When multiemployer pension funds submit an application for Special Financial Assistance (SFA), the PBGC has 120 days to act on said application. It just so happens that there are 12 applications that are hitting the 120-day threshold this week with 7 of those slated for today (12/6). This is potentially a tidal wave of activity for the PBGC, which has been handling 1-2 a week, at most. Based on the PBGC’s files, 11 of the 12 applications are supplementing previous submissions. The one non-supplemental application is the massive Central States, Southeast & Southwest Areas Pension Plan, which is seeking nearly $35 billion in SFA support for its roughly 365,000 participants. To put the size of the Central States’ request into perspective, the $35 billion is nearly 4 times greater than the $8.9 billion paid out to date, and it represents just under 40% of the anticipated SFA distributions for the whole ARPA program.
We believe that the applications are approved if no action is taken within the 120 periods. It could be an exhausting week for the team at the PBGC. In any case, it will be a great week for those plans that have asked for additional resources to support the promises made to the plan participants.
With the tryptophan effects finally wearing off, the PBGC is reporting that 2 pension plans – The Defined Benefit Plan for the Operative Plasterers’ and Cement Masons’ International Association Local Union 394 Pension Trust Fund (may just be in the running for the longest pension fund name) and the Retail Clerks Specialty Stores Pension Plan – have filed their initial applications for Special Financial Assistance. These plans are the first of the Priority Group 5 members to file. As a reminder, Priority Group 5 plans are those that are projected to become insolvent before 3/11/2026.
Combined, these plans provide retirement benefits for 1,743 participants. They are seeking $65.7 in SFA. The PBGC is currently reviewing 42 applications, many of which are supplemental filings. Happy to report that there were no applications denied or withdrawn during this most recent weekly period. In addition, the Local 966 Pension Plan, had its SFA application approved. They will receive a little more than $54 million for the 2,356 plan participants.
The information in the chart above does not include supplemental applications
Most fixed-income managers are required to outperform a generic market index benchmark. Usually, it is one of the Lehman, now Bloomberg Barclay’s (BB), indexes designed by Ron Ryan when he was the Lehman Director of Fixed Income Research from 1997-1983. As a result, fixed-income managers have to be concerned and focused on anything that affects the pricing of these bonds such as:
Interest rate sensitivity – bonds are extremely interest rate sensitive which usually accounts for over 90% of their total return. Interest rates are extremely volatile and uncertain not only in levels but in the shape or slope of the yield curve. Speculating on interest rates has been a difficult, if not a losing proposition, for many bond managers so they tend to become closet index fund managers by not straying from the interest rate sensitivity of these indexes… like doing key rate duration matching.
Credit ratings – This is a daunting and constant vigil exercise. S&P, Moody’s, and Fitch tend to upgrade and downgrade 100s of credit ratings each year. Such credit changes lead to bond price changes and total return effects. Fortunately, this volatility of credit changes has not been translated into defaults in the investment-grade corporate bond universe. According to the S&P 2022 Global Default Study, there have been only 4 investment grade defaults since 2010. However, bonds have historically been downgraded to high-yield status (BB, B, CCC) before going into default status.
Call features – since bonds were in a bull market from 1982 thru 2021, many bonds are priced at a premium and are targets of being called. This will reduce the yield and the total return of these bonds.
Total return volatility is in sharp contrast to what Cash Flow Matching (CFM) or Cashflow Driven Investments (CDI) strategies are focused on. CDI is focused on funding benefits in a cost-efficient manner with prudent risk. Benefits are future value payments and as such… benefits are not interest rate sensitive. CDI’s concerns are liquidity and solvency. Liquidity is produced by creating monthly cash flows (interest and principal) that match and fund monthly liability cash flows (benefits + expenses). Fortunately, solvency is a hallmark of investment-grade bonds as the S&P study proves. Ryan ALM further assures solvency thru a series of credit filters such as:
Must be investment grade in the Bloomberg Default Probability rankings
NO YTM outliers of >2 STDs from other credits with similar maturities
NO negative watch or outlook on Moody’s, S&P, and Fitch
NO Baa3 or BBB- bonds
If the true objective of a pension is to fund benefits in a cost-efficient manner with prudent risk… then the Ryan ALM cash flow matching product (Liability Beta Portfolio™) is the best fit.
