The Asset / Liability Mismatch is a Killer

Defined benefit plans are once again being stressed today. Assets are getting whacked, while interest rates plummet, leading to significant growth in plan liabilities.  In fact, liability growth is estimated to be about 15% year-to-date on a mark-to market basis (Ryan ALM), while assets are mostly flat to up marginally (at least until this morning).

Traditional approaches to asset allocation continue to reduce fixed income exposure, as asset consultants anticipate higher rates, while not being able to justify holding bonds at these “historically” low rates.  Unfortunately, this action has lead to a huge asset / liability mismatch, that continues to put pressure on funded ratios, funded status and contribution costs as rates continue to fall.

At KCS we have been espousing a very different asset allocation model that allocates plan assets to beta and alpha buckets.  In our approach we convert traditional fixed income into a liability beta portfolio eliminating interest rate sensitivity, while dramatically improving liquidity.  In addition, this approach extends the investing horizon for the alpha assets which can now capture the liquidity premium that exists, but often isn’t captured through premature selling.

I am very much looking forward to speaking at the FPPTA conference next week, as I will be re-introducing this topic.  DB Plans cannot afford to live with the excessive volatility associated with pursuing the ROA. NOW is time for change before the DB plan goes by the way of the dinosaur.

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