PHOENIX – Responding to a report that downplayed the importance of unfunded public pension liabilities, investors said they value the funded-liability metric and see pensions in general as a significant problem.

Portfolio managers told The Bond Buyer that while an issuer's pension fund's actuarially unfunded liability isn't the only way they think about pension risk, it can weigh heavily in their investment decisions. That thinking is in contrast to that in a University of California report last month that downplayed the importance of the funding ratio under what it characterized as flawed accounting rules.

Marilyn Cohen, chief executive officer at Los Angeles-based Envision Capital Management, said that pension worries are a fact of life for investors now, and that isn't going to go away.

"Finally I think we're at the end of the asphalt on this road," said Cohen. "It's seen the light of day now and it's not going back."


Envision Capital Management chief Marilyn Cohen says unfunded pension liabilities are a key factor in evaluating general obligation debt.

Cohen said she had seen the report, authored by former Rhode Island Treasurer senior policy advisor Tom Sgouros, and disagreed with its argument. Sgouros argued in that paper that not fully funding pensions wasn't necessarily a problem, and added that accounting procedures allowing localities to overspend while pushing the impact onto future budget years was a bigger concern. He called for new accounting rules that in his view would lead to a more accurate picture of what states and municipalities should be spending on their pension systems.

Cohen said that even though she still thinks many pension systems are being somewhat dishonest in how they calculate their expected returns, continuing to bank on investment earnings higher than they are likely to achieve, she still uses the unfunded actuarial liability of a pension as one of her main yardsticks when evaluating certain types of issuer debt.

"It's one of the top ones," said Cohen. "When we're looking at [general obligations], absolutely."

Cohen said she has increasingly steered away from GO bonds because of this risk, in the aftermath of municipal bankruptcies such as Detroit and San Bernardino, in which pensioners have consistently come out well ahead of bondholders in recovery. She prefers the protected repayment streams provided by revenue bonds.

"The pensioners win over the bond holders, plain and simple," Cohen said. "This is a trend in motion, and it's going to stay this way."

Tom Schuette, a partner and co-head of investment research and strategy at Gurtin Municipal Bond Management who said he was familiar with Sgouros' argument, explained his own thinking on pension liabilities.

"I don't know that we necessarily take sides in this debate, but what I would say that as investors, we view pension liabilities as one part of an obligor's overall credit profile," Schuette said. "Pensions are not the 'end all, be all' of credit analysis but rather are an important factor in what should be a holistic view."

Schuette said that his firm looks at pension unfunded liabilities, along with other factors, as part of an analysis that could end up showing that even an issuer with major liabilities could still be in good position down the road.

"We look at an obligor's pension burden and consider it relative to their financial flexibility, debt capacity and likely future economic and demographic profile," Schuette said. "After all, some obligors facing significant liabilities may still be well positioned to address these concerns given strengths in all of these other areas. We do consider all the actuarial metrics and plan assumptions released by obligors. I would say that we also heavily weight the burden an obligor's annual pension contributions are placing on its budget, and we stress test potential future trajectories for this contribution assuming various scenarios to see if an obligor has the flexibility to withstand increases."

But Schuette said he does believe that some in the market are pushing too hard for major changes to fully fund pensions quickly.

"Pensions are definitely a concern for investors, and rightly so, but we believe many in the market are painting all obligors with a broad brush when it comes to unfunded liabilities and placing too high of an emphasis on fully funding plans immediately," he said. "Many plans are sufficiently funded to buy them time to make incremental adjustments to what remains a very long term liability that does not need to be addressed all at once."

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