Anyone who has read my blog throughout the years knows that I often rail about decisions taken in NJ with regard to the state’s pension system, but this is one time that I am firmly with NJ and all the other states that have seen their economies wracked by Covid-19-related expenditures.

In yesterday’s post, I mentioned that Senate Majority “Leader” Mitch McConnell and the Republican Senate didn’t appear to be willing to provide assistance to states and municipalities. In fact, McConnell was quoted as saying that he would prefer that states file for bankruptcy rather than receive a Federal bail-out despite the fact that everyone else is getting one at this time. Here is why McConnell’s thinking is so shortsighted. It was reported that another 140,139 New Jerseyans filed for unemployment last week, bringing the tally to an unbelievable 858,000 workers desperate for checks. The state has already dished out $1 billion or so in unemployment benefits. Some perspective: At this time last year, there were just 84,000 residents collecting from the state’s unemployment pool.

As everyone knows, NJ’s economic environment is already challenged by one of the country’s worst out-migration trends that has been brought about through a combination of high state income taxes, excessive property taxes, and out-sized housing costs that make it challenging for a large percentage of the state’s residents. Couple those impediments with a pension system that has a colossal deficit, and not surprisingly, you create a terrible economic environment. Sure, and to be fair, some of this has been brought on by mismanagement, especially when it came to the state’s failure to make the full annual required contribution, which they haven’t done since Washington slept here! But, the unprecedented impact from this virus is crushing NJ’s budget and those of many other states and municipalities.

Does it make any sense to let states collapse? Do we really want to see mass lay-offs in the public sector that would mirror those in the private sector? Isn’t it imperative that we have the tools and resources now to meet this crisis head-on, and not wait for some resolution in the courts to begin to defeat this menace? Governor Murphy said, “come on, man” when reacting to McConnell’s stance. I couldn’t agree more! As a point of reference, I am honored to be an elected official (Councilman) for the town of Midland Park, NJ. In my capacity as a Councilman, I am seeing first hand how state and local budgets are being stretched in ways that we’ve never considered or imagined. Midland Park certainly doesn’t have a rainy day fund of the size necessary to meet these unanticipated burdens. Why should we expect that any state or municipality would?

On the other hand, the US government does benefit from having a fiat currency that can be used at this time to prop up and support our displaced workers and their families, retirees, businesses, AND government entities. It would be foolish to “punish” any one of these important constituencies when we have the economic capacity to provide life saving measures. For once, can we put politics aside and do what is best for our country? If not, then you don’t deserve to “lead” us!

We truly understand and appreciate the funding concerns that all DB plan sponsors are challenged with at this time. However, we are particularly focused on the issues surrounding public pension funds, as they are getting crushed with the doubly whammy of falling asset levels and potentially skyrocketing contribution expenses, in an environment of plummeting sources of revenue, as the closing of the US economy significantly reduces tax and fee revenues.

Senate Majority “Leader” Mitch McConnell and the Republican Senate, don’t appear to be willing to provide assistance to states and municipalities at this time. In fact, McConnell is quoted as saying that he would prefer that states file for bankruptcy rather than receive a Federal bail-out despite the fact that everyone else is getting one at this time. Having US states declare bankruptcy was roundly panned by both Republican and Democratic governors during and after the Great Financial Crisis, as this action would cause disruption to bond markets, while simultaneously driving interest rates higher and raising the cost of borrowing at a time when every dollar matters. Why is it acceptable now?

Given that the financial position of many US states is precarious at best, state and municipal pension systems need time to weather this storm. As we shared during the Opal/Ryan ALM webinars (4/15 and 4/22), one of the significant advantages of using a cash flow matching strategy (CDI) to meet promised benefit payments is that it buys time (extends the investing horizon) for the alpha assets to perform. This extension, which keeps the plan from forcing liquidity where it doesn’t naturally exist, allows the plan’s assets to recover from the significant draw-down experienced year-to-date, but also provides an extended time frame for all of the private assets that have found their way into plans.

