Following two straight years of sub par performance for DB pensions versus their ROA target AND Plan Liabilities, 2016 is going to be the year that Pension America embraces derisking as a prudent approach to the day-to-day management of plan assets.
Derisking can be achieved by any DB plan whether that plan is fully funded, well funded or poorly funded. The idea behind derisking is to achieve a greater knowledge of plan liabilities, then using that insight to develop a sounder approach to asset allocation, investment management structure and cash flow (liquidity) management.
How does one gain greater transparency of plan liabilities? Through the creation of a Custom Liability Index (CLI), which uses the output of the annual actuarial report, but unlike the actuarial output, the CLI’s information is made available monthly or quarterly depending on the frequency that the client desires. With this greater insight comes the ability to adjust the playbook to meet the challenges of the current environment.
With regard to those challenges, 2016 is looking very much like a year in which both equities and bonds will likely produce modest results, at best, making the achievement of the ROA an even more difficult objective. Furthermore, the volatility associated with traditional asset allocation models can lead to wide fluctuations in the performance of assets versus liabilities putting further pressure on funded ratios and cash flow.
Given that the US Federal Reserve has already moved on interest rates, traditional active fixed income will likely struggle to achieve a return commensurate with portfolio’s yield. Sponsors should seek an alternative approach that works for the plan and not against it. What might that be? The strategy that we would suggest is Cash Flow matching, which can be done far more inexpensively than traditional fixed income (10 bps versus 25-30 bps). We also believe that the cash flow matching strategy is superior to duration matching, and may result in significant cost reduction. Have we grabbed your attention yet?
Regrettably, traditional ROA-centric approaches have not worked. It is time to move onto a different course. One in which a plan sponsor has greater knowledge of their liabilities, and uses that information to dynamically drive a responsive asset allocation and liability matching. Let us help you make 2016 a superior year for your pension plan.