Good, But Not Great!

While many private sector DB pension systems have reduced risk in their portfolios as they approached full-funding, many public and multiemployer pension systems have taken on more risk trying to enhance returns to help close their pension deficits. Both public and multiemployer plans have strategically allocated significant assets into both equities and alternatives since the Great Financial Crisis, and the total combined exposure is now greater than it was prior to the 2008 meltdown. For those plans riding greater exposure to equities and alternatives, 2019 must be a phenomenal year. Everything is up! Just look at the S&P 500, which is up a very strong 18.5% for the first 6 months.

The markets have rewarded plan sponsors for their aggressive asset allocation, but not to the extent that most sponsors and their consultants would have had you believe. How is that possible? Well, plan liabilities have grown rapidly, too. Ryan ALM has produced performance numbers for a generic asset allocation of 60% S&P 500 (18.5%), 30% Bloomberg Barclay Aggregate Index (6.1%), 5% MSCI EAFE (14.5%) and cash (1.5%) the combination produces a very solid, and ROA beating, 13.8% year-to-date return. But, managing a pension plan isn’t about beating the ROA, but eclipsing plan liability growth, which is up a robust 10.1% YTD (according to Ryan ALM) when using the U.S. Treasury STRIPS curve. If one were operating under FAS 158 accounting liability growth would be even stronger at 14.3% YTD or 0.5% greater than the generic asset allocation cited above.

Why has liability growth been so robust? Most plans have a duration on their liabilities somewhere between 10-15 years. Long U.S. interest rates have plummeted since November 2018. In fact, as of today (7/8), the U.S. 10-year Treasury’s yield is down 121 bps since 11/8/18, while the U.S. 30-year Treasury’s yield has fallen 100 bps from its peak on 11/2/18.

Why is this important? Pension liabilities are bond-like (when marked-to-market) and the present value of liabilities grows as yields fall. For a plan with a liability duration of 12 years, liabilities will have grown somewhere between 12-15% since the latest peak in yields just on price movement alone.

Unfortunately, this follows the very poor fourth quarter of 2018 when asset growth underperformed a generic pension plan liability by more than 13%. I suspect that most plan sponsors are feeling great about recent asset performance, but when overlaid onto plan liabilities the story isn’t nearly as robust. Managing a DB pension without knowledge of how the opponent is doing (plan liabilities) is like trying to play a sport when you only know your score. It is impossible to adjust your strategy confidently without greater transparency on how your liabilities are performing.

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