Fred Smith, CFA, a portfolio manager for a large investment advisory firm, is reviewing background information on Mid-South Trucking Company. John Oliver, formerly a senior partner of a management consulting firm and the recently elected president of Mid-South, has learned that Mid-South 's defined-benefit pension plan is invested 100 percent in bonds, with a maximum maturity of 10 years. Oliver believes that "anyone can buy bonds and sit on them" and that "a pension plan should be managed so as to maximize return within well-defined risk parameters." He has requested that Smith, as an informed and objective observer, advise him on possible changes in the plan's asset mix.

The Company

Mid-South is the eighth largest domestic trucking company, with annual revenues of $850 million. Revenues have grown about 8 percent a year for the past five years, with one down year. The company employs about 7,000 people, and its annual payroll approximates $300 million. The average age of the workforce is 43 years. Company profits last year were $20 million, compared to $ 12 million five years ago.

The Pension Plan

Mid-South's defined-benefit plan was established in 1965. The company annually contributes 7 percent of payroll to fund the plan. During the past five years, portfolio income has covered payments for retirees, and company contributions have been available for investment. Although the plan is currently adequately funded, unfunded past service liabilities are equal to 40 percent of plan assets. This liability is being funded over the next 35 years. Plan assets are valued annually on a rolling four-year average for actuarial purposes.

Although actual plan results have averaged 10 percent a year for the past 20 years, for purposes of this analysis, Mid-South's management, in consultation with the actuary, has decided to use an assumed annual rate of 7 percent. (FAS 87 requires an annual reassessment of the assumed rate of return). Based on past company experience, wages and salaries are assumed to increase 5 percent a year.

The Task

Before the meeting, Smith reviews his firm's latest investment projections through continued prosperity is considered the most likely outlook for the next three to five years, two alternatives have been allowed for: a return to high inflation, or a move into deflation/depression. Smith is to prepare an investment policy statement appropriate for the Mid-South Trucking Company's plan and recommend changes to the existing all-bond asset allocation. He feels that this recommendation should be limited to domestic stocks, domestic bonds, and cash equivalents, deferring discussion of other asset classes and instruments to a later date.

Would you be able to make a quick investment policy statement?

Answer rating: 100% (QA)

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