I’m going to be a bit of a jerk this morning, so please bear with me. I was reading an article about the new crop of DB pension CIOs and how they are likely to be better prepared than the previous lot that barely weathered the market crisis of 2007-2009. In fact, there are 13 new CIOs among the 20 largest DB plans. Despite not having endured the pain of the incredible market volatility and lack of liquidity that prevailed daily for nearly 18 months, we are to believe that because this “new class” of investor is better with data that all things will be great for these DB plans. They better be right, for most of these plans cannot afford another significant increase in contribution expenses. The next crisis may in fact be the last one for many of these plans.
The article described how several of these plans and their consultants had stressed-tested their pension systems through a number of iterations for both return and liquidity. But, I tend to remember that during the last crisis nearly everything correlated toward 1. In addition, during any crisis it becomes very difficult to alter one’s path to try to take advantage of any market dislocations. That needs to be done well ahead of the actual crisis. Others were cited, as having reduced their return on asset assumption, which I tend to believe, is a very prudent decision.
In another example, a plan with an experienced CIO had increased fixed income exposure from 34% to 46% explaining that the fixed income portfolio was less risky. Okay, but equity exposure was only reduced to 64% from 66% because they are now using leverage. Are you kidding me?
Plans need to act before the next crisis. They need to ensure that liquidity is in place to meet monthly benefit payments (Retired Lives liabilities) so that less-liquid assets aren’t sold under less than ideal conditions to meet those payments. Time (investment horizon) is an investor’s friend – the longer the better – especially for all of the alternative assets that have been brought into these systems.
Sponsors should be taking risk off the table now, but they should be bifurcating their asset allocation into beta and alpha assets, where the beta assets (bonds) are cash flow matched to meet benefit payments, while the alpha assets (everything else) have time and no liquidity pressure to meet future liabilities. This is a low-risk, prudent, and time-tested strategy for plan sponsors to adopt, especially in this low-interest rate environment where returns going forward may be challenged.