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

Dallas, TX voters may be asked to approve nearly $1 billion in debt this fall to help the city deliver a long-promised new police academy, while also providing financial flexibility ($500 million) for ongoing contributions into the city’s police and fire pension fund. Jack Ireland, the city’s chief financial officer, told the council that voter approval of pension obligation bonds (POB) wouldn’t trigger the issuance of new debt, but would “give the City Council the financial flexibility to approve its usage if interest rates improved in the future.”

However, not everyone is in agreement regarding the potential POB issuance. Councilman Adam Bazaldua said “asking voters to support another bond package, including the conditional approval of pension obligation bonds, sends the wrong message”. “It’s hard enough for us to decipher and educate our voters with the language that is required by state law, that will tell them their tax rates will go up with these bonds, but now we have to explain to them we’re asking you to approve half a billion dollars that we may not ever even touch or use,” Bazaldua said. “I’m adamantly opposed to this.”

A City Council vote is set for Aug. 12. If approved, any bond proposals would appear on the general election ballot on Nov. 3.

What would you do? Unfortunately, conventional thinking would have the City issue the bonds and contribute the proceeds into the P&F fund, where trustees and their advisors would apply those funds to the current asset allocation. The conventional POB strategy essentially says:

Borrow at X% → put the proceeds into the pension → invest in the existing portfolio expecting Y% → hope Y > X%.

That process is exactly the arbitrage framework that makes POBs controversial. The Government Finance Officers Association (GFOA) explicitly identifies the possibility that invested proceeds fail to earn more than the bond interest rate as a principal POB risk—and recommends against POB issuance largely because of risks such as this. I ran around the country in 2020-2021 arguing that historically low interest rates made the issuance of POBs sound but only if the proceeds were used to defease the plan’s liabilities – not invest them in traditional markets. What followed was 2023’s -18% return for the S&P 500 and a -12% return for the Aggregate index. Just what I and the GFOA warned against.

We believe that using cash flow matching (CFM) for the proceeds makes ultimate sense. At only 36% funded, this fund is facing insolvency due to significant negative annual cash flow and annual contributions that fall short of the ADC. This fund needs an economic boost and putting $500 million to work immediately and securing the next couple of years of benefits will buy some time for the growth assets to perform. Actually, they need significantly more than $500 million to get back on the right footing, but anything is better than nothing. As a reminder, a pension plan that is roughly only 1/3 funded and striving for a 6.5% return, actually needs to generate a nearly 20% annual return just to maintain the funding deficit.

I would describe our process as creating two portfolios: A liquidity bucket consisting of the CFM strategy and a growth buck that contains all non-core bonds. Furthermore, I would add any existing core bonds from the legacy assets into the liquidity bucket to be used to further build out the CFM portfolio. Here are the roles for the two portfolios/buckets:

Cash Flow Matching	Legacy / Growth Portfolio
Secure pension benefits	Generate long-term growth
Provides needed liquidity	Market-dependent relative returns
Uses bond principal + interest	Contains equities/alternatives/etc.
This portfolio is Liability-focused	Total return-focused
Creates cash flow roadmap	Creates uncertain cash flows
Eliminates a cash sweep	Can withstand market risk
Buys time	Uses that time

With a pension as poorly funded, it is impossible for traditional pension management to perform two conflicting jobs simultaneously: generate high returns and provide liquidity to pay benefits.

I know that our recommendation goes against the traditional approach, but CFM brings an element of certainty to the management of pension assets that is desperately in need of some certainty. Dallas needs a dramatic improvement in the plan’s funding. Why should they continue to ride the rollercoaster of returns, which only guarantees volatility and may lead to further funding erosion? Use the POB proceeds, but only if near-term liabilities can be secured.