How has 2023 Begun for TRS Bond Managers?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We all know that 2022 was a terrible year for total return-seeking (TRS) bond managers. In fact, it was the worst year by far since the creation of the Lehman Aggregate Index more than 4+ decades ago. Rising interest rates will do that to bond managers whether your duration is shorter or longer than the index. By the end of the calendar year 2022, the Aggregate Index had declined -13.01%, far eclipsing the -2.9% produced in 1994. Furthermore, it was only the fifth negative total return recorded in the Index’s history. That is a pretty amazing achievement.

What is happening in 2023? January was a terrific month as US interest rates fell in anticipation of a Federal Reserve that was going to moderate its increases in the Fed Funds Rate (FFR). For the month, the Aggregate Index rose +3.08%. A far cry from the activity of the previous 12 months. However, the celebration didn’t last too long, as January’s fine performance was quickly replaced by a -2.59% February. The economic environment hadn’t calmed down to any great extent and the anticipation that the moderation in FFR increases would be replaced by a pause or the “Great Pivot” proved to be illusionary.

So, at this point, we have a Fed that continues to promise further increases in the FFR (5.375% is the current target with a projected terminal rate at 7.0%!) and an inflationary environment that isn’t close to falling back to the 2% target that they have established. With a historic labor market and rising wages, it doesn’t appear that inflation will be contained in the near future. This environment will continue to prove challenging for TRS managers to provide a positive return despite the much higher yields offsetting principal losses.

We once again ask the question: Why don’t you de-risk your pension system’s exposure to fixed income by migrating the core total return-seeking mandates to cash flow matching assignments? This action will SECURE the promised benefits as far into the future as the allocation will cover while mitigating interest rate risk for that portion of the portfolio. Furthermore, you have now bought time for the plan’s alpha assets to grow unencumbered, as they are no longer a source of liquidity. This eliminates the common practice of sweeping cash from all assets to fund benefits (B) + expenses (E). Let your bond allocation pay B+E.

Great uncertainty exists within the US markets – both bond and stock – as a result of the Fed’s actions. Why gamble that we are close to the end of their activity? Secure the promises through cash flow matching B+E and let yourself and your participants sleep well at night knowing that markets won’t crush their promised benefits.

It Shouldn’t be an Amusement Park Ride!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Fidelity has recently reported that the average 401(k) balance declined by -23% in 2022. Vanguard reported that their “average” 401(k) account declined by -20%. In case you thought IRAs may have performed better – think again! The average IRA also declined by-20%! These are shocking results, especially given the fact that the S&P 500 declined by -18%, while the Bloomberg Barclays Aggregate index fell -13%. What were these plan participants investing in that they suffered considerably greater losses?

The average American Worker is saddled with incredible expenses that are being negatively impacted by the current inflationary environment. The ability to continue to contribute to a “retirement” fund is becoming more challenging. According to the Fidelity and Vanguard releases, nearly 17% of participants have taken loans and the average contribution (employee and employer) remains at about 13.5%, which is below an appropriate target of 15%. For those that have recently retired the loss of >20% of one’s corpus is devastating. For those that were close to retirement, those plans have likely been delayed.

Saving for one’s golden years and being able to fund a dignified retirement shouldn’t depend on when one retires. Yet, the sequencing of returns is a critical variable for most Americans who have little savings outside of their home equity and what gets put away in a self-directed defined contribution plan. Riding these markets up and down is no way to plan for one’s future. Why do we continue to allow Target Date Funds to be the QDIA when they assume much too much risk for the average investor?

Average 401(k) fund balances, which don’t truly reflect the financial conditions of the average American since many don’t participate in a plan, remain extremely low. Fidelity is reporting that the average 401(k) participant has a balance at year-end of just $103,900, while Vanguard’s average participant has <$113,000. Neither of these account balances will ensure a dignified retirement, especially when one thinks about the 4% rule that would provide them with between $4,155 and $4,502 per year to spend. OUCH! I believe that it would be much more meaningful to provide the median balances for each organization. I’m sure that the output would be chilling!

I’m still flabbergasted by the average returns in 2022 by plan participants of both Fidelity and Vanguard. A traditional mix of 50% in equities (S&P 500) and 50% in bonds (BB Agg) would have resulted in a -15.5% return for 2022. The fact that the average account holder in Fidelity underperformed by 7.5% is both shocking and unacceptable. The average American worker shouldn’t be expected to fund, manage, and then disburse a retirement benefit. It is poor policy to think that they possess the skills needed to effectively execute the job. We need to bring back DB plans or face a retirement crisis that could cripple our economy for generations to come.

