Ron Ryan and I have been trying to get plan sponsors and their consultants to de-risk pension systems for years. In Ron’s case: decades! Our thoughts are often met with skepticism for a variety of reasons, but one of the biggest reasons from multiemployer and public plans has to do with the return on asset (ROA) assumption. We’ve written about the ROA for years and the problems with focusing on this number as if it were the Holy Grail. The pension plan’s objective should be securing the promised benefits, but they continue to dismiss that notion.
One of our largest clients adopted our Liability Beta Portfolio (LBP) strategy that cash flow matches corporate bonds with plan liabilities chronologically in August 2018. This was done despite the fact that US interest rates were low at that time and bond exposure would not help achieve the desired return for the account versus the ROA. The client and their consultant converted a portion of their fixed income allocation to this strategy with the purpose of securing the benefits, improving liquidity, removing interest-rate sensitivity while extending the investing horizon for the remainder of the growth assets (alpha) to capture the liquidity premium.
We recommend building our LBP to secure the Retired Lives Liability for 1-10 years. However, in this case, they decided to go out 8-years through 2026. How has the client fared? From August 31, 2018, until March 11, 2020, our LPB has produced a 9.54% return, while outperforming the client’s liability objective rather handily. This was done in an environment in which the S&P 500 return was -2.62%! Which asset exposure was going to negatively impair the client’s ability to achieve the ROA? By focusing on the ROA, plan sponsors have been forced to inject more risk into their asset allocation process. This action guarantees more volatility but does nothing to secure the benefits. Isn’t about time that we all focus on the right objective?