I am tired of writing about the problems within our retirement industry, of which there are many. I need something positive to write about, but I’m having difficulty during this chaotic time finding such a topic. Perhaps we can get excited at the prospect that Congress is actually thinking about cobbling together a fourth stimulus proposal following the recent passage of the $2.2 trillion CARES legislation.
There are rumblings that members of the House are preparing to include the Butch Lewis Act (BLA) in the next round of support. The Critical and Declining plans (roughly 125) were already teetering on the brink of insolvency. The stock market’s recent terrible performance will only speed up the time frame to insolvency, while likely pushing many of the multiemployer plans that were deemed to be in “Critical” status into the Critical and Declining bucket. Support for these pension funds is absolutely critical, as nearly 1.4 million American retirees and active plan participants could lose a significant percentage of their earned benefit. Their contribution to our economy, through the monthly benefit payments, is huge. We can’t afford any more revenue and demand shocks to our economy at this time.
While my fingers are crossed that we might see some action to help these struggling plans, I am not holding my breath, as pension reform for multiemployer plans has been on going for years and years. Stay well and stay safe!
The following quote was from my November 5, 2019 blog of the same name. I had just returned from speaking at the IFEBP in San Diego on Enhanced Asset Allocation.
“I certainly don’t know when the next recession might occur, but it will. Do we really want to have these plans sitting with their highest equity exposure when it hits the fan? Shouldn’t we be looking for ways to reduce risk after a long cycle of outperformance?”
“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” Confucius
It should be fairly clear at this time that chasing return has created an environment of great uncertainty for Pension America. As Confucius suggests above, if the primary goal is paying the benefits that have been promised, then don’t change that important goal: adjust the action steps. Our industry has chased performance for decades with little success to show for the effort. Isn’t it finally time to adjust the approach?
Building a cash flow matching portfolio that secures those promised benefits would create far less anxiety for all participants involved in pensions. This approach would have worked beautifully during the first quarter when asset values plummeted and liquidity became scarce. Those “return-focused” assets that took it on the chin would now have time to recover, as the cash flow matching portfolio would have provided the necessary liquidity to meet the promised payouts.
I continue to be amazed by the asset allocation decisions of Pension America. The laser-like focus on the return on asset (ROA) assumption has placed pension plans on the asset allocation roller-coaster to hell! The picture above, which is the Star Jet roller-coaster at Seaside Heights, NJ following Superstorm Sandy, reminds me of the process. Plans ride the good markets up and then down repeating the process with every changing cycle until they get crushed and end up all wet. We need to finally get off this ride before all of Pension America collapses.
We are currently living through potentially the worst quarter of US equity market performance since 1987’s fourth quarter. I was working on Wall Street at that time – this feels worse! As the chart above highlights, we have had 29 10% or worse corrections since 1968. Three of those corrections were 48% or worse with two of them coming in just the last 2 decades. Remember that when markets fall 50%, they need to rebound by 100% just to get back to even. Regrettably, these market events have brought Pension America to its knees and driven many private sector pensions to the sidelines. The American worker has suffered as a result.
Are we finally going to see pension plans get back to the basics? Will we once again focus our attention on the promises that were made to the participants as the primary objective in managing a pension plan? Markets only trade at fair value accidentally, as they move from over-valued to under-valued. Let’s get away from trying to “guess” where we are in the market cycle and once again establish an asset allocation strategy that has two purposes. The first asset bucket is used to secure the promised benefits through a cash flow driven investing (CDI) approach to match the plan’s Retired Lives liabilities. The remaining assets can now be focused on the pension system’s long-term future liabilities that have been given the benefit of a longer-time frame in which to meet that future liability growth rate. Neither of these asset buckets has the ROA as its objective. Why should you?
The Great Financial Crisis of 2007-2009 highlighted the need for liquidity in pension plans. The lack of liquidity that was witnessed as the result of moving significant assets into private market investments spawned the growth of the secondary markets, while driving asset prices lower as liquidity was forced where natural liquidity didn’t exist. Well, it doesn’t appear as if our industry learned much, if anything, from that crisis. As we’ve reported on several occasions, pension plan allocations to equities and equity-like products are at levels greater than where they were in 2007, alternative investment allocations are up, and guess what, liquidity is once again a challenge. Did we not learn anything?
