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

Uncertainty related to the Fed and the US economy has begun to impact equity markets during the past couple of weeks. Will the Fed cut rates? Is the US plunging toward a recession? Is the Fed too late? These and many other questions are being asked by the investment community. Expectations for a rate cut in September have become nearly unanimous. As a result, investors have been positioning portfolios in anticipation of future Fed action.

The US bond market has been extremely active with significant flows moving into bonds. In particular, US Treasuries of varying maturities. This has resulted in a significant move down in yields across the yield curve, but primarily in Treasury Notes with maturities 1-5 years, where rates have declined from 49 to 63 bps.

Information provided by Steve DeVito, Ryan ALM’s Head Trader

Has this move in rates also been witnessed in investment grade corporate bonds? If so, will the lower yields negatively impact cash flow matching (CFM) portfolios yet to be funded? Lower yielding bonds do reduce the potential cost savings that can be achieved in a CFM mandate, but there is good news on that front. Corporate bond yields, which had been incredibly tight to the equivalent Treasury bond, have widened considerably during the last month. Ryan ALM, Inc. prefers using IG corporate bonds in our CFM portfolios given the higher yields that can be accessed providing our clients with greater funding cost savings.

As the data above reveals, corporate spreads have widened quite a bit relative to Treasuries. For a BBB rated corporate with a 10-year maturity, the current yield spread would be about 146 basis points above the 10-year Treasury or about 5.4% based on today’s market action. That remains a very attractive rate for a pension plan looking to take risk off the table by securing future benefit payments through our defeasement strategy. Fortunately, the widening of yield spreads hasn’t been only found in BBBs, as yields for both A and AA bonds have also expanded relative to the comparable Treasury.

The widening that we’ve witnessed in A-rated corporates is indeed similar to that which has occurred in BBB. So, an A-rated corporate bond would yield about 5.05% today, given the 109 bps spread over the 10-year Treasury. Given the uncertainty in the economy, the capital markets, and with the Fed, why subject 100% of the pension plans assets to a traditional asset allocation framework? Bifurcate your plan’s assets into two buckets – liquidity and growth. The liquidity bucket will use IG corporate bonds with the attractive rates cited above to secure the promised benefits chronologically as far out as the allocation will go. While the liquidity portfolio is being used to make the monthly benefit payments, the remaining assets (non-bonds) will be growing unencumbered, as they are no longer a source of liquidity. Importantly, the liquidity bucket is the bridge that spans all of the potential uncertainty. Growth assets that have an extended investing horizon will see an enhanced probability of meeting their objectives.

Despite the fact that yield spreads have widened, there is no guarantee that those relationships will be maintained. Don’t let market events diminish your opportunity to reduce risk by securing your promises. We’ve witnessed too many occurrences where a delayed response has meant that a wonderful opportunity has been lost. Act today.

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

I’ve been fortunate to have participated in the investment/pension industry for more than four decades. I’ve seen the business from several perspectives, including as an asset/liability consultant and an investment manager. I’ve been involved in shops focused on equities, fixed income, and alternatives. I’ve also benefited from seeing the business through the lens of both fundamental and quantitative approaches. Lastly, I’ve worked at both large and small firms. As a student of our industry, I’ve learned a few things.

Based on my experience, having expertise in a particular investment discipline has always been the key to success. Another important data point in producing the desired outcomes is knowing when your AUMs have exceeded the natural capacity of that strategy. Yet, there seems to be this belief that size matters (scale). According to a recent article in FundFire, participants in the survey overwhelmingly indicated that scale was the most important characteristic in their hiring decision. Incredibly, specific asset class specialization was down at #4 with only 53% of respondents believing that was an important attribute. Seriously?

Our industry continues to “reward” larger firms, whether they be equity, fixed income, and/or alternative related with new mandates whether those firms actually add value or not. Importantly, there is only so much capacity within a single investment discipline, and our industry tends to overwhelm those capacity limits and the insights that are used. The quant crash in 2007 was brought about by having too much money chasing a few ideas. Those ideas got run over by the growth in the space. Insights can and did get arbitraged away by that AUM growth. This cycle of boom and bust is constantly being repeated, as we are seeing today with the loading up on products “investing” in anything AI-related. Yet, capacity is only a consideration for 22% of the participants.

Want to know why the average “active” investment manager isn’t adding any value? That firm has likely far exceeded the natural capacity in their strategy. Having the discipline to say “NO” to new mandates is not easy, but in the long run it is essential. Why potentially engage in an activity that might risk the entire franchise for the chance to bring in a few more $s? I recall limiting individual position size based on the percentage of a day’s trading volume. We constrained our exposure to <25% of the daily volume. At the same time, a larger competitor of ours had 34 days volume in the same stock. Try getting out of that stock without moving the market.

If I’m sitting in the plan sponsor’s chair, I am focused on three critical investment management attributes, and size (large) isn’t one of them. I would want to work with a firm that constantly evaluates the insights that they bring to their product to make sure that those insights are still adding value. If not, it is time to cast that idea aside and bring new insights to the table. I’d want to work with a firm that doesn’t push off the shelf product but can design a unique solution that meets my specific needs. Finally, I’d want to work with an investment management organization and not a sales shop. The true investment firm will understand just how much capacity there is in the strategy and they will do everything that they can to work within that restriction.

