By: Russ Kamp, CEO, Ryan ALM, Inc.

There is hardly ever a good time to panic when managing a defined benefit pension plan. No one ever wants to be a forced seller because liquidity is needed and not available. Too often what looks like a well-diversified portfolio suddenly has all assets correlating to 1. I’ve seen that unfold many times during my nearly 44-years in the business.

It is critically important that the appropriate asset allocation framework be put in place long before one might be tempted to panic. As we’ve mentioned many times before, having all of your eggs (assets) in one basket focused on a return objective (ROA) is NOT the correct approach. Dividing assets among two buckets – liquidity and growth – is the correct approach. It ensures that you have the necessary liquidity to meet benefits and expenses as incurred, and it creates a bridge over uncertain markets by extending the investing horizon, as those growth assets are no longer needed to fund monthly payments.

Furthermore, the liquidity portfolio should be managed against the plans liabilities from the first month as far out as the allocation to the liquidity bucket will take you. Why manage against the liabilities? First, the only reason the plan exists is to meet a promise given to the participant. The primary objective managing a pension should be to SECURE the promised benefits at a reasonable cost and with prudent risk. Second, a cash bucket, laddered bond portfolio or generic core portfolio is very inefficient. You want to create a portfolio that defeases those promises with certainty. A traditional bond portfolio managed against a generic index is subject to tremendous interest rate risk, and there certainly seems to be a lot of that in the current investing environment.

The beauty of Cash Flow Matching (CFM) is the fact that bonds (investment grade corporate bonds in our case) are used to defease liabilities for each and every month of the assignment (5-, 10-, 20- or more years). Liabilities are future values (FV) and as such, are not interest rate sensitive. A $1,000 benefit payment next month or any month thereafter is $1,000 whether rates are at 2% or 10%. If one had this structure in place before the market turbulence created by the tariff confusion, one could sleep very comfortably knowing that liquidity was available when needed (no forced selling) and a bridge over trouble waters had been built providing ample time for markets to recover, which they will.

Yes, now is not the time to panic, but continuing to ride the rollercoaster of performance created by a very inefficient asset allocation structure is not the answer either. Rethink your current asset allocation framework. Allow your current funded status to dictate the allocation to liquidity and growth. The better funded your plan, the less risk you should be taking. DB pension plans need to be protected and preserved. Creating an environment in which only volatility is assured makes little sense. It is time to bring an element of certainty to the management of pensions.