We continue to marvel at how many pension plans, primarily in the public and multiemployer space, drive asset allocation decisions through a return on asset (ROA) lens. This is done despite the fact that the ROA is NOT a calculated number, but is often determined because it solves the equation regarding a certain contribution level that is “acceptable”. At best it is a rough guess, and at worst it is nothing more than a Goldilocks solution – not too high, not too low, just about right!
Given this understanding, I read with interest that Axios reported, from data generated by eVestment, that 206 public pension plans with roughly $4.0 trillion in AUM now had an average allocation to fixed income that was at 28.4% at the close of the first quarter, up from 24.5% at year-end 2019. I can’t imagine that this was some kind of strategic or dynamic shift given that equities (R3000) declined by about 21%, while bonds were up 3.2% (Agg.). Furthermore, for comparison purposes, P&I’s asset allocation data indicates that the top 1000 corporate plans had an average allocation to fixed income of nearly 48%, as of September 30, 2019. Despite the significantly greater exposure to fixed income assets corporate plans still saw their funded status decline during the quarter. One can only imagine what the funded status hit would look like for non-FASB plans if a true discount rate were used in the calculation of plan liabilities.
A true ROA can be calculated by utilizing the Asset Exhaustion Test (AET) that is required under GASB 67 and 68. We’ve often found that the real ROA needed to fund these plans tends to be less than the current return target, meaning that plans can utilize a more conservative asset allocation. Furthermore, by incorporating a cash flow driven (CDI) approach to matching and funding near-term benefit payments, these plans that are utilizing a greater exposure to alternative products now have more time to meet future liability growth without needing to have them become a source of liquidity.
Let’s try a new course. Can we agree that the pension promise that has been made to participants is important and that it needs to be funded? Can we also agree that by focusing on pension liabilities, we can devise an asset allocation strategy that is more precise in meeting the needs of the plan? We believe that blazing this new course will help a plan stabilize contribution expenses and the funded status. Furthermore, the pension plan will improve liquidity to meet benefit payments, reduce overall risk, extend the investing horizon for the alpha assets, and eliminate interest-rate risk for the portion of the portfolio that is now cash flow matched. Not bad, at all! You don’t believe that all of these benefits are possible? Call us.