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

ESG, short for environmental, social, and governance, are considerations alongside financial investment insights used in investment decision making. ESG considerations have been around for a long time, and in most instances, they were prohibitions on the purchase of a particular investment. I recall early in my career a social issue not to invest in South Africa. This was followed by tobacco-free, sin stock-free, and many other imposed limitations on a variety of industries and sectors.

Today, the primary motivation in considering ESG factors is the idea of sustainability. What initiatives should a company take to ensure that their business will not only survive, but thrive, in the future. I’m not going to get into the politics surrounding ESG, but I do agree that sustainability should be a consideration in any investment. However, it shouldn’t be limited to the investment management community. Defined benefit pension plans should operate with the goal of being sustainable. I produced a post many years ago (01/2017) titled, “Perpetual Doesn’t Mean Sustainable“ in which I implored Pension America to rethink the approach to pension management.

Most, if not all, states, cities, and municipalities believe that they are perpetual, and they are correct, but it doesn’t mean that the funding of their public pension fund is sustainable, if the cost to administer the plan becomes onerous for the sponsoring entity. We’ve certainly witnessed the freezing of DB plans within the public sector, and it could continue to happen if changes aren’t adopted. I frequently rail about the traditional approach to asset allocation that has 100% of DB plan asset bases on a rollercoaster ride to reach an ROA target in which they ride markets up and then down only to basically stay in place from a funding standpoint – but contribution expenses certainly don’t!

If plans really want to become sustainable, and we certainly need them to be, they need to adopt as their primary objective the securing of the promises that have been given to their plan participants. Riding the rollercoaster in pursuit of a return objective has only ensured volatility of the funded ratio and contribution expenses. It hasn’t guaranteed success in meeting the objective, which is the securing of the benefits at a reasonable cost and with prudent risk. Why do plan sponsors continue to pursue a return objective and all the volatility surrounding that pursuit when there are strategies that can be used, for at least a portion, if not all, of the assets, that would bring certainty to the process of managing pension plans. A sustainable approach, I might add.

I read a post from a friend of mine yesterday (thanks, Chris), in which he showed a chart from BofA Research that looked at the price to normalized EPS for the S&P 500 over 10-year periods. BofA is forecasting a 3% per annum return for the 10-years ending 2034. Oh, wow! That isn’t going to help pension funding if it is anywhere close to reality. As the chart below suggests, the reality hasn’t been much different from the forecast.

So, what can plan sponsors do to make up for the potential shortfall? There is some great news. If you desire a more attractive return than a potential 3% per annum for the S&P 500, with all of the corresponding annual volatility, you can reallocate your bond exposure from a ROA return focus to a cash flow matching (CFM) mandate that will fund and match the plan’s liability cash flows. By securing the liabilities chronologically, you buy time for the residual (alpha) assets to grow unencumbered as they are no longer a source of liquidity. Importantly, once you match the asset cash flows (interest and principal) with the benefits (and expenses) you mitigate interest rate risk, while working to stabilize the funded status and contribution expenses.

Bringing some certainty to a very uncertain process is the ultimate in sustainability. Given how challenging many American workers are finding the management of a defined contribution offering, protecting and preserving defined benefit plans should be in everyone’s best interest.

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

Milliman has once again provided perspective on the “average” public pension system with the release of the Public Pension Funding Index (PPFI), which analyzes data from the nation’s 100 largest public defined benefit plans. January’s result has the Milliman 100 PPFI funded ratio declining slightly from 78.2% at the end of 2023 to 77.7% as of January 31, 2024.

They attribute the decline to flat investment gains (-$11 million in market value), -$9 in net negative cash flow, and a slight increase (?) in the value of plan liabilities resulting in a change in funding by $33 million. The current funding gap of the index constituents is now -$1.4 trillion. But is that really what took place in January? We know that pension liabilities are bond-like in nature and move up and down with changes in US interest rates. The US rate environment changed quite a bit in January as yields moved higher across the US Treasury yield curve. Unfortunately, because most public plans are using their return on asset assumption (roughly 7%) to discount the plan’s liabilities, changes in interest rates are not reflected in the calculation of a plan’s liabilities.

