By: Russ Kamp, Managing Director, Ryan ALM, Inc.

When I was managing the Invesco quantitative group (>$30 billion in AUM), we attempted to take advantage of human biases that keep us from being great investors. By capturing those biases in a systematic framework, we were able to consistently apply our insights. By doing so, we removed a lot of uncertainty from within our process. I mention my history only because it amazes me how much uncertainty is being embraced by the pension plan sponsor community and their advisors.

The following is from an article by Catherine A. Sanderson, Ph.D., from September 21, 2021, in Psychology Today. The key points from her article are the following:

• When facing ongoing uncertainty, our bodies stay at a high level of physiological arousal, exerting considerable wear and tear.
• Uncertainty exerts a strong pull on our thoughts and inhibits our ability to act, leaving us in a suspended waiting game.
• We can manage uncertainty by figuring out what we can control, distracting ourselves from negative thoughts, and reaching out to others.

By embracing an antiquated approach to asset allocation in which all of plan assets are focused on a return objective, plan sponsors live with great uncertainty, as markets are truly out of the control of the individual. By continuing to ride the asset allocation rollercoaster, plan sponsors are negatively impacted by their inability to act. As a result, we continuously ride markets up and down. The result of this behavior has led to significant volatility around contributions and funded status.

How can plan sponsors get off this rollercoaster and begin to take some control of their plan’s destiny? Stop aggregating all of the pension plan’s assets into one giant return bucket. The primary objective in managing a DB plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. By chasing a performance objective you are subjecting all of the assets to great uncertainty. The Ryan ALM solution is to bifurcate the plan assets into two buckets – liquidity and growth. The liquidity assets will be bonds (investment grade preferred) whose cash flows of interest and principal will be used to match the plan’s liability cash flows (benefits). Once this process is completed, the plan will have brought certainty to at least that segment of the portfolio, as the asset and liability cash flows will move in lockstep whether interest rates move up or down.

Furthermore, the growth assets have now been given the luxury of time! With an extended investing horizon, growth assets have a much greater probability of achieving the expected outcome, as the volatility associated with 10-year periods is far smaller than volatility on 1-2-year horizons. As your plan’s funded status improves, port excess growth assets into the liquidity bucket further reducing uncertainty.

No one wants the psychological wear and tear associated with uncertainty. Stop embracing it through a traditional asset allocation. Adopt the Ryan ALM approach to asset allocation and you’ll be embracing greater certainty. As Catherine suggested, we can “manage uncertainty by figuring out what we can control“. Securing the promised benefits for even a relatively short period of time (say 10 years) sets us on a path to greater control. How comforting!