By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Not sure if it was a case of Spring fever or the PGA golf event in Rochester, NY, (how about Michael Block?), or just an overwhelming array of applications to get through, but the week ending May 19th didn’t produce a lot of “results” for the PBGC and their implementation of the ARPA legislation. In fact, there were only two reported actions during the week and both involved the same pension plan, and I’m confused as to the actual events. Plasterers and Cement Masons Local No. 94 Pension Fund submitted and withdrew their application on the same day – May 15th. In somewhat of a chicken-and-egg scenario, did this fund submit and then withdraw its application or did it withdraw an application that had already been submitted, made the appropriate edits, and then resubmit? I’ll have to do some further research to see if I can determine the path that this application traveled.

In any case, this MPRA Suspension and Partition Priority Group 2 plan is only seeking $3.2 million for its 108 plan participants. Priority Group 2 plans began submitting applications way back at the end of 2021. It certainly has taken some time for this plan to get the application to a point that meets the PBGC’s needs. As a reminder, MPRA Suspension and Partition plans had seen benefits cut under 2014’s legislation. These plan participants have waited a long time to get the promised benefits reinstated, while also being made whole for the previously lost pension earnings. Let’s hope that their wait isn’t much longer.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

First recognized by the United States Congress on May 15, 2006, Endangered Species Day falls every year on the third Friday in May. The day is intended to raise awareness about protecting endangered species and their habitats. Endangered species not only include mammals, such as the African elephant or panda bear, but all living things including animals, birds, insects, plants, and other organisms.

I think that this is a critical effort, and it should be given as much consideration as possible. That said, I am not trying to trivialize it when I suggest adding to this list defined benefit (DB) plans, which have seen a tremendous decline in their use since the 1980s. As recently as the late 1980s, there were an estimated 114,000 DB plans within the private sector covering more than 40% of the private sector workforce. Regrettably, the number of companies offering DB plans is down to just over 43,000 as of 2021 with many of those no longer accruing benefits for participants or accepting the enrollment of new employees. Fortunately, DB plans are still being used to a greater extent among public sector sponsors (roughly 5,400 covering 80+% of public sector employees) and unions where there are approximately 1,400 multiemployer plans.

The private sector participation in DB plans has been replaced by defined contribution (DC) plans, where companies are asking untrained employees to fund, manage, and then disburse a “retirement” benefit with little ability to execute that responsibility. As of 2021, there were roughly 638,000 employer-sponsored DC plans. Yet, not every worker is covered by a retirement plan, as there are about 33 million small businesses in the country with a significant percentage employing 10 or fewer workers. As we’ve previously reported, the median balance for those that are covered was a measly $24,503 (2020). Given that reality, providing workers with the means to achieve a dignified retirement is what is truly endangered.

By: Russ Kamp, Managing Director, Ryan ALM, Inc. and Ron Ryan, CEO, Ryan ALM, Inc.

Plan Sponsors and their advisors need to focus on the economic value of the pension plan’s liabilities, which are a yield curve or term structure of actuarial projections of benefits and expenses. Pension liabilities are not a single maturity or duration on a liability yield curve. Anyone who knows the Ryan ALM organization knows that we espouse cash-flow matching (CFM) for that very reason. With CFM you get not only the liquidity to fund monthly benefits and expenses, but you also get duration matching for each and every month that the CFM portfolio covers. Unfortunately, with duration matching, you are only able to “match” the interest rate risk sensitivity of assets to liabilities at a single point in time (average duration) or a handful of points (key rate duration of 5 to 7 average maturity spots on the liability yield curve).

The objective of duration matching is to have the market value or PV changes (growth rate) in the bond portfolio match the market value or PV changes (growth rate) in liabilities for a given change in interest rates. Many fixed-income managers attempt to match the average duration of the bond portfolio to the average duration of a generic bond market index with a similar duration to liabilities (i.e., Bloomberg Barclays long Corporate index). They use the generic bond index as a proxy for liabilities.

Unfortunately, there are many issues with this approach, including:

1. A generic bond index cannot replicate any client’s unique liability cash flows. A client’s liabilities are like snowflakes: different labor force, salaries, mortalities, plan amendments, etc.
2. Average durations give erroneous information because there is an infinite number of combinations of maturities for a bond portfolio that can all have the same average duration, but they will not have the same risk/reward profile.
3. Duration matching is only accurate for small parallel shifts in the yield curve. But the yield curve rarely moves an equal number of basis points at every point along the curve.

Speaking of the yield curve, just look at how the shape of the US Treasury yield curve has changed in the last 14 months, as the Federal Reserve has tightened monetary policy as they aggressively fight inflation. Has the Treasury yield curve moved both incrementally and in parallel? Absolutely not! The short-end of the curve has seen a dramatic rise, as 1-month T-bills are up nearly 5.5% since the Fed ended its zero-interest rate policy, while longer-term US Treasury note and bond yields have only ratcheted up marginally, in most cases < 80bps during that time frame.

