By: Russ Kamp, Managing Director, Ryan ALM, Inc.
My two sessions have been completed at the IFEBP’s Advanced Trustees and Administrators conference in Seattle, WA. It is always a pleasure to share the podium with Ian Jones and Troy Brown (AndCo), two exceptionally experienced asset consultants, despite our varying perspectives on what lies ahead. Both our sessions were related to investment discussions. Our first session pertained to “where are we” which is always easy and doesn’t leave a lot of room for debate. However, the “where are we going session” leaves a lot of room for discussion with varying interpretations of where markets may be going and the significant influences that will dictate our future course.
With regard to my thoughts about the future of pension plans and Pension America, I need to state that my crystal ball is no clearer than anyone else’s. That said, here are my concerns: Most members of our pension community have NOT worked in a rising interest rate environment. They have NOT experienced inflation. They’ve NOT experienced both equities and bonds selling off at the same time. Most of the investment strategies being utilized today were only tested in a favorable investing environment of falling (low) interest rates and benign inflation. I’ve been told by many that we can’t look at the ’70s as a guide because things are different, but are they?
Sure, being a long-term investor for someone involved in pensions is sound advice, but does that mean that we shouldn’t or can’t do something different? Liquidity is not abundant in this market. Asset allocations have migrated significant assets to alternatives further restricting liquidity. Forcing the sale of assets to meet liquidity needs is not an effective strategy in declining market environments.
As a reminder, the primary objective in managing a pension plan should not be to achieve the ROA. It should be all about securing the promised benefits. We’d highly recommend bifurcating your assets into liquidity and growth buckets. With this approach, a plan sponsor uses the liquidity bucket to meet those promises through a defeasance strategy, which will buy time for your growth assets so that they can withstand periods of dislocation such as this period. How does one begin the transformation? We don’t recommend dismantling your plan’s asset allocation. Simply migrate your current total-return-seeking fixed income into a cash flow matching strategy that will secure the promised benefits. This will provide the necessary liquidity to meet benefits and expenses for as long as that allocation lasts. There is comfort in knowing that those promises made to your participants are now secured no matter where markets, inflation, and/or rates go.
The last four decades have been extraordinary for the investment community and Pension America. What is the probability that we experience anything like this period as we move forward? Where is the amazing stimulus going to come from given that US interest rates are rising after forty years? The Fed is currently waging a battle against inflation. They have promised to be relentless in that quest. Soft landing? Doubtful! Also, please don’t look at the long-term as being the last 10-, 20-, or 30 years and think that it represents different environments. Sure, we’ve had booms followed by busts during the last forty years, but in every case, US interest rates continued to fall, and inflation remained muted. That party is now over!