Ken Fisher: A New View of Pensions
04/11/2003 12:00 am EST
“Here are 70 billion reasons that stocks should do well: corporations, governments, and foreigners will all add unexpectedly large amounts of cash to their under-funded pension plans, investing much of the money in stocks. This year I expect net equity purchases by these three groups of $70 billion. If you are like the majority of Wall Streeters, you see pension charges as a negative. High pension means lower earnings after all, which could depress stock prices. I concede the point, but believe that the supply-and-demand effect will overwhelm the earnings effect. Investors have already figured pension problems into their earnings expectations; they have not figured in the size of the stock purchases. Another important point is that more than half this demand comes from buyers for whom there is no S&P 500 earnings effect – namely state and local governments or private pensions.
“All this is about defined benefit plans, the traditional pension plans promising a certain monthly dollar benefit to retirees. The alternative, defined contributions plans like 401(k)s, make no promises and expose the sponsor to no liability, and aren’t pension plans. Every year, the actuaries for a pension plan estimate its future liabilities, future benefits already earned, plus expected future benefits. En route, actuaries make lots of assumptions about career spans, average future employee pay, inflation, and retiree life spans. They also estimate the value of present assets, and a future return. They usually take a smoothed average of the past three years, and then estimate a future return based on their assets. Three years of bear market declines knocked the three-year average down. With it, pessimism has lowered their return assumptions, ratcheting double-downward estimates of future earnings. This is backwards. Depressed stock prices, if anything, should boost the future returns on the portfolio. The time to lower future return assumptions was five years ago, not now. But no one ever does it that way.
“Anyway, estimated future liabilities are subtracted from future assets and any spread is ‘underfundedness’, which must be made up by paying that amount into the pension slowly, yearly, over the life of the plan. Those who disagree with me note that money is put into pension plans every year, but this year it will go unexpectedly through the roof. The newly injected cash buys mostly stocks and bonds, as corporate plans typically hold about 60% stocks. This year, General Motors will inject $3 billion into its fund and use almost $2 billion of it buying stocks. The pension manager won’t do this, but imagine that they just bought GM stock. Earnings would fall, but GM shares would rise with increased stock demand. This is bullish, just as stock buybacks are bullish. To be sure, corporations buy each other’s stocks for pension funding, not their own, but they create the same overall effect.
“There has been no national media mention of this issue and hence, it will surprise investors and be all the more bullish. This is a state or municipality’s number one legal liability and must be paid. They will pay for it mostly by issuing municipal bonds, relatively painlessly. Based on this analysis, my recommendation is that investors buy money management firms. Money management is a great business, but it suffers bouts of depressed revenues when stock prices fall (since fees are a percentage of assets).
Editor’s note: “While you can’t buy shares in Ken Fisher’s private money management firm, he does note that you can buy Amvescap (AVZ NYSE), which also is known by INVESCO, AIM, or Atlantic Trust. Fisher says, “It has fallen more than half again as much as the S&P 500 since 2000. It’s a good firm with an excellent chief executive officer. And it’s too cheap.” Fisher also notes that other money managers to buy include hugely diverse Alliance Capital (AC NYSE), Gabelli Asset Management (GBL NYSE), run by the legendary Mario Gabelli, Neuberger Berman (NEU NYSE), and Martin Sosnoff (ATL NYSE).”