How meaningful can the difference in accounting rules be among corporate and public plans? Just take a look at the Ryan ALM Pension Monitor for calendar year 2022, and you’ll note that the difference was substantial. In fact, both types of pension plans investing in the same markets, with reasonably similar asset allocations, had starkly different outcomes (a 32.1% difference!) as a result of the accounting rules used. Furthermore, Milliman reported that corporate plans actually showed improved fund ratios in January as a result of the discount rate change on plan liabilities. “The PFI projected benefit obligation, or pension liabilities, decreased to $1.316 trillion at the end of January 2024 from $1.337 trillion at the end of December 2023. The change resulted from an increase of 14 basis points in the monthly discount rate, to 5.14% for January from 5.00% for December 2023.” (Milliman)

Ron Ryan wrote an incredibly insightful book titled, “The US Pension Crisis” in which he placed appropriate blame on the accounting rules and the differences in how pension liabilities are calculated between FASB (corporate) and GASB (public) methodologies. Why these differences exist is beyond me, especially when one also understands that there exists a third methodology (IASB) that uses an even more conservative standard to measure a plan’s liabilities. Managing a pension plan is not easy, especially when the true value of a pension plan’s liabilities is unknown.

So, January was good for Corporate America’s pension funding, but bad for Public pension plans. With US interest rates having risen sharply since March 2022, the value of plan liabilities is closer to reality, but there still exists a gap today. It would be wonderful if the actuarial profession could agree on one methodology so that we didn’t get conflicting outcomes on an ongoing basis.

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

In a country as divided as ours, it is incredibly rare when one sees such unanimity as 83% of Americans believing that all workers should have access to a pension plan. This result is according to a recent study conducted by the National Institute on Retirement Security (NIRS). According to the survey, the American worker is not confident in the least that they will enjoy a dignified retirement given the current state of affairs.

According to NIRS, “Eighty-three percent of Americans say that all workers should have a pension so they can be independent and self-reliant in retirement, and more than three-fourths of Americans agree that those with pensions are more likely to have a secure retirement.” Imagine that, a super majority of American workers want access to a pension plan so that they can be independent and self-reliant! They aren’t looking for a handout from the federal government, but that is what they’ll be forced to incur should our retirement industry continue to fail our workers.

Furthermore, “79 percent of Americans agree there indeed is a retirement crisis, up from 67 percent in 2020. More than half of Americans (55 percent) are concerned that they cannot achieve financial security in retirement.” Not shocking that a majority of Americans are concerned about achieving financial security. A good chunk of our working population doesn’t have access to an employee-sponsored plan and when they do, most workers can’t put in nearly enough to achieve the financial independence that they desire. These findings are detailed in a new report from the National Institute on Retirement Security (NIRS), Retirement Insecurity 2024: Americans’ Views of Retirement. The report findings are based upon a national survey of working age Americans conducted by Greenwald Research.

There is also great anxiousness involving the securing of Social Security. More than 90% of the respondents to the survey believe that securing SS needs to be a priority for the next administration. SS is a critical benefit that currently supports >67 million Americans. In many cases, SS is the only source of funds for older Americans. I am incredibly concerned about the lack of retirement progress in this country. DB plans need to be the backbone of any retirement system, as asking untrained individuals to fund, manage, and disburse a “benefit” is just poor policy.

I’m less concerned about our government’s ability to continue to fund SS given our fiat currency. I am concerned that those in Congress don’t necessarily understand our monetary system and will enact unnecessary changes in order to fix something that isn’t broken.

Defined benefit plans were once used effectively by corporate America to attract and retain talent. They were a tool to manage a workforce from the initial hire to retirement. By migrating from DB to DC plans, corporate America has lost that ability, as the American worker now goes up and down the elevator with their “retirement” benefit in their back pocket. There are investment strategies that can be deployed to reduce the volatility of the funded status and contribution expenses that worked against retaining DB plans. Will DB plan asset allocations finally take advantage of these investment ideas to get off the performance rollercoaster? I significant majority of Americans sure hope so!

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

Good morning, and welcome to the last week of February. Wow, this month seems to have flown by.

With regard to the PBGC’s implementation of the ARPA legislation, activity is picking up. There were five applications submitted through the PBGC’s portal. These included 3 Priority Group 6 members and two funds without a priority designation. The five funds are the Retail, Wholesale and Department Store International Union and Industry Pension Plan (the initial application), the Bakery and Confectionery Union and Industry International Pension Fund, United Food and Commercial Workers Unions and Employers Midwest Pension Plan, the Radio, Television and Recording Arts Pension Plan, and the GCIU-Employer Retirement Benefit Plan.

