By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Producing posts/articles on the Ryan ALM, Inc. blog has been very rewarding for me. I’ve now produced more than 1,160 posts that date back 2019 when I joined Ryan ALM and prior to that during my days at Kamp Consulting Solutions (KCS). Producing a blog on a fairly regular basis is challenging in that I want to make sure that what we produce is relevant and helpful for the pension/investment industry. I hope that it has proven to be. Furthermore, there is also no place to hide! Everything that has been produced is there for all to see on the Ryan ALM web site http://www.RyanALM/Insights/White-Papers.
I have great respect for the people in our industry but often find myself challenging how pension plans are operated, which seems to be driven by the status quo. After more than 41-years in this business I’ve come to the conclusion that given each plan’s unique liability stream, it is critically important that a custom solution be created to ensure that the plan’s benefit promises (liabilities) to its participants are SECURED at both a reasonable cost and with prudent risk.
It is fine to claim to be a long-term investor, but it is another thing not to react to a market environment that appears to be entering a watershed event, which don’t present themselves often. The nearly 40-year decline in US interest rates from 1982 that fueled the massive equity and bond returns during that period of time had gotten long in the tooth despite the incredible returns posted by US equity markets in 2021. I highlighted my concerns in a November 22, 2021 post titled “This is No Time to be Greedy”. My concerned centered on the fact that asset allocations had gotten much more aggressive and allocation to both bonds and cash had been significantly reduced.
I said, “the thought that fixed-income assets could be a source of liquidity when equity investments were under pressure was a very reasonable assumption during the last 39 years of a bull market for bonds. However, the next equity market crash may be driven by inflationary pressures forcing US interest rates higher. In that case, all bets are off as to the ease by which bonds can be sold and cash raised! I further stated, “bonds should be used for their value… the certainty of their cash flow – period! “An additional benefit (of cash flow matching) includes the mitigation of interest rate risk on the portion of the portfolio that is being defeased through CDI, as cash flows are funding future benefits which aren’t interest-rate sensitive.”
Pension plans’ fund status had improved, and funded ratios were more elevated than they’d been in years. I challenged those in the pension industry to not sit idly. That after 40 years of easy money we were about to experience a paradigm shift that would significantly impact pension America. The US Federal Reserve doesn’t believe that the current inflation is transitory. As such, they are committed to raising US interest rates until they have accomplished the job of getting inflation back to 2%, whether or not you believe that is the right objective. Given strong employment and wage growth, the Fed has their job cut out for them. This idea that the Fed will engage in a great pivot seems unreasonable. Core inflation remains too high, US rates are likely to continue to rise putting additional pressure on return-seeking fixed income strategies and equities. Have you prepared your portfolio to deal with this likely reality? There was an opportunity at the end of 2021 to take some risk off the table. Are we going to miss another opportunity in 2022? We, at Ryan ALM, urge pensions to separate liquidity assets from growth assets. Let the fixed income allocation be the liquidity assets that buy time for the growth assets to grow unencumbered!