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

The old adage of selling in May and going away is looking as if it were once again prophetic. We’ll see where markets close today, but the last couple of weeks should be a reminder that markets do go down, too.

That said, let’s focus on the task at hand: ARPA and the pension legislation that has been so powerful in rescuing 1+ million promised retirements. The latest week didn’t see a tremendous activity level, but progress was still made by the PBGC. Two new applications seeking SFA were received, including those from Oregon Processors Seasonal Employees Pension Plan and the Lumber Industry Pension Plan. Both non-priority group members filed their initial application. The Oregon processors are seeking $19.1 million in SFA for its 7,279 participants, while the Lumber plan is requesting $103.3 million for its 5,834 plan members.

In other news, Printing Local 72 Industry Pension Plan, was awarded $39.4 million in SFA and interest that will go to supporting the retirement benefits for 787 plan participants. The Printers were a Priority Group 5 member and their application had been withdrawn twice before in December 2022 and September 2023 before resubmitting a successful application in April 2024.

Fortunately, no plans were denied SFA and no applications were withdrawn. There were no plans agreeing to return a portion of the SFA as overpayment due to faulty population numbers. Lastly, there were no additions to the waitlist and no members on the waitlist that hadn’t locked in their discount rate did so in the latest week.

The tremendous move down in US interest rates will hurt plans that have locked in the discount rate at higher levels, as less SFA will be received. They will also be buying into a bond market that is now more expensive reducing the coverage period for those plans utilizing fixed income for a significant percentage of their forecasted benefits. As mentioned previously, we are happy to model different investment scenarios for plans that will soon be receiving SFA.

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

Twice in the last two days, I’ve been asked by very knowledgeable industry professionals to define for them our benchmark. Knowing that we are a fixed income manager focused on defeasing (securing) pension liabilities through our cash flow matching (CFM) capability, they correctly assumed that it wasn’t the Lehman (now Bloomberg Barclay’s) Aggregate Index (homage to Ron Ryan who designed the AGG as Director of Fixed Income Research at Lehman), as no generic index can adequately replicate the unique liabilities of a plan sponsor’s liability cash flows. The answer is… in order to successfully manage a CFM mandate, one has to build a Custom Liability Index (CLI) so that the assets know what they have to fund and when the assets need to be available, especially given that benefit payments are needed on a monthly basis and actuarial reports provide annual forecasts.

The use of a CLI seems fairly obvious although it is not yet a standard practice. However, there is a second “benchmark”, too. Not all CFM managers are created equal. There are tremendous skills necessary to create an optimization framework that minimizes excess cash reserves while maximizing the cost reduction created through the construction of the CFM portfolio. It isn’t always easy to evaluate one investment firm or investment product versus another. Often, the size (defined as AUM) of the manager is a differentiator. Other factors might include fees, number of professionals assigned to a product, years implementing the strategy, etc. But rarely do consultants and their clients get to see under the hood. I’m speaking specifically of the efficiency of the model.

We at Ryan ALM, Inc. take great pride in our Models. The Models are the system! We treat our Models (discount rates, CLI, and CFM) as assets of the firm and not just products. We are particularly proud of the fact that all of the development has occurred in-house over decades. When we produce a cash flow matching portfolio, we also highlight the Model’s efficiency as it relates to that specific portfolio/mandate. We often produce a free analysis of what a potential mandate will look like for the consultant, plan sponsor, or both, which provides them with that look “under the hood”. If they are looking at multiple managers for a potential assignment, they should be getting this free look from the other firms, as well. They should be demanding to see how efficient the other offerings are. Why? Greater Model efficiency results in lower cost for the program, which should be the determining factor in whether one manager gets chosen over another, and not the other factors that often play a role.

Managing a cash flow matching assignment is not the same as building a laddered bond portfolio. Bond math is very straightforward. The higher the yield and the longer the maturity, the lower the cost. You want your CFM portfolio producing abundant cash flows that will cascade throughout the years of the mandate, but you don’t want excess cashflows given the potential negative impact of reinvestment risk. Having the most efficient model will reduce the negative impact of excess reserves building throughout the program. It will maximize the yield advantage from longer maturities and the cash flow that is produced from those longer maturities that will be used to meet near-term benefits and expenses. Let us know if you are interested in CFM. As stated above, we are always willing to produce a free analysis that will help guide you in your decision making. You’ll learn quickly just how efficient our system and models are.

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

Given the improved funded status for most defined benefit pension plans, there is increased plan sponsor interest in reducing some of the risk from a traditional asset allocation. Asset Liability Management (LDI) is the process by which this objective can be implemented. We are pleased to provide you with an LDI checklist that provides you with some important questions that should be answered by prospective investment managers. We specifically discuss the two primary LDI strategies – cash flow matching and duration matching.

Hopefully these insights will prove most useful to you. There is also a plethora of additional research on how to de-risk a pension plan at https://www.ryanalm.com/white-papers. Lastly, don’t hesitate to reach out to us if we can be of any further assistance. Our experience in this space dates back to the 1970s.