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

The PBGC’s Final Final Rules have not been released, but I’ve been sent a “fact sheet” highlighting three areas of “improvement”. First, and most importantly, all 18 MPRA plans that “reconfigured” benefits will be made whole enabling pension funds to restore previous levels of benefits without driving these plans back into insolvency. That is great news for all of the participants in those plans and the highlight of this announcement.

The other two areas addressed in this release are the ROA/discount rate and the permissible investments. With regard to the discount rate, the release states that there will now be two ROAs, with one for the SFA and one for the non-SFA assets. Huh? We don’t need two ROAs… we need discount rates! We need a different discount rate (currently = PPA’s 3rd segment + 200 bps) which determines the size of the SFA grant. It doesn’t matter what the SFA assets earn as they should be used to defease and secure the promised benefits.

With regard to permissible assets in the SFA bucket, I’m really disappointed to see that they are expanding the potential investments beyond bonds. If 2022 has shown us anything, it is that markets can go down and go down severely. How does one secure the promised benefits to 2051 by allowing equities (uncertain cash flows) that can’t defease liabilities? The sequencing of cash flows and returns is critically important to this process. Yes, equities will outperform bonds roughly 80% of the time over 10-year periods, but what happens if the US falls into either stagflation or recession in the near term that dramatically reduces equity valuations? There won’t be enough left in the SFA bucket to meet the 2051 promises! Permitting only 33% is better than 100%, but they should have kept the original mandate.

Why must they overcomplicate these matters? All they had to do was lower the discount rate for determining the SFA grant from the current 3rd segment plus 200 bps to using all three segments under PPA with no additional hurdle and ensure that the promised benefits are met by mandating that asset cash flows in the SFA be used to defease liability cash flows, which would allow for a more risky asset allocation in the legacy asset bucket to meet future liabilities beyond 2051. These are three easy steps to securing the benefits, while keeping these plans viable for current employees and those that will join in the years to come. UGH!!!

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

I am pleased to share with you another thought-provoking research piece from Ryan ALM’s CEO, Ron Ryan, CFA. This article, “The Pension ROA is Plural… ROAs” explores how the return on asset assumption (ROA) is derived, but more importantly how the pension return target is misunderstood. Most pension plans within the public and multiemployer arenas have a ROA equal to or greater than 7%. Does this mean that every investment in the pension system’s portfolio needs to achieve this hurdle? Of course not! Each asset class has its own distinct ROA. Yet, it is amazing how often we hear from various pension professionals that investing in a cash flow matching strategy (CDI) in lieu of a traditional total return-seeking fixed income strategy will HARM the plan’s ability to achieve the plan’s ROA.

That retort is incredibly silly given that a significant majority (all?) of plans have fixed income exposure and have maintained investments in fixed income despite the collapsing US yield environment that we’ve just lived through since 1982. There was no way that a core fixed income strategy benchmarked to the Bloomberg Barclays Aggregate Index yielding <3% was going to generate returns anywhere close to a 7% ROA objective. If every asset category needed to achieve the ROA, then why were bonds still in the fund? If it was to provide liquidity to meet benefits and expenses, then a CDI program would provide a superior link between the promises made and the necessary funds to meet those obligations! Furthermore, a CDI implementation that utilizes 100% corporate bonds would have provided a 75 bps to 100 bps yield advantage depending on the maturity of the program. As a result, using a CDI program in lieu of traditional core bonds would enhance the probability of achieving the plan’s ROA, not diminish it!

I know that you are going to be impressed with Ron’s logic that there is no one ROA, but a series of ROAs that must complement each other in order to achieve the overall objective of funding the promised benefits. As always, don’t hesitate to reach out to us with any questions that you might have regarding this piece or any other that we’ve produced.

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

I hope that you and your families enjoyed a Happy Fourth of July weekend. My family and I enjoyed some traditional American activities this past weekend as we took in a Mets game (all 18 of us) at Citi Field on Saturday and the Ridgewood, NJ parade on Monday, which has been an annual tradition in our family since my oldest guy was just 9 days old in 1986. Of course, our weekend culminated in a BBQ in our backyard. Fortunately, the weather in Northern NJ was spectacular as reflected in the picture below.

As for ARPA, it was a slow week in terms of activity although two pension systems filed their initial applications for Special Financial Assistance (SFA) with the PBGC. Bricklayers and Allied Craftsmen Local 7 Pension Plan, a Priority 2 category member, as they are a MPRA Suspension & Partition plan, filed on June 27, 2022, seeking SFA of $31.6 to protect the benefits for their 397 members. Bricklayers Union Local No. 1 Pension Fund of Virginia filed their initial application on June 30, 2022, seeking only $8.7 million for their 395 members. Bricklayer Local No. 1 is a Priority Group 1 member, as they are currently a plan that is insolvent.