If you are an asset consultant or plan sponsor that wants to truly address interest rate risk while enhancing the fund’s liquidity to meet the promised monthly payouts then cash flow matching is the strategy that should be used and not duration matching. For more information on this subject please go to Ryanalm.com where Ron Ryan and the team have produced a plethora of research on these concepts.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I hope that everyone had a wonderful Mother’s Day Weekend.

We are pleased to provide you with the weekly ARPA legislative update. This past week’s activity included one new application submitted, one supplemental application approved, an application withdrawn, and another plan added to the waitlist.

Local Union No. 863 I.B. of T. Pension Plan, a Priority Group 5 plan, submitted a revised application. They are seeking more than $322 million in SFA grant money to support their 2,487 participants. Local 966 Pension Plan received approval for their supplemental request in the amount of $8.6 million. They’d been awarded $54.1 million last December. This Priority Group 2 plan has 2,356 participants. Pension Plan for Bricklayers and Stone Masons Union Local No. 2 is the latest non-Priority Group plan to request to be added to the waitlist. That list now has 108 plans on it.

In other action, U.T.W.A. – N.J. Union – Employer Pension Plan, a priority Group 2 plan, withdrew its revised application on May 11th. This plan is seeking $7.5 million in SFA grant money to cover their 449 participants. Happy to report that no applications were denied during the last week. There were also no waitlist plans that locked in a valuation date. Clearly, there is still a tremendous amount of activity left for the PBGC to address.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

If there’s one thing that I think of when I reflect on our industry, it is the plethora of data/information that is available to those of us in the investment community. As a result, I found it a bit surprising that following the most recent FOMC meeting the Fed pronounced their intentions to become more data-dependent! I would have expected that they were focused on the inputs all along.

I hesitate to add to your stockpile of inputs as you assess whether or not the US Federal Reserve will pause with their rate-raising campaign, further increase the Fed Funds Rate, or do what almost everyone is expecting or hoping for, which is to begin to ease once again. Obviously, inflation has fallen from the peak levels achieved last summer. Recent inflationary data is also supportive of a Fed pause, if not a pivot, but does history support this view.

I posted this info earlier this week on LinkedIn.com. I shared that I had seen a very interesting chart that had been prepared by Goldman Sachs. As the graph below highlights, dating back to the mid-80s, there have been seven times when the Fed has paused raising rates in which the employment picture was considered “tight” (left side of the graph). In only ONE of those observations did the Fed cut rates within the next 6 months and there was also one time that they proceeded to raise rates again. Given the significant strength currently observed in our labor markets, it seems misguided to think that the Fed will pause and immediately begin to cut.

Again, until we witness a meaningful change in our labor force, rates are not likely to move much or at all before year-end. It was reported just yesterday that the Unemployment Insurance Weekly Claims Report – Initial Claims had come in at 265K, which was up substantially from the previous week’s reading. Could this be the beginning of some weakness in the US Labor Force or is it the result of seasonal effects that might have skewed the data? Personally, I don’t see the unemployment rate spiking to a level that the Fed would see as confirming inflation tamed anytime soon. In fact, the Atlanta Fed’s GDPNow model is showing a 2.7% annualized GDP growth rate as of today for Q2’23. If that GDP # is anywhere close to accurate, that is much stronger growth than I think most in our industry are anticipating.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I have been thinking about producing a post on uncertainty for a while. An email that just came across my desk pushed me to finally write something on the subject. You would think that someone who has been in the investment industry for 41+ years has accepted that uncertainty is just part of the job. I haven’t, and I’m constantly looking for ways to minimize uncertainty to the greatest possible degree.

As textbooks explain, our minds actively work to reduce uncertainty as much as possible. We all want solutions — answers to our questions and problems. When the answers aren’t apparent, we find it difficult to stop ourselves from obsessing over the uncertainty. The impact of these uncertainties seems to magnify during periods of great stress (market dislocations). For most of us, uncertainty can feel very uncomfortable. It sure does for me.

Yet, those of us in the pension arena continue to exacerbate uncertainties, by focusing on a return objective (ROA) that doesn’t guarantee success in lieu of focusing on the true objective of managing a pension, which is to secure the promised benefits at a reasonable cost and with prudent risk. Why? Insurance companies and lottery systems discovered long ago that defeasing liabilities was the surest way to reduce risk and achieve the desired objective. They don’t cobble together a collection of asset classes with the hope that the combination will somehow achieve that return objective. No, they take a present value (PV) calculation of what the future value promise (FV) looks like and they fund that obligation with certainty. No games!

