Ryan ALM’s Believe It Or Not!

A generic asset allocation that we have been tracking for more than two decades produced a -12.3% return for the first quarter of 2020. That same pension system with a 15-year duration on it’s liabilities allocated equally across maturities and using a US Treasury STRIPS discount rate produced a +18.7% gain in the quarter. Shockingly, pension assets underperformed pension liabilities by 31% during the first 3 months of this year. As a result, assets have now underperformed liabilities by an incredible -288.5% since 12/31/99. A pension system that started with a funded ratio of 100% in December 1999 would now see their funded ratio at 48%.

For those plans that use ASC 715 discount rates (corporations) your underperformance was -14.8%, while those operating with the ROA as it’s objective (publics and many multiemployer plans) would have realized underperformance of -14.1%. In any case the impact on the funded status is extraordinary and clearly unacceptable. It further highlights that managing a pension without paying heed to a plan’s liabilities is not an effective long-term strategy.

Those Aren’t Lessons Learned – They Are Penalties Inflicted on the Participants

We are very much looking forward to presenting “Pension Lessons Learned” with the Opal Group beginning on April 15th. This is the first in a series of Ryan ALM and Opal Group webinars addressing this important topic. But, in order to discuss potential lessons learned from this crisis, we need to reflect on what lessons were learned following the Great Financial Crisis of 2007-2009, when pension America saw its funded status plummet and contribution expense dramatically escalate.

Unfortunately, with regard to the private sector, we continued to witness an incredible exodus from defined benefit plans and the continued greater reliance on defined contribution plans, which is proving to be a failed model. That activity appears to have benefited corporate America, but how did that work for plan participants, who are now forced to fund, manage, and then disburse this benefit through their own actions, which is asking a lot from untrained individuals, who in many cases don’t have the discretionary income to fund these programs in the first place.

With regard to public pension systems, we saw a lot of action. There were steps to reduce the return on asset assumption for many systems – fine. But, that forced contributions to rise rapidly, creating a greater burden on state and municipal budgets that began to siphon precious financial resources needed for other social issues. In addition, there was great activity in creating additional benefit tiers, in which newer plan participants, and some existing members, were asked to fund more of their benefit through new or greater employee contributions, longer tenures before retirement, and more modest benefits to be paid out at retirement. Again, not a pension lesson learned, but a penalty for participants.

Multiemployer plans were certainly not immune to these developments. We have seen greater contribution expense and lower ROA targets for these plans, too, but have we seen improved funding? We have more than 300 multiemployer plans that went into 2020 in either Critical status or worse, Critical and Declining status. Given what has transpired in the markets to begin this year, it is highly likely that a number of other plans will have seen their funded status deteriorate to the point that they are also in Critical status.

It seems to me that most of the “lessons learned” have nothing to do with how DB pension plans are managed, but rather asks that plan participants bear the consequences of a failed pension model. A model to has focused on the ROA as if it were the Holy Grail. Pension plans should have been focused on the promise that was made to their participants, and not on how much return they could generate, which has done very little in terms of return, but certainly created a lot more uncertainty and volatility. As we’ve been reporting, equity and equity-like exposure within multiemployer and public pension systems was greater coming into 2020 then where they were in 2007. What lesson was learned?

Pension America is once again suffering under the weight of declining asset values and falling interest rates. When will we truly learn that continuing to manage DB plans with a focus on return is NOT correct? The primary objective needs to be securing the promised benefit at low cost and prudent risk. Shifting wads of money into private equity and thinking that you’ve diversified away equity exposure is just silly. Too much money has flowed into private equity that would have likely diminished returns prior to our economy being shut down. The consequences from an economy that has been placed on life support are likely to result in private equity valuations being sliced by 33% to 50%. That won’t help a plan’s funded status!

News For the ROA Chasers

A pension system’s primary objective should be to secure the promised benefits at low cost and prudent risk. Seems obvious, but regrettably that objective has NOT been the primary focus for most public and multiemployer plans for decades now. We can debate the reasons why when the dust settles, but that isn’t going to help us right now.

Unfortunately, the focus for most asset consultants, actuaries, and plan sponsors has been return. As a result, we’ve insured that the funded status and contribution expenses have become incredibly volatile. Instead of securing the promise and winning the game, we’ve decided to play Russian roulette. How has that worked out? Again, it shouldn’t be surprising, but that pursuit of the ROA has failed to stabilize anything pension-related. Many state budgets are being strained, as contributions become a bigger share of annual state budgets and more than 125 multiemployer plans (likely more after this market crash) face insolvency within the next 15 years.

We’ve written a few posts in the last 6 months or so highlighting our concern that equity and equity-like allocations within pension systems for public and multiemployer plans were at levels that were greater than that which we’d witnessed prior to 2007. The excuse was that bond yields were so low that they couldn’t justify having them in their portfolio because they wouldn’t achieve the ROA objective. How’s that worked out? For the record, the S&P 500 through March 31, 2020 has achieved a 4.8% return for 20 years! Meanwhile, the Bloomberg Barclays Aggregate (it will always remain the Lehman Agg. to me) index is up 5.1% during that same 20-year period. Wow, bonds have actually outperformed equities by 0.3% per year for 20-years!