The cash flow matching portfolio (beta assets) will be used to meet on-going monthly benefit payments for as long as the current allocation to fixed income can support. With little disruption, a CDI portfolio can be implemented that won’t impact the return on asset assumption (ROA) or the plan’s asset allocation. In fact, it is highly likely that the Ryan ALM CDI portfolio will out-yield the current core fixed income account, thus improving the plan’s ability to achieve the ROA target, at lower cost – management fees and transaction costs. In fact, the conversion from an active, highly interest-rate fixed income portfolio to a CDI approach is quite simple, as the existing portfolio can be transferred-in-kind to us for conversion, saving more money in the process.

It is truly understandable why trustees might be feeling overwhelmed at this time from the negative impact of the Covid-19 virus. They are dealing with falling asset levels, falling interest rates that impact the true liability cost, the likelihood of escalating contribution expenses in an environment of challenged revenue sources, and concern for themselves, family members, and colleagues. It would be enough for anyone to want to go into a bunker. Please don’t. By making this simple (really) conversion from active fixed income to a CDI approach the plan sponsor buys critical time needed to help the plan navigate these troubled waters. But, they also create an enhanced asset allocation process that secures benefits, improves liquidity, eliminates interest rate risk, and likely out-yields the current capability, thus enhancing the ability to achieve the ROA. That is a lot of reward for not a lot of effort. Skeptical? Call us or check us out at RyanALM.com.

According to Milliman’s survey of the largest US 100 public DB pension plans, funded ratios collapsed to 66% from year-end’s 74.9%, as plan’s recorded an average decline of nearly 11% for the quarter. The devastating decline was the largest ever recorded by Milliman in the history of producing their firm’s public pension funding index (PPFI). Furthermore, the losses ($419 billion in market value) wiped out all of the improvement generated by these funds in 2019.

The weak quarter impacted these plans in many ways, as the current deficit (liabilities – assets) ballooned to $1.82 trillion from $1.33 trillion just three months prior. The total liability for this universe of public plans now stands at $5.36 trillion. Only 4 plans currently remain at >90% funded ratios, while 35% of the plans are now below 60%. Can you imagine what these stats would look like if pension liabilities were discounted at a more legitimate rate than GASB’s ROA?

I want to once again thank the folks from Preqin for providing the following chart:

I’m not surprised by these results, but the responses may be quite premature. How many plan sponsors and consultants have seen performance results for the first quarter? Do they truly know how private investments in both equity and fixed income have been impacted by the closing of the US economy? I’ve seen reports guesstimating that the average private equity fund could be down substantially. It is one thing to claim that your ship is steady as it goes, but the tsunami may truly alter your course!

As we will be discussing on the Opal/Ryan ALM webinar today, there is a way to enhance the cash flow necessary to meet current benefit payments, while extending the investing horizon for all of this private investment. We are happy to share those details.

We once asked where the beef was, and if she were alive, Clara Peller would be able to tell us. As an industry we think we understand where the beta is, but do we really? As the chart below indicates (thank you, Preqin), hedge funds once again proved that most of their exposure is still nothing but beta. Where was the alpha or hedge? Yet, we as an industry continue to pay ridiculous levels of fees to gain exposure to them. Why?

Comparisons don’t look any better as we extend the time frame to 10-years or even 20-years, despite the inclusion of 3 sharp market sell-offs. It might make sense for endowments and foundations or HNW individuals to use hedge funds given that they have an absolute orientation because of their annual spending policy, but it really makes no sense for pension systems given that their mandate is a relative one – plan liabilities. Cheap beta (S&P 500) is much cheaper today than at year-end, and the cost to access it is a basis point – not some formula that includes high base fees and a percentage of gains.

