Today was the day that I was supposed to be at FRA’s “Made In America” conference in Las Vegas.  Ironically, the title of our panel discussion is “Digging Out Of Your Underfunded Status”. There certainly is a lot of digging our going on in the Northeast, but regrettably it has little to do with funded ratios or funded status for Pension America.

The basis of my presentation today was to focus on the need to first stabilize the plan through some fairly simple steps, but one’s that throw common pension orthodoxy out the window. So in that regard, not simple at all, as we are finding that there is great reluctance (inertia) to change one’s approach.

At KCS, we are espousing a three step approach to setting DB pension plans on the right course to improved funding.  The process begins with a thorough analysis of the plan’s liabilities through the creation of a Custom Liability Index (CLI). This index utilizes readily available data from a plan’s actuary, but instead of getting an annual look at your liabilities through the actuarial report, a plan sponsor can get a monthly view through the CLI.  The CLI will showcase the growth rate, interest rate sensitivity, and the term-structure of the plan’s liabilities.

With this output, we can determine how much alpha is needed relative to the liabilities, not the plan’s stated return on asset objective (ROA), in order to close the funding gap over the modified duration of the plan’s liabilities. Furthermore, we can determine how much of the plan’s assets can be placed in the beta portfolio (a cash matched or duration matched strategy) to begin to immunize near-term liabilities.  The balance of the assets will be in the “alpha” portfolio with the goal, as stated before, of exceeding liability growth.

The final step in our process is to begin to implement our beta / alpha approach by converting the current fixed income portfolio, with all its credit and interest rate risk, into a more effective beta portfolio. With these three steps, the DB plan’s funded ratio will be stabilized, and the plan will now be on a glide path toward full funding, and contribution volatility will be lessened.

Unfortunately, current pension thinking would have one ratcheting up the ROA, jumping into new products / asset classes, trimming benefits, extending retirement age, lowering costs, etc., all in an attempt to stabilize the plan. Well, striving for the ROA has only lead to greater funding volatility, and given how the global markets have behaved so far in 2016, more volatility is not the medicine that we should be ingesting.

Click to access KCS4Q15.pdf

It seems almost silly that we are presenting you with a Fourth Quarter review for 2015 given what has transpired in the markets through the first 19 days of 2016.  However, we think that it is important that one understand that 2015 wasn’t as bad for pensions and Pension America as most people believe, and certainly not nearly as bad as 2014.

Why? Well, despite the significant underperformance of plan assets relative to DB plan ROA’s, assets actually modestly outperformed liability growth last year.  Thanks to Ron Ryan and his firm (Ryan ALM), we have a great understanding of what is happening to pension liabilities on a monthly basis, and you should, too. Unfortunately, most DB plans only get a yearly view on their liabilities, and then only valued at the ROA as the discount rate.

We hope that you continue to find our thinking on pension related issues useful.  As always, please don’t hesitate to call on us if we can be of any assistance.  You can also glean our insights from the KCS website, blog and social media accounts that are highlighted in the attached review.

May 2016 be a year filled with great health, much laughter, many friends, and peace!

Click to access KCS4Q15.pdf

The Kamp Family hopes that 2016 is a wonderful year for you, your family and friends.  May it be filled with much laughter, great health, calmer markets, and peace. 

Certainly global stock markets have gotten off to an ugly start in 2016.  Don’t panic! Maintain your long-term asset allocation policy, and since most equity-oriented assets have seen significant pullback, this means re-balancing back to policy normal levels. Why? There are significant regression to the mean tendencies in our markets, and as a reminder, it is much better to buy low and sell high.

This is not to say that our markets are stable, that equity markets can’t fall further from these levels, but we would caution you on selling into this weakness only to lock in losses that are only on paper at this time.  Furthermore, although the US economy appears to be slowing (Atlanta Fed is forecasting a 0.8% Q4’15 GDP growth rate), we do not see a recession in the foreseeable future, and significant market corrections are usually driven by recessionary environments.

