Why Should A DB Plan De-Risk?

Many corporate DB plan sponsors have have begun to de-risk their plans by adopting some form of a liability driven investing (LDI) approach.  Despite this trend, there remains a significant subset of corporate plans, and most public and Taft-Hartley plans that haven’t begun to de-risk their plans.

According to Prudential the top 100 corporate plans saw their funded status decline by roughly 50% from 1999 to the present (135% funded to 83% today) while at the same time they contributed a collective $600 billion in contributions.  Oh, my!

There has been significant volatility in both funded ratios and contribution costs in the last 15 years, and a lot of it has to do with plans trying to achieve an ROA objective instead of providing the promised benefit at the lowest cost possible.  Traditional approaches to asset allocation inject significant risk into the process.

Adopting a cash flow matching strategy for near-term retired lives does not impair a plan’s ability to improve funding, as the yield on the cash matching portfolio will far exceed the yield on a Barclays Aggregate portfolio.

Don’t continue to live with the excessive volatility of traditional asset allocation approaches, which may compromise the stability of your DB plan, when successful, time-tested approaches exist that will stabilize your funded status on annual contribution costs.

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Looking For Global Equity Managers

KCS is in the process of searching for Global equity managers for one of our clients. The only requirement is that the fund be offered in either a mutual fund or commingled vehicle. We are not opposed to using smaller shops (small AUMs) with young track records (no minimum requirement). Interested firms should contact Russ Kamp at rkamp@kampconsultingsoultions.com. Thank you, and have a great day.

Russ Kamp on Asset.TV – The Retirement Crisis

We are pleased to share the following link, which provides access to a recent interview of Russ Kamp by Asset.TV.

https://www.assettv.com/player/default-player/100435

The interview focuses on the US retirement crisis, and particularly the need to preserve DB plans or re-establish them if they’ve already been terminated.  Why? We are asking too much from our untrained employees.  These individuals aren’t investment professionals and this critical task should be left to those that are.

 

 

Rethinking Traditional Fixed Income In A DB Plan

Ron Ryan, Ryan ALM, and the KCS team would like to encourage plan sponsors and their consultants to re-think the use of traditional fixed income in a defined benefit plan, especially given where rates are after a 3o+ year bull market for bonds.  It is truly unfortunate that most plans have dramatically underweight fixed income during the last 15+ years, and as a result they’ve created a significant asset / liability mismatch, while missing one of the greatest performance periods for U.S. fixed income.

First, we’d like for you to ask yourselves what is the value in having Bonds in your portfolio? As mentioned above, yields are historically low suggesting below average potential returns. Historically, the PIPER study shows that active bond management adds little to no value versus their index benchmark based on the median bond manager versus the Barclay’s Gov/Corp index. But, it gets worse, as this comparison is shown “before fees”.

After fees the median manager would lose consistently to the index benchmark.
So, what is the value in bonds? Answer: Cash Flows. Bonds are the only asset class with a known cash flow. That is why bonds have been used for defeasance, dedication, immunization and de-risking strategies. The most cost effective way to de-risk a pension is “cash flow matching”, as opposed to duration matching liability driven investing. For example, a Liability Beta Portfolio (LBP) model (produced by Ryan ALM) will cash flow match liabilities at a cost savings of 4% on 1-10 year and 10% on 1-30 year liabilities given its yield advantage.  That is tremendous savings on a $200 million portfolio ($8 to $20 million).

Second, pension liabilities are “Interest Rate Sensitive” just like bonds. Since they have on average longer durations than bond indexes they are more interest rate sensitive, and by a factor of 2, maybe 3 times. Since 1982 (the beginning of the great bond bull market) interest rates have been in a secular decline, which has created significant growth in the present value of DB pension liabilities.

When interest rates go up as a trend, the opposite effect will happen. The present value growth of pension liabilities will be very low, and importantly, perhaps even negative. This will provide the best chance for DB Plan Funded Ratios to recover to a fully funded status. Pension assets will need little positive growth to outgrow liabilities and create significant liability Alpha.  As we’ve stated many times, the ROA isn’t the objective for a DB plan, but that plan’s liabilities certainly are!

By converting your current fixed income from a performance oriented portfolio to one that is used to cash flow match, we set the plan on a de-risking path, remove interest rate sensitivity, and begin to stabilize contribution costs. Let us know how we can help you!

Makes Me Shake – How About You?

We remain concerned about the singular focus by plan sponsors on the return on asset assumption (ROA) to drive asset allocation.  Why? First, the ROA is not reflective of a plan’s liability growth.  Second, trying to create an asset allocation that achieves a 7.5% (average ROA) objective in this market is leading to excessive volatility.

It was once a fairly easy objective when interest rates provided a healthy 5%-6% return.  However, in this low interest rate environment the standard deviation of returns around a 7.5% objective is roughly 17%-18%.

What does that mean for the plan sponsor and their asset consultant? It means that 68% of the time (1 standard deviation), the annual return for a DB plan will be anywhere from 25% to -10% (using 17.5% as the standard deviation).  It also means that 95% of the time (19 out of 20 years) the return to the pension plan could be 42.5% to -27.5%.  WOW!! You can drive multiple trucks through that gap.  Is this range of results comforting to you?  It shouldn’t be!

What is particularly troubling is the fact that there are well funded and less well funded plans using the same 7.5% objective and roughly the same asset allocation.  How does this make sense?  One would think that a plan with a 90% funded ratio would remove a significant portion of the above mentioned volatility from the asset allocation process.  Either one plan’s asset allocation is too conservative or the others is way too aggressive.

We need to protect and preserve DB plans as the primary retirement vehicle.  Injecting too much risk into the asset allocation process is destabilizing these plans.  We need to rethink this approach before it is too late.

 

KCS March 2016 Fireside Chat

We are pleased to provide you with the latest edition of the KCS Fireside Chat series. This article is titled, “DC Plan Participants Speaking Up”, and boy are they! Just when corporate America thought that they were reducing the company’s liability by freezing / terminating the DB plan, plan participants in defined contribution plans are reminding them that there is still significant liability to be had. Don’t be fooled into thinking that these DC lawsuits and DOL audits only occur in large entities. DC audits have been know to be taken on plan’s as small as $1 million in AUM.

http://www.kampconsultingsolutions.com/images/KCSFCMar16.pdf

If you haven’t rebid your platform provider / record keeper within the last 5-7 years, you are a prime candidate for an audit.

We hope that you find the thoughts from Dave Murray, KCS’s DC Practice Leader, useful and compelling. Please don’t hesitate to call on us if we can assist you in making sure that you and your DC plan are prepared for an audit. A little time and money invested today, can save you a lot of both in the near future.

Be well, and thank you for your on-going support.

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