Bonds are Getting More Attractive

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

At Ryan ALM, Inc., we love bonds because of their cash flows, carefully matching those principal and interest payments with a pension plan’s unique liability cash flows (benefits). Importantly, one doesn’t have to give up much these days in terms of potential return relative to other asset classes for those consultants and plan sponsors not inclined to defease pension liabilities. A glance at the chart below quickly highlights the unattractiveness of equities relative to the US 3-month T-Bill, which is currently yielding 4.78% as of 4 pm today. The S&P 500 Earnings Yield (Earnings/Price) is at a 21-year low versus the yield of the 3-month T-Bill. Equities haven’t been this unattractive since roughly 2000, and we know what happened to stocks during the next few years.

We have been espousing cash flow matching (CFM) as a strategy since the firm’s inception in 2004. However, for much of the time since then US interest rates trended lower eventually hitting all-time low levels during the initial Covid-19 onslaught. Given today’s inflationary environment and the Federal Reserve’s aggressive policy action, US interest rates are trending higher and will likely continue on that path for some time. At Ryan ALM, we are constructing investment-grade bond portfolios used to defease pension liabilities with yields in the mid-5 % range. Plan sponsors can SECURE their pension liabilities with little volatility and capture a big chunk of the annual ROA target without suffering FOMO from not being invested in a total return fixed income strategy or US equities. Isn’t time to explore risk reduction strategies before the markets make securing your promised benefits more challenging?

ARPA Update as of February 24, 2023

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to provide you with this very brief update on the implementation of the ARPA legislation. I know that kids in our local school district were off for the week inclusive of the President’s Day holiday, but it seems like many others may have been too. There were no new applications filed last week seeking Special Financial Assistance (SFA). There were also no applications approved or denied. In fact, the only activity according to the PBGC’s weekly update was the withdrawal of one application. IBEW Local No. 237 Pension Plan, A MPRA Suspension plan, withdrew its application on February 19th. This plan had been seeking roughly $30 million for its 430 plan participants. The initial application was filed on December 29, 2022, well after most, if not all of the Priority Group 2 plans had filed their initial applications, and in many cases, supplemental applications seeking additional funding support.

As the chart above highlights, Priority Group 6 members have been slow to file their applications despite the window having been opened on February 11th. We estimate that 16 eligible plans have still yet to file, while another 6 withdrawn applications need to be resubmitted. Again, it isn’t obvious to me what transpires once the non-Priority Group plans can begin filing. The possibility of nearly 220 plans filing in short order may truly overwhelm the PBGC’s ability to respond within the mandated 120 days following receipt of an application. On your mark, get set…

Why A Rethink Is Necessary

Russ Kamp, Managing Director, Ryan ALM, Inc.

The following post was drafted on March 22, 2022. I’m not sure why I didn’t publish it then, but the content remains quite relevant. It isn’t too late to do something to help SECURE your pension system.

Following a terrific performance year for Pension America in 2021, which was highlighted by outsized performance results and improved funded status, plan sponsors and their advisors (actuaries, consultants, and investment advisors) are once again dealing with turbulent markets that threaten to significantly unwind the funding progress. This situation is certainly not unique, as the focus on the return on asset assumption (ROA) as a plan’s primary objective creates these boom and bust cycles. We’ve described this phenomenon as the rollercoaster to uncertainty driven by an aggressive asset allocation of plan assets as they strive for an optimistic return in the 7% to 7.5% range for most plans.

Given the uncertainty created by elevated inflation concerns, a fear that the 39-year bull market in bonds is over likely leading to higher interest rates, supply chain disruptions, lingering covid-19 implications, equity valuations that are stretched, and now a war in Ukraine that may further destabilize global markets and access to important commodities – oil and nickel to name just two, it isn’t surprising that heads are spinning. What should a plan sponsor do in this environment? What can they do?

We’d suggest that the pension plan’s Investment Policy Statement (IPS) needs to be revisited to reflect new thinking. First, plans need to realize that the primary objective in managing a DB pension plan is to SECURE the promised benefits at both reasonable costs and with prudent risk. The pursuit of the ROA has insured greater volatility, but not guaranteed funding success. In addition, we’d recommend that a plan’s asset allocation should reflect the goal of securing the pension promises (benefits). In order to accomplish this goal, plan assets should be bifurcated into two buckets – Beta and Alpha. The Beta (liquidity) bucket will be invested in bonds whose cash flows are carefully matched with the liability cash flows (benefits and expenses). We suggest cash flow matching assets to liabilities that will defease the next 10-years of the Retired Lives Liability.

