Bridge over ocean
1 January 1977 Financial Analysts Journal Volume 33, Issue 1

The Major Shortfall of ERISA

  1. William S. Gray, CFA

One of the prudent man sections of ERISA is so worded that the investment aspects of pension funds will continue to be heavily influenced by the principles of the pre-ERISA law of trusts. One of those principles is that each individual investment holding must stand on its own in meeting the prudent man standard. The influence of this principle has been so great that fiduciaries have historically given little sophisticated attention to the manner in which the individual holding influences the characteristics of an entire portfolio.

Consider, for example, two holdings sensitive to different kinds of economic and market developments. Because their prices are unlikely to rise and fall in unison, the volatility of the combination is less than the average of their respective volatilities. It follows that diversity among a portfolio's holdings, rather than compromising its basic objectives, can actually enhance its ability to meet those objectives.

If the prudent man standard of ERISA were to be interpreted as focusing on total portfolio characteristics, investors would probably use a greater diversity of common stock issues, including more issues of small and medium sized companies. If, on the other hand, the traditional security-by-security interpretation is adopted, pension investors will make less use of such companies than ever.

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