There were no applications approved, denied, or SFA proceeds paid out during the previous week. However, there have been some rumblings that the Office of Management and Budget (OMB) has completed its review of the PBGC’s proposed Final, Final Rules. We continue to monitor the PBGC’s website hoping to see an announcement on what, if anything, is being changed by the PBGC as they continue to implement the ARPA legislation first begun nearly one year ago.

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

Last Friday we produced an update on market performance through 1H’22. What jumps out is the fact that both bonds and stocks are down to start the year, and down big. It got us thinking about the last time that both bonds (Bloomberg Barclays Aggregate) and stocks (S&P 500) were down in the same year. On a total return basis (including income of dividends and interest), the S&P 500 and the BB Aggregate have NEVER been down in the same calendar year! We’ve come mighty close (1994) when the S&P 500 squeaked out a marginal gain of 1.94% while the Aggregate Index fell by -2.92%. The -2.9% decline in ’94 has been the greatest negative annual return in the history of the Agg index dating back to 1976 when Ron Ryan and the team at Lehman Brothers created it.

For the first half of 2022, the S&P 500 Index plunged by -19.96%, while the Aggregate index declined by -10.35% setting the stage for the first occurrence ever of these two major indexes declining simultaneously in a calendar year. As we’ve stressed, the last 40 years of capital market activity should not be viewed as “normal” given the precipice from which US interest rates fell, while inflation remained muted. Capital market performance during the remaining six months of 2022 will be driven primarily by the US Federal Reserve’s interest rate action. The Fed’s individual Governors have stated on numerous occasions that they will remain singularly focused on tamping down inflation despite the fact that this action might result in the US economy falling into recession. As a reminder, recessionary environments are not a cure for weak stock markets.

We’ll of course need to wait to see what transpires in the markets during the remaining six months of 2022 to see if for the first time both important asset classes declining in the same calendar year, but it doesn’t mean that the plan sponsor and asset consulting communities need to wait. As we’ve been espousing, an environment of rising US interest rates will weigh on markets for the foreseeable future. Convert total return fixed income into a defeasance strategy matching asset cash flows (bonds) with the plan’s liability cash flows, which will buy time for the non-bond assets to grow unencumbered as they are no longer a source of liquidity to meet benefits and expenses. Although rising rates are generally bad for bonds and stocks, they may not be necessarily bad for pension plan liabilities whose present value might fall faster and further than asset levels.

For more info on why higher rates are good for pensions, go to our website… ryanalm.com/insights/whitepapers.

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

The first six months of 2022 have come and gone, but not before leaving some destruction in its wake! However, before we dive into the numbers, we want to wish you and yours a wonderful Fourth of July holiday weekend. May we all take a few moments to just catch our collective breath before we embark on what may be a very challenging second half.

Not since 1970 have we had a start to a new year in equities (as measured by the S&P 500’s total return) as that which we’ve experienced so far this year with the index down -19.96% through yesterday’s close. I was 11 at that time in 1970 and very much not focused on how Nixon’s economy and markets were performing. I suspect that most market participants were much younger than that! Unfortunately, there was very little that one could do within equities to avoid these challenging 2022 results, as the Russell 2000 (small cap) underperformed the Russell 1000 (-20.94%) by 1.5%, while the NASDAQ 100 declined -29.22%. Only 1 S&P 500 GICS Sector produced a positive result and it isn’t surprising that it was energy at +31.8%. The worst performing sector on a total return basis was Consumer Discretion at -32.82%. A consolation prize should be handed out to Utilities that nearly squeaked out a positive result at -0.55%.

For bonds, the story is even more unique, as the Aggregate Index has never had a start to a year with as historic a loss as that which has occurred so far in ’22, as the “bond market” fell >-11%. The ICE BofA Corporate Index fell -13.93% as corporate spreads widened making for a more challenging first six months than similar-maturity Treasuries. HY bonds were off -14.04%. The worst performing area of fixed income was long bonds. The Ryan Index 30-year U.S. Treasury fell by -23.3%, on a total return basis. Long bonds have now produced a -2.83% return for the last 3 years and only a 1.7% annualized return for the last 5 years through June 30, 2022.

The carnage was not just felt in the good old USA either. International markets for both bonds and stocks were rocked by all of the same factors that profoundly impacted the US markets. Japan (-8.3%), Germany (-19.5%), Canada (-11.1%) are representative of the losses incurred in those regions. Only one of the countries that we follow (Argentina) produced a positive result in the first half at 5.93%. You got me as to why.

