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

I’ve been extremely fortunate to participate in the Opal Public Fund Summits – both East and West – for the better part of the last 10 years. I used to attend these events and almost never hear the word liability uttered, especially as it related to a pension liability. They might have spoken about so and sos golf swing being a liability or some teams QB, but pension liabilities were missing in action.

I’m thrilled to say that several of the panels/panelists mentioned pension liabilities, with terms such as ALM, defeasement, immunization, de-risking, duration, and even cash flow matching (CFM), and not just by me, also being uttered. It was so refreshing. They are right to be discussing this strategy at this time given the sea change that has occurred in US interest rates. The cost to implement asset/liability management strategies, especially CFM, have been reduced significantly in the last two years.

That said, there are still so many misconceptions regarding CFM. It is NOT a laddered bond portfolio, which would be quite inefficient and costly. It IS a highly sophisticated cost optimization process that maximizes cost savings by emphasizing longer maturity bonds (within the program’s parameters = # of years defeased) and higher yielding corporate bonds, such as A and BBB+.

Furthermore, it is not just a viable strategy for private pension plans, as it has been deployed successfully in public and multiemployer plans for decades. It is also NOT an all or nothing strategy. The exposure to CFM is a function of several factors, including the plan’s funded status, current allocation to core fixed income, Retired Lives Liability, etc. Many of our clients have chosen to defease their pension liabilities from 5-30 years or beyond. When asked, we recommend a minimum of 10 years, but again that will be a function of each plan’s unique funding situation.

CFM strategies are NOT “buy and hold” programs. CFM implementations must be dynamic and responsive to changes in the actuary’s forecasts of benefits, expenses, and contributions. There are also continuous changes in the fixed income environment (I.e. yields, spreads, credits) that might provide additional cost savings that need to be monitored and managed. Plan sponsors may seek to extend the initial length (years) of the program as it matures which will often necessitate a restructuring or rebalancing of the original portfolio to maximize potential funding coverage and cost reductions.

CFM programs CANNOT be managed against a generic index, as no pension plan’s liabilities will look like the BB Aggregate or any other generic index. Importantly, no pension plan’s liabilities will look like another pension plan given the unique characteristics of that plan’s workforce and plan provisions. The appropriate management of CFM requires the construction of a Custom Liability Index (CLI) that maps the plan’s liabilities in multiple dimensions and creates the path forward for the successful implementation of the asset/liability match.

Importantly, CFM programs are NOT going to negatively impact the plan’s ability to achieve its desired ROA. In fact, a successful CFM program, such as the one we produce, will actually enhance the probability of achieving the return target. How? Your plan likely has an allocation to core fixed income. Our implementation will likely outyield that portfolio over time creating alpha as well as SECURING the promised benefits. Given the higher corporate bond interest rates, an allocation to this asset class can generate a significant percentage of the ROA target with risks substantially below those of other asset classes.

What a successful CFM implementation does is the following:

Secures benefits for time horizon LBP is funding (1-10 years +)

Buys time for the alpha assets to grow unencumbered

Outyields active bond management… enhances ROA

Reduces Volatility of Funded Ratio/Status

Reduces Volatility of Contribution costs

Reduces Funding costs (roughly 2% per year)

Mitigates Interest Rate Risk as benefits are future values that are not interest rate sensitive.

It was a great conference spurred on by the fact that folks are beginning to think outside the “performance/return” box. Taking advantage of higher US interest rates is the prudent action today. CFM strategies accomplish a lot for the plan and plan sponsor, but most importantly it provides everyone with a great night’s sleep.

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

Welcome to the first ARPA update of 2024. I hope that your year has gotten off to a great start.

With regard to the PBGC’s recent activity, there isn’t much to report at this time, as there were no new applications received or approved. Fortunately, there were no applications under review that were denied. There was one application that was withdrawn on 1/5/24. The United Food and Commercial Workers Unions and Employers Midwest Pension Plan, a Priority Group 6 member, withdrew its previously revised application seeking nearly $1.2 billion for its 35,223 plan participants. Let’s hope that the third time proves to be the charm.

There was one additional plan added to the waiting list. Local Union No. 1430 Pension Fund was supposedly added to the queue on 12/28/23, but this is the first time that I’ve seen them listed. That makes 112 non-priority pension funds that are seeking Special Financial Assistance (SFA) under ARPA. Of the 112 plans on the waitlist, 22 have been given approval to submit their applications. Of those 22, 5 have had the applications approved, 11 are under review, and 6 have withdrawn to presumably revise data in some way.

