For years now, we’ve been hearing that U.S. interest rates MUST rise due to the aggressively easy monetary policy that will lead to inflation. We’ll, glad that we weren’t holding our collective breath! The following chart once again highlights how difficult it is to forecast interest rate changes.
Unfortunately, many plan sponsors and their asset consultants were forecasting higher inflation and interest rates. The higher inflation guesses lead them to plow into commodities in 2009 and 2010 only to be significantly disappointed when inflation never reared its ugly head and commodities performed woefully as the S&P GS Commodity index is -10.0% for 10-years and -14.4% for 5-years through 9/30/17. Oh, my!
Furthermore, the premature forecast of dramatically higher interest rates lead them to significantly reduce domestic fixed income exposure. This has created the greatest mismatch ever between assets and liabilities within defined benefit plans.
At KCS, we’ve been encouraging (imploring) our clients and prospects to get out of the interest rate guessing game despite correctly forecasting that rates would NOT rise (please see a number of previous blog posts questioning the rising rate crowd). We believe that managing a pension plan is a cash flow matching exercise and not a return game.
We encourage sponsors to transition their current fixed income allocation into a cash matching strategy that ensures near-term benefit payments will be met. In the process, the plan has enhanced liquidity to meet those payments, removed interest rate sensitivity, while also extending the investing horizon for the balance of the assets that now benefit from more time allowing the liquidity premium to be captured.
Why continue to “guess” where rates will go when a strategy exists to get your DB plan onto a glide path toward full funding and more level contribution expense.