By: Russ Kamp, Managing Director, Ryan ALM, Inc.
You may recall that I wrote on May 3rd that rising US interest rates might just be the antidote needed to slow the demise of DB pension plans, as rising rates make the present value (PV) of those future benefit payments cheaper. Happy to report that Bloomberg’s John Authers has written on this subject in his daily blog (which is always excellent). Importantly, John wrote, “If pension managers can match their liabilities with yields at their present level, they have a huge incentive to buy bonds. Yes, yields might rise still further, but the opportunity to be able to finance their pension guarantees with certainty may not come again.” All hail, John!
A rising US interest rate environment will create significant headwinds for a traditional fixed-income portfolio. Instead, have the wind at your back by using bond cash flows to match pension liability cash flows and you have SECURED the promises chronologically for as far out as the allocation will permit. Why live with great uncertainty regarding the plan’s funded status? Bi-furcate your plan’s asset allocation. First, establish a cash flow matching strategy by replacing your current core and core-plus fixed income allocation to help stabilize your funded ratio. Second, let the remainder of your assets now occupy an alpha bucket used to enhance the funded status. Furthermore, given what has transpired in the markets to date, you are buying time for the alpha assets to grow unencumbered without being a source of liquidity that would lock in recent losses.
Now is not the time to just sit on the sidelines…be responsive!