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

We recently shared with you the Ryan ALM, Inc. Newsletter. Attached for you review is the Ryan ALM, Inc. Pension Monitor. This document uses the asset allocation output from P&I’s annual survey of the top 1000 defined benefit plans. Their survey clearly highlights significant differences in the asset allocation of corporate and public DB plans, most notably the exposure to fixed income presumably for hedging purposes.

In addition, we highlight the fact that different accounting rules (FASB vs. GASB) often lead to different conclusions. 2023’s performance differential favoring public plans was significantly smaller than the outperformance of corporate plans in 2022.

As always, we stand ready to respond to any of your questions. Please don’t hesitate to reach out to us if we can help you think through your risk reducing goals. Corporate plans have engaged in these strategies for years and the differential in funded status is stark. The US interest rate environment is providing a wonderful opportunity to take risk off the table without a substantial impact on potential returns.

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

We are once again pleased to share with you the Ryan ALM, Inc. Newsletter. This edition is a review of 2023. It was a surprisingly good year for Pension America. Markets overcame significant uncertainty related to the Fed’s action related to interest rates, inflation, economic growth, war, etc. Much of the outperformance of plan assets to liabilities is attributable to equities, both domestic and foreign, which enjoyed significantly improved results following 2022’s challenging markets.

US interest rates were on a rollercoaster for a good chunk of the year, as the Fed continued to elevate the FFR to its present level of 5.25%-5.5%. However, during the path upward in the FFR we had markets rocked by the regional banking crisis which sent yields plummeting only to have them reach decade high levels by October. A pause by the Fed with regard to additional FFR increases has convinced many investors that the Fed will now aggressively reduce rates. As a result, the Treasury yields curve dropped since October with most maturities seeing yields plummet by at least 1% to levels below 4%. That action seems premature.

As always, we welcome feedback related to this newsletter. Please don’t hesitate to reach out to us with any questions. We are always available to assist you in thinking through asset/liability issues. May 2024 be your best year yet!

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

I recently reported on Milliman’s Corporate Pension Plan Index that indicated aggregate funding for the top 100 plans had settled at 102% at the end of November. Today, P&I ran a report form Willis Towers Watson (WTW), that suggested that the aggregate funding for 358 of the Fortune 1000 companies with a defined benefit plan had reached 100%, up 2% since the end of 2022. Both reports are highlighting considerable strength for Corporate America’s pension funding. Great!

Now what?

After a great 2021, we asked not only what Corporate America would do regarding their pension systems, but pension plans in general including public and multiemployer. Unfortunately, they didn’t do much and the Fed’s aggressive interest rate moves beginning in March 2022 created a lot of angst and uncertainty for sponsors and large drawdowns in asset values. The rising rates led to a significant reduction in the present value of those future benefit payments or the funding situation would have been much worse.

Well, 2023 was a surprisingly good year for pension plans from both an asset and liability standpoint. Will plan sponsors and their advisors work to protect the gains or will they once again allow the markets to dictate the funded status? We believe that a defined benefit plan is superior to a defined contribution plan. We believe that they act as great recruiting and retention tools. As a result, DB plans need to be protected and preserved. SECURING the promised benefits at a reasonable cost and with prudent risk should be the goal. Chasing a return through a traditional asset allocation only leads to excessive volatility in contributions and funded status.

US interest rates are still at very attractive levels. Take advantage of this environment to secure the promised benefits through a defeasement strategy. Use your current bond allocation to match bond cash flows with liability cash flows (benefits and expenses) chronologically as far into the future as the allocation will permit. Your fund will now have the necessary liquidity to meet your monthly needs, while buying time (extending the investing horizon) for the plan’s alpha assets to grow unencumbered.

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

Happy New Year! I hope that your 2024 is filled with great health, prosperity, joy, and friendships! Higher US interest rates would be welcomed, too, as that makes managing defined benefit pensions and the Special Financial Assistance (SFA) much easier.

With regard to the PBGC’s implementation of the ARPA legislation, they reported (12/29) no activity for the week. So, no new applications received, denied, approved, and no new pension funds added to the waiting list, which hasn’t seen a new addition since 8/23. Here is the current status of the activity:

There remains a ton of work before the PBGC can declare an end to this process, as only 69 applications have been approved to date, which is 35% of the 197 total applications that will eventually be processed. Importantly, those 69 approved plans have received $53.5 billion in SFA.

