By: Russ Kamp, Managing Director, Ryan ALM, Inc.
While the investing community holds their collective breath in anticipation of the latest US Federal Reserve Fed Fund’s Rate announcement, those plan sponsors using cash flow matching (CFM) can sit back knowing that interest rate movements provide little impact on their bond allocation that is used to defease their plan’s liabilities. How comforting! Despite the significant interest rate gyrations in 2022 that saw US rates rise rapidly through October (US 30-year Treasury Bond yield peaked at 4.34%) only to pull back as long-bonds recently rallied (US 30-year Treasury Bond yield is at 3.54% today), CFM is doing exactly what it proclaims to do. Importantly, the CFM portfolio is providing the necessary liquidity to meet monthly benefits and expenses, while the bond’s assets and the pension’s liabilities track very closely minimizing the impact on a plan’s funded status and contribution volatility.
We are quite fortunate to work with an array of clients who have asked us to cash flow match pension liabilities covering various lengths of time from 3 years to 30+ years. Since every client’s liabilities are different, there is no “standard” portfolio that is built by Ryan ALM, as we need to carefully match each client’s unique liability cash flow needs with bond cash flows of interest and principal (and reinvested interest income). For the first 9 months, bond asset values fell as rates rose, but so did the present value of pension liabilities that are bond-like in nature. For the two months since the current peak in rates, both assets and liabilities have seen their values rise. On a year-to-date basis through November 30, 2022, both assets and liabilities are down modestly, with a representative Ryan ALM CFM bond portfolio showing “alpha” of about 80 bps, as our yield advantage (skewed to A/BBB corporate bond exposure) buffers the portfolio versus the plan’s liabilities valued using a AA custom liability index (ASC discount rates).
As we’ve reported on numerous occasions in our blog, total return core or core plus bond programs managed against the Bloomberg Barclays Aggregate Index (-12.62% through 11/30/22) have suffered significant asset underperformance in 2022 as US interest rates rose significantly. Furthermore, these portfolios are not designed to provide the liquidity necessary to meet monthly benefits and expenses so bonds and other assets must be sold in order to meet those cash needs. Many pensions do a cash sweep of all assets including performance assets (i.e. dividends from stocks). This is troubling in down markets such as those that we’ve experienced this year when losses are realized. Wouldn’t you like knowing that come 2:30 pm you can sit back and not worry what the Fed is going to say or do? It is comforting knowing that your pension liabilities have been secured through a CFM mandate, which mitigates interest rate risk since benefits are a future value and future values are not interest rate sensitive. We’d be happy to model your plan’s liabilities to see how CFM can help you.