Furthermore, we’ve recently reported that the private equity markets are likely to see massive write-downs of their portfolio companies (33%-50%), as our economy has been shuttered. I have recently seen the results of a business survey conduced in Northern NJ that indicated that 45% of small businesses would not survive three more weeks and that 83% of businesses would be forced to close down if this situation were to extend to the end of June. Think about those jobs and wages lost and the impact on demand for goods and services.

The move to less liquid investments -private equity and debt, real estate, infrastructure, etc. – is also exacerbating the poor performance of pension funds that are forced to sell assets into this weakness in order to make benefit payments. As you know, it didn’t have to be this way. Are we finally going to get off this asset allocation roller coaster that I wrote about earlier this week? Defined contribution plans are NOT retirement vehicles, but if we don’t do a better job of managing DB plans, they will be the only game in town. Our plan participants, retirees, and the US economy will suffer the consequences.

Looking for Something Positive to Write About

I am tired of writing about the problems within our retirement industry, of which there are many. I need something positive to write about, but I’m having difficulty during this chaotic time finding such a topic. Perhaps we can get excited at the prospect that Congress is actually thinking about cobbling together a fourth stimulus proposal following the recent passage of the $2.2 trillion CARES legislation.

There are rumblings that members of the House are preparing to include the Butch Lewis Act (BLA) in the next round of support. The Critical and Declining plans (roughly 125) were already teetering on the brink of insolvency. The stock market’s recent terrible performance will only speed up the time frame to insolvency, while likely pushing many of the multiemployer plans that were deemed to be in “Critical” status into the Critical and Declining bucket. Support for these pension funds is absolutely critical, as nearly 1.4 million American retirees and active plan participants could lose a significant percentage of their earned benefit. Their contribution to our economy, through the monthly benefit payments, is huge. We can’t afford any more revenue and demand shocks to our economy at this time.

While my fingers are crossed that we might see some action to help these struggling plans, I am not holding my breath, as pension reform for multiemployer plans has been on going for years and years. Stay well and stay safe!

Here we Go Again?

The following quote was from my November 5, 2019 blog of the same name. I had just returned from speaking at the IFEBP in San Diego on Enhanced Asset Allocation.

“I certainly don’t know when the next recession might occur, but it will. Do we really want to have these plans sitting with their highest equity exposure when it hits the fan? Shouldn’t we be looking for ways to reduce risk after a long cycle of outperformance?”

Cash Flows NOT Returns

“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” Confucius

It should be fairly clear at this time that chasing return has created an environment of great uncertainty for Pension America. As Confucius suggests above, if the primary goal is paying the benefits that have been promised, then don’t change that important goal: adjust the action steps. Our industry has chased performance for decades with little success to show for the effort. Isn’t it finally time to adjust the approach?

Building a cash flow matching portfolio that secures those promised benefits would create far less anxiety for all participants involved in pensions. This approach would have worked beautifully during the first quarter when asset values plummeted and liquidity became scarce. Those “return-focused” assets that took it on the chin would now have time to recover, as the cash flow matching portfolio would have provided the necessary liquidity to meet the promised payouts.

Pension Asset Allocation – It’s All Wet!

AP Photo/Mike Groll, File

I continue to be amazed by the asset allocation decisions of Pension America. The laser-like focus on the return on asset (ROA) assumption has placed pension plans on the asset allocation roller-coaster to hell! The picture above, which is the Star Jet roller-coaster at Seaside Heights, NJ following Superstorm Sandy, reminds me of the process. Plans ride the good markets up and then down repeating the process with every changing cycle until they get crushed and end up all wet. We need to finally get off this ride before all of Pension America collapses.

We are currently living through potentially the worst quarter of US equity market performance since 1987’s fourth quarter. I was working on Wall Street at that time – this feels worse! As the chart above highlights, we have had 29 10% or worse corrections since 1968. Three of those corrections were 48% or worse with two of them coming in just the last 2 decades. Remember that when markets fall 50%, they need to rebound by 100% just to get back to even. Regrettably, these market events have brought Pension America to its knees and driven many private sector pensions to the sidelines. The American worker has suffered as a result.

Are we finally going to see pension plans get back to the basics? Will we once again focus our attention on the promises that were made to the participants as the primary objective in managing a pension plan? Markets only trade at fair value accidentally, as they move from over-valued to under-valued. Let’s get away from trying to “guess” where we are in the market cycle and once again establish an asset allocation strategy that has two purposes. The first asset bucket is used to secure the promised benefits through a cash flow driven investing (CDI) approach to match the plan’s Retired Lives liabilities. The remaining assets can now be focused on the pension system’s long-term future liabilities that have been given the benefit of a longer-time frame in which to meet that future liability growth rate. Neither of these asset buckets has the ROA as its objective. Why should you?