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

As I posted on December 19, 2023, I believe that the investing community has gotten too far ahead of the Fed with regard to potential interest rate policy changes in 2024. The move down in Treasury yields of more than 100 bps across the curve has been incredible. Despite this rapid repricing, the current Fed Fund Futures are anticipating 6 rate cuts in 2024. Given the strength of the US economy, labor force, and significant deficit spending, how realistic is that expectation? Furthermore, given that 2024 is a presidential election year, will the Fed act aggressively leading up to November?

If history is our guide, it is not likely that we will see the Fed insert themselves into the campaign. The Fed has set the explicit Fed Funds rate since 1994. How many times in those nearly 30 years have they changed rates during a presidential election year? The answer is only 3 times – 1996, 2008, and 2020. In 1996, they cut one time by 25 bps in January and were finished for the year. In 2008, they drove rates to zero in reaction to the Global Financial Crisis, and in 2020 they reduced rates from 4% to zero as the impact of Covid-19 and the pandemic took hold.

Based on this history, it will take a nearly unprecedented event to see the Fed act to the extent that is currently priced into the market, especially given the current expectation of a “soft” landing. Furthermore, it has been an extremely rare event to have the Fed cut US interest rates when the labor market has been this strong and unemployment <4% (currently 3.7%). Yet, market participants continue to drive Treasury rates lower as witnessed yesterday, when the yield on the 10-year note fell another 11 bps.

According to Jim Bianco (and shared by Steve DeVito, Ryan ALM’s Head Trader), a move of that magnitude is incredibly rare. Here are the observations during the last 62 years:

December 29, 2010 = -0.13% to 3.3489%

December 28, 2007 = -0.12% to 4.0732%

December 27, 2001 = -0.13% to 5.0650%

December 30, 1991 = -0.11% to 6.7160%

December 31, 1981 = -0.19% to 13.9820%

December 26, 1980 = -0.17% to 12.2520%

The yield on the 10-year Treasury note sits at 3.82% this morning, which is down 117 bps since late October. With Core inflation remaining at 4% and proving to be quite sticky, “investors” are accepting a real yield that is negative when compared to core inflation. As Ron Ryan pointed out recently in his blog post, the 10-year note has provided investors with a real yield of between 2% and 3% dating back to at least 1953. Given the Fed’s target of 2% core PCE would suggest nominal 10-year Treasury rates of 4.0% to 5.0%. Investors hoping to get a return greater than the current yield may be in for quite the surprise.

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

Americans nearing retirement are in most cases unprepared for the hopefully next 20-25 or more years. Sure, there is Social Security (thank goodness), but the average monthly SS payment is only $1,827 or $21,924 per year. When you figure that the average rent for an apartment is $1,372 per an August 2023 review by Apartment List, that doesn’t give the SS recipient a lot of disposable income. In addition to housing costs, Seniors need to be concerned about healthcare costs that tend to dominate expenditures during one’s later years. There are obviously many other regular expenditures, including food, transportation, clothing, etc.

According to the Bureau of Labor Statistics, the “average” 65-year-old had an annual expenditure of $57,818 as of 2022. What is the median average income for Americans of a similar age? Unfortunately, it is only $50,290 (U.S. Census Bureau), including SS and any and all retirement accounts (DB, DC, IRA, ). So, before the year even begins, the average American 65-year-old or older is behind the 8 ball by more than $7,500, and that is before the potential extraordinary expense that could further sabotage one’s retirement.

This is bad, and the story is getting worse. According to Benzinga, the average American retiree had <$171,000 in retirement savings, but 37% of Americans have saved nothing for retirement, which is an increase of 7% just since 2022. In addition, 71% of Americans are carrying non-mortgage debt in retirement of just under $20,000. Student loan debt (Parent Plus Loans) and medical expenditures are contributing to this burgeoning total. In many cases the lack of retirement resources has been the result of an early retirement brought about because of a disability rendering the possibility of working beyond 65 a moot point.

Again, asking employees with little discretionary income, no or little investment acumen, and a cloudy crystal ball to help with planning until one’s demise makes the use of defined contribution plans a silly alternative to traditional defined benefit plans as one’s primary retirement plan. As an FYI, my Mom and Dad have lived on my Dad’s small DB monthly payout ($1,400ish), Social Security, and a little savings for 32+ years. They have never been wealthy, but they’ve been secure in knowing that that check will arrive every month. My Dad is now 94. I can’t imagine that he would have been able to afford a retirement in which he had to “manage” monthly distributions for the last 3+ decades and hopefully more to come.