Did anything work in 2022? Well, yes, but you would have needed to be in commodities, which advanced by 26.4% as measured by the S&P GSCI. Energy and grains were the key drivers although a couple of metals, such as nickel, produced positive results to start the year. Despite the troubling inflationary environment, neither gold nor silver was up. The US $ was also a winner advancing by 9.4% so far in 2022. Mexico and Brazil witnessed price appreciation, as well, although neither advanced as much as the US.

Despite the loss associated with traditional pension plan exposures – equities and bonds – the first quarter wasn’t nearly as troubling as the second quarter when it comes to pension funding. The return on long Treasuries, as noted above by the Ryan Index, fell by a greater percentage than the Aggregate index. Pension funding improved as the present value of those future benefit payments fell by more than plan assets on average. The second quarter started off in a similar fashion, but the recent rally in Treasuries likely reduced some of that funding improvement. You’ll have to wait until we produce the Ryan ALM Q2’22 Newsletter to see how plan assets stack up versus plan liabilities so far this year.

Inflation and interest rates will be the key drivers of pension plan performance during the remaining 6 months of 2022. The US Federal Reserve has stated that they will aggressively pursue a policy of tightening until they have reigned in inflation. Will they be successful without pushing the economy into recession? We’ll continue to provide you with our thoughts on this subject and what we believe you need to do to prepare your fund for the next scenario. Stay tuned. Now go enjoy your BBQ.

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

My two sessions have been completed at the IFEBP’s Advanced Trustees and Administrators conference in Seattle, WA. It is always a pleasure to share the podium with Ian Jones and Troy Brown (AndCo), two exceptionally experienced asset consultants, despite our varying perspectives on what lies ahead. Both our sessions were related to investment discussions. Our first session pertained to “where are we” which is always easy and doesn’t leave a lot of room for debate. However, the “where are we going session” leaves a lot of room for discussion with varying interpretations of where markets may be going and the significant influences that will dictate our future course.

With regard to my thoughts about the future of pension plans and Pension America, I need to state that my crystal ball is no clearer than anyone else’s. That said, here are my concerns: Most members of our pension community have NOT worked in a rising interest rate environment. They have NOT experienced inflation. They’ve NOT experienced both equities and bonds selling off at the same time. Most of the investment strategies being utilized today were only tested in a favorable investing environment of falling (low) interest rates and benign inflation. I’ve been told by many that we can’t look at the ’70s as a guide because things are different, but are they?

Sure, being a long-term investor for someone involved in pensions is sound advice, but does that mean that we shouldn’t or can’t do something different? Liquidity is not abundant in this market. Asset allocations have migrated significant assets to alternatives further restricting liquidity. Forcing the sale of assets to meet liquidity needs is not an effective strategy in declining market environments.

As a reminder, the primary objective in managing a pension plan should not be to achieve the ROA. It should be all about securing the promised benefits. We’d highly recommend bifurcating your assets into liquidity and growth buckets. With this approach, a plan sponsor uses the liquidity bucket to meet those promises through a defeasance strategy, which will buy time for your growth assets so that they can withstand periods of dislocation such as this period. How does one begin the transformation? We don’t recommend dismantling your plan’s asset allocation. Simply migrate your current total-return-seeking fixed income into a cash flow matching strategy that will secure the promised benefits. This will provide the necessary liquidity to meet benefits and expenses for as long as that allocation lasts. There is comfort in knowing that those promises made to your participants are now secured no matter where markets, inflation, and/or rates go.

The last four decades have been extraordinary for the investment community and Pension America. What is the probability that we experience anything like this period as we move forward? Where is the amazing stimulus going to come from given that US interest rates are rising after forty years? The Fed is currently waging a battle against inflation. They have promised to be relentless in that quest. Soft landing? Doubtful! Also, please don’t look at the long-term as being the last 10-, 20-, or 30 years and think that it represents different environments. Sure, we’ve had booms followed by busts during the last forty years, but in every case, US interest rates continued to fall, and inflation remained muted. That party is now over!

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

Regular readers of my blog will know that I’ve often written about Carol, a hard-working union (Local 805) member whose dignified retirement dreams were crushed when her fund filed for benefit relief under MPRA and was granted permission to slash her monthly benefit through no fault of her own. I chronicled the impact of these cuts through the eight blog posts that follow below. Carol was very generous to share the details of her situation and how the decision to reduce her pension would dramatically and negatively impact her life. Regrettably, Carol’s situation was far from unique.

