It Is Time To Look At The Results!

“However beautiful the strategy, you should occasionally look at the results.”

– Winston Churchill

Pension America has been approaching the management of DB plans the same way for more than 50 years.  My colleague, Larry Zielinski, likes to call it pension orthodoxy. Well, given that Funded Ratios continue to fall, while contribution costs rise, I’d say that it is about time that we look at the results! If not now? When?

The focusing on the ROA to drive asset allocation and investment structure decisions has to stop! It isn’t working, and trying to hit the ROA in the next 5-10 years will likely prove more daunting than it has been in the last 15 years.  We need to preserve and protect DB plans, but doing the same thing over and over again despite the poor results is just silly!

Call us, write to us, visit us, and / or ask us to visit you. We can help, but don’t expect us to follow the same path. Our path is definitely the one less followed!


Liabilities – Missing, and Presumed Dead!

Why Pensions’ Last Defense Is Eroding

Long-term returns for U.S. public pensions are expected to drop to the lowest levels ever recorded

The above is the title of an article appearing in today’s WSJ. The “lowest levels ever recorded” is a bit of a reach!  Wilshire’s Trust Universe Comparison Service (TUCS) has been measuring the 20-year return for public pension plans for the last 16 years.  They are estimating that the June 30, 2016 20-year return will be 7.47%, which is below the average return on asset assumption for public DB plans, and if the estimate is correct, it will be the lowest 20-year return ever recorded by TUCS. That said, we’ve certainly had some shorter-term periods that were far more onerous for Pension America.

Unfortunately, pension plans continue to focus almost exclusively on the asset side of the equation, and if that is all one does, of course one would be concerned about that 20-year result, especially given that traditional bond and stock markets appear frothy at this time.  However, DB pension plans can certainly survive and even thrive in a low return environment if their plan’s liabilities are performing more poorly than the asset side.  Liabilities are assumed to grow at the ROA (GASB), but that is not how they grow, as they are bond like and go up and down with changes in interest rates (and other benefit and workforce related factors).

Should we get into an environment of improved economic growth, with a little inflation, U.S. interest rates could back up.  If that were to happen, liability growth would be modest, if not negative.  A DB plan’s funded status could see significant improvement in such an environment.  However, given that most plans don’t know the term-structure, growth, rate, and yield of their liabilities, they likely wouldn’t know that assets are outperforming liabilities.

The U.S. retirement industry needs to change its approach to managing DB plans.  It isn’t a return arms race! The ROA is not the Holy Grail. These plans must be sustained, and in order to accomplish that objective, they must be derisked! Measure and monitor your plan’s liabilities, and use that information to create an investment structure and asset allocation that reflects your current funded status.  Your plan’s beneficiaries are counting on you, and so are the taxpayers of your fine state, city and / or municipality.

Why Derisk? Less Volatility, Lower Costs

The U.S. DB pension industry has engaged in a returns-based “arms race” for the last 50+ years in an attempt to meet or exceed their ROA objective.  In many cases plan’s have achieved their stated return objective, but plan funding continues to deteriorate with funded ratios falling and contribution costs escalating.

There are many reasons for this phenomenon to have occurred, but the primary reason (for corporate plans) has been that liability growth has far outpaced asset growth during the 30+ year bond bull market.  If FASB and GASB had similar methodologies for valuing liabilities, public plan liabilities wouldn’t be as understated as they are.

For the past 5 years, we at KCS have been encouraging sponsors to begin derisking their plans despite moderate to low funded ratios.  Focusing exclusively on the return has injected far more risk into the asset allocation process than is necessary.  It is amazing that the last financial crisis didn’t sound the death knell for pensions, but the next one likely will.

Contribution costs as a percentage of payroll are nearing levels that are not sustainable.  The excess volatility found in today’s markets will only exacerbate this issue should another correction occur.  Return forecasts for the next 5 to 10 years are quite low, and reasonably so, given valuation levels for traditional bonds and equities.  Most DB pension plans generated a weak result in the 12 months ending June 20th (CalPERS was up just 0.61%), and this is with markets hitting all-time highs.

Our derisking methodology is quite simple (and logical). We suggest converting current fixed income holdings into a cash-flow matched portfolio to meet near-term retired and terminated vested lives (both known and easily calculated). The benefits are many! First, liquidity is improved to meet benefit payments (no longer have to sell illiquid assets) on a monthly basis net of contributions. Second, the conversion to a cash matched strategy significantly reduces interest rate sensitivity.  Finally, the investing horizon is extended for the growth assets, which benefit from time (capture the liquidity premium).

We recently undertook a project for a mid-sized public fund that asked us to restructure their fixed income.  This plan had all the fixed income bells and whistles, including high yield, bank loans, international and emerging markets, as well as a core plus manager. Through our derisking approach, we were able to shorten duration (by 0.34 years), improve the overall yield (>$750,000 / year), reduce management fees by $500,000 annually, while stabilizing contribution costs.

The cost savings and yield improvement are substantial. Obviously derisking doesn’t mean greater costs as some would have you believe.  Intrigued? Let us do a similar evaluation for you. We think that you’ll be pleasantly surprised by the results!











KCS Quarterly Review – 2Q’16

We are pleased to share with you the KCS quarterly review.  Pension America continues to find difficult footing, as traditional approaches to asset allocation inject much risk for little reward.  In this edition we discuss the market’s impact on plan liabilities, which continue to grow relative to plan assets.

As always, please don’t hesitate to reach out to us if we can provide any assistance to you or your participants.

A Wake Up Call?