Unfortunately, most of us have become traders instead of investors, and that goes for holders of mutual funds and ETFs and not just individual stock pickers.  Given the significant pullback in stocks associated with energy (-21% to as much as -47%, depending on the market capitalization index) and commodities ( -32.9% in 2015), and those impacted by the hit to energy and commodities, including emerging markets (-14.6% in 2015), miners, transportation companies, and MLPs (-32.6% in 2015), there are some significant dislocations that might just provide very attractive long-term opportunities.

If you already have a policy allocation to some of the above mentioned instruments / exposures, re-balance back to policy.  If you don’t currently have exposure to these potential investments now is a great time to begin educating yourself on the products available to you.  Don’t worry, they’ve been beaten down so badly that you won’t miss the opportunity, if you don’t get into them today.  Happy hunting!

Happy New Year! May 2016 be filled with great health, much laughter, and prosperity.

We are pleased to share with you the latest edition of the KCS Fireside Chat series, in which we present three of our top blog posts from 2015 based on viewership and comments.

Click to access kcsfcjan16.pdf

As you’ve come to know, we are not shy about suggesting alternative approaches to standard DB pension orthodoxy. We believe that it is imperative that new thinking be given serious consideration based on the current state of Pension America.

Please don’t hesitate to call on us if we can be of any assistance to you.

First, my colleagues at KCS and I would like to wish you and your families a very Happy New Year filled with great health, lots of laughter, and much prosperity!

2015 is over, and as you will soon find out, it was not a good year for DB pension plans.  This marks the second consecutive year in which pension funds have missed their ROA targets.  However, unlike 2014 when plan assets also dramatically underperformed liabilities, 2015 will likely reveal that most total funds were flat to slightly UP versus their liabilities last year.

That said, funded ratios likely fell since liabilities aren’t marked to market while assets are, and funded status likely further deteriorated, which will negatively impact contribution costs.  What, if anything, are you going to do about this?  Unfortunately, this trend has been evident for more than 15 years now, and nothing seems to have been done.

Well, something needs to be done! Striving to achieve the ROA has lead to asset allocation decisions that have greatly increased volatility, but certainly not the probability of success.  Adopting a strategy that pays heed to a plan’s specific liabilities, in addition to the assets, will likely lead to a very different asset allocation, especially within traditional fixed income.

Are you ready to learn more?

Following two straight years of sub par performance for DB pensions versus their ROA target AND Plan Liabilities, 2016 is going to be the year that Pension America embraces derisking as a prudent approach to the day-to-day management of plan assets.

Derisking can be achieved by any DB plan whether that plan is fully funded, well funded or poorly funded.  The idea behind derisking is to achieve a greater knowledge of plan liabilities, then using that insight to develop a sounder approach to asset allocation, investment management structure and cash flow (liquidity) management.

How does one gain greater transparency of plan liabilities? Through the creation of a Custom Liability Index (CLI), which uses the output of the annual actuarial report, but unlike the actuarial output, the CLI’s information is made available monthly or quarterly depending on the frequency that the client desires. With this greater insight comes the ability to adjust the playbook to meet the challenges of the current environment.

With regard to those challenges, 2016 is looking very much like a year in which both equities and bonds will likely produce modest results, at best, making the achievement of the ROA an even more difficult objective.  Furthermore, the volatility associated with traditional asset allocation models can lead to wide fluctuations in the performance of assets versus liabilities putting further pressure on funded ratios and cash flow.

Given that the US Federal Reserve has already moved on interest rates, traditional active fixed income will likely struggle to achieve a return commensurate with portfolio’s yield.  Sponsors should seek an alternative approach that works for the plan and not against it. What might that be? The strategy that we would suggest is Cash Flow matching, which can be done far more inexpensively than traditional fixed income (10 bps versus 25-30 bps). We also believe that the cash flow matching strategy is superior to duration matching, and may result in significant cost reduction. Have we grabbed your attention yet?

