Rethinking The Retirement Gameplan

Rethinking The Retirement Gameplan

We at KCS have been contemplating new approaches to the management of retirement assets since our founding in August 2011. We’ve shared many of these thoughts with you through a variety of means, including our monthly Fireside Chat series, which we hope you’ve found educational.

In this month’s addition, we begin to introduce annuities into the conversation. With the demise of DB plans comes the need to create a monthly cash flow for retirees. Annuities are certainly an effective way to accomplish this objective. However, they come in a confusing array of choices and in some cases, steep costs. We believe that sponsors, both DB and DC, as well as anyone hoping to retire at some point will benefit from this article.

As usual, please don’t hesitate to reach out to us if we can clarify any point raised in this piece or if we can be of any service to you.

When everyone expects one thing, you may want to prepare for a different outcome

On January 9th, and again on April 4th, we at KCS addressed the issue that US interest rates wouldn’t necessarily rise, and in fact, with everyone in the world seemingly believing that interest rates had only one way to move – UP – we thought that there was a good chance that rates might fall.  In fact, the interest rate on the 10 year US Treasury has fallen by more than 30 bps so far this year.  That is a fairly meaningful move.  With many plan sponsors and asset consultants trimming, eliminating, and restructuring their US fixed income exposure, a plan’s asset allocation is now more disconnected from the liabilities than before.  This disconnect exacerbates the volatility in funded ratios and contribution costs. 

Don’t believe us, then how about the following.  Here is a brief research piece that I found on Cullen Roche’s website today.

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

The US Retirement industry cannot afford to get the direction of rates wrong.  A continuation in the decline of rates will only further inflate the underfunding of US pension liabilities, and continue to put pressure on both private and public DB plan sponsors to do something else, such as close or freeze the DB plan and move more participants into DC.  At KCS, we’ve spoken and written about alternative strategies that go along way to improving funded ratios and stabilize contribution costs.  We are waiting to hear form you.

The beneficiaries of our collective effort cannot afford to have us screw up any more. DC plans are not the answer, but are quickly becoming the only game in town.

 

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

U.S. Treasury STRIPS – The Naked Truth

At KCS, we have been sharing ideas with plan sponsors to reconfigure their existing fixed income exposure into an enhanced asset allocation framework that might just stabilize a plan’s funded status and contribution costs.  The motivation has been driven by the fear of rising interest rates.  Unfortunately, this fear has provided the impetus for many of our friends in the industry to shed exposure to domestic fixed income programs.  Stop!

Despite the near unanimous expectation that rates have to rise from these “historically low levels”, the fact is that interest rates have actually fallen rather significantly year to date.  In fact, the U.S. 10-year Treasury Bond has seen its yield fall by 37 bps (as of 4/15).  The KCS crystal ball is no clearer than that of any other market participant, so why “guess” where rates are going.

We think it would be advantageous for plan sponsors to reconfigure their existing fixed income exposure to include a separate, lower risk portfolio that matches near term benefit payments for the next 5-7 years depending on the current funded ratio of the plan and projected future contributions. This strategy will improve the plan’s liquidity, while extending the investing horizon for less liquid assets that we would use to support their active portfolio.

We have recommended that the lower risk portfolio be invested in U.S. Treasury STRIPS to match benefit payments.  However, that instrument’s name raises more questions than answers, and has often turned potential users off before the conversation really heats up.  We are here today to say that STRIPS, although misunderstood, are actually low risk, useful fixed income securities.

STRIPS is an acronym for “separate trading of registered interest and principal securities”. Treasury STRIPS are fixed-income securities, sold at a significant discount to face value and offer no interest payments because they mature at par, which is why they are so good at matching projected cash flows. Backed by the U.S. government, STRIPS, which were first introduced in 1985, offer minimal risk and some tax benefits in certain states, replacing TIGRs and CATS (…retired to the zoo?!) as the dominant zero-coupon U.S. security.

If you are concerned about your plan’s funded status, the direction of interest rates and / or the current composition of your fixed income assets, call us to discuss a new path forward. We are here and ready to help you!

KCS First Quarter Summary

KCS First Quarter Summary

We are pleased to share with you the KCS First Quarter Summary. The markets proved to be more volatile during the last three months, but still positive when all was said and done. Unfortunately, plan liabilities outperformed assets by more than 5% during the quarter, reversing the trend that we witnessed in 2013. Importantly, KCS continues to provide education to a variety of market participants through various conference appearances. We feel that this is one of the most important functions for any asset / liability consulting firm.

Oops! What Happened to Interest Rates Rising?

Having had the chance to speak at and attend 18 conferences in the last 13 months, I can tell you that there was near universal acceptance of the expectation that interest rates in the US and abroad were going up. The thought was that all of the stimulus provided by QE would have to create economic growth and inflation.  What happened?

