On Labor Day, September 2, 1974, President Gerald Ford, in one of his first official acts after having succeeded Richard Nixon upon the latter’s resignation the previous month, signed into law a measure that probably had as much if not more to do with how my career ultimately developed than any other law on the books, with the possible exception of the Internal Revenue Code, to which I was attached professionally for nearly 20 years.
I was utterly oblivious to this development at the time, of course. I had just started the fall semester at the University of Texas School of Law, having finished the summer term shortly before getting married on August 24. On that Labor Day, my new wife and I had barely moved into our one-bedroom Austin apartment, having been married for ten whole days. I wasn’t paying much attention to events anywhere outside of that apartment and the law school’s Townes Hall, where my classes were held, and I certainly had no clue that the new President might be up to something that would in the fullness of time prove to be personally significant to me.
The law President Ford signed that Labor Day came to be known as ERISA, which is short for the Employee Retirement Income Security Act of 1974. Its title spoke of its origins, for it was born of the outrage that followed the shuttering nearly nine years earlier by the automaker Studebaker of its South Bend, Indiana, assembly plant and the subsequent termination by Studebaker of its pension plan. Those actions left the pension plan beneficiaries, who were mostly assembly line workers, high and dry, and the injustice of those events was what propelled the United Auto Workers on a warpath to see that nothing like that could happen to its members ever again.
The UAW took its crusade to Congress, which somehow, after years of hearings and study, while still in the midst of the Watergate scandal and the final acts of the Vietnam war, managed to pass ERISA.
Naturally enough, the law’s principal objective was the protection of pension fund beneficiaries from the loss of their benefits as a result of the mismanagement of their fund. (Shockingly, in a futile attempt to stave off its inevitable bankruptcy so it could continue to pursue its passion for building some of the most godawful ugly automobiles ever devised by the mind of man, Studebaker had borrowed money from its pension plan, and these funds it had failed to repay.)
But ERISA also brought about a wholesale reform of pension law in the process, including injecting a modicum of certainty into the process by which pension plan trustees could select investments for a pension fund’s balance sheet without risk of being sued for alleged wrongdoing.
Prior thereto, the legal standard to which pension plan trustees had been held vis-a-vis their investment decisions had varied from state to state and depended on principles of common law that were, at best, uncertain in their application to any individual situation.
Once signed into law, ERISA replaced this legal hodgepodge with a single rule for judging the standard to be applied to plan trustees in their role as investors.
Specifically, under ERISA, trustees, whether they be of a private corporate plan such as Studebaker’s or one of the numerous plans sponsored by state governments, such as the California Public Employees Retirement System or the Teachers Retirement System of Texas, are held to the standard of “prudent experts” in choosing which investments a plan will make. This standard was further developed over time through rules and regulations to make it clear that it could be met if the trustees established and followed a reasonable process of due diligence and inquiry, including through the use of objective subject matter experts such as consultants and in-house staff. Stated differently, the work of staff and consultants could be relied on by the plan’s fiduciaries for assurance that they had satisfied the “prudent expert” standard if the latter invested based on the studied recommendations of the former.
This assurance was especially valuable when it came to investment opportunities in those asset classes that are rather more difficult to get a grip on than, say, your traditional stocks and bonds.
Such as private equity, hedge funds, and private real estate.
You see, before ERISA, pension fund trustees had been chary about investing in alts (alternative investments) because, under the law then in effect (as best anyone could tell), trustees might potentially be held personally liable for damages if one of several perceived risks of investing in alts were to cause an investment to go bad.
Now what were the perceived risks of investing in alts that caused trustees to shy away from them in the days before ERISA?
Well, they were these: illiquidity, valuation opacity, concentration, leverage and higher fees.
Sounds familiar, right? These are the very same risks that often cause individuals to shy away from including alts in their personal portfolios.
The “prudent expert” standard and related processes solved this problem, thus opening up alts as investable by public and private pension funds.
