U.S. Falls 3 Places in Global Retirement Rankings

In a recent article on Foxbusiness.com, it was reported that the U.S. has fallen three notches in the global retirement rankings.  Although disappointing it cannot come as a surprise to anyone in our retirement industry. For a country as rich as ours, we are doing very little for the majority of our workers.

The issue isn’t just the demise of the traditional DB pension plan leaving very few with access to these important retirement vehicles, but it is compounded by the fact that most employees working in small companies (those with fewer than 50 employees) don’t have any access to an employer-sponsored plan.  Furthermore, we have done an incredibly poor job of providing financial literacy in our public schools.  Given this fact, why would we think that there would be a positive outcome from the migration of workers from DB plans to DC plans when the burden to manage this effort falls on the individual?

The article highlights the fact that we are living longer, which places a greater burden on our employees to save more, but for the average worker, incomes haven’t kept pace with inflation during the last two decades. Furthermore, although the “average” American may be living slightly longer, we recently reported on the fact that life expectancy has actually declined for those in the 45-55-year-old cohort that don’t possess more than a high school degree.

You want to improve outcomes? Let’s start by creating an educational system that does a more effective job of giving students the skills to meet the needs of tomorrow’s employers – not yesterday’s! Furthermore, let’s start investing in job growth and improved wages so that the average American can actually set aside some money for a potential retirement. There is a certain level of income necessary just to live, let alone to save for retirement. Many Americans (most?) aren’t there today! Shameful!

RI Pension Plan Files for Receivership

GoLocalProv is reporting that the St. Joseph Health Services of Rhode Island
pension fund has filed for receivership — the filing puts thousands of
pensions at risk.

This is one of the largest pension failures in Rhode Island in recent
history. It will take months to determine the total financial impact on the
pensioners.

What hasn’t been reported is the curent funded status of the plan (liabilities minus assets) or what lead to the funding crisis.  Unfortuantely, we will likely see more of these actions, especially if the US equity market begins to crack.

 

Are Low Interest Rates An Impediment to Derisking a DB Plan?

We had a very interesting conversation with a plan sponsor prospect recently who was intrigued with the idea of beginning to derisk their DB plan but had been cautioned by their asset consultant that the strategy made no sense in this low interest rate environment.  We strongly disagree with the consultant’s conclusion.

First, and without question, every DB pension plan should have a glide path in place to derisk their plan as the funded ratio and funded status improves.  This does not mean you only do it as your plan’s funded ratio exceeds 90%.  It certainly means that a plan with a 90% funded ratio should have a very different asset allocation than one with a 50% funded ratio.  Unfortunately, because most plans are focused on the ROA, most plans striving for the same ROA will have very similar asset allocations.

Second, when the topic of de-risking is raised, most consultants immediately think of LDI strategies, that most often try to match durations at an average duration of the liability stream (usually 12-15 years). We would agree that sticking a bunch of fixed income assets out on the curve in order to try to match a segment of the liability stream doesn’t make much sense.  There is a lot of interest rate risk in this strategy, especially when one considers that there will likely still be a big mismatch between assets and liabilities given the average funded status of plans in this country.

What KCS and Ryan ALM espouse is a cash-matching strategy that immunizes the nearest retired lives, and extends out this strategy as the funded status improves. A cash matching immunization is a much more precise implementation than one that tries to match durations.  Currently, most DB plans have a decent exposure to domestic fixed income despite the low rates. With our strategy, one migrates that current fixed income into the immunization portfolio.  With this move, the plan sponsor reduces the interest rate risk, improves liquidity to meet future net cash flows, and extends the investing horizon for the remaining assets.

These residual assets are the growth assets whose job it is to beat liability growth and not the ROA.  As the growth portfolio meets with success, siphon the excess assets and port them to the immunized portfolio.  This migration of assets will be used to extend the glide path toward full funding.