The five plans are seeking $5.5 billion in SFA for slightly more than 200k plan participants. The Bakery and Confectionery Union is seeking nearly 60% of the $5.5 billion in SFA grant money. The Bakery and Confectionery Union cooked up applications in March 2023, October 2023, and again in February 2024. Hopefully, they have the right recipe this time.

In other news, there were no applications approved, but the Laborers’ International Union of North America Local Union No. 1822 Pension Fund did receive the SFA payment of nearly $16 million for its 525 participants. Fortunately, there were no applications denied and none were withdrawn.

The US interest rate environment continues to be favorable for plans receiving SFA grants, as higher rates mean that the future benefit payments can be defeased at lower cost. Given the strength of the economy and labor force, it is less likely that the US will experience a recession keeping the current rate environment higher for longer.

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

I’ve been asked to speak to this topic on many occasions. In one such case, the IFEBP conference in October 2017, I returned to New Jersey and penned a post on the subject. In reviewing what I wrote that day and where we are today, I have to ask: What has changed? We are nearly 6 1/2 years removed from that event, but one needs to ask have pension asset allocations truly evolved.

For most plan sponsors and their consultants, the concept of “Advanced Asset Allocation” has to do with altering exposures to one asset class or style category (growth vs value) versus another. The adjustments often result in token shifts of 2-3% from one asset class to another. Is that really an advanced asset allocation discussion? Does the inclusion of private debt or equity really support the concept of a dramatic improvement in asset allocation, especially when one contemplates that these strategies come with higher fees, a lack of transparency, and poor (non-existent) liquidity? NO!

The problem with most asset allocation frameworks is that they focus attention on returns and not nearly enough on the benefit promise that has been given to the plan participant. With a focus on the return on asset assumption (ROA), volatility of the funded status and contribution expenses is assured, but the full funding of the plan is not, as we continue to ride the asset allocation rollercoaster up and down. Currently, the cars on that rollercoaster are making their way up, but who knows when the peak will be breeched and the cars will once again plummet, leading to further funding shortfalls and the need to get more aggressive with the return target and composition of the portfolio.

I don’t believe that approaches to pension asset allocations have changed much, especially among public pension systems. Sure, there have been moves among the asset classes, especially from public markets to private, but does that highlight an advancement? I suggest that it doesn’t. However, we have witnessed the markets change quite dramatically. We currently have a US interest rate environment that we haven’t experienced in two or more decades. In addition, we have a US equity market that is experiencing an “unprecedented” concentration in leadership (Tech) that is leading to persistent underperformance by active managers trying to eclipse the S&P 500’s return. Furthermore, we’ve had significant assets moving into private debt (>$3 T) at a time when higher rates may create problems for the companies trying to cover their interest expenses. Do you want to discuss real estate or private equity that have their own issues at this time? Does shifting marginally among these asset classes protect the funded status of the pension plans?

An advanced asset allocation framework would be one that gets the pension system off the performance rollercoaster. It is one that SECURES the promised benefits at both a reasonable cost and with prudent risk. It is one that stabilizes the funded status and contribution expenses. It is one that creates a liquidity profile that ensures that monthly benefit payments and expenses are met without having to liquidate assets, perhaps during periods of market disruption. Importantly, having an enhanced liquidity profile buys time for the remainder of the assets – presumably the fund’s alpha assets – to now grow unencumbered, as they are no longer funding monthly payments for several years or more.

Furthermore, an advanced asset allocation strategy understands that a pension plan’s liabilities need to be the focus of any asset allocation framework. Those liabilities need to be measured, monitored, and managed. A once per year, at best, review of the plan’s liabilities doesn’t accomplish the objective. Could you play a football game without knowing how many points your opponent has scored? Of course not! Then how can you manage a pension plan without knowing how the plan’s promises (liabilities) are behaving?

Having an advanced asset allocation that factors into the equation both liabilities and risk doesn’t mean that 100% of your assets have a new mandate. The funded status and the sponsoring entity’s ability to contribute will provide guidance on just what percentage of your assets will be impacted. There is no excuse for a plan with a 60% funded status to have the same asset allocation and ROA as one that is 90% funded. Yet, we see this all the time when both plans are striving for the same or similar ROA.

We, at Ryan ALM, Inc. understand and preach advanced asset allocation strategies. Our cash flow matching (CFM) capabilities become the backbone of the new asset allocation framework. CFM provides the necessary liquidity, while buying time for the alpha assets (non-bonds) to meet future liabilities. Our approach actually secures the promised benefits. This is a “sleep well at night” process that brings certainty to a very uncertain environment. We’d be happy to do a free analysis for you to highlight what can be done to truly create an advanced asset allocation framework.