Thus it came to pass that in the late 1970s, and accelerating through the 1980s and beyond (after the Internal Revenue Code was amended to make clear that income earned by a tax-exempt pension fund from debt-financed private real estate would not be subject to tax), the capital deployed into PRE (private real estate) by public and private pension funds went from a trickle to a flood of Noah’s Ark proportions. In doing so, it had the effect of elevating PRE to the status of an institutional quality asset class.
Now, those pension plan investments took a number of different structural forms, and that will be the subject of a future post. For now, though, the moral of the story, and its potential relevance to an investment in PRE today, is simply this.
If you or I or anyone else is offered the opportunity to invest side-by-side with a pension fund in an alt product, we can take a modicum of comfort from the fact that, between the fund’s in-house staff and consultants, the trustees of that pension fund are convinced that the expected return from the investment is worth running whatever risks there may be in the form of liquidity, valuation opacity, leverage, high fees, etc.
Given their access to such sophisticated and expert analysis, and their ability to decide on the merits of making an investment in preference to other opportunities that they’re presented within the marketplace, such institutions are well-positioned to make this determination.
Those oh so clever and whimsical bankers on Wall Street have a term for this. They call it “schmuck insurance.” Rough translation: If you and I invest alongside one or more huge pension funds who have all these smart and seasoned staffers and consultants that recommended that their employer/client go long that very same position, maybe involving amounts of capital in the hundreds of millions of dollars, and nevertheless the investment subsequently underperforms, then the fact that it was a disappointment even for the so-called “smart money” means that no one can call us a schmuck.
Of course, being a product of Wall Street, the phrase “schmuck insurance” is little more than snickering, smart-aleck slang, but there’s a grain of truth in it.
As in, who among us can afford what it costs to do the kind of underwriting a pension fund must do to justify having the “prudent expert” view that is required before it makes an investment?
Very few of us, is the answer.
For this reason, therefore, it should be of interest to anyone who is considering an investment in the Accordant ODCE Index Fund (ODCEX) to know that ODCEX invests in exactly the same $10 billion IDR ODCE Index Fund that some of the nation’s preeminent state pension funds have been investing in over the last nearly ten years, to the tune of hundreds of millions of dollars each.
It certainly had something to do with my decision to go long ODCEX, although there is another aspect to the size of the IDR ODCE Index Fund, one having important implications for the liquidity of my personal investment in ODCEX, which may be an even more important consideration. I’ll return to that in a subsequent post.
Accordant Investments LLC (“Accordant”) is an SEC registered investment adviser. For more information about our services and disclosures, please visit our website at www.accordantinvestments.com.
This article reflects the personal views and experiences of the author and is provided for informational purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any product or service offered by Accordant Investments or its affiliates.
Jim Hime is an investor in the Accordant ODCE Index Fund. He receives a salary and other ordinary employment compensation from the adviser in connection with his role at the firm. He did not receive any additional or separate compensation for providing this statement. Because of his employment relationship and his personal investment in the fund, he has financial incentives to promote the fund. This statement reflects his personal views and experience and should not be considered a guarantee of future results or representative of the experience of all investors.
An investment in the Accordant ODCE Index Fund (“ODCEX”) is suitable only for investors who can bear the risks associated with investments in the Underlying Funds and the various real estate equity and debt strategies which such Underlying Funds utilize, with potential limited liquidity. Even though the Fund makes quarterly repurchase offers for its outstanding Shares, investors should consider the Shares to be viewed as a long-term investment within a multi-asset personal portfolio and should not be viewed individually as a complete investment program.
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Investing in the Fund involves a high degree of risk. The following list is not exhaustive. Please review risks related to an investment in the Fund set forth in the “Risk Factors” section of the prospectus. These include, but are not limited to the following: convertible securities risk, correlation risk, credit risk, fixed income risk, leverage risk, and risk of competition between underlying funds.
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Investing in the Accordant ODCE Index Fund (“ODCEX”) involves risk, including the risk that you may receive little or no return on your investment or that you may lose part or all your investment. The Fund’s investment objective is to employ an indexing investment approach that seeks to track the NFI-ODCE Index on a net-of-fee basis while minimizing tracking error. There can be no assurance that the actual allocations will be effective in achieving the Fund’s investment objective or delivering positive returns. It is not possible to invest in an index.
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