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

Uncertainty abounds! That uncertainty continues to drive expectations for oil, inflation, and interest rates up and down like a Yoyo. However, recent inflationary trends suggest that U.S. interest rates could continue higher. The U.S. 30-year Treasury bond’s yield is only 4 basis points off it’s cyclical peak since rates began rising aggressively in March 2022.

At Ryan ALM, we recently completed a cash flow matching (CFM) analysis for a public fund in which we were able to defease the pension plan’s liabilities out to 2100. The portfolio that we created to accomplish that objective had a YTM of 6.03%. Barring any defaults (occur at <0.2% in IG space), that is what the plan sponsor should expect to receive over the life of the program. Unlike a broadly diversified pension asset allocation striving to hit an ROA target and all of its standard deviation, there is NO volatility associated with that long-term return and cash flows. There is no potential for a major drawdown impacting future contributions and the plan’s funded status.

Just how has the bond market changed? This morning, our head trader, Steve Devito, shared with us the characteristics for a couple of bonds that had been shown to him. Here is an incredible example of where rates have gone: $2mm par value of ORCL 6.70 maturing in 2056 @ +245 above the comparable Treasury offered at a 7.70% YTM (quality:Baa2 / BBB-). WOW! Here you have an investment-grade corporate bond trading at a yield of 7.7%. The average ROA for a public pension plan is roughly 6.75%. In another example, Steve shared: $2mm GOOGL 6.50 maturing in 2066 @ +124 above the comparable Treasury at a YTM of 6.50% AA (40-year maturity). Google is offering a AA credit 40-year bond at a YTM of 6.5%!

I suspect that there are many other examples of high quality corporate bonds trading at yields greater than 6%. So, I ask: At what level of rates do U.S. corporate bonds become too much competition for U.S. equities and all their uncertainty? As a pension plan sponsor, wouldn’t you prefer to have the certainty of a CFM portfolio securing your pension liabilities from next month chronologically as far into the future as your allocation goes? In the meantime, your residual alpha assets have just been granted a longer investing horizon allowing them to wade through today’s uncertainty without being encumbered with a cash sweep of dividends and capital distributions.

As we regularly write, we are always willing to showcase how CFM can positively impact your plan by providing a free analysis. You will get a better understanding of your plan’s cash flow requirements and an understanding of the potential cost reduction of the future benefit payments. You’ll also have a greater appreciation for the possible significant reduction in asset management fees that is achieved through the use of CFM. Now is the time to act before the markets negatively react to these rising U.S. interest rates.