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

The Milliman organization has just released its year-end “results of its Multiemployer Pension Funding Study (MPFS), which analyzes the funded status of all multiemployer defined benefit pension plans in the United States, based on data and assumptions from these plans’ latest Form 5500 filings.” The analysis covers 1,207 multiemployer plans. 

It is not surprising to see dramatic improvement in the aggregate funding of these plans given the strong performance of markets in 2023 and the continuation in providing Special Financial Assistance (SFA) grants under ARPA. How dramatic was the improved funding? According to the study, Milliman estimates that the aggregate funding is now at 89% up from 79% at the end of December 2022. As I report on a weekly basis, 70 multiemployer plans have now received more than $54 billion in SFA, with more than 120 plans still expecting to receive an SFA grant before the program ends in 2025. Without these grants, aggregate funding would fall to 83%. ARPA is proving to be such an incredible lifeline to these troubled plans and the participants that are counting on receiving their earned benefit.

According to the analysis by Milliman, 37% of the plans are at 100% funded or greater, while 78% have a funded status at or >80%. Given that there are still more than 100 pension systems expecting to file for SFA, it isn’t surprising that a small subset of multiemployer plans (9% are at <60%) are still struggling.

Just as we have suggested for those plans receiving SFA grants, we’d say the same thing to those plans with a funded status >100%. Now is NOT the time to take risk given so many cross-currents in the economy and markets. Multiemployer plans receiving the SFA can secure the promised benefits within the segregated bucket by using a cash flow matching (CFM) strategy to defease those promises as far into the future as the grant goes.

For those plans enjoying a fully funded status, bifurcate the plan’s assets into liquidity and growth buckets. The liquidity bucket will also be a defeased bond strategy that secures the promises as far into the future as the allocation goes. The remaining assets now have the benefit of an extended investing horizon. Should markets wobble once again, the growth assets will no longer be a source of liquidity to meet benefits and expenses, and as such, they can continue to grow unencumbered. Subjecting 100% of the assets to the performance rollercoaster created by traditional asset allocation strategies is not prudent.

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

Having spent more than four decades in the investment pension/industry, I’ve seen more than enough cycles to know that history does repeat. The specifics of the trend/cycle may be different from one event to the next, but the outcomes are normally quite similar. Nothing in our industry stays at equilibrium. Valuations matter and they move from one extreme to another on a fairly continuous basis. We may be nearing a peak once again within the S&P 500’s sector weightings. I’m specifically referring to the weighting of the tech sector (information processing to be more precise).

Source: @liamdenning, @opinion

As the above graphs highlight, we are once again witnessing tremendous exposure within the S&P 500 to information processing. The last time that this sector’s weight eclipsed 30% of the index was just before the Tech bubble burst. Again, it is different. Companies within this sector have great businesses and actual earnings but do they have valuations that can justify the current stock prices? Perhaps we’ll find out more this afternoon when Nvidia announces their latest results.

In any case, it seems a bit shocking to me that Nvidia’s capitalization is now greater than that of the entire S&P 500 Energy sector. Furthermore, only Energy and Utilities have a forward P/E multiple that resides below the average for the last 25-years as reflected in this FactSet chart.

We are all taught the importance of buying low and selling high, but most of us get caught up in the excitement of today’s “story” failing to realize that momentum is created by cash flows moving into that theme and that they will eventually peak. It is at that time that Momentum as a factor can reverse quickly. Need we remind you that the NASDAQ 100 declined by 83% from its peak in March of 2000.

The S&P 500 was the place to invest last year. It wasn’t that great the year before (2022). Where will 2024 take us? I wish that I knew. I can tell you that these rollercoaster events are not good for a pension plans funded status or contribution expenses. Adopting a focus on the ROA and not securing the promised benefits has created an asset allocation framework that guarantees volatility, but not necessarily a successful outcome. Securing the pension promise (benefits) at a reasonable cost and with prudent risk does! Why continue to ride the asset allocation rollercoaster for all of the plan’s assets? Given the valuations highlighted above, there doesn’t seem to be a lot of “value” investing in the S&P 500 at this time. Remove some risk and create greater certainty by defeasing a portion of your plan’s liabilities. Not only will you secure those benefits, but you will extend the investing horizon for the remainder of the assets so that they can successfully wade through potentially choppy markets. It is a “win/win”.