I spoke before about 600 trustees (2 sessions) at the IFEBP in San Diego in October 2019. My topic was enhanced asset allocation strategies. As an aside, I’ve spoken on that subject at more than one dozen conferences in the last couple of years. I asked the members of the audience how many had been trustees when the GFC took place. I was pleased to see that well more than 50% of the audience had been long-tenured trustees. I also asked them if they remembered what they were thinking about in 2006 and early 2007 as it related to their pension systems. Were they thinking that a stock market crash was around the corner? More importantly, what are you thinking about now (10/19)? I challenged them to start thinking very hard because the bull market at that time was 10+ years old and we don’t know when or why a sell-off will occur, but it will happen – it always does.
I suspect that little was done to protect pension plans from seeing their funded status crushed during this recent crisis. I read with interest this morning an article in Chief Investment Officer magazine by Michael Katz titled, “It’s a Terrible Time for Pensions to Have Weak Liquidity” followed by “Market downturn could force some public pensions to sell assets for a loss.” Here we go again. Did we not learn anything?
The article went on to say that according to S&P, US public pension plans have an average of 1% of their portfolio assets held in cash and short-term investments to pay ongoing expenses, such as benefit payments and administrative costs. Well, that just isn’t good enough. Again, my feeling is that Pension America has been misdirected in focusing on return instead of the primary objective of securing the promised benefits.
Had pension plans adopted the cash flow driven investing (CDI) approach that Ron and I have spoken about for years, there would be no issue today. They would have the cash on hand to meet expenses, no interest rate risk, a longer investing horizon for the alpha assets, and no forced liquidity that would exacerbate the poor performance of their plan. Will this time be different? Will they actually adopt a new strategy or will we once again be discussing this liquidity issue in 2025?
I saw a brief article today in the WSJ regarding conversations that are taking place about possibly restricting the ability to short stocks in the U.S. I was extremely fortunate to be leading Invesco’s quant group during the Great Financial Crisis when the U.S. last restricted short selling. We were managing a series of products that utilized shorting techniques, and the restrictions were harmful, as we had about $3 billion in AUM in those strategies. I felt that it was a mistake back then and I continue to believe that it would be a mistake once again.
As a reminder, when selling a stock short, investors are hoping to sell high and then buy lower. Typically, an investor taking a short position does not own the shares prior to the transaction, but borrows the stock through a prime brokerage relationship from another investor. The risk to the short seller is that the security’s price increases, instead of falling, that triggers a loss when the investor must buy it back at a higher cost. There is also a cost to borrow the stock that is to be shorted. Depending on the demand for that issue, the rebate rate can be quite high. An investor needs to have a fairly high conviction that the price fall will exceed the cost to borrow.
I believe, as do many market participants, that the ability to short equities creates a more liquid and efficient market. There are many academic papers that support this claim. ““We shouldn’t be banning short selling,” Securities and Exchange Commission Chairman Jay Clayton said Monday in an interview on CNBC. “You need to be able to be on the short side of the market in order to facilitate ordinary market trading”” (WSJ). James Overdahl, the SEC’s Chief Economist from 2007-2010 was recently quoted as saying “what we found was, on net, it was harmful. There were many unintended consequences”. We have enough to be worried about at this time. Let us not had more hurdles.
Ron Ryan and I will be participating in a new webinar series hosted by the Opal Group. The series, titled “Pension Lessons Learned” will have at least 2 episodes. The first session slated for 2pm DST on Wednesday, April 15, is “Protection From Market Disruptions” and the second webinar in the series in slated for April 22nd at the same time, and it will address “Enhanced Asset Allocation” strategies. We hope that you will consider joining us.
As a reminder, the true objective of a pension plan is to secure benefits in a cost-effective manner. Regrettably, Pension America has gotten away from focusing on the primary objective and has instead chased the return on asset (ROA) assumption. This has lead to a dramatic increase in allocations to risk assets, created a poorer liquidity profile, and lead to greater uncertainty in achieving the securing of plan benefits.
We hope that you can join us for both sessions. You can check out the following links for more information on the Opal Group website and the instructions to register for these events.
The financial security for so many Americans is directly correlated to the successful management of these important retirement vehicles. Continuing down the same asset allocation path has failed all of us. We need to take a path that is less traveled and one that might just return us to a route taken when pension plans were first introduced. Tune in – you won’t be disappointed!