There appears an article in today’s WSJ (Brexit adds to pension funds’ pain, that is long overdue. “Brexit should be a wake-up call for pension plans because it means interest rates are going to stay low or go lower and it makes it even less likely [the plans] are going to achieve the 7.5% rate of return that most of them are assuming,” said former San Jose, Calif., Mayor Chuck Reed.

Rip Van Winkle slept for a shorter period of time than many plan sponsors and asset consultants have with regard to this issue. The continuing focus on the return on asset assumption (ROA) has lead to a significant mismatch between assets and liabilities, which continues to be exacerbated by the declining U.S. interest rates. The impact on private DB plans is more immediate than public funds (accounting differences between FASB and GASB), but both are hurt by their unwillingness to focus on plan liabilities as the primary objective.

Since KCS’s inception (8/1/11), we have frequently written and spoken on the subject of plan liabilities needing to be the plan’s primary objective. We recently presented the output from a project that we were asked to do for a large public pension plan.  The project was to restructure the plan’s fixed income assets.  With a focus on the plan’s liabilities, we put together a program that shortened duration (1/2 year), enhanced income (roughly +$750,000), reduced management fees (roughly -$500,000), improved liquidity, while insuring that the plan’s liabilities were covered for the next 10 years.

If this all seems too good to be true, we encourage you to reach out to us to find out more. Achieving the plan’s ROA doesn’t guarantee success. Focusing on your plan’s liabilities is a necessary path forward to improving funding success. Our beneficiaries are depending on all of us to secure the promised benefit.



It is Time to Know WHY?


At my weekly Rotary meeting (every Thursday morning, if you care to join me), I was introduced to a video that I’d like to share with you.

It is a terrific presentation from Simon Sinek on how great leaders inspire.  The discussion revolves around the Why, How and What we do.  For most of us, as you will hear, we focus on the What, but it is really the Why that is most relevant.

I have been fooling myself into believing that our clients, prospects and industry contacts truly know WHY KCS was formed nearly 5 years ago (8/1/11).  Where has the time gone? But in reality, I’m sure that I / we have focused too much attention on the What and How, and not nearly enough on the WHY!

After nearly 30 years in the investment industry, I had an epiphany! I became more acutely aware of the impending U.S. retirement crisis.  I am not sure why it took me that long to truly appreciate the magnitude of the problem, but it could have been that fact that for the 20 years prior to that moment I had been part of an investment management team focused on only a small sliver of a retirement portfolio (forest for the trees syndrome?).  None-the-less, I should have been more in tune with the reality of the situation because my family was a living example of the crisis that was unfolding.

On one hand my Mom and Dad were enjoying a terrific retirement helped in large part by my Father’s participation in a defined benefit plan (DB), and also supported by a profit sharing plan and my Mom’s small 401(k). On the other hand, my mother-in-law was not as fortunate, as she had no DB plan and a rather insignificant 401(k) plan.  As a single mom who worked many part-time jobs during her children’s early lives (3 daughters), “life got in the way”, and it impacted her ability to save for retirement, as it has for many in similar situations. Unfortunately, it never got any easier for her!

Today, we have a small portion of our private sector work force participating in a defined benefit plan (roughly 14%), and nearly 50% of our private sector employees don’t even have access to a retirement plan through their employer.  Oh, how the times have changed from just 30 years ago when roughly 46% of our private sector labor force participated in a DB plan.

Furthermore, managing a retirement program is not easy, especially when one hasn’t been trained to handle that responsibility. We go to great lengths to make sure that plumbers, electricians, doctors, lawyers, etc. are licensed, but we expect individuals who have never taken an investment course to handle the management of their retirement program? Really?

Remember, defined contribution plans were initially used as supplemental income plans for high income earners.  They were never intended to be anyone’s primary retirement vehicle. But, we are on a slippery slope as a nation by having nearly our entire private sector being asked to fund and manage their own program.  Regrettably, but not surprisingly, the results have been disastrous. Oh, sure, there are examples of individuals who have amassed small fortunes, but they are very small subset. According to the National Institute on Retirement Savings (NIRS), 40 million American households (age 25-64) have no retirement accounts, and the typical working-age household has on average retirement savings of only $2,500!

So WHY is there a KCS?  Since our founding, our mission has been to try to get every household or individual an appropriate retirement, one much more like my parents. We prefer that DB plans be preserved, as we fear the social and economic ramifications from our society’s failure to provide a retirement system that supports our employees. As a society we are living longer, but what is the worth of a few more years of life if it is spent in abject poverty?

At KCS, we have shared with our readers the What and How we do what we do, and we are very happy to take the time to further educate you on our approach.  Please know that we are different than most asset consultants because we don’t see the current industry practices creating a different outcome at this time.  Failure to adjust ones approach may just lead to having a significant percentage of our elderly population (it is worse for women over the age of 65 than it is for men) experiencing a very difficult time in their “golden” years.

Time to Adjust

Just got back from presenting at the FPPTA conference KCS’s ideas on DB plans becoming more liability aware.  We believe that a plan’s unique liabilities should be used to drive investment structure and asset allocation decisions.

We don’t believe that traditional asset allocation models are in the best interest of plan sponsors and their participants, as they inject too much risk into the process, especially in this market environment in which equity and bond valuations appear stretched.

Given the extremely low level of US interest rates (doesn’t mean that they can’t go lower), we would suggest that plans shorten duration and focus on matching near-term retired lives.  It wouldn’t take too much of a back up in rates to have liability growth be negative.  In that environment, a shorter-duration, cash-matched fixed income portfolio should easily outperform liability growth.

The cash-matched strategy will reduce interest rate sensitivity from your portfolio, improve liquidity to meet those near-term retired live benefit payments, and will extend the investing horizon for your growth (alpha) assets.

Let us know if you’d like to discuss this in greater detail. Happy Fourth of July Weekend!