Regrettably, traditional ROA-centric approaches have not worked.  It is time to move onto a different course.  One in which a plan sponsor has greater knowledge of their liabilities, and uses that information to dynamically drive a responsive asset allocation and liability matching. Let us help you make 2016 a superior year for your pension plan.

As reported by P&I, defined contribution plans consistently underperform defined benefit plans, most likely due to higher investment fees, said a new research brief issued Tuesday by the Center for Retirement Research at Boston College. The report covered the period 1990-2012.

The BC report cited investment fees, which typically account for 80% to 90% of total expenses, as the most likely reason for DC plans’ underperformance as DC plans invest mainly through more expensive mutual funds and DB plans invest through other vehicles such as separate accounts and / or less expensive commingled trusts.

We would also suggest that a big reason for the underperformance of DC plans relative to DB plans is the reliance on the individual in the DC plan to handle this responsibility relative to professional management of DB plans.

Unfortunately, the report also found that individual retirement accounts (IRAs), which now hold more assets than DB or DC plans, produced even lower returns than DB or DC plans.

The report was based on a review of Investment Company Institute data and Form 5500 filings, which found that IRAs returned an average 2.2% per year between 2000 and 2012 , compared to 3.1% for defined contribution plans and 4.7% for defined benefit plans.

A DC plan account owner would have earned an additional $85,777 (on a beginning balance of $100,000) or 42% more by achieving a 4.7% return versus the 3.1% achieved on the average DC plans during this 23 year time frame.

The research report was written by Alicia Munnell, director of the Center for Retirement Research; Jean-Pierre Aubry, associate director of state and local research at the center; and Caroline Crawford, a research associate at the center.

The full report is available on the center’s website.

MLPs as an investment category have been whacked severely year-to-date according to the Alerian MLP Index, which has fallen 42.9% through December 4th! As a contrarian by nature, I am always looking to get into a potential investments that have gotten beaten up provided that nothing fundamentally has changed to permanently impair the investment category.

I am not close to being an expert in this area. So as I began to get more intrigued with MLPs I reached out to a friend, Jeremy Hill, Old Blackheath Companies, who is and who was kind to share his views.  Here you go:

As for MLPs, I don’t think there is much of a catalyst other than the stabilization of the price of oil. That seems odd because it assumes that pipeline capacity is a function of the price of oil. It is not. It is a function of how much oil is piped. So far, pipelines continue to be busy. Where the pipelines (MLPs) go wrong is that they have frequently become vertically integrated oil and gas companies that call themselves pipelines and they have a lot of debt. The idea that because the price of oil is down, less oil will be sucked out of the ground, therefore less oil pumped and piped and therefore less revenue/profits for the pipelines is intuitive. It is intuitive investing, not math-based investing.

Take a look at Kinder Morgan. Although they are not an MLP, they are lumped in with the MLPs. They cut their dividend severely and the stock is doing nothing but going up. For a pure reversion to the mean type of investment, I think KMI may be interesting at these levels. Their credits may be even more interesting. And, possibly selling puts could be a nice strategy for some of these companies.

The rub, of course, is that so long as investors (largely retail in MLPs) conflate the oil price/MLP equation, these stocks have a lot of embedded gamma risk. The real risk to these stocks is that banks stop financing them. I also think that there are likely to be more dividend cuts. In sum, I wouldn’t step into MLPs any time soon.

Thanks, Jeremy! We will continue to monitor MLPs for possible investment opportunities, but it looks like a 2016 event at this point.

We are happy to report that the Association of Benefit Administrators, Inc. has published an article by KCS in their Fall 2015 Newsletter.  The article, titled “The Truth Will Set You Free”, addresses the need for plan sponsors to focus more attention on DB plan liabilities to drive asset allocation and investment structure decisions.

We would be happy to send you the article upon request.