Ryan ALM has written a lot on the subject of pension inflation and why it doesn’t make sense to have an allocation to TIPS in your pension plan since they don’t hedge pension inflation. Our extensive research on this subject can be found at Ryan ALM.com. That said, I wanted to highlight why in this environment it makes absolutely no sense to have an allocation to TIPS. Presently, TIPS at all maturities are offering a negative yield. For the 30-year maturity the yield is -0.36%. So, a plan is paying to own these bonds, as opposed to owning an investment grade corporate credit (BBB) that would pay roughly 3.11%, which is based on our universe of BBB bonds with maturities between 28-30 years.

Steve DeVito, Ryan ALM’s Head Trader, stated “it’s a gamble that inflation will rise significantly enough to provide a positive yield.” Furthermore, “after X number of years earning a negative yield how big of a positive yield and for how many years will an investor need to make up for lost income and do better than just breakeven?” Good question, Steve!

We’ve written a lot on the subject of maximizing the efficiency of the plan’s asset allocation. In all honesty, there is nothing efficient in allocating <3% to any strategy and thinking that it will provide value-added to 100% of a pension plan. In the case of TIPS, a <3% allocation is just creating opportunity cost, while becoming a drag on achieving the ROA or any other goal for that matter.

It won’t come as a surprise to many pension investors that Bonds have enjoyed an historic run. In fact, for most of my career, which now spans 39+ years, bonds have enjoyed a significant tailwind of falling interest rates. Unfortunately, this tremendous bull market run coincided with a significant decline in exposure to fixed income within both public and multiemployer pension plans, while corporate plans have increased their exposure as de-risking strategies ramped up. What may come as a surprise is the fact that 2020 has once again proven to be the year of the bond, not James, but the long bond and specifically, 30-year STRIPS.

Ron Ryan and his team were the first to create a U.S. Treasury yield curve index series back in 1983. When STRIPS were born in 1985, the Ryan team were again the first to create a U.S. Treasury STRIPS yield curve index series. According to our analysis at Ryan ALM, the U.S. 30-year Treasury auction index and the 30-year Treasury STRIPS index both outperformed the S&P 500 for calendar year 2020. The Treasury 30-year index gained 19.7% and 30-year STRIPS index was up 25.4% versus the S&P 500 at 18.4%. The return for the S&P 500 was quite impressive given the significant market correction experienced during the first quarter, but it once again paled in comparison to long-bonds.

Do you think that this was a one-off result? Hardly. For the 20-year period ending December 31, 2020, the 30-year Treasury index outperformed the S&P 500 by 0.7% / annum (8.0% vs. 7.3%). Given the historically low level of interest rates, long bonds may not continue to be the performance drivers that they have been historically. But we believe that the intrinsic value in bonds is the certainty of their cash flow. We highly recommend bonds as the “core portfolio” to cash flow match liabilities chronologically. In addition, equities may be overvalued given the historic high P/E multiples that they currently carry.

Most defined benefit pension plans are in significant negative cash flow situations in which benefit payments dwarf contributions. These mature plans need liquidity and forcing liquidity to meet those monthly payments may result in a pension plan trying to raise liquidity through the sale of equities and other performance assets. As a solution, a cash flow driven investing (CDI) bond strategy is just the right prescription for your liquidity needs that will buy time for your performance assets to grow unencumbered. Please don’t hesitate to reach out to us to learn more about improving liquidity in your plan