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

We hope that you enjoyed your President’s Day. I remember way back in my grammar school years getting both Lincoln’s (2/12/1809) and Washington’s (2/22/1732) birthdays off from school. However, that fun was squashed in 1971, when the Uniform Holiday Act was passed by Congress, which moved some federal holidays to specific Mondays. Thus “President’s Day” was created as the third Monday in February.

As for the ARPA legislation, the PBGC didn’t quite open the floodgates, but they did allow the application portal to open wide enough to allow four initial applications to be submitted. These plans included, the Carpenters Pension Trust Fund – Detroit & Vicinity, Pension Plan for the Arizona Bricklayers’ Pension Trust Fund, Pension Plan of Local 102, and Maryland Race Track Employees Pension Plan. These funds are all non-priority group members. There have now been 27 plans from the waiting list to see some action in the ARPA process. As a reminder, there are 111 pension funds that were non-priority members.

For those four applications, the plans are seeking a combined $642.7 million in Special Financial Assistance (SFA) for their more than 25k plan participants. In other ARPA happenings, there were no applications approved or denied, and only one plan withdrew its application. The America’s Family Benefit Retirement Plan, a Priority Group 1 member, withdrew the revised application on February 13th. They are seeking $188 million in SFA for 3,109 members. As a reminder, Priority Group 1 members began filing applications in July 2021. Twenty-four of the 30 expected Priority Group 1 members have received approval and SFA funding to date.

US Treasury yields have risen by more than 30+ bps across the yield curve since the beginning of 2024. These elevated yields help reduce the present value (PV) cost of those future benefit payments. Cash flow matching strategies will take advantage of these higher yields and lock-in the savings (cost reduction) as soon as the asset cash flows from bonds (principal and interest) and the liability cash flows (benefits and expenses) are matched. 

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

The WSJ recently produced an article that highlighted the US economic activity relative to the other leading developed nations of Europe and Asia, with a particular focus on both the UK and Japan. In the case of Japan, which suffered an economic contraction over the latter part of 2023, its economy saw GDP growth contract by -0.8% in Q3’23 and -0.1% in Q4’23. This economic weakness has resulted in Japan falling to fourth place behind Germany in a ranking of economic powerhouses with a GDP of roughly $3.9 trillion. At the same time that Japan was witnessing weakness, the UK’s “statistics agency Thursday said gross domestic product fell at an annualized rate of -1.4% in the final three months of 2023.”(WSJ)

At the same time that these “leading” economies were experiencing economic contraction, the US was defying expectations posting a 3.3% GDP annualized growth rate in the fourth quarter. Why? All three economies have tight labor markets which would normally lead to economic expansion and not contraction. In fact, US and UK wage growth is finally eclipsing inflation, while Japan’s wage growth still lags. So, why is the US outperforming these other economies to the extent that they are? I believe that it is the US government’s deficit spending that is providing the stimulus necessary to keep the consumer demanding goods and services at a far greater extent than in Japan and the UK. According to the WSJ, they agree, stating that “government spending in the U.S. has also remained at historically high levels for periods outside of recessions, giving the economy an added boost.” 

As I’ve mentioned before, the US deficit (currently at $34 trillion) is an asset of the private sector. The ability of the US to deficit spend is an economic driver. The debt is actually “income” which is providing stimulus on top of what is being created by the private sector. The US deficit in fiscal year 2023 was $2 trillion. That is tremendous stimulus. So, the US is NOT facing a “debt crisis”, but a potential issue of greater inflation if the US economy cannot match the enhanced demand for goods and services through production created by this government stimulus.

Those expecting US rates to fall because of a looming recession have not appropriately considered the significance of the government stimulus. Instead of this debt being a burden it is economic rocket fuel. Furthermore, US rates remain low relative to history. The 10-year Treasury yield averaged approximately 6.5% from 1971 to 2021. Today, the yield on that note is only 4.31%. Furthermore, Yardini Research, Inc. has produced a long-term chart that indicates that the “real return” on the 10-year Treasury has been just over 3%. Today, the “real yield” is about 1% based on the latest CPI reading of 3.3%. Prognostications of 6-7 rate cuts for 2024 are appearing silly at this time. Inflation targets haven’t been achieved, US interest rates are not stifling economic growth, and the US government debt is not a burden but a driver of economic activity.