The U.S. defined benefit pensions have enjoyed a good performance run during the last 10 years. Funded status has improved for a majority of plans, although contribution expenses continue to rise. Is it time to take some risk off the table? We believe that it certainly is the right time. But, taking risk off the table doesn’t mean that our approach would harm a plan’s ability to meet the return on asset (ROA) objective for both public and multiemployer plans.
There are only two ways to secure the promised benefits: 1) through a pension risk transfer (PRT – annuity), and 2) cash-flow matching. We believe that PRTs are expensive, and not a realistic strategy/opportunity for poorly funded plans so we focus on cash-flow matching.
Our approach is called the Liability Beta Portfolio (LBP), which is trademarked and our cash-flow driven investing (CDI) approach provides many benefits that are listed below:
- Reduces risk (de-risks) by cash flow matching benefit payments with certainty
- No interest rate risk since it is funding future values (benefit payments)
- Reduces funding costs by 3% + (1-10 years) to 8% (1-30 years)
- Reduces asset management costs (Ryan ALM fee is only 15 bps)
- Enhances ROA by out-yielding active bond management
- Reduces volatility of the funded ratio and contributions
- Buys time (extends the investing horizon) for the remainder of the plan’s assets to outgrow future liabilities
The value-added of the LBP model is the cost savings and risk reduction that it provides. Performance should not be based on returns although the LBP will outyield liabilities creating some excess returns versus liability growth. Why subject the entire corpus to the whims of the markets, especially given the extended bull markets for both equities and bonds. Take risk off the table before the markets once again highlight the fact that what goes up will go down at some point.