One of the true positives for me in getting involved in the Butch Lewis Act legislation (H.R. 397) has been meeting (through social media) passionate advocates for pension reform such as John C. Anderson, a retired member of the teamsters, who constantly provides important updates on their legislative initiatives. John has recently posted this update:

Actually there are THREE Newly Applied Funds seeking Reductions that are “In Review”…

#1..ROOFERS Local #42…https://www.treasury.gov/…/Composition-Roofers-Local-42-Pen…

#2..IBEW Local # 237…https://www.treasury.gov/…/IBEW-Local-237-Pension-Fund-Seco… (Has Applied Twice Now)

#3..SHEET METAL LOCAL FUND Troy MI…https://www.treasury.gov/…/Sheet-Metal-Workers-Local-Pension… (Had applied previously a year ago March, then ‘Withdrew’)

It is truly unfortunate that these struggling plans are filing for benefit relief at this time.  I realize that the legislative process has moved at a snail’s pace, but I remain hopeful that Congress finally understands the severity of their inaction. Let’s hope that the above referenced plans can hold off a little longer. Although the proposed legislation calls for reinstituting the benefits previously cut through MPRA, there is significant cost associated with going through the process, and these plans, the employees, and employers cannot afford any more cost that further impacts their funded status.

Despite my comment regarding the Senate’s acknowledgment that something needs to be done, I still believe that ideological differences among the parties will lead to proposed legislation that has the potential to do more harm than good, while costing more than the implementation of H.R. 397.

In a follow-up to our August 2nd post titled, “OPEBS – Just How Awful is the funding Issue?” I’ve come across some excellent work by the folks at Milliman, who have produced the following graph.

The funded ratios for the OPEBs of their corporate 100 index are atrocious. They even make the funded ratios for public pension systems look healthy! This information masks the fact that several entities have funded ratios that are much poorer than the average.  I can only imagine the current status for many of our larger cities.

A LIMRA Secure Retirement Institute (SRI) study “finds 8 in 10 private-sector DB plan sponsors (who also offer a defined contribution plan) are at least somewhat interested in a pension risk transfer transaction (PRT). Four in 10 plan sponsors say they are very interested in PRT, marking a 12 percentage-point increase from plan sponsors surveyed in 2014.”

What is driving this interest? Cost! Benefit plan sponsors are increasingly concerned about the cost of providing a retirement benefit. We know the trend has been for private plans to be shuttered, and according to the study, 46% of the companies that offer both a DB and DC vehicle have frozen their DB plan.

The pace of PRTs has accelerated in the last 18 months.  What had been a strategy dominated by the big boys – Verizon, GM, AT&T, etc – has now migrated to small and midsized plans. SRI indicates that more than $1 billion in the last 18 months and the number of contracts has increased 76% from 2014.

But, we at Ryan ALM feel that the PRT transactions can be expensive. In fact, when comparing PRTs to a cash flow matching strategy for the 1-5 year liabilities a plan sponsor can save an estimated 3%-4% relative to the PRT cost. If longer-dated liabilities are also being immunized, the savings can be closer to 10% to 12%. That is quite a savings in $ terms on that >$1 billion in transactions. Please reach out to us if you’d like to get a better feel for how the savings are achieved.

For many of us living on the East Coast, August was a beautiful month to spend time on the beach.  Unfortunately, it wasn’t as pleasant for those managing a U.S. defined benefit plan, as the “perfect storm” hit with both a market decline and rapidly falling interest rates. According to a study by Mercer, the funded ratio for the S&P 1500 declined an incredible 4% to 82%, and the pension deficit grew by a whopping $129 billion to nearly $450 billion. There is nothing sunny about those numbers.

The only way to have protected plan funding was to have engaged in a de-risking program through either a cash-flow matching strategy or through duration matching using long-duration Treasury bonds or operate under GASB accounting and pretend that liabilities and assets both grow at the same rate. Since we know that isn’t the case, funding once again deteriorated for both multiemployer and public pension systems.

A Unique Perspective on CTAs

I normally dedicate this blog to matters pertaining to pensions, pension funding, and the social and economic impact from our failure to do that effectively, but I also like to discuss other aspects of pension management that could potentially enhance a fund’s ability to meet the promised benefits. In this case, I want to highlight a product that has struggled to meet the expectations on both return and risk. CTAs are valuable diversifiers, particularly when it is needed most. However, since the Global Financial Crisis (GFC) performance has been disappointing, to say the least! The researchers at Spring Valley Asset Management have produced a research study in which they’ve developed a unique framework for understanding CTA performance and exploring the causes of underperformance over the past ten years.

Since CTAs represent an important source of diversification, especially at this point given the equity market’s continuing bull market advance, it is critical to understand the underlying mechanics of CTA strategies and how their performance varies across different environments. While the researchers drill down on the different factors that impact the performance of CTAs, they also provide a promising outlook. With the clarity this research provides, it is difficult to imagine that the reasons CTAs have underperformed will become permanent features of the markets. I highly recommend you read this paper!

Having just reported on the current condition of the U.S. high yield market, we find it somewhat disconcerting that the U.S. investment grade bond market continues to see record-breaking issuance. According to an article that appeared on Bloomberg and written by Brian W. Smith and Michael Gambale, U.S. companies have issued a staggering $74 billion this week alone (the previous record of $66 billion was established in 2013). That is a sum that has never been reached in the 47 years of recorded data (1972).

Clearly, these entities are taking full advantage of the plummeting U.S. interest rate environment, and in many cases are retiring more expensive debt, but that isn’t the case for every company.  I don’t have any perspective on whether these “high-quality” firms are rated BBB or higher.  However, the issuance of new bonds during the last decade has been unprecedented, and it will be interesting to see what transpires during the next recession, whenever that occurs.