Let’s Focus On Carol

The Personal Struggles and Why ARPA is so Critically Important

Real People, Real Implications

Mr. Senator – Are You Listening?

Appalling!

There Is No Comparison, But…

The Deniers Need To Read This Post!

A Very Real and Painful Reality

I’m thrilled to report that Carol posted an update yesterday. Her words:

“Well, I spoke to Local 805 this morning. They confirmed that on July 1st, my retro check will be deposited in my IRA, AND, my monthly check will be $1,600.00 MORE than it has been since 2019! 8 days and counting……

Oh, and he confirmed that the second they received the money, and then my payment request form, that money became part of my estate.”

How exciting and wonderful it is to be able to report some great news resulting from the passage of this pension legislation. This was a crisis for 1+ million Americans who either had their pension benefits already slashed or they were in funds that were designated as in Critical and Declining status that would soon fail. It took years to get to this point, but thankfully justice is being served and these hard-working Americans are finally getting the resolution and restitution that they so deserve. Only a small fraction of the eligible plans have filed for Special Financial Assistance based on their Priority Group (1-3 are currently eligible to file). Let’s hope that this legislation continues to provide the relief so very necessary to the long-term health of these plans.

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

Buying the dip is always a challenging objective. Given the current inflationary environment and the goal of the Federal Reserve to conquer inflation, buying this dip may be premature.

As the graph above depicts, the spread between the US 10-year Treasury bond yield and the consumer price index (CPI) has been significantly positive (i.e. inflation premium) throughout history with a few exceptions. As of April 30, 2022, the negative real return from owing the 10-year Treasury was the greatest in history. May’s inflation # of 8.6% certainly didn’t reduce this unusual relationship. Yet, recent market activity seems to suggest that the Fed’s recent 75 bps increase in the Fed Fund’s Rate may have already started the US economy on a slippery slope to recession. I think that is a bit premature.

Fed Governor Bowman was quoted in the WSJ yesterday stating that “since inflation is unacceptably high, it doesn’t make sense to have the nominal federal-funds rate below near-term inflation expectations”. She continued, “I am therefore committed to a policy that will bring the real federal-funds rate back into positive territory.” Can her message be any clearer? Given that the 10-year Treasury yield’s real rate is -5.5% today, it seems obvious to me that the Fed is nowhere close to slowing down its forecasted rate increases, even if you assume some magical collapse in the inflationary environment to roughly 4% by year-end.

There have always been short-term rallies throughout the history of market corrections, but they often don’t signal the bottom of the markets. Given the drivers of inflation and the primary objective of the Fed to curtail said inflation, buying this dip may be premature. You might have to wait until you can buy the canyon! Stagflation or recession? Neither is good for stocks and rising rates are a killer for total return-focused bond programs. Bifurcate your assets into two buckets – liquidity and growth. Use bond cash flows to meet liability cash flows… liquidity assets. This strategy will enhance your fund’s liquidity while buying time for those growth assets to grow unencumbered. You won’t have to guess when you’ve hit the bottom of a cycle.

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

I’ve recently seen questions raised about the recent interest rate increase in the Fed Fund’s Rate and the potential impact that has on the pension rescue through ARPA. I’m happy to address this issue since the discount rate chosen was a source of concern for me and others. Interest rate increases, such as we’ve witnessed so far in 2022, have the potential to impact both the pension plan’s liabilities and assets.

First, and as it pertains to the legislation’s impact, the recent increase in the Fed Fund’s rate of 75 basis points will have little to no impact on the discount rate used to calculate the potential SFA. As a reminder, legislators chose to use the 3rd segment (under PPA) plus 200 bps as the discount rate in helping to determine the size of the Special Financial Assistance (SFA). The three rates under PPA reflect different maturity buckets. It was surprising that the third segment was used given that it reflects benefits that would be paid for periods greater than 20 years. Obviously, pension systems eligible for SFA payouts will be paying benefits for the next 20 years. At the very least all three segments under PPA should have been used in the discount rate calculation. In addition, this rate uses a 24-month smoothing in its calculation. So, Fed Fund Rate increases have little impact on the 3rd segment rate given these are short-term rates that are being increased. Fortunately, that works to the plan sponsor’s advantage given that a higher discount rate would lessen the amount of the potential SFA allocation.

