By: Russ Kamp, Managing Director, Ryan ALM, Inc.
I am pleased to share with you another thought-provoking research piece from Ryan ALM’s CEO, Ron Ryan, CFA. This article, “The Pension ROA is Plural… ROAs” explores how the return on asset assumption (ROA) is derived, but more importantly how the pension return target is misunderstood. Most pension plans within the public and multiemployer arenas have a ROA equal to or greater than 7%. Does this mean that every investment in the pension system’s portfolio needs to achieve this hurdle? Of course not! Each asset class has its own distinct ROA. Yet, it is amazing how often we hear from various pension professionals that investing in a cash flow matching strategy (CDI) in lieu of a traditional total return-seeking fixed income strategy will HARM the plan’s ability to achieve the plan’s ROA.
That retort is incredibly silly given that a significant majority (all?) of plans have fixed income exposure and have maintained investments in fixed income despite the collapsing US yield environment that we’ve just lived through since 1982. There was no way that a core fixed income strategy benchmarked to the Bloomberg Barclays Aggregate Index yielding <3% was going to generate returns anywhere close to a 7% ROA objective. If every asset category needed to achieve the ROA, then why were bonds still in the fund? If it was to provide liquidity to meet benefits and expenses, then a CDI program would provide a superior link between the promises made and the necessary funds to meet those obligations! Furthermore, a CDI implementation that utilizes 100% corporate bonds would have provided a 75 bps to 100 bps yield advantage depending on the maturity of the program. As a result, using a CDI program in lieu of traditional core bonds would enhance the probability of achieving the plan’s ROA, not diminish it!
I know that you are going to be impressed with Ron’s logic that there is no one ROA, but a series of ROAs that must complement each other in order to achieve the overall objective of funding the promised benefits. As always, don’t hesitate to reach out to us with any questions that you might have regarding this piece or any other that we’ve produced.