The email that hit my desk today was titled “Expect Uncertainties”. As I stated earlier, anyone who has spent any time in this industry appreciates that there are uncertainties. If there weren’t then pension plans would be fully invested, 401(k) balances would be robust, and the customers would have yachts instead of just a few hedge fund managers. Managing against a return objective is fraught with peril. There is a plethora of risks that contribute to the uncertainties. Perhaps there is no greater risk right now than the impact of inflation on our markets going forward. What will the Fed do? How will their decisions impact public and private markets? Will there be a pivot and if so, what will the magnitude be, and will it be timed appropriately or will it be premature? Inflation is just one risk. There are countless others that can create uncertainty.

Is there anything that a plan sponsor can do to significantly reduce this uncertainty? Must they continue to live with these uncomfortable feelings? Yes and no. As we’ve discussed on many occasions, the FOMC’s interest rate increases have played havoc on markets and nerves, but the spike in rates has also created wonderful opportunities to SECURE the promised benefits while reducing the uncertainties associated with investing in the markets. How comforting would it be for managers of pension systems, the sponsors that help fund them, and the participants that are counting on receiving a promised benefit to know that a significant portion of the uncertainty has been eradicated?

Don’t continue to focus your energy on allocating ALL of the pension plan’s assets to return-seeking products. Split the assets into a liquidity bucket and a growth bucket. The liquidity bucket will have all of your investment-grade bonds providing the necessary cash flow to meet the projected benefits and expenses through both the interest and principal cash flows, while the growth bucket will consist of all non-bonds that now can grow unencumbered with the purpose of meeting tomorrow’s liabilities. The cash flow matching (CFM) strategy will eliminate the uncertainty of where the cash will come from to meet benefits and expenses. Furthermore, the CFM portfolio will remove the uncertainty of interest rate risk since future values are not interest rate sensitive.

If uncertainty makes you uncomfortable, adopt a CFM strategy that can significantly reduce uncertainty by securing those promises. You and everyone else associated with that pension plan will surely appreciate the reduction in one’s level of stress.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

If it’s Monday, it must be ARPA update day. I’m a little late today in providing an update as a trip to and from Baltimore to empty a dorm room pushed my delivery back. That said, there isn’t a whole lot to provide in terms of news. There was a revised application filed on May 2nd by the Ironworkers Local Union No. 16 Pension Plan. This MPRA suspension (Priority Group 2) plan is seeking slightly more than $73 million to help cover the promised benefits for 996 plan participants. The PBGC has until August 30, 2023, to act on the application.

In other ARPA news, there were no applications approved, denied, or withdrawn. However, four previously approved plans were paid on May 1st. These four entities received $450.2 million in supplemental payments for the 34,658 participants in these plans. The New York State Teamsters Conference Pension and Retirement Fund received a significant percentage of the grant monies for coverage of its >33,600 beneficiaries. Lastly, there was one more plan added to the waitlist, as the Communications Workers of America Local 1109 Pension Plan emailed their intention to be added to the list on May 4th.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Pension Obligation Bonds (POBs) were all the rage in 2021 following the historic collapse in US interest rates during the initial market reaction to Covid-19. You may recall that I wrote and spoke quite often on the subject, especially in 2021 and into 2022. We published “POBs – All the Rage!” in early September 2021 and followed that up with “Why POBs? Reason #2 – Reversion to the Mean” later that same month. I was imploring plan sponsors and their advisors to take advantage of the historically low rates, but more importantly, as you’ll read in the second piece, I was concerned about the extraordinary performance results that had been generated by public equities, which I didn’t think were sustainable. As you know, 2022 produced a -18.1% return for the S&P 500, while the BB Aggregate Bond Index declined a historic -13.0%.

If plan sponsors had issued POBs to shore up the plan’s economics, they could have capitalized on an interest rate environment that we are not likely to witness again. According to S&P, there were 72 POBs issued in 2021, which significantly eclipsed the average annual issuance of 25, but given the 20,000+ defined benefit plans, the 72 didn’t register as even a rounding error. What a wasted opportunity! Well, all may not be lost. As the chart below reflects, US interest rates for maturities 5 years and out have seen little increase in the last 12 months despite very aggressive tightening by the Fed.

It is incredible to see just how little movement there has been in the longer-dated Treasury yields. Plan sponsors can still capture an impressive arbitrage opportunity by issuing POBs in this environment. Importantly, the proceeds can be invested in a cash flow matching (CFM) strategy that will secure the plan’s benefits and expenses as far into the future as the POB proceeds will permit. This CFM portfolio will invest in investment-grade corporate bonds that will currently provide a yield to worst (YTW) in the low 5% range. While the CFM portfolio’s assets are used to fund all of the benefits, the plan’s legacy assets can be invested more aggressively now that the plan has bought considerable time (extended the investing horizon). Given the market’s poor performance since the end of 2021, being able to invest at substantially lower valuation levels should be pursued with vigor.