OOPS! I guess that forecasts anticipating the “collapse” of the US labor market were a bit premature. The announcement that the US added 263,000 new jobs blew away forecasts. The fact that October’s job # was revised to 284,000 new jobs won’t help either. Wage growth increased to 0.6% for the month and last month’s # was revised up by 0.1%. Real Rates? We aren’t close to having real rates. As a result, interest rates are once again rising today after weeks of bonds rallying out of anticipation that the job market was weakening and as a result, the Fed would have to soon pivot. In a post that we recently produced, “Slowing? Possibly.” we highlighted that the Fed was continuing to focus on jobs, wages, and real rates and that a Fed pivot wasn’t likely at this time.
Unfortunately, others didn’t see it that way. It certainly didn’t seem to matter to market participants that the Fed has said repeatedly that they needed to see the EVIDENCE of a weakening labor market, lower wage growth, and a desire to raise rates until a level of REAL rates is created. Clearly, none of that has happened! Yet, until today both equity and bond markets rallied as if all of the Fed’s concerns had been realized. Again, I don’t believe that a Fed Funds range of 3.75% to 4.0% is going to dramatically thwart economic activity. Market participants need to move away from the concept that rates will remain low forever. This Fed seems hell-bent on not repeating the failures of the 1970s to early ’80s Fed two-step. Will market participants and forecasters finally believe this Fed?
Is bigger better? Do firms that have huge research staffs perform better than investment shops that don’t have the same internal resources? How do you know? Where do experience and expertise get factored in? Shouldn’t the firm with the greatest experience and expertise be favored… quality vs. quantity? Have you actually evaluated their security selection relative to a generic universe?
I ask these questions because we’ve had a number of meetings recently in which leading consulting firms have implied that Ryan ALM’s size (four senior asset managers with 168 years of combined experience) is an impediment to our ability to achieve the goals and objectives of a Cash Flow Matching mandate. With only one product (cash flow matching) Ryan ALM has a truly dedicated staff with a wealth of experience. We are asset liability management specialists as our name implies. When you need surgery, we assume you want a specialist to operate on your heart and not a general practitioner.
In one case we conducted a “lunch and learn” for a major consulting organization that asked us to present cash flow matching as they hadn’t been using the strategy since they favored duration matching. We were very pleased to present to roughly three dozen members of their team. Here is a bit of the feedback following our 1-hour meeting. “We appreciate you coming in person to teach and remind us about cash flow matching. A few of us agreed that the cash flow matching approach can be used to mitigate volatility in today’s environment”. However, “for now we are focusing on larger managers where we already have client assets.” My response was, why didn’t those larger managers take the time to remind you about the benefits of cash flow matching instead of doing what everyone else was espousing in terms of using duration matching?
In another meeting, we were told that Cash Flow Matching models are like commodities. That the real value add is in credit research. Really? Have you spent the time to examine the models? Did you ask to see the software that supports each optimization process? I would suggest that you present each of your manager candidates with the same set of liabilities (benefits and expenses) and ask that they produce a portfolio based on that information. I guarantee that there will be differences that might just prove to be substantial. The firm producing the greatest difference in cost between the future value (FV) of the benefits and expenses relative to the present value (PV) cost has the most efficient model. These systems are not commodities! If that were the case, every fixed-income shop would be claiming to have this capability, especially in this market environment in which total return fixed-income products have produced significant negative performance, and will continue to be under pressure as the Fed further tightens rates.
With regard to internal credit research, how valuable is that firm’s investment in internal talent when investment-grade bonds have experienced minimal credit risk during the last four 4 decades? Unlike total return-oriented bond portfolios, duration matching and cash flow matching should be concerned about solvency since you can hold the bonds for a long horizon… maybe maturity. Ryan ALM has had no defaults under our proprietary credit filtering system since our inception in 2005. Have you asked those firms with big internal research departments to provide the value-added achieved from their “greater” security selection? It would be very simple to ask for the performance of their bond universe and then ask for the performance of the subset that was used to construct the client’s portfolio. My guess is that the “value-added” will be quite insignificant. It would likely be insignificant relative to what a firm using the output from the credit agencies, Bloomberg, and other readily available quantitative and qualitative inputs could achieve. Furthermore, human beings possess 23 behavioral traits, many of which work against us as “investors”. It takes a contrarian view to make money yet being a contrarian is very challenging, and has been described as being as painful as chewing off one’s left arm!
As the chart below suggests, there are very few individuals who truly possess the ability to add value through security selection. In this example, we are highlighting the inefficiencies of stock pickers. Do you think that bond managers/analysts have greater skills? I would suggest that the much smaller standard deviation among like bonds makes the task that much more challenging.