Regrettably, most plans did not consider a de-risking strategy in the late 1990s when most public and private plans were well-funded.  This oversight has cost DB plans billions, if not trillions, in additional contributions and lost opportunity cost.

Lastly, plan sponsors who fear that this strategy will compromise their ability to earn a rate of return in excess of the ROA should know that the average yield on a cash-flow matched portfolio will likely be greater than the average yield on a Barclays Aggregate-type portfolio. Why? The immunized portfolio will have a yield advantage because most of the bonds will be BBB and A (still investment grade) thus enhancing a plan’s ability to meet the asset objective.

Many DB plans have been helped by returns during the last 8+ years of equity market returns, but despite these outsized gains, few plans are fully-funded.  Equity returns will likely be muted during the next decade.  Furthermore, another market decline similar in magnitude to the 2000-2002 and 2007-2009 corrections would likely drive many public plans to seek relief through defined contribution offerings, which would only exacerbate the retirement crisis unfolding in our country.

 

Benefits of Fiscal Stimulus

If you had any question as to the benefits provided by fiscal stimulus in a currency issuing country just look at the recent data coming from Japan.  Japan has produced strong economic growth despite maintaining low interest rates, low levels of unemployment, modest inflation, large fiscal deficits, and high public debt for decades.

For some time we’ve been concerned about the long-term impact of austerity in the Euro Zone, primarily because none of the countries are currency issuing entities. Austerity measures have certainly wreaked havoc on Greece’s economy, as well as others.  In our very humble opinion, the Euro is not sustainable in the current construct.

For more information on this subject, we would highly recommend that you read today’s blog by Bill Mitchell, an Australian economist, which can be found at http://bilbo.economicoutlook.net/blog/.

Performance Fees in Long-only Mandates – Why Not?

At a recent Opal Public Funds conference in Newport, RI, the conversation turned to fees, and specifically to performance fees for long-only mandates.  As usual, there seemed to be less acceptance of these fee structures for long-only products than there is for “alternative” product.  I don’t get it!  What’s the difference?

Why would any plan sponsor or consultant be willing to pay a long-only manager their full fee with absolutely no promise of delivering an excess return? One of the arguments raised was the “likelihood” that a manager would try to juice returns.  I don’t know about that argument. Why would any asset management firm jeopardize their entire franchise to try to earn a few extra shillings?  It doesn’t make sense!  Furthermore, why are you hiring that manager in the first place if you don’t trust them to be good shepherds of your money?

Years ago, when I was involved in the Invesco quant area, we had roughly 10% of our client mandates on some type of a performance fee schedule, and these weren’t just market-neutral, 130/30 or portable alpha clients. We actually encouraged our clients to use performance fees for long-on mandates, and not because we thought we might earn more in fees, as we calibrated the performance fee and asset-based fee at the targeted excess return. Our rationale was that it was better for the client, and thus, better for us in the long-term.

If a plan sponsor or consultant is leery of excess risk being injected into a product using a performance fee, just ask to see a list of all the returns and tracking errors for the clients in that particular product.  You don’t need to see the name of the client, but it will be pretty obvious if they are running your mandate more aggressively than they are the others.

One of the contributing factors in the movement to passive investing from active management has been the lack of “reward” for the fees paid.  Using a performance fee schedule, and we’d recommend a high watermark methodology as opposed to a moving average arrangement, is one way to ensure that you won’t be paying more than index fees for sub par active performance.

Don’t hesitate to reach out to us if you’d like to discuss this subject in greater detail.

 

KCS August 2017 Fireside Chat

We are pleased to share with you the latest edition of the KCS Fireside Chat series.  In this article, we discuss once again Pension Obligation Bonds (POBs), but there is a twist.  Ryan ALM and KCS are working with key multi-employer executives to create legislation that would provide government guaranteed loans to critical and declining plans.  These loans, similar to POBs, would help close funding gaps for these poorly funded plans.  However, unlike traditional POBs, the proceeds must be used to immunize retired lives.  Enjoy!

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