POBs were panned by certain entities because of the uncertainty of investing the bond’s proceeds into a traditional asset allocation. We’ve removed that uncertainty by recommending that the proceeds be used to defease a plan’s liabilities. No reason to play the markets with all of the risk and uncertainty that accompanies that strategy. Please consider POBs again.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The US Federal Reserve didn’t disappoint anyone today, other than those who for some strange reason have been expecting the Fed to have eased by now and in some cases all the way back to last Summer. The Fed has now raised rates for 10 straight meetings bringing the Fed Fund’s Rate to 5% – 5.25%, which is up 500bps since they began elevating rates last March in an attempt to tamp down inflation.

Like you, I get tons of emails every day from one research firm after another proclaiming that this time has to be the last time of Fed hiking in this rate cycle. One firm stated just today that “in the past, cumulative hikes of more than 300bp or so have been enough to push the economy into recession.” But we’ve also never had a starting point of ZIRP (zero interest rate policy) and incredible stimulus in reaction to Covid-19 lockdowns. Doesn’t the starting point matter?

As a reminder, US interest rates bottomed in July 2020, with US Treasury Bills and Notes with maturities < 5 years posting yields below 0.3%, while the 10-year yield hit 0.55% and the 30-year had a yield of 1.2%. These were historic low rates. They were not sustainable and ultimately contributed to the inflation that we are still wading through today. But, even with the Fed’s increases, US Treasury yields are not much higher than they were 12 months ago for those with maturities of 5 years or more. In fact, the difference in yield for the 5-year Note 12 months ago versus today is ONLY 37 bps. Do you really believe that economic activity is going to be crushed with a yield differential of 37 bps? The spread for 7 years, 10 years, and 30 years today versus 12 months ago are not meaningfully different, too (32 bps, 41, bps, and 69 bps, respectively). Once again, do you really believe that these increases are crushing?

As I reported last week, the average 10-year Treasury yield for the last 70+ years has been 5.1%, a full 1.7% higher than the current environment. In order to combat inflation in the late ’70s and early ’80s, the Fed elevated the effective FFR to 22.29% or more than 4 times the current level. That was crushing!

You Gotta Love Charlie

Charlie, as in Charlie Munger, Warren Buffet’s right-hand man (last 45 years), and a 99-year-old billionaire, is not one to mince words. During the past weekend, he is quoted as saying “that the company’s success (Berkshire Hathaway) was by and large the result of low-interest rates, low equity values, ample opportunities,” suggesting that he lived during “a perfect period to be a common stock investor.” I’d add to that list investors of bonds, real estate, private equity, private debt, and any other financial instrument that was supported by a nearly 4-decade tailwind that often resembled a tornado!

Charlie also went on to say that “investment managers are nothing more than fortune tellers or astrologers who are dragging money out of their client’s accounts.” Harsh, but probably in many cases true. I’ve written on numerous occasions that the significant tailwind of falling rates and low inflation witnessed during the last 40 years has made us all appear smarter than we really were or are. This next rate cycle is going to help identify the real investors. Investors can hope all they want that the Fed will soon come to its collective senses, but in the meantime, employment remains firm and inflation sticky.

You can continue to ride the asset allocation rollercoaster to ruin or you can take substantial risk off the table by focusing on the promise that has been made to the plan participant. I know what I’d do.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to provide you with the weekly update on the PBGC’s progress in implementing the ARPA legislation. They’ve been diligently stewarding this process Since July 2021. There are still many more potential grants to be awarded, as reflected in the chart below.

May was brought in with a flurry of activity. It was reported that five multiemployer plans had the SFA applications approved last week. These plans, United Independent Union – Newspaper Guild of Greater Philadelphia Pension Plan, the Pension Plan of the Bakery Drivers and Salesmen Local 194 and Industry Pension Fund, the United Furniture Workers Pension Fund A, the Western States Office and Professional Employees Pension Fund, and the Building Material Drivers Local 436 Pension Plan will receive awards totaling $1.062 billion to help support the pensions of 20,846 participants. Four of the plans had their initial application approved, while the United Furniture Workers had its revised application approved. This brings the total approved applications to 46 as of last Friday, April 28th.

In addition to the 5 approved accounts, there were 3 applications withdrawn, no applications that were denied, and none of the nine approved applications received their wire transfers. There were no additions to the “waiting list”, while one of the plans on the waiting list elected to lock in its valuation date. G.C.U. Local No. 96B Pension Plan filed to have their valuation date be 1/31/23. They are the second plan to use that date, while 103 have chosen 12/31/22.