In my 41 years in this business, I’ve come to appreciate that there is a natural capacity associated with every investment strategy. Many of the larger firms in our industry have far eclipsed that capacity and as a result, they ultimately arbitrage away the potential value added from their insights. What they’ve proven to be is mostly effective sales organizations. In today’s challenging market environment, we need real solutions provided by true specialists. Size doesn’t matter, but capability and execution do!
I hope that you had a wonderful Thanksgiving holiday.
We are pleased to provide the weekly update on the PBGC’s activity as it relates to the ARPA legislation. As one would imagine, activity during the holiday week was tame, as only one fund, Bricklayers Union Local No. 1 Pension Fund of Virginia, submitted a revised application seeking $12.7 million for the plan’s 395 participants. The initial application was filed on June 30, 2022. The PBGC has until March 23, 2023, to act on the application.
In other ARPA news, there were no applications denied or withdrawn during the previous week. Two plans, Teamsters Local Union No. 52 Pension Fund and the New York State Teamsters Conference Pension and Retirement Fund are waiting to receive the SFA that was approved earlier this month. Local 52 is expecting to receive nearly $85 million for its 769 participants, while the NYS Teamsters are approved for more than $963 million for their 33,643 participants.
The chart above is as of November 25th. To date, 35 funds have been approved to receive SFA (not counting supplemental filings) for a total of $8.9 billion. There is still much work to be done by the PBGC, as they anticipate as many as 252 additional funds will be eligible to eventually file for the legislation’s Special Financial Assistance.
With great anticipation, the Federal Reserve’s notes from the November 2nd meeting were released at 2 pm EST. Immediately, both equity and bond markets rallied. I was sure that there must have been language in the notes that indicated that the Fed had come to the conclusion that they had accomplished the objective of containing inflation and that the “great pivot” was about to begin as inflation neared their 2% target. But no! What they said, was “a number of participants observed that, as monetary policy approached a stance that was sufficiently restrictive to achieve the committee’s goals, it would become appropriate to slow the pace of increase in the target range for the federal funds rate.” But that doesn’t mean stopping the increases. It also doesn’t mean that the Fed believes that it has accomplished its goal. In fact, FOMC members said inflation was “unacceptably high” and “well above” the committee’s longer-run 2% target, the minutes showed.
Why the rally? How does this change anything that was already anticipated? Whether the increase is 50 bps or 75 bps, the Fed will continue to raise rates. Despite the majority opinion that a tempered pace may be more acceptable, “A few other participants noted that, before slowing the pace of policy rate increases, it could be advantageous to wait until the stance of policy was more clearly in restrictive territory and there were more concrete signs that inflation pressures were receding significantly,” What can the Fed point to at this time that clearly demonstrates that the tightening to date has worked? Sure, mortgage applications have fallen, but new home sales exceeded expectations by 62K in today’s release. The labor market is still strong, despite a slight increase in the initial unemployment claims data that was also released today (up +15,000 over expectations).
“With inflation remaining stubbornly high, the staff continued to view the risks to the inflation projection as skewed to the upside,” according to the minutes. With so much uncertainty, shouldn’t plan sponsors of DB plans seek alternatives to asset allocation strategies singularly focused on the ROA? Why not devise a strategy that improves liquidity in the short-term, while extending the investment horizon for those alpha assets that need time to achieve their long-term potential? Doing the same old, same old has never been a winning strategy. Given so much uncertainty in today’s investing climate, it is doomed before it begins.
I don’t know Bob Michele, JP Morgan’s CIO for fixed income, but I absolutely agree with his sentiment when he said on Bloomberg Television’s “Wall Street Week” that “bonds are back”! He said, “Every wealth-management platform in JPMorgan, every institutional client — they’re coming to us, they’re putting money in bonds.” Clearly one of the reasons for his and his clients’ excitement has to do with the dramatic increase in yields this year. The BB Aggregate Index is currently yielding 4.75% up from roughly 1.75% at the start of 2022. What he failed to mention was the fact that return-seeking fixed-income strategies benchmarked to the Agg. have produced a nearly -13% year-to-date return.
We, at Ryan ALM, love bonds, too, but we don’t believe that they are performance drivers. Importantly, they are income producers. Bonds are the only asset class with a known terminal value and semi-annual cash flows. Given the uncertainty in the markets due to Fed policy, we believe that those bond cash flows should be used to secure a defined benefit plan’s promised benefits (and expenses). We don’t know where interest rates will be in the near future. But we do know that pension plans have a monthly obligation to make benefit payments. Establish a liquidity portfolio through a cash flow matching product using bonds that will make sure that the cash necessary to fund those promises is there.