According to analysts at Goldman Sachs, 2019 is shaping up to be a very challenging year for the high yield market, as the three-month trailing annualized default rate is running at nearly a 5% clip up from a low of 1.3% achieved in 2018. There have been $36 billion of defaulted “junk bonds” in the first 8 months. The post-financial crisis high was $43 billion in 2016. The Energy sector is where many of the problems are occurring, but given the slowing global growth, there remains concern that the Energy contagion (which is secular in nature), could spread to other challenged sectors through a cyclical shift in economic prosperity.

According to Michiel Tukker, Oxford Economics’ global strategist in a note Friday, 18% of high yield companies have recently reported negative quarterly earnings, which is the highest post-crisis level outside of the Energy sector collapse in 2014-15.

Although the high yield market is showing signs of deterioration, few if any, expect U.S. defaults to reach the level of 14% achieved during the GFC, unless there is a full-blown recession.  Given the U.S. government’s incredible stimulus (deficits >$1 trillion) a deep recession is highly unlikely.

However, as yields on HY bonds continue to compress, profit-taking from that segment of your portfolio may be the correct strategy in this environment.

I had the great pleasure of speaking with Traci Dority-Shanklin last week about the multiemployer pension environment generally and more specifically about the Butch Lewis Act (H.R. 397). It was a great conversation because Traci had a firm grip on the issues confronting multiemployer plans and the plan participants.  The retirement crisis that is unfolding for participants in the more than 120 Critical and Declining plans is speeding forward and it will impact everyone (all taxpayers) if we allow these plans to fail, thus pushing them onto the PBGC.

Hopefully, you’ll find my insights beneficial. Please don’t hesitate to reach out to me if I can be a resource for you in the struggle to rescue these critically important pension systems.

Now, before everyone gets upset, I am not referring to generic drugs. I am specifically speaking about generic indexes to replicate liability streams for pension benefits, which seem to be all the rage these days.  Corporate America has been derisking their pension systems for years and many use generic indexes to approximate duration. Unfortunately, duration strategies are never going to be able to match precisely any liability stream, as durations change daily with changes in rates.

Furthermore, a generic index couldn’t possibly work for more than one company in matching needed benefit cash flows unless those two companies have the exact same labor force characteristics. They would have to have the same benefit formula for their plan, and the employees would have to be the same age, started in their jobs on the same day, made the same wages, etc. I think that you get the picture. But, unfortunately, plans are still engaging in their use despite the potential for a significant margin of error.

The only way to properly de-risk a pension system is through a cash flow matching approach in which net liabilities (after contributions) are matched precisely with cash flows from a bond portfolio. Future values don’t change daily, which allows for the precise matching of cash flows with net liability payments. We believe that Pension America should be engaged in the derisking of their portfolios in order to meet near-term Retired Lives benefit payments for a variety of reasons.  In order to accomplish this objective, a Custom Liability Index, no generics please, must be created to model that plan’s specific net liability cash flows. We’d be happy to do that modeling for you.

I found an article in The Hill this morning, titled “If A Recession Is Coming, Pension Managers Need To Prepare”, and I got excited that the writer, Jarrett Skorup, opinion contributor, might actually discuss strategy. Unfortunately, that wasn’t to be the case. He did highlight the fact that in recessions it is easy to find excuses not to fully fund the plan through the annual required contribution, which is important, but not preparing your portfolio for a recession and its likely impact on the plan’s performance because of the asset allocation is much more critical.

As Ron Ryan and I have been espousing for years, asset allocation predicated on the return on asset assumption (ROA) places the plan on the asset allocation roller coaster from hell. Your plan will ride up and down through the various markets until eventually the fund, like the roller coaster, ends up broken. We’ve seen it too many times before, and after this protracted run of very good equity and bond market returns are you prepared to see your plan’s funded status get crushed once more?

Another one of the biggest problems facing plan sponsors during the last significant and protracted bear market was liquidity risk. Many plans that had invested heavily in equities and alternatives were forcing liquidity where it wasn’t naturally found thus compounding the downward spiral for these assets.

As a result of these events, contributions ratcheted significantly higher. Ryan ALM estimates that most public pension systems have seen contributions increase by 5 to 10 times what they were in 2000. We are aware of at least one fund that has seen their contributions increase from $68 million to more than $3 billion, a >38Xs increase in the last 18 years. Incredible, outrageous, abominable – pick your adjective of choice!

However, there is an easy way to mitigate these risks, but it will force you to take a different path. Let’s all embrace Robert Frost, who “took the one less traveled by, and that has made all the difference”. What we are talking about is bifurcating your asset allocation and adopting a new objective for your plan, which should have been the objective all along. We believe that managing a pension plan should be about meeting the promised benefits at both reasonable cost and risk. By bifurcating your asset allocation to focus on Retired Lives in the near-term and Active Lives longer-term, we can insulate the portfolio from the ups and downs associated with the market and economic moves.

Unfortunately, most plans have dramatically reduced the fixed income exposure because of their fear that the ROA would not be achievable given these low level of interest rates. However, through a combination of a cash flow matching strategy (beta) using corporate bonds to meet Retired Lives and a growth (alpha) strategy heavily dependent on equities and alternatives, the combination will accomplish many objectives, including reducing interest rate risk, enhancing liquidity, and extending the investing horizon for the growth assets to capture the liquidity premium that is associated with these assets.

If in 2006 you weren’t preparing for the possibility of a major market crash you likely got crushed.  Well, it is 2019 and we are now 10+ years into a bull market for equities, the yield curve has recently inverted, and global growth is waning. If you aren’t preparing your portfolio for the inevitable market decline then please be prepared for the consequences of a falling funded status and escalating contribution costs. Act now before it is too late.