Multiemployer pension reform has been decades in the works with still no outcome that protects and preserves the earned benefits for millions of American Workers. As Congress debates the merits of HR397 or some bi-partisan piece of legislation the cost grows and the economic impact looms ever larger. The full impact of the current economic crisis brought about by Covid-19 is not yet understood, but we know that it is having a major impact on Pension America from the loss of asset values, to growth in liabilities (using a legitimate discount rate), to the loss of jobs and contributions. Something needs to be done almost immediately or a significant percentage of the Critical and Declining plans will be lost forever. The PBGC is not currently funded to handle anywhere close to the number of participants that might become their responsibility.

The debate continues to rage over whether or not this legislation is a government bailout despite the fact that low-interest loans to sure up these plans will have 30-years to make interest and principal payments. That is 30-years of benefit payments that wouldn’t be received if these critically important funds are allowed to fail, and they will fail without help now! There is no way for these cash-starved funds can earn their way to solvency. We actually have a wonderful environment to provide these loans as 30-year Treasuries are currently trading at 1.21% and the loan would be issued at that the prevailing rate plus 25 basis points.

According to several sources, including the NIRS and Michael Scott, Executive Director, NCCMP, the Federal government stands to lose far more in lost tax revenue than they would gain by doing nothing at this time. It is estimated that in 2015 alone, the multiemployer system provided $158 billion in taxes to the U.S. Government. They also provided $41 billion in pension income to retirees and paid more than $203 billion in wages to the 3.8 million active workers. Combined, the pension and wage income supported 13.6 million American jobs and generated $1 trillion in GDP. Furthermore, original estimates for the then 114 Critical and Declining plans (now roughly 130) calculated that $32 billion in tax revenue over 10-years would be lost to the Federal government should the C&D plans be allowed to fail. That $32 billion was more than 50% of the expected “cost” of the loan program. Lastly, this estimated cost would decrease with every loan that is repaid, and with these low interest rates, that probability is improved.

Obviously, we are in unprecedented times, and much needs to be done to sure up our economic system, the businesses, and workers before this crisis escalates beyond our capacity to rescue it. However, that doesn’t mean that retirees should be ignored at this time. They deserve every protection that any other American is receiving at this time. Failure to secure funding is not an option.

We are very pleased to announce the launch of Ryan ALM’s new website. Please check us out at RyanALM.com. Hopefully, you will appreciate the look and feel of the site, but more importantly, you’ll be able to find the information that you seek with ease. We welcome your feedback, especially if you find our site wanting for any reason. Thank you, and stay healthy!

Forbes has an article in their latest edition that speaks to the strengths and weaknesses of the US retirement industry. I think that a real strength for plan participants in the retirement industry is a traditional pension plan that provides a monthly benefit no matter what is happening to markets. When discussing the strengths for 401(k) plans the Forbes writer highlights the fact that “these plans have enabled millions of workers to accumulate savings to supplement Social Security and any pension or annuity benefits that they receive”. Okay, but that’s not a lot to hang one’s hat on.

Under weaknesses they highlighted the fact that only about 50% of workers have access to a 401(k) plan and plans often fail to help participants convert retirement savings into a monthly income stream (annuity). That’s it? Those are the main deficiencies? How about the fact that plan participants must fund these accounts, then manage, and lastly disburse this benefit. What about the fact that a majority of Americans are now living paycheck to paycheck and can’t possibly afford to make contributions into a retirement account. This Covid-19 crisis is certainly highlighting this sorry state of affairs.

Furthermore, Corporate America is already announcing the elimination of their company match into these programs, which reduces by about 50% the annual contribution made into these accounts. This is a similar action that we witnessed following the Great Financial Crisis that ended in April 2009. In addition, Federal Reserve action to dramatically lower rates during the last 10+ years is forcing many plan participants and recent retirees to assume more risk in an attempt to preserve their retirement corpus. As a result, many participants went into this latest severe market downturn invested in less liquid, equity-like products as opposed to being in investment grade fixed income instruments that paid a decent yield and that which would provide some income to help reduce the call on principal.

