We truly understand and appreciate the funding concerns that all DB plan sponsors are challenged with at this time. However, we are particularly focused on the issues surrounding public pension funds, as they are getting crushed with the doubly whammy of falling asset levels and potentially skyrocketing contribution expenses, in an environment of plummeting sources of revenue, as the closing of the US economy significantly reduces tax and fee revenues.
Senate Majority “Leader” Mitch McConnell and the Republican Senate, don’t appear to be willing to provide assistance to states and municipalities at this time. In fact, McConnell is quoted as saying that he would prefer that states file for bankruptcy rather than receive a Federal bail-out despite the fact that everyone else is getting one at this time. Having US states declare bankruptcy was roundly panned by both Republican and Democratic governors during and after the Great Financial Crisis, as this action would cause disruption to bond markets, while simultaneously driving interest rates higher and raising the cost of borrowing at a time when every dollar matters. Why is it acceptable now?
Given that the financial position of many US states is precarious at best, state and municipal pension systems need time to weather this storm. As we shared during the Opal/Ryan ALM webinars (4/15 and 4/22), one of the significant advantages of using a cash flow matching strategy (CDI) to meet promised benefit payments is that it buys time (extends the investing horizon) for the alpha assets to perform. This extension, which keeps the plan from forcing liquidity where it doesn’t naturally exist, allows the plan’s assets to recover from the significant draw-down experienced year-to-date, but also provides an extended time frame for all of the private assets that have found their way into plans.
The cash flow matching portfolio (beta assets) will be used to meet on-going monthly benefit payments for as long as the current allocation to fixed income can support. With little disruption, a CDI portfolio can be implemented that won’t impact the return on asset assumption (ROA) or the plan’s asset allocation. In fact, it is highly likely that the Ryan ALM CDI portfolio will out-yield the current core fixed income account, thus improving the plan’s ability to achieve the ROA target, at lower cost – management fees and transaction costs. In fact, the conversion from an active, highly interest-rate fixed income portfolio to a CDI approach is quite simple, as the existing portfolio can be transferred-in-kind to us for conversion, saving more money in the process.
It is truly understandable why trustees might be feeling overwhelmed at this time from the negative impact of the Covid-19 virus. They are dealing with falling asset levels, falling interest rates that impact the true liability cost, the likelihood of escalating contribution expenses in an environment of challenged revenue sources, and concern for themselves, family members, and colleagues. It would be enough for anyone to want to go into a bunker. Please don’t. By making this simple (really) conversion from active fixed income to a CDI approach the plan sponsor buys critical time needed to help the plan navigate these troubled waters. But, they also create an enhanced asset allocation process that secures benefits, improves liquidity, eliminates interest rate risk, and likely out-yields the current capability, thus enhancing the ability to achieve the ROA. That is a lot of reward for not a lot of effort. Skeptical? Call us or check us out at RyanALM.com.