The Pension Fund Portfolio

Abstract

PENSION TRUSTS have several characteristics which make them considerably different from personal trust accounts, the investment of which has been the normal problem of the trust investment officer. The purpose of the pension trust is to provide the cost of the liabilities assumed when the company signs the agreement to provide specified pensions to its employees. Cost includes the expenses of administration, as well as the money paid to the retired employees. During the first years of the plan, the annual disbursements of the fund are usually much less than the cash contributions paid by the employer. Eventually the point is reached where, barring a larger working force and rising pay scales, the fund has enough earnings so that, together with the annual contribution, it will meet the liability as determined by estimates of the actuaries. Because of this feature, the investment results should be measured by combining income and principal performance of the fund. Another characteristic, and a happy one, is that in most instances monthly, quarterly, or annual additions are made to the account. This is in great contrast to the vast majority of trust accounts where a sum of money is made available all at once to the trustees for investment, and that's it. The periodic contributions place the trustee in a position to dollar-average his purchase of common stocks without necessarily selling bonds to provide the funds. One of the most perplexing problems for the trustee in dealing with the normal personal trust account is to determine whether or not to commit all the money at the prevailing level of stock prices and money rates or to spread purchases over a period of months or years. Cash being given to the pension-fund trustee at regular intervals simplifies the life of a trustee on this score. Pension trusts also have their problems. One of the great uncertainties is the fact that the annual contributions are based on the people now employed. Although employment has for the past fifteen years been at a very high level, a prudent trustee must be prepared for a return to business swinging through wider gyrations. Declines in employment, and therefore in contributions, normally should coincide with dips in business activity. From this follows the fact that, at this point, corporation earnings are probably at a somewhat lower level, and stock prices should be affected by these developments. The trustee of the pension trust is lulled into a state of complacence by the periodic additions of cash, which he can use for the purchase of bonds, preferred stocks, or common stocks as he sees fit. Under the new circumstances, the cash might be a half or a quarter of the previous figure, or in extreme cases it might be omitted entirely. Will he take advantage of the lower prices of common stocks by securing buying power from the sale of bonds, or will he simply confine his program to the smaller amount of cash available? Investment decisions in many trust accounts are modified by the tax consequences. Since the pension trusts qualified under Section 165 are not subject to income taxes, the trustee has a relatively easy time on this score. Nevertheless, his program does not have so smooth a road as it seems. In the great majority of plans, the actuary uses the book value rather than the market value of the investments in the pension trust, in order to determine the contribution needed that particular year for the fund to continue sound actuarily. In other words, the difference between market and book value is disregarded. We expect that, in years of good business, a book profit on the securities will be shown, the company's earnings will be good, making the tax deduction for pensions particularly worth while, and the company's cash position will be strong. If at this point the trustee should take a substantial amount of profits, the book value of the fund would be increased correspondingly. Such a rise would reduce the company's tax-free contribution at the time when making the payment is the most advantageous (or least painful), from the point of view of the employer.