Remember 130/30 Strategies?

I saw this headline from P&I:

“84% of Investors Apply or are Considering, ESG” – Morgan Stanley survey claims

To say that I’m skeptical would be a major understatement.

I couldn’t help but think about the “excitement” surrounding 130/30 products back in the 2005-2007 era when Merrill Lynch and others were predicting $1 trillion in these products within a relatively short timeframe. We know what happened once the Great Financial Crisis hit.  Is there a 130/30 strategy still being utilized?

As we’ve said many, many times, managing a pension plan is not about the return (the ROA is not the Holy Grail), but about meeting the promised benefit at the lowest cost.  How does ESG help a plan sponsor achieve that goal? There are a lot of claims as to the success of these programs, but I hear similar praise being hyped on OCIO offerings, too, with very little proof that there is consistent value added.

During my 37 years in this industry, I’ve witnessed many cycles, which always seem to come with the next “greatest” product offering.  Wouldn’t it be refreshing if we just got back to basics within the retirement industry by securing the promise without playing games with the employee, employer, and taxpayer money?

 

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No, It Doesn’t!

The U.S. Government does not have a spending problem just because recent outlays have eclipsed receipts and the U.S. Federal deficit is projected to be close to $1 trillion in 2018! Several U.S. states do have a spending problem, as well as many (most?) Americans, but trying to equate the federal government’s ability to meet its debt obligations with those other entities is just wrong! The only difference that matters is that the U.S. Government has a fiat currency, while the others do not. Can you imagine New Jersey issuing its own currency? As my friend and former Invesco colleague, Charles DuBois, recently noted, our current fiscal stimulus should be greeted with shouts of “Happy Days are Here Again!”.

According to the Monthly Treasury Statement, budget results for the month of May have been in deficit for the 63 of the last 64 fiscal years since 1955. Yet, the sky hasn’t fallen, and our economy is certainly much larger today than it was back then. What’s up?

We’ve mentioned in previous KCS blog posts that a large part of the deficit increase feeds right into business profits. When the private sector (both corporations and individuals) are incapable of generating economic activity, we need the government to step into the fray, as they did so wonderfully in 2009 and beyond. According to Charles, this increased fiscal stimulus is why the stock market is proving to be resilient despite numerous “risks”, including interest rates, tariffs, investigations, etc.

Most Wall Street analysts are concerned with the wrong elements of the U.S. Government debt.  For instance, the fear of rising interest expense is misplaced, as the cost to the government is actually the private sector’s interest income.

They also worry excessively about the crowding out myth – believing that higher Treasury issuance will push up rates.  This is false, as all the selling of Treasuries does is mop up the reserves created by deficit spending – so there are no such upward pressures on rates.

As we have shared, the potential problem is none of these referenced above, but rather too much of a good thing (happy days…).  If private sector income is too high because of the deficit spending, inflation could become a problem.  That is if our economy was already at full capacity.  However, according to Bill Mitchell, and other MMT disciples, the U.S. economy still has excess capacity providing further room to grow.

Anyway, if the government is spending more into the economy than it is taking away through taxes, that’s “obviously” a good thing.  No one seems to get the basic accounting that the public sector deficit = the private sector surplus.  It is about time that they did!

Will Long Bond Demand Weaken?

We sincerely appreciate when friends share with us meaningful graphs/charts/articles – thanks, Chris, for the chart below!

According to Deutsche Bank Research, demand for stripped securities has been very strong from pension plans. Despite this increased appetite, long rates have been rising.  Come September, corporate plans will no longer be able to deduct pension contributions at the previous 35% rate. As a result, have pension plans accelerated their contributions? We think so, as they try to beat the 9/15/18 deadline. A $1 billion defined benefit contribution would save the company $350 million under the old tax laws, but only $210 million beginning later this summer.

bondstripping

Will long interest rates rise as a result of likely lower demand for long bonds?  Again, we believe that they just might. Couple the lower demand from pension systems and the stronger US economic growth, and you have a formula for rising rates.

We’d be happy to discuss our strategy to cash flow match near-term liabilities chronologically, which we believe is a much more cost-effective strategy in a rising rate environment.