As we witnessed during the first three months of 2014, interest rates for US Treasury bonds fell.  In fact, the yield on the 10-year fell 31 bps in the quarter, and the 30-year T-bond rallied nearly 11%!  Wow! Global growth is waning, many of the globe’s regions are experiencing extremely low levels of inflation, and high unemployment is lessening the demand for goods and services.  All of these factors, and more, are tamping interest rates. Today’s bond market activity is only further exacerbating this move.

As we wrote in early January, we think that DB plans should not reduce their current fixed income exposure, but reconfigure it.  Here is what we wrote earlier this year.  We still think it makes sense.

From the KCS Blog on January 9, 2014:

What I’d like to highlight today is a new use for a plan’s current fixed income exposure. In day two of the conference, I attended a panel discussion titled, “Opportunities in Fixed Income and Credit Markets”.  The panel was occupied by 4 senior investment pros (plan sponsor, consultant, and investment managers).  They generally discussed the likelihood that interest rates were going to rise (I’m beginning to wonder if there is anyone out their who doesn’t think that rates will rise), and the implications of that movement on traditional fixed income portfolios.  Most of the panelists talked about various sub-sectors (mortgages, asset backs, bank loans, etc) and which ones might hold up better. There was discussion about shortening duration, etc. They also talked about fixed income’s traditional role as an anchor to windward, a risk reducer, and a provider of liquidity.

However, only one individual mentioned taking a step back to truly contemplate the “role” of fixed income.  He didn’t provide any further perspective, which is why I’m addressing the issue here and today.  I believe (as do my partners at KCS) that a plan’s liabilities should be the focal point of any pension discussion.  As such, they need to be the primary objective for the plan, the driver of asset allocation decisions and investment / portfolio structure.  The asset class most similar in characteristic to liabilities is fixed income.  As such, fixed income needs to play a prominent role in a defined benefit plan.

Instead of worrying about the implications from a rising interest rate environment on an LDI strategy that currently consists of long duration corporates, change the emphasis to matching near-term liabilities, by converting your current fixed income portfolio into a Treasury STRIP portfolio that matches cash flows with projected benefits (Beta portfolio).  First, you are improving liquidity.  Second, duration is shortened in an environment that may not be conducive to long bonds.  Third, you are lengthening the investing time horizon for the balance of the corpus, which will allow asset classes / products with a liquidity premium a chance to capture that performance increment (Alpha portfolio). Finally, the funded status and contribution costs should begin to stabilize.  As the Alpha portfolio outperforms liability growth (hopefully), siphon excess profits and extend the beta portfolio.

This is a proactive move to restructure the fixed income portfolio in an environment of uncertainty.

Lastly, I am not of the general school of thought that interest rates are definitely going to rise, and soon.  I believe that we still have slack demand in our economy, brought on by underemployment, which will keep inflation in check and provide room for stable to slightly lower rates.

 

Here is some DC advice that you should take seriously!

Here is some DC advice that you should take seriously!

How your 401(k) could disinherit your kids via

The above Tweet caught my attention earlier today.  I hope that you’ll take a few moments to read the article.  The advice that they give is critically important.  KCS partner, Dave Murray, experienced this issue while working with one of his clients.  In Dave’s case, a young woman, with a decent-sized DC plan balance passed away.  Her parents assumed that they would inherit her plan balance, but unfortunately years before she had designated a boy friend as her beneficiary.  Despite the fact that this young man was no longer in the picture, the plan document superseded her will, and he was given the proceeds. 

Given the serious consequences that this lapse can create, we’d recommend that you review your designated beneficiary(ies) annually.

Europe isn’t wittnessing a great recovery!

As readers of the KCS Blog know, we have been and remain negative on the Euro-zone for a variety of reasons, but specifically because the Euro is a failed model. Without the ability of the Euro-zone constituents to devalue their currency when needed, and they can’t because it isn’t a Fiat currency, these economies / countries will continue to stagger.

Here is some perspective brought to us by Mark Grant:

“Let us peer specifically at Europe. Real inflation in Europe, adjusted for
austerity taxes, has been running at -1.5% for the past five months according to
London’s Telegraph. They are experiencing a very real bout of Deflation. Prices
are down -5.6% in Italy, -4.7% in Spain, -4.0% in Portugal and even -2.0% in
Holland. According to Bloomberg the EU is missing its Inflation target by more
than 150 bps on the downside. Bank of America has opined that the current
stagflation could cause a rise in France’s official debt to GDP to 105%, 148% in
Italy and 118% in Spain. The ECB has said that it is discussing some type of
Quantitative Easing though what it might be has yet to be seen. Yields are down
across Europe but the economies are no better.”

As we’ve discussed, austerity hasn’t worked. Debt to GDP is rising in most Euro-zone countries, employment remains incredibly high, and growth and inflation are non-existent. Clearly this isn’t a great formula for success.

Only time will tell, but don’t be shocked if one or more constituents are no longer sharing the Euro in the next 2-3 years.