By: Russ Kamp, Managing Director, Ryan ALM, Inc.
There seems to be major confusion with regard to the investment of the APRA legislation’s Special Financial Assistance (SFA). When the PBGC released the Interim Final Rules in July 2021, potential investments of SFA grant proceeds were limited to investment-grade (IG) bonds with a maximum of 5% in “Fallen Angel” bonds that were now considered High Yield. There was no mention of the phrase return-seeking assets (RSA). However, in the PBGC’s Final Final Rules (might we still get a new category of Absolute Final Final Rules?), the phrase return-seeking asset was injected into the conversation. Return-seeking asset (RSA) investments were now going to be permitted, but only to a level equal to 33% of the total SFA segregated pool.
However, investment grade bonds are return-seeking investments unless they are specifically used to defease liabilities. One only needs to look at the YTD return for the Bloomberg Barclays Aggregate Index through 8/15/22 (-8.68%) to realize that there is downside risk, and potentially substantial risk if inflation isn’t tamed and interest rates rise substantially as a means to contain inflation. So, unless the PBGC states specifically that IG bonds are to be used to defease the plan’s liabilities , they are return-seeking…plain and simple! Thus, 100% of the SFA may in fact be RSA, which violates the PBGC’s guidance as to no more than 33% in RSA.
Why is it not understood that bonds are performance instruments when not used to secure liabilities? Is it the fact that in only 4 of the last 40 years have we witnessed a negative return for the Aggregate Index with -2.92% in 1994 being the worst performer? We have been in a falling rate environment for most of those four decades leading to this historic period for bonds. However, the 30 years prior to 1982 was a lengthy bear market. Might we be headed for a similar fate today?
If the PBGC truly intends to keep the RSA exposure to no more than 33% in any 12-month period, it MUST mandate that the IG exposure be used to defease pension liabilities chronologically from the first payment as far out as the SFA allocation will go. The remaining 33% may now be invested in RSA as approved in the Final Final Rules. Please remember that the legislation was passed with the expectation that promised benefits would be secured through 2051. By allowing a portion of the SFA assets to be invested in RSA, the securing of benefits becomes much more uncertain. It is truly an unfortunate development. The lack of understanding that bonds are also RSA is shocking!