Furthermore, we now have emergency actions by Congress that will allow plan participants to withdraw from 401(k) plans penalty-free up to $100,000. There are clearly many emergency situations being faced by members of our society, but permitting these withdrawals is only taking from Peter to pay Paul, and will certainly jeopardize their long-term financial security. It further highlights that these plans are nothing more than glorified savings accounts. We need to reinstate pension plans as the true retirement vehicle. Defined contribution plans are great as supplemental income funds, but they shouldn’t be anyone’s primary retirement vehicle. Asking untrained individuals to handle this responsibility is just poor policy.

Ryan ALM in conjunction with the Opal Group is presenting a two-part webinar series on Pension Lessons Learned beginning tomorrow April 15, at 2pm EST. The first session “Protection From Market Disruptions” will discuss the issues surrounding Pension America’s struggles to stabilize both the funded status and contribution expense, while providing a detailed process on what we believe DB pension systems need to do to protect and preserve these critically important benefits.

Here are the links to the webinar:

Website: https://opalgroup.net/conference/pension-lessons-learned-2020/

Registration link: https://zoom.us/webinar/register/6015852510588/WN_PM4XlQuNR9aL7N78aDR4tQ

The second webinar titled “Enhanced Asset Allocation” will be April 22nd at 2pm, and we are excited to announce that Brad Heinrichs, President/CEO, Foster and Foster, who will provide his perspective on asset allocation from an actuarial standpoint, will join us. We hope that you will join us, too. Don’t be shy to ask questions either during the sessions or after, as we are excited to discuss these topics with you. Have a great day and stay healthy.

You may recall that in August 2016, I penned the following blog post –

New Jersey slashes hedge fund portfolio in asset class overhaul
The New Jersey State Investment Council on Wednesday unanimously approved an overhaul of its hedge fund portfolio for the New Jersey Pension Fund including cutting the target allocation in half, reducing the number of hedge funds and cutting fees significantly. (P&I Daily)

I don’t know who first had the “brilliant” idea to allocate so much of NJ’s DB pension portfolio to alternatives following the GFC when cheap beta was so severely discounted, but to now slash the allocation when equity and fixed income valuations are stretching their limits is ridiculous!

First, DB plans have a relative objective (plan liabilities) and not an absolute objective; despite the fact that plans think they need to achieve the ROA.  These aren’t endowments or foundations with positive spending policies. Liabilities are missing in action when it comes to investment structure and asset allocation decisions, and it is leading to the injection of too much risk into their funds.

We are huge proponents of DB plans being the retirement vehicle of choice, but they need to be managed responsibly.  First, identify the primary objective (liabilities) and manage to that objective.  Second, STOP buying high and selling low. Furthermore, I think that the fees associated with hedge funds are outrageous and in most cases, unwarranted, but the NJ plan already has the exposure. Don’t sell it now, as you just might need some uncorrelated assets in the coming months.

I bring this up again, because focusing on the return on asset assumption (ROA) keeps plans chasing performance. I have no idea what NJ was trying to “hedge” in 2009 after the U.S. equity market was already haircut by 50%, but they built a very large hedge fund portfolio only to unwind about $7 billion of it by 2016, which was well after they already suffered the lost opportunity cost of not having been in cheap beta after the GFC. I suspect that they would have loved that exposure heading into 2020. Unfortunately, NJ is not unlike many (most) pension plans that chase performance in the HOPE that they achieve the ROA.

How many pension systems moved into commodity or other inflation hedges in 2009, as a result of fear that Federal stimulus would prove to be inflationary? I don’t know to what extent, but I know that it was massive. Well, it shouldn’t be shocking that we didn’t get inflation, but worse, the S&P GS Commodities Index is down -10.6% / annum for 10-years! Pension systems would have done so much better had they just managed to their plan liabilities during the last 20-years, as bonds (BB Agg.) have outperformed equities (S&P 500) during this period of time, with so much less volatility. But, we never learn!