It wasn’t that long ago that the world was fixated on every economic development in China, and when China Sneezed the world caught a cold.  Well, as usual, our focus on a subject seems to last for a month or two, and then we are onto something else.  Well, we might just want to refocus our attention on the Chinese property market.

KCS friend and supporter, Kieth Jurow, has once again shared information with us that we feel warrants sharing with you. It seems to him (and us) that the property markets in China are nearing a top, and the last blow-off wasn’t pretty.  Here is what he shared.

Chinese Consider Home Prices “High and Hard to Accept,” but Buying Frenzy Surges

Chinese Consider Home Prices “High and Hard to Accept,” but Buying Frenzy Surges

Thanks, again, Keith for keeping us informed about developments in global real estate.

The U.S. economy is consumer driven! There is no arguing that fact, as nearly 70% of the U.S. economic output is driven by consumption.  Well, then, what happens to a consumer driven economy when its citizens don’t have the financial wherewithal to consume? It tanks! Get ready for some rocky times ahead, as our future retirees don’t have nearly the same spending power as the older Baby Boomers and previous generations have had.

The demise of the defined benefit plan will have a meaningful impact on U.S. economic growth.  Who says? We, at KCS do, but more importantly, the folks at the National Institute on Retirement Security (NIRS) do!  They have just released their latest study, which looks at the positive impact on spending from the roughly 24 million recipients of monthly pension checks from 2014. The results highlight the significant contribution to our economy from those receiving a pension benefit.  On the contrary, the loss of DB pensions being replaced by the underwhelming defined contribution account balances has the potential to depress economic activity.  Here are the NIRS findings:

The NIRS report, “Pensionomics 2016: Measuring the Economic Impact of Defined Benefit Pension Expenditures”, finds that economic gains attributable to defined benefit (DB) pensions in the U.S. are substantial. Retiree spending of pension benefits in 2014 generated $1.2 trillion in total economic output, supporting some 7.1 million jobs across the U.S. Pension spending also filled government coffers, with retirees paying a total of $190 billion in federal, state and local taxes on their pension benefits and spending 2014.

“Household spending drives the U.S. economy, accounting for more than two-thirds of U.S. economic output. In fact, American retirees’ pension spending supported one-tenth of such economic output nationwide,” said Diane Oakley, NIRS executive director. “So it’s clear that the growing number of retired Americans must have adequate income for consumer spending that continues to drive our economy.”

Pensionomics 2016 comes at a time when economists are predicting dramatic drops in economic growth in the coming decades. A recent McKinsey Global Institute study indicates that factors including an aging workforce and declines in population growth could reduce economic growth by one-third in the U.S. and 40 percent globally.

“A stable and secure pension benefit that won’t run out enables retirees to pay for their basic needs like housing, food, medicine and clothing. It’s good for the economy when retirees are self-sufficient and regularly spend their pension income. Retirees with inadequate 401(k) savings and fearful of running out of savings tend to hold back on spending. This reduced spending stunts economic growth, which already is predicted to drop by one-third as the U.S. population ages,” Oakley explained.

The study finds that in 2014:

Nearly $519.7 billion in pension benefits were paid to 24.3 million retired Americans including:
$253 billion paid to some 9.6 million retired employees of state and local governments and their beneficiaries (typically surviving spouses);
$78.8 billion paid to some 2.6 million federal government retirees and beneficiaries; and
$187.9 billion paid to some 12.1 million private sector retirees and beneficiaries.
Expenditures from these payments collectively supported:
7.1 million American jobs that paid $354.8 billion in labor income;
$1.2 trillion in total economic output nationwide;
$627.4 billion in value added (GDP); and
$189.7 billion in federal, state, and local tax revenue.
Pension expenditures have large multiplier effects: Each dollar paid out in pension benefits supported $2.21 in total economic output nationally.

The National Institute on Retirement Security is a non-profit, non-partisan organization established to contribute to informed policymaking by fostering a deep understanding of the value of retirement security to employees, employers, and the economy as a whole. Located in Washington, D.C., NIRS’ diverse membership includes financial services firms, employee benefit plans, trade associations, and other retirement service providers.

We are pleased to share with you the following article that was written by Keith Jurow, creator and author, Capital Preservation Real Estate Report. We’ve been very impressed with Keith’s many articles / reports, and we thought that you’d appreciate receiving his perspective, too.

“Fueled by institutional money and hot funds escaping from China, the US office market roared back – until the end of 2015. Now the hottest markets are showing signs of tanking and the smart money is getting out”, according to Jurow.

http://www.advisorperspectives.com/articles/2016/09/12/the-danger-in-office-market-reits

If Keith is correct in his assessment of the commercial real estate market, it further exacerbates a growing problem for plan sponsors and their asset consultants, who are struggling to find assets without significant over-valuations.  Given the current, and nearly impossible, challenge of cobbling together an asset allocation in pursuit of the ROA, we suggest that plan sponsors try a different approach.

Reach out to us if you ‘d like to hear how KCS can reduce your plan’s contribution volatility, while stabilizing the funded ratio.  Also, don’t hesitate to reach out to Keith with any of your real estate questions.  He’s an incredible resource.

P&I reported in their September 6th edition that the Society of Actuaries and the American Academy of Actuaries Joint Task Force has challenged the practice of valuing liabilities at the ROA discount rate for public pension and Multi-employer plans. They, as do we, believe that liabilities should reflect economic reality, with the risk free rate (Treasuries) being used as the discount rate.

After much internal debate the Joint Task Force initially refused to release the draft report.  Fortunately, they changed their minds and recently released the paper.  It is being reported that NCPERS is trying to squash this movement.  It is truly unfortunate.