The Alpha (growth) assets will consist of all non-bonds. This bucket will now have as its goal the meeting of future liabilities. Since this collection of assets will not be used for liquidity purposes, the assets can now grow unencumbered. One of the most important investment tenets is time. Our asset allocation approach has now created a runway that spans 10-years. Studies have shown that 47% of S&P 500’s total return since 1940 on a 10-year moving average basis has come from dividends and dividends reinvested. Regrettably, pension systems have a tendency to sweep cash from all assets each month to meet cash flow needs. Doing so creates a significant drag on equity performance and mitigates the benefits from reinvesting dividends.

A cash flow matching strategy ensures that plan liabilities and assets move in lockstep. Importantly, benefits are future values (FV). A $1,000 payment due in April 2027 is $1,000 no matter what happens to interest rates. Given this reality, cash flow matching eliminates interest rate risk for those assets that are defeased. On the other hand, a total return-focused bond program would likely be severely damaged during a rising rate environment. For instance, given the current level of interest rates, a 7-year duration bond would only need to see rates rise roughly 30 bps to create a negative total return for the year (we saw that and a whole lot more!). That interest rate movement can occur in a week.

Defined benefit pension plans are incredibly important for our workforce and we must do whatever we can to secure their future. Asking untrained individuals to fund, manage, and then disburse a benefit through a 401(k) plan is just poor policy. Why do we think that everyone can be a portfolio manager? However, in order to secure their future, we must get off the asset allocation rollercoaster to uncertainty. We must adopt a new approach that secures the promised benefits, improves a plan’s liquidity, protects the plan from rising interest rates while creating an environment for equity and equity-like product to grow unencumbered in order to meet future liabilities. Today’s thinking doesn’t accomplish those objectives. Are you ready to adopt new thinking? If not now, when?

Just Not Right!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I just got my latest email from the folks at the IFEBP – thank you! They provide wonderful and relevant content each day, if not more frequently. The following grabbed my attention: “Each year since 2001, Gallup has tracked Americans’ self-reports of delaying medical care in the past 12 months due to cost. In Gallup’s latest annual Health and Healthcare poll conducted in November 2022, 38% say they or a family member put off treatment due to cost, up 12 percentage points from 2021.” I generally focus my attention on defined benefit pension issues, but I just had to comment on this information, as it speaks to a greater issue.

Many Americans, in this case nearly 4/10, can’t afford basic essentials that would provide a quality existence. We have Americans not being able to fund a retirement account through a DC plan, pay for college unless taking on massive debt, and put a roof over their head given the dramatic increase in rents and the cost of homeownership. Yet, we have “investors” lamenting the fact that wage growth and full employment are contributing to inflation. After decades of no to low “real” wage growth, it is about time that the average American worker is seeing some growth in their wages, but at roughly 5% annually, they are still falling further and further behind as inflation continues to outpace that growth. How did we let this happen?

It is sinful to me that the greatest and wealthiest country in the world can’t figure out how to provide necessary medical procedures at a reasonable cost. Educate students without hemorrhaging their financial future. Retire with dignity! I am blessed with five healthy and happy children, who have good educations and terrific occupations, yet I see how they struggle with the cost of housing, healthcare, childcare, etc (we have nine grandkids). Most of my kids and in-laws don’t have access to a defined benefit plan, so funding a 401(k) or 403(b) is challenging, to say the least. They appreciate the need to do so but don’t have the means to set aside as much as is necessary to ensure a dignified retirement. I certainly understand! Again, how’d we get here?

It is Not an Absolute Objective

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I recently returned from an industry event focused on public pension plans. There were many important topics covered by excellent presenters. That said, I have to push back on the idea that public pensions have an absolute objective in managing pension assets despite the fact that the accounting rules under GASB allow for pension liabilities to be discounted at the return on asset assumption. The primary (only) objective in managing a pension system should be to fund (secure) the promised benefits in a cost efficient manner and with prudent risk. This makes the objective relative (assets versus liabilities)!

Was 2022 a good or bad year for pensions? Well, unfortunately that answer depends on if you are talking about private plans using FASB accounting or public/multiemployer plans using the ROA to discount pension liabilities. For private plans that use a AA Corporate rate to discount liabilities… it was a wonderful year despite the travails in the equity and bond markets as liabilities had a large negative growth rate (-25.52% E). On the other hand, public pensions had a “horrible” year as plan assets dramatically underperformed the ROA. Why should the outcomes be so different for pension systems with similar asset allocations investing in the same markets? It makes little sense and may in fact create an environment in which benefit and contribution decisions are incorrectly applied.

