Having had the chance to speak at and attend 18 conferences in the last 13 months, I can tell you that there was near universal acceptance of the expectation that interest rates in the US and abroad were going up. The thought was that all of the stimulus provided by QE would have to create economic growth and inflation.  What happened?

As we witnessed during the first three months of 2014, interest rates for US Treasury bonds fell.  In fact, the yield on the 10-year fell 31 bps in the quarter, and the 30-year T-bond rallied nearly 11%!  Wow! Global growth is waning, many of the globe’s regions are experiencing extremely low levels of inflation, and high unemployment is lessening the demand for goods and services.  All of these factors, and more, are tamping interest rates. Today’s bond market activity is only further exacerbating this move.

As we wrote in early January, we think that DB plans should not reduce their current fixed income exposure, but reconfigure it.  Here is what we wrote earlier this year.  We still think it makes sense.

From the KCS Blog on January 9, 2014:

What I’d like to highlight today is a new use for a plan’s current fixed income exposure. In day two of the conference, I attended a panel discussion titled, “Opportunities in Fixed Income and Credit Markets”.  The panel was occupied by 4 senior investment pros (plan sponsor, consultant, and investment managers).  They generally discussed the likelihood that interest rates were going to rise (I’m beginning to wonder if there is anyone out their who doesn’t think that rates will rise), and the implications of that movement on traditional fixed income portfolios.  Most of the panelists talked about various sub-sectors (mortgages, asset backs, bank loans, etc) and which ones might hold up better. There was discussion about shortening duration, etc. They also talked about fixed income’s traditional role as an anchor to windward, a risk reducer, and a provider of liquidity.

However, only one individual mentioned taking a step back to truly contemplate the “role” of fixed income.  He didn’t provide any further perspective, which is why I’m addressing the issue here and today.  I believe (as do my partners at KCS) that a plan’s liabilities should be the focal point of any pension discussion.  As such, they need to be the primary objective for the plan, the driver of asset allocation decisions and investment / portfolio structure.  The asset class most similar in characteristic to liabilities is fixed income.  As such, fixed income needs to play a prominent role in a defined benefit plan.

Instead of worrying about the implications from a rising interest rate environment on an LDI strategy that currently consists of long duration corporates, change the emphasis to matching near-term liabilities, by converting your current fixed income portfolio into a Treasury STRIP portfolio that matches cash flows with projected benefits (Beta portfolio).  First, you are improving liquidity.  Second, duration is shortened in an environment that may not be conducive to long bonds.  Third, you are lengthening the investing time horizon for the balance of the corpus, which will allow asset classes / products with a liquidity premium a chance to capture that performance increment (Alpha portfolio). Finally, the funded status and contribution costs should begin to stabilize.  As the Alpha portfolio outperforms liability growth (hopefully), siphon excess profits and extend the beta portfolio.

This is a proactive move to restructure the fixed income portfolio in an environment of uncertainty.

Lastly, I am not of the general school of thought that interest rates are definitely going to rise, and soon.  I believe that we still have slack demand in our economy, brought on by underemployment, which will keep inflation in check and provide room for stable to slightly lower rates.

Too many of us take for granted that we will one day be able to retire, and retire with dignity!  Unfortunately, a proper retirement is becoming a pipe dream for most of us.  If you are among the select few in the private sector that receives the benefit from or currently participates in a defined benefit plan, consider yourself to be extremely fortunate.  Corporate DB plans may soon be as rare as a NY Mets championship.  Employees in the public sector still participate at a high rate (roughly 87%), but there is growing pressure on their plans to shift the liability from municipalities / counties / states, etc. to the individual participant through defined contribution plans.  By whatever means you have, you should fight this trend!

At KCS, we have written a number of articles on the importance of DB plans to individuals, families and more broadly, our society.  These articles are available on our website at http://www.kampconsultingsolutions.com.  I would encourage you to review some of our thoughts on the subject, as your future retirement may just be on the line.

Asking an untrained individual to make retirement decisions for their own account is a formula for disaster! Yet, that is precisely what we are doing by transferring our employees into defined contribution plans.  Asking an employee making less than $40,000 / year, who has a spouse and children, to divert a portion of their compensation to fund a retirement program is a JOKE!.  Life gets in the way, and it is silly to think that individual can safely put away enough to generate even a modest retirement income.  Allowing a participant to have access to their retirement assets prematurely is a structural failure! 

It is shameful that most of us in the investment industry have done extremely well financially by picking at the DB carcass, while too many participants can’t retire. SHAMEFUL! It is time that we as an industry rally around the issue of retirement security, and begin to pose real solutions to this crisis that adequately places the risk on the shoulders of those that can handle the responsibility before we don’t have anyone retiring in this country.  Just imagine the social, economic and political implications of that development!