The higher US interest rate environment has reduced the present value (PV) of those future value (FV) benefit payments promised by sponsors of DB plans to their plan participants. Perhaps this development will encourage plan sponsors to maintain, if not reopen, their DB plan. The current American retirement landscape is not good, and it will only continue to get worse, as members of younger cohorts (Millennials, Gen X, and Gen Z) move along toward their retirement age. Unfortunately, these generations have been burdened with greater expenses associated with education, childcare, and housing affordability. Funding a retirement account becomes such a secondary consideration to just being able to make ends meet.

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

We at Ryan ALM, Inc. wish you and your family a joyous holiday season and an incredible 2024.

Once again, there isn’t a lot to report on the activity of the PBGC as they implement the ARPA legislation. There were no new applications submitted. Nor were there any applications approved or denied. However, there was one application withdrawn, as Teamsters Local 11 Pension Plan withdrew their previously revised application. This non-priority plan is seeking nearly $29 million for its 2,012 participants. Perhaps the third time will prove to be the charm.

In addition to the one withdrawal, there were two plans that received payment following approval of their applications. Twin Cities Bakery Drivers Pension Plan and United Association of Plumbers and Pipefitters Local 51 Pension Fund received their funds ($26 and $16.5, respectively) on December 21st. The SFA payments will help support the pensions of 2,587 plan participants. Congrats!

We anticipate a tremendous level of activity in 2024, as implementation of the legislation enters its third full calendar year. As the chart above highlights, there are still nearly 90 plans expecting to secure some SFA. Good luck.

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

I am preparing for a session that I will conduct in late January for the FPPTA. I’ve been asked to speak about US equity indexes, which I’ve done before despite my current role at Ryan ALM, Inc. It is a fun topic and I’ve evolved it over the years to use index performance as a predictor of future relative performance. As most everyone in our industry appreciates, we have two primary equity cycles involving Growth and Value and Large cap and Small cap. The style cycles are driven by economic conditions, but often exacerbated by fund flows. We do have a tendency in our industry to overwhelm ideas and opportunities through massive asset movements.

I’ve written a bit recently on the current state of domestic US equity. Where large cap growth and the S&P 500 are significantly outperforming small cap value, as the “Magnificent Seven (M7)” large cap tech companies become an ever-bigger percentage and influence within these two cap weighted indexes. Currently, the M7 are >30% of the S&P 500 and have a combined market cap that is greater than the UK, France, Japan, and China! The question that everyone should be asking is if this level of concentration and superior performance is sustainable?

As my graph above highlights, we’ve witnessed boom and bust cycles for both Large Growth (R1000G) and the S&P 500 before. Both experienced superior outperformance versus Small Cap Value (using the R1000V index) at periods ending March 1999 and September 2020. The gradual climb to those peaks took years, but the reversal was incredibly swift. Once the momentum was wrung out of those stocks the relative performance reversal came on like a bullet train.

In fact, it only took 19 months from the peak achieved by Large Growth vs. Small Value (relative outperformance for 12-months of 50.14%) to have that relative performance erased. It only took another nine months for Small Value to have outperformed Large Growth by an incredible 66.98% over the previous 12 months. This pattern was once again on display and magnified by Covid-19. For the 12 months ending February 2019, LG had outperformed LV by 2.2%, while the S&P 500 had only beaten the SV index by 0.26%. During the next 19 months, and fueled by the Pandemic, these two indexes outperformed by 50.41% and 30.03%, respectively.

But investors shouldn’t have gotten complacent, for within 6 months of reaching peak relative performance, Small Value would outperform Large Growth by 34.3% and the S&P 500 by more than 40% as of March 2021. Oh, my. The relative performance reversal was incredibly swift and relentless.

Where are we today? As I stated earlier, Large Growth and the S&P 500 have both dramatically outperformed Small Value by 30.9% and 18.57% through November 30, 2023 on a 12-month trailing basis. We aren’t near previous peaks achieved in the past, but the outperformance is certainly meaningful. What will be the catalyst that reverses the current trend? Will it be the fact that the economy is actually performing better than expected and we are not likely to see a significant recession? I’m not smart enough nor is my crystal ball any clearer than yours, but I would suggest that taking profits off the table from Large Cap growth and the S&P 500 and redeploying those assets into Small Cap Value is likely to reward pension plan sponsors during the next equity cycle or get really radical and take domestic equity profits and use the proceeds to defease your Retired Lives Liability (RLL) chronologically from next month as far into the future as that allocation will go.