By: Russ Kamp, Managing Director, Ryan ALM, Inc.
We at Ryan ALM, Inc. truly appreciate every opportunity that we get to speak with plan sponsors, consultants, and actuaries. We find the give and take during those conversations to be incredibly educational. During one such recent meeting, we received a question from a plan sponsor that had to do with the trading activity of a Cash Flow Matching (CFM) process relative to a Key Rate Duration (KRD) strategy. This individual assumed that there was far greater activity in a CFM mandate than in a KRD process since we were using cash bonds. That assumption/conclusion is not correct. Yes, a CFM program is going to be dynamic in its responsiveness to actuarial changes, but those usually only happen once per year. KRD products must respond to changes in the level of interest rates and the shape of the yield curve. These adjustments could occur daily.
Furthermore, the beauty of CFM is in the certainty of the outcome. When asked to defease a Retired Lives Liability, the bond portfolio that we construct to match assets to pension liabilities locks in the difference between the present value of the assets and the future value cost of the liabilities at the time that the portfolio is built. Whether rates rise or fall, that relationship and “savings” is secured. Furthermore, the liquidity necessary to make those monthly payments will be available as needed. Unfortunately, there is no such guarantee that the liquidity that is needed to meet payments will be available through a KRD strategy.
Lastly, because CFM is providing the monthly liquidity needed to make each benefit/expense payment, we are providing monthly duration matching. A 30-year CFM program would have 360 unique durations, unlike KRD which picks a modest # of spots along the yield curve. Intrigued? Call us. We wrote the book on CFM.