Colorado (PERA) Initiating Pension Reform?

Samantha Fillmore is reporting on the Heartland Institute’s website that Colorado Public Employees’ Retirement Association has enacted some reform measures to help them close a huge funding gap. However, the reforms seem quite modest, at best.

It is being reported that the State’s defined contribution plan will be made available to local government members in the PERA defined benefit plan, which until now had only been available to state workers.  In addition, contribution rates for those remaining in the plan will escalate from 8% to 11% of pay during the next two years.

But, it doesn’t seem that PERA employees will be mandated to now participate in the DC plan. Sure, employees participating in the DC plan will now have the option to move assets with job changes, but they are still going to be responsible for funding, managing, and dispersing this retirement benefit with no promise of a set benefit upon retirement. We wonder just how many local government employees see this as a positive change?

What isn’t addressed is how the pension assets are being managed. Are they still going to be trying to generate a return commensurate with an ROA target or will they take the prudent course and begin to manage their assets against a liability focus? Continuing to do the same old, same old doesn’t seem to reflect the reform that is needed to right this ship.

 

 

Why Are Americans Tapping Their Retirement Accounts?

As a follow-up to our previous blog post, the St. Louis Federal Reserve is reporting that “real” weekly wages since Q1 1999 have only grown from $335 to $350 through Q1 2018. Is it not surprising that a significant percentage of Americans are either not saving for retirement or they are forced to tap into their retirement accounts to meet an outstanding debt or an emergency bill.

Come on, the cost of everything, including housing, education, healthcare, food, clothing, etc. would have a worker needing far more than an additional $15 per week for the last 20 years! Even the WSJ is reporting today that the anticipated wage bump from tax changes and the perceived tighter labor market are not being reflected in workers’ pay once adjusted for inflation. The timetable that they are highlighting is the most recent three years.

Despite recent strength in retail sales, diminishing real wage growth should negatively impact the US economy as the consumer gets more stretched. A further increase in debt will naturally lead to more Americans tapping into their retirement accounts, which just exacerbates an already untenable situation.

But, What Are They To Do?

We’ve often claimed that defined contribution plans were little more than a “glorified savings account”, and the following data from GoBankingRates supports our conclusion.
apping into one’s retirement dollars early is considered to be a foolish practice. But, because most Americans don’t save outside of their employer-sponsored plan it becomes a necessity when an emergency arises.

According to a recent report by GoBankingRates, a significant percentage of Americans are hitting their retirement accounts and in most cases (85+%) it is to fund debt payments, including emergency expenses, such as a medical bill or to bridge an unemployment situation.

 

We are pleased to see that folks aren’t tapping their retirement plans to fund college costs or home purchases. But, plan borrowing limitations (50% of plan assets or $50,000) may be tempering those activities.

At KCS we recommend creating a six-month cash reserve to cover day-to-day expenditures and the emergency bill that might crop up.  However, most Americans are not in a position to build this type of nest egg, as real wages have been fairly stagnant for the past couple of decades, while the cost of education, insurance, housing, etc has ratcheted up.  We’ve previously reported on the significant percentage of Americans who cannot cover an emergency $400 expenditure – it is frightening!

GOBankingRates polled nearly 2,000 people who dipped into their retirement funds.

Brown: Pensions In Danger!

Sen. Sherrod Brown, D-Ohio, said during a hearing of the Joint Select Committee on the Solvency of Multiemployer Pension Plans that any proposal emanating from this body must address both the pension plans (1.3 million participants in failing plans) and the Pension Benefit Guaranty Corporation or the current crisis will only be repeated. We couldn’t agree more!

We are particularly pleased to read the comments from Sen. Rob Portman, a Republican on the panel, who said that if the PBGC fails, retirees from plans like the Central States, who are already facing the prospect of pensions cuts, would see reductions of about 90 percent if the PBGC becomes insolvent.

The potential loss of the pension benefits doesn’t only impact the recipient, but the broader economy. It is estimated that more than $1 trillion in economic activity was generated by the recipients of benefits from the 114 “Critical and Declining” systems in the last year.  In addition, there are more than 200 plans designated Critical. I wonder what the economic impact would be should those plans fail.