It’s all about pensions.

A generation or two ago, governments and private companies both offered what became known as defined benefit pension programs. Although there were lots of bells and whistles, basically an employee who qualified for a pension was paid a specified percentage of his/her salary at retirement each year for the rest of the retiree’s life.

Two issues:

–this is expensive, so companies have to put lots of money aside to meet this obligation, and

–publicly-traded stocks are the bulk of these holdings. But although stocks are probably the highest earning assets, they don’t just lie there. They typically either go up a lot, or down a bunch. In the latter case, the company may be called on to add more assets to the plan, to ensure it’s about to meet all its retirement promises.

Because of this last, most companies have long since shifted to defined contribution plans, in which companies make periodic contributions to tax-deferred, employee-owned accounts (most often, employees can add something extra, too) while the employees are still working. At retirement, the employee gains control over the entire sum–and the employer’s obligation ends. Two pluses for the company: its total payments are probably smaller than with a defined benefit plan and there’s no risk that an ugly bear market will shrink the plan assets to the point that the firm has to chip in more.

The one exception to this is state and local governments, which continue, by and large, to offer defined benefit plans to employees. Employees want them and arguably accept lower salaries than they would if offered only defined contribution plans.

Two issues here:

–how to deal with the ups and downs of the stock market–specifically the appearance of underfunding at the bottom of a bear market, and

–how to generate better investment returns than stocks, if possible, in order to reduce the proportion of public funds being put aside to fund pensions.

The answer, if that’s the right word: private equity and private credit.

More tomorrow