With regard to increased interest rates on assets, there are both benefits and drawbacks. First the drawbacks. US interest rates are rising as a result of decades high inflation. The Federal Reserve is aggressively pursuing a tighter monetary policy in an attempt to thwart the onerous impact of this inflation spiral. Increased interest rates are negatively impacting most asset classes that pensions invest in, especially stocks and bonds. These asset classes have experienced double-digit losses so far in 2022. This reduces the current value of the legacy assets. This result doesn’t help those plans that have already filed the application and received SFA payment, but it reduces the existing asset value for SFA calculations for those plans that have yet to file which will increase the potential SFA. The impact will be very much dependent on the size of the legacy portfolio, expected return on investment, forecasted contributions, etc.

Plans that have received the SFA are currently mandated to invest those proceeds in investment-grade fixed-income only (bonds). This mandate may change based on the Final, Final Rules that we’ve all been waiting to get since the Interim Final Rules were shared last July. Any investment in a total return-seeking fixed income strategy will have suffered losses as a result of the rising rate environment. The size of the loss is very much dependent on the timing of the investment implementation. As mentioned previously, the Fed has promised to be diligent in its fight to moderate inflation. This suggests to me that we have not seen the end of rising US rates. Further increases in US interest rates will continue to weigh heavily on fixed income returns within the SFA bucket and those of other asset classes in the legacy asset pool.

We’ve been encouraging recipients of SFA payouts to cash flow match their future benefits and expenses chronologically. By matching asset cash flows of principal and income with liability cash flows (benefits and expenses) the impact of rising rates is mitigated since we are dealing with future values (cash flows) that are not interest-rate sensitive. Even the present values are not an issue as those values will rise and fall in lock-step with each other. It is unfortunate that many plans that have received SFA payouts have not initiated a cash flow matching program. The legislation specifically had as its goal to SECURE the promised benefits for 30 years. You can only secure benefits through either an insurance annuity or cash flow matching. Plans that haven’t pursued a cashflow-driven investment (CDI) program are jeopardizing the security of those assets.

For plans that haven’t yet received the SFA, the rising rate environment is a blessing, as the cost to secure benefits and expenses is falling rapidly across the yield curve, including short-term interest rates most affected by the Fed’s action. As an example, we recently produced a cash flow matching portfolio for an SFA-eligible multiemployer plan that would have those benefits secured for the next 17 years. The yield-to-maturity (YTM) on that portfolio was a robust 5.34% and it was accomplished using a conservative universe of potential bond investments restricted to BBB+ credit ratings or better. Furthermore, this portfolio saved the client nearly $93 million in future payouts equaling about a 34% savings. Further increases in rates will continue to lower the cost of securing those benefits.

It really makes no sense given the current rate environment to engage in an active total return-focused bond program. Use the rising rate environment to secure the promised benefits as sought by the ARPA legislation. Everyone will sleep better knowing that the promised benefits have been secured for some extended timeframe!

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

Although it seems like everyone is busy at this time of year, the PBGC bucked that trend with little activity once again. During this past week, there were no SFA applications either approved or denied. Two funds received the SFA payments whose applications had been approved – Management-Labor Pension Fund Local 1730 and ILA Iron Workers Local 17 Pension Fund, which received $110.9 million to help cover the benefits for 2,378 participants. In addition to this activity, I’m pleased to report that two applications were submitted. The Southern California, Arizona, Colorado & Southern Nevada Glaziers, Architectural Metal & Glass Workers Pension Plan (this fund gets an award for the longest name of any SFA application) refiled an application that had been initially submitted to the PBGC in December 2021. This Priority Group 1 plan is seeking $422.5 million in SFA for its plan that covers the benefits for 3,606 participants.

The second plan to file was the Sheet Metal Workers Local Pension Plan out of Massillon, OH, which is a Priority Group 2 plan, seeking $27.9 million in SFA for its 1,649 participants. The PBGC has 120 days from the June 13th filing date to act on this application. Since the inception of the ARPA legislation in July 2021, 26 pension systems have received approval for their SFA applications totaling $6.7 billion in grants, and all but one of these plans have received their payments as of June 17th.

While Nero fiddled Rome burnt. While we await the Final, Final Rules from the PBGC/OMB, the capital markets are plummeting. Will this market action impact the PBGC’s decisions on various aspects of the legislation? Again, I hope not as the ARPA legislation is designed to secure benefits through the SFA payments for as long as possible. The securing of benefits can only occur through either an annuity purchase or a defeasing bond strategy. The Federal Reserve’s tightening action to tame inflation has negatively impacted both bonds and stocks. Given recent comments by Fed officials, it doesn’t seem that they are inclined to pause their pace of increases in the Fed Fund’s Rate. This action will likely continue to weigh on markets until the Fed’s objective is met. What that ultimately means for the market’s performance is anyone’s guess.