Given where the level of interest rates are at present, we believe that it is a great time to bite the bullet and mark plan liabilities at a true risk free rate.  Liabilities are bond-like, and they are likely not going to grow substantially from this level, and may in fact decline if the U.S. economy can generate a little growth and inflation that will lead to interest rates rising.  This may not occur in the immediate future, but it will happen eventually.

For more than 30 years, DB pensions have been under pressure from falling interest rates (liabilities have dramatically outperformed asset growth).  Regrettably, many, if not most, DB plans did not capture this great bull market for fixed income as plans anticipated that the lower bond yields would harm their ability to exceed the return on asset assumption (ROA). As everyone knows, bond values are not just determined by yield, and bonds, especially longer-dated issues, have provided outstanding returns during this period of falling rates.

Furthermore, pricing the liability at an inflated discount rate has artificially reduced annual contributions, while leading plans to take on much more risk in pursuit of the ROA through traditional asset allocation approaches. Given where equity and bond valuations are at present, it is highly unlikely that we are going to earn our way out of this underfunding.  We think that plans should initiate a different course in managing both assets and liabilities, and an honest accounting of the liabilities is a great place to start.

Just think what heroes plan sponsors and trustees will be when liability growth is negative in a rising rate environment and DB plans that were once assumed to be on their death bed are once again flourishing.  It won’t take heroic annual asset returns to close the funding gap in an environment in which liability growth is negative. Funded ratios could improve quite dramatically in this scenario. Your participants are counting on everyone to secure this incredibly important benefit.  The time is now to do something different!

According to Wilshire TUCS performance results for the 12 months ended June 30, are as follows: corporate plans had the highest median return at 1.64%, followed by Taft-Hartley health and welfare funds at 1.37%; public funds, 1.07%; Taft-Hartley DB plans, 1.04%; and foundations and endowments, -0.26%. Well, they aren’t very impressive!

Given the very different objectives of DB plans versus E&Fs, one would think that the results would have been quite different, but alas, these pools of assets use the same asset consultants, who basically have the same approach to investing no matter what type of plan.  E&Fs have an annual spending policy that should dictate much more of an absolute return orientation.  Yet, it is these funds that saw their median result at -0.26%.  Also, corporate and public DB plans have different accounting rules for their liabilities as FASB and GASB treat liabilities quite differently.  Yet, their results are nearly on top of one another.

Isn’t it time for another approach?  At KCS we’ve been highlighting our unique asset allocation for nearly 5 years. In our approach we bifurcate the assets into two buckets, which are insurance (beta) and growth (alpha) assets.  The insurance assets are a cash flow matching  strategy to meet near-term benefit payments.  The growth assets are non-fixed income assets with the objective to beat liability growth.  The plan’s funded ratio and contribution history will dictate how much goes into each bucket.

For plans that have funded ratios in the  70%-80% range, we would have allocated a substantial percentage of the assets to the insurance portfolio.  Unfortunately, most plans have seen their fixed income exposure dramatically reduced as interest rates fell, which has created an asset/liability mismatch.

If plan’s had adopted our approach, they would have done substantially better than the median results highlighted above as the Barclays Aggregate index generated a 6% return for the 12 months ending June 30th.  Plan sponsors need to focus more on their specific liabilities and not the ROA, which is injecting too much risk into the asset allocation decision.  Call us if you want greater insight into how we can help you improve your plan’s funded status.

We are pleased to share with you the latest edition in the KCS Fireside Chat series. We hope that you continue to find value in our insights.

Click to access KCSFCSep16.pdf

In this article we provide our readers with an update on multiemployer plans. There has been a lot of press recently related to what is happening within the Central States Teamsters plan that may result in significant benefit reductions. We are obviously concerned about the implications of such a cut on the plan participants. Plans that are struggling to meet minimum funding thresholds are required to develop a rehabilitation plan. In this article we share with you our game plan for putting these plans on a new and improved path.

As always, please do not hesitate to reach out to us for any assistance. We thank you for your continuing support, and we wish for you and your family a wonderful Labor Day weekend. Travel safely!

KCS was pleased to contribute an article to the Association of Benefit Administrators, Inc. (ABA) Insights newsletter for the spring / summer 2016 edition. The article titled, “Rethinking the Use of Traditional Fixed Income in a DB Plan”, highlights KCS’s approach to asset allocation that is driven by a greater understanding and transparency of the plan’s specific liabilities.

We believe that all DB plans should be preserved!  Given different PBGC rules / support we are particularly concerned abut the long-term viability of multi-employer plans and the potential impact on the beneficiaries should any of those plans fail.

We would be pleased to send or email you a copy of the article. Please don’t hesitate to reach out to us at info@kampconsultingsolutions.com or rkamp@kampconsultingsolutions.com.

Regular readers of the KCS blog know that we believe that the pension accounting rules (GASB  and to a lesser extent, FASB) have created many of the issues facing Pension America today, especially for public pension plans given their focus on the ROA as the discount rate for plan liabilities.

Instead of having to listen to us once more on this subject, I am sharing with you today the thoughts expressed by Ron Ryan, Ryan ALM, who is one of the most thought provoking investment professionals and pension experts in our industry.  The following link is to a presentation that he will be delivering to the Florida Public Pension Trustees Association (FPPTA).

http://kampconsultingsolutions.com/images/ROAPENSIONCRISIS.pdf

I encourage you to review this material, as it will give you great insight into why the focus on returns (ROA) has lead to a massive mismatch between a plan’s assets and their liabilities, and why in this low return environment, it is leading to huge increases in contribution rates.

Please don’t hesitate to reach out to either KCS or Ryan ALM with any questions and / or comments.

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.