Note that the minimum values for the PPA Benchmark and  the Life Insurance Benchmark portfolios are less extreme. That is, they are  less negative than for the Wilshire 5000. To get a sense of how much “less  extreme” they are, note that the minimum monthly net-of-liability return  for the PPA Benchmark is negative 12.39 percent and for the Life  Insurance Benchmark is negative 15.09 percent in contrast to the  minimum negative return value for the Wilshire 5000 of negative 24.42  percent. Because returns on the two highest-performing benchmark  portfolios with significant allocations to bonds—the PPA Benchmark and  the Insurance Benchmark portfolios—have less extreme negative values,  lower semi-standard deviations, and lower standard deviations than the  returns on Wilshire 5000, there is a strong possibility that the probability  distributions associated with these returns have assign less probability to  on extreme negative values than the probability distribution associated  with the Wilshire 5000 returns, characteristics that are consistent with and  are associated with the PPA and Life Insurance Benchmark portfolio  returns having skewness statistic estimates that exceed the (negative)  skewness statistic for the Wilshire 5000 returns.
The fact that the three best performing portfolios over the 1976 through  2009 period in this particular analysis were the PPA benchmark, the  Wilshire 5000, and the Life Insurance Benchmark does not necessarily  mean that any of these portfolios would be appropriate for the PBGC  going forward. The results of any particular analysis will depend on the  performance statistics used and how these performance statistics balance  risk and reward, and criteria would also need to be established for  meaningful differences in these measurements. Also, as noted earlier, an  asset allocation exercise would look at multiple possible future scenarios,  not one particular historical period. High allocation to equities would be a  particularly controversial matter for the PBGC because of the lower, and  potentially, negative correlation between equity returns and new claims.  The various alternative static portfolios used in this report were analyzed  for the purpose of a “what-if” analysis—a historical comparison of  alternative investment strategies versus the fluctuating asset allocation  that the PBGC actually employed; they were not for the purpose of  recommending a particular static asset allocation going forward.
section_title: Appendix IV: Comments from the Department of Labor
section_title: Appendix V: Comments from the Pension Benefit Guaranty Corporation
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the above, Orice Williams-Brown, Charles A. Jeszeck,  Thomas McCool, Frank Todisco, Serena Agoro- Menyang, James Bennett,  Susan Bernstein, Lawrance Evans Jr., Charles Ford, Kimberley M.  Granger-Heath, Michael Hoffman, Gene Kuehneman, Sheila McCoy,  Michael Morris, Christopher Ross, Margie Shields, and Craig Winslow  made important contributions to this report.
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