Furthermore, if managing a pension plan had an absolute objective, why would those plans continue to invest in assets that don’t have an absolute objective, such as equities, bonds, real estate, etc.? Endowments, Foundations and individual investors have an absolute objective because they have annual spending needs/requirements. Pension plans have a relative objective because their liabilities are bond-like and the present value (PV) rises and falls with changes in interest rates, which we are witnessing currently. Why wouldn’t a pension system want to know the true value of their promises? How do you know if you are actually winning the pension game if you only get the market value of your plan’s assets on a regular basis?  If assets are always priced at market values, why shouldn’t liabilities be priced at market values? Then, and only then, can you compare and manage assets versus liabilities.

The nearly four decade decline in US interest rates hurt Pension America’s funding and it caused a spike in contribution expenses. It appears that we are finally in an environment of rising US rates. Wouldn’t it be a great time to value those pension promises using market rates? Given the much higher rates, with potential higher levels to come, it is a great time to explore taking risk of the table by defeasing the Retired Lives Liabilities, while allowing the remaining alpha assets to grow unencumbered to meet future liability growth. As an industry we failed to do this after 1999. We can’t afford to miss this opportunity to secure these incredibly important retirement programs. The American worker is counting on us.

Public Pension ALERT – ASOP 4 now Effective!

By: Ryan ALM, Inc

ASOP 4 requires pricing liabilities (as an adjunct to funding requirements) at yields for Low Default-Risk Obligations (LDROM) that are reasonably consistent with cash flow matching liability cash flows. Ryan ALM feels strongly that only two discount rate choices meet these new rules: U.S. Treasury STRIPS and ASC 715 yield curves.

Ryan ALM is one of few vendors that supply both STRIPS and ASC 715 discount rates. We’ve recently posted a research piece on ASOP 4 on our website at Please don’t hesitate to contact us for more info and to explore how Ryan ALM can assist you with this new requirement.

ARPA Update as of February 17, 2023

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to provide you with the weekly update on the implementation of the ARPA pension legislation. It took the New England Teamsters Pension Plan no time at all to file its application for Special Financial Assistance (SFA). This plan is categorized as a Priority Group 6 member. Those plans were only able to begin filing as of February 11th, which is exactly what they did becoming the first and only Priority Group 6 member to file as of yet. New England teamsters is seeking $5.5 billion in SFA for its 72,141 participants.

In other news, the PBGC approved the supplemental SFA applications for 4 plans, including the Retirement Plan of Local 1482 – Paint and Allied Products Manufacturers Retirement Fund, the Freight Drivers and Helpers Local Union No. 557 Pension Plan, the Sheet Metal Workers Local Pension Plan, and the Gastronomical Workers Union Local 610 and Metropolitan Hotel Association Pension Fund. These entities sought a combined $25.8 million in Supplemental SFA for their combined 6,700 participants. They will actually receive $26.7 including interest. There are still a lot of activity remaining for the PBGC, as each Priority Group still has applications that need to be filed and reviewed except for Priority Group 3 (Central States).

There were no applications either denied or withdrawn during the previous week.

The information in the graph above is limited to the initial applications (or revised initial applications) and does not include supplemental applications. We revise this data as the PBGC updates their weekly spreadsheet.

The Median Inflation Input is Rising – Uh, Oh!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The Federal Reserve claims to be data driven. If that is truly the case, we are likely in for a longer rising interest rate cycle. I’m not referring to either of today’s major statistical releases – Retail Sales and the NAHB Homebuilder Survey – both of which blew past expectations. No, I’m basing my expectations based on the information produced by the Cleveland Fed that measures the median price increase for all of the CPI constituents. Regrettably, this index continues to rise.

Despite the positive inflation trend related to Goods, which clearly showed a transitory nature and one related to production disruptions, the median constituent in the inflation calculus is rising, with half of the inputs now above 7%. It isn’t just eggs, folks! This latest development clearly demonstrates to me that the Fed has accomplished little to date. They certainly have a major job ahead of them if they truly want an environment in which inflation moderates (plummets) to 2%. As we’ve been saying since the onset of this inflationary cycle, strong labor markets that are enjoying above trend wage growth are not likely to suffer significantly diminished demand for goods and services, which is exactly what we are currently experiencing. 

One can blame the warm weather all they want when it comes to retail sales, home buying activity, travel, etc, but the fact is that this enhanced demand is keeping inflation elevated. As we’ve been stating, the strong labor market and decent wage growth will make it difficult for the Fed to tamp down inflation unless they get much more aggressive. Forget about a great “pivot” occurring anytime in 2023.