Say It Ain’t Snow?

Today was the day that I was supposed to be at FRA’s “Made In America” conference in Las Vegas.  Ironically, the title of our panel discussion is “Digging Out Of Your Underfunded Status”. There certainly is a lot of digging our going on in the Northeast, but regrettably it has little to do with funded ratios or funded status for Pension America.

The basis of my presentation today was to focus on the need to first stabilize the plan through some fairly simple steps, but one’s that throw common pension orthodoxy out the window. So in that regard, not simple at all, as we are finding that there is great reluctance (inertia) to change one’s approach.

At KCS, we are espousing a three step approach to setting DB pension plans on the right course to improved funding.  The process begins with a thorough analysis of the plan’s liabilities through the creation of a Custom Liability Index (CLI). This index utilizes readily available data from a plan’s actuary, but instead of getting an annual look at your liabilities through the actuarial report, a plan sponsor can get a monthly view through the CLI.  The CLI will showcase the growth rate, interest rate sensitivity, and the term-structure of the plan’s liabilities.

With this output, we can determine how much alpha is needed relative to the liabilities, not the plan’s stated return on asset objective (ROA), in order to close the funding gap over the modified duration of the plan’s liabilities. Furthermore, we can determine how much of the plan’s assets can be placed in the beta portfolio (a cash matched or duration matched strategy) to begin to immunize near-term liabilities.  The balance of the assets will be in the “alpha” portfolio with the goal, as stated before, of exceeding liability growth.

The final step in our process is to begin to implement our beta / alpha approach by converting the current fixed income portfolio, with all its credit and interest rate risk, into a more effective beta portfolio. With these three steps, the DB plan’s funded ratio will be stabilized, and the plan will now be on a glide path toward full funding, and contribution volatility will be lessened.

Unfortunately, current pension thinking would have one ratcheting up the ROA, jumping into new products / asset classes, trimming benefits, extending retirement age, lowering costs, etc., all in an attempt to stabilize the plan. Well, striving for the ROA has only lead to greater funding volatility, and given how the global markets have behaved so far in 2016, more volatility is not the medicine that we should be ingesting.

KCS Fourth Quarter 2015 Update

Click to access KCS4Q15.pdf

It seems almost silly that we are presenting you with a Fourth Quarter review for 2015 given what has transpired in the markets through the first 19 days of 2016.  However, we think that it is important that one understand that 2015 wasn’t as bad for pensions and Pension America as most people believe, and certainly not nearly as bad as 2014.

Why? Well, despite the significant underperformance of plan assets relative to DB plan ROA’s, assets actually modestly outperformed liability growth last year.  Thanks to Ron Ryan and his firm (Ryan ALM), we have a great understanding of what is happening to pension liabilities on a monthly basis, and you should, too. Unfortunately, most DB plans only get a yearly view on their liabilities, and then only valued at the ROA as the discount rate.

We hope that you continue to find our thinking on pension related issues useful.  As always, please don’t hesitate to call on us if we can be of any assistance.  You can also glean our insights from the KCS website, blog and social media accounts that are highlighted in the attached review.

May 2016 be a year filled with great health, much laughter, many friends, and peace!

Click to access KCS4Q15.pdf

Regression to the Mean

Certainly global stock markets have gotten off to an ugly start in 2016.  Don’t panic! Maintain your long-term asset allocation policy, and since most equity-oriented assets have seen significant pullback, this means re-balancing back to policy normal levels. Why? There are significant regression to the mean tendencies in our markets, and as a reminder, it is much better to buy low and sell high.

This is not to say that our markets are stable, that equity markets can’t fall further from these levels, but we would caution you on selling into this weakness only to lock in losses that are only on paper at this time.  Furthermore, although the US economy appears to be slowing (Atlanta Fed is forecasting a 0.8% Q4’15 GDP growth rate), we do not see a recession in the foreseeable future, and significant market corrections are usually driven by recessionary environments.

Unfortunately, most of us have become traders instead of investors, and that goes for holders of mutual funds and ETFs and not just individual stock pickers.  Given the significant pullback in stocks associated with energy (-21% to as much as -47%, depending on the market capitalization index) and commodities ( -32.9% in 2015), and those impacted by the hit to energy and commodities, including emerging markets (-14.6% in 2015), miners, transportation companies, and MLPs (-32.6% in 2015), there are some significant dislocations that might just provide very attractive long-term opportunities.

If you already have a policy allocation to some of the above mentioned instruments / exposures, re-balance back to policy.  If you don’t currently have exposure to these potential investments now is a great time to begin educating yourself on the products available to you.  Don’t worry, they’ve been beaten down so badly that you won’t miss the opportunity, if you don’t get into them today.  Happy hunting!





KCS Fireside Chat – January 2016 – The Best of the KCS Blog

Happy New Year! May 2016 be filled with great health, much laughter, and prosperity.

We are pleased to share with you the latest edition of the KCS Fireside Chat series, in which we present three of our top blog posts from 2015 based on viewership and comments.

Click to access kcsfcjan16.pdf

As you’ve come to know, we are not shy about suggesting alternative approaches to standard DB pension orthodoxy. We believe that it is imperative that new thinking be given serious consideration based on the current state of Pension America.

Please don’t hesitate to call on us if we can be of any assistance to you.IMG_1237

So, What are You Going To Do About It?

First, my colleagues at KCS and I would like to wish you and your families a very Happy New Year filled with great health, lots of laughter, and much prosperity!

2015 is over, and as you will soon find out, it was not a good year for DB pension plans.  This marks the second consecutive year in which pension funds have missed their ROA targets.  However, unlike 2014 when plan assets also dramatically underperformed liabilities, 2015 will likely reveal that most total funds were flat to slightly UP versus their liabilities last year.

That said, funded ratios likely fell since liabilities aren’t marked to market while assets are, and funded status likely further deteriorated, which will negatively impact contribution costs.  What, if anything, are you going to do about this?  Unfortunately, this trend has been evident for more than 15 years now, and nothing seems to have been done.

Well, something needs to be done! Striving to achieve the ROA has lead to asset allocation decisions that have greatly increased volatility, but certainly not the probability of success.  Adopting a strategy that pays heed to a plan’s specific liabilities, in addition to the assets, will likely lead to a very different asset allocation, especially within traditional fixed income.

Are you ready to learn more?