We appreciate Mr. Michele’s enthusiasm for bonds but understand that a rising rate environment will negatively impact the price of bonds. As a reminder, a bond with a 10-year duration will suffer a -10% price loss for every 100 bps move up in rates. We’ve had several Fed Governors suggest that Fed Funds rates need to rise significantly above their current level to achieve real rates with an inflation premium. Return-seeking fixed-income strategies will get hurt. Cash flow matching eliminates interest rate risk, as future values are not interest rate sensitive while buying time for the plan’s alpha assets to grow unencumbered. This is the epitome of a “sleep well at night” strategy. Go bonds!
As we begin this holiday week, we at Ryan ALM, Inc. wish you and yours a very Happy Thanksgiving!
The window has been opened for Priority Group 5 multiemployer pension plans (effective November 15th). Did any of those plans take advantage of the opportunity? Simply put – no! Actually, there were no new or supplemental applications filed in the last week. We are happy to report that two plans, Teamsters Local Union No. 52 Pension Fund and the New York State Teamsters Conference Pension and Retirement Fund had their revised applications approved. Both of these plans were Priority Group 2 members (MPRA suspension and Critical and Declining) that will receive $84.9 and $963.4 million, respectively. They join the Bricklayers and Allied Craftsmen Local 7 Pension Plan as the only three approved plans that have yet to receive the SFA funds.
As a reminder, the PBGC is anticipating that as many as 15 Priority Group 5 plans will file. The Priority Group 6 members must wait until that window becomes ajar currently slated to occur on February 11, 2023.
US capital markets remain in a state of flux as US Federal Reserve action continues to put pressure on interest rates as they attempt to thwart decades-high inflation. Forecasts as to the eventual peak in inflation, US rates, and stock and bond performance range broadly, as you can imagine. Given this great uncertainty, we continue to believe that pension systems receiving the SFA are best served by defeasing pension liabilities with bond cash flows of principal and interest. Securing the promised benefits was the original intent of the ARPA legislation. It is by far the most fiduciarily prudent implementation.
Early this week I published a post titled “I Don’t Get It”, in which I questioned the incredible reaction of market participants to last week’s modest improvement in the inflationary environment. Please understand that I’m not rooting for high inflation, rising rates, and falling returns for both equities and bonds, but I am questioning the reaction of market participants to the current events. Every article that I have read and continue to read that cites comments from US Federal Reserve Governors supports the notion that there is NO PIVOT in our immediate or near-term future. The language being used seems to be fairly straightforward English. There is no “Fed speak”. Yet, there seems to be a great expectation among market participants (perhaps hope) that the Fed will soon declare victory! They will soon announce that everything that they had set out to tackle has been accomplished. Inflation has been tamed and the Fed’s 2% target has been met. Victory is ours!
Yet, as much as I would like to believe that I don’t think that the Fed is close to accomplishing what they set out to achieve. I don’t believe for one minute that they will soon divulge that they were only kidding that their mandate was to tame inflation down to a 2% level. You see, with the CPI sitting at 7.7% and the core inflation rate at 6.3%, they haven’t gotten to a level of “real” rates – not even close. Furthermore, with US Treasury Bonds, Notes, and Bills rallying during the last month, the Fed’s job has gotten harder in its attempt to tamp down inflation. How much economic activity will truly be thwarted by a Fed Fund’s Rate with a range of 3.75 to 4.0%? Remember, in 1980, when we last experienced the ravages of high inflation, US interest rates reached double digits and the Fed Fund’s Rate hit 20%! Furthermore, US unemployment was nearly 10% and not the 3.7% level that we currently sit at.
So, if you don’t believe me, here is a bit of sobering commentary from St. Louis Fed President James Bullard who said, “interest rates have not reached a level that could be justified as sufficiently restrictive, even with generous assumptions.” Furthermore, “to attain a sufficiently restrictive level, the policy rate (Fed Fund’s Rate) will need to be increased further”. He went on to say that the FFR would need to reach a minimum of 5% and possibly as high as 7%. There shouldn’t be any misunderstanding with what he’s said, and his fellow governors have been sharing similar expectations/thoughts.
I suspect that nearly 40 years of Fed easing could possibly blind some people to the fact that US Fed policy isn’t always accommodative. The road to ZIRP contributed significantly to our current inflationary environment. It is highly unlikely that this Fed makes a U-turn back onto that path. They seem singularly focused on not repeating the mistakes of the Federal Reserve during the 1970s. If that is true, brace for higher rates, choppy markets, and an inflation struggle that takes longer to rein in.
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