A generic asset allocation that we have been tracking for more than two decades produced a -12.3% return for the first quarter of 2020. That same pension system with a 15-year duration on it’s liabilities allocated equally across maturities and using a US Treasury STRIPS discount rate produced a +18.7% gain in the quarter. Shockingly, pension assets underperformed pension liabilities by 31% during the first 3 months of this year. As a result, assets have now underperformed liabilities by an incredible -288.5% since 12/31/99. A pension system that started with a funded ratio of 100% in December 1999 would now see their funded ratio at 48%.

For those plans that use ASC 715 discount rates (corporations) your underperformance was -14.8%, while those operating with the ROA as it’s objective (publics and many multiemployer plans) would have realized underperformance of -14.1%. In any case the impact on the funded status is extraordinary and clearly unacceptable. It further highlights that managing a pension without paying heed to a plan’s liabilities is not an effective long-term strategy.

We are very much looking forward to presenting “Pension Lessons Learned” with the Opal Group beginning on April 15th. This is the first in a series of Ryan ALM and Opal Group webinars addressing this important topic. But, in order to discuss potential lessons learned from this crisis, we need to reflect on what lessons were learned following the Great Financial Crisis of 2007-2009, when pension America saw its funded status plummet and contribution expense dramatically escalate.

Unfortunately, with regard to the private sector, we continued to witness an incredible exodus from defined benefit plans and the continued greater reliance on defined contribution plans, which is proving to be a failed model. That activity appears to have benefited corporate America, but how did that work for plan participants, who are now forced to fund, manage, and then disburse this benefit through their own actions, which is asking a lot from untrained individuals, who in many cases don’t have the discretionary income to fund these programs in the first place.

With regard to public pension systems, we saw a lot of action. There were steps to reduce the return on asset assumption for many systems – fine. But, that forced contributions to rise rapidly, creating a greater burden on state and municipal budgets that began to siphon precious financial resources needed for other social issues. In addition, there was great activity in creating additional benefit tiers, in which newer plan participants, and some existing members, were asked to fund more of their benefit through new or greater employee contributions, longer tenures before retirement, and more modest benefits to be paid out at retirement. Again, not a pension lesson learned, but a penalty for participants.

Multiemployer plans were certainly not immune to these developments. We have seen greater contribution expense and lower ROA targets for these plans, too, but have we seen improved funding? We have more than 300 multiemployer plans that went into 2020 in either Critical status or worse, Critical and Declining status. Given what has transpired in the markets to begin this year, it is highly likely that a number of other plans will have seen their funded status deteriorate to the point that they are also in Critical status.

It seems to me that most of the “lessons learned” have nothing to do with how DB pension plans are managed, but rather asks that plan participants bear the consequences of a failed pension model. A model to has focused on the ROA as if it were the Holy Grail. Pension plans should have been focused on the promise that was made to their participants, and not on how much return they could generate, which has done very little in terms of return, but certainly created a lot more uncertainty and volatility. As we’ve been reporting, equity and equity-like exposure within multiemployer and public pension systems was greater coming into 2020 then where they were in 2007. What lesson was learned?

Pension America is once again suffering under the weight of declining asset values and falling interest rates. When will we truly learn that continuing to manage DB plans with a focus on return is NOT correct? The primary objective needs to be securing the promised benefit at low cost and prudent risk. Shifting wads of money into private equity and thinking that you’ve diversified away equity exposure is just silly. Too much money has flowed into private equity that would have likely diminished returns prior to our economy being shut down. The consequences from an economy that has been placed on life support are likely to result in private equity valuations being sliced by 33% to 50%. That won’t help a plan’s funded status!

A pension system’s primary objective should be to secure the promised benefits at low cost and prudent risk. Seems obvious, but regrettably that objective has NOT been the primary focus for most public and multiemployer plans for decades now. We can debate the reasons why when the dust settles, but that isn’t going to help us right now.

Unfortunately, the focus for most asset consultants, actuaries, and plan sponsors has been return. As a result, we’ve insured that the funded status and contribution expenses have become incredibly volatile. Instead of securing the promise and winning the game, we’ve decided to play Russian roulette. How has that worked out? Again, it shouldn’t be surprising, but that pursuit of the ROA has failed to stabilize anything pension-related. Many state budgets are being strained, as contributions become a bigger share of annual state budgets and more than 125 multiemployer plans (likely more after this market crash) face insolvency within the next 15 years.

We’ve written a few posts in the last 6 months or so highlighting our concern that equity and equity-like allocations within pension systems for public and multiemployer plans were at levels that were greater than that which we’d witnessed prior to 2007. The excuse was that bond yields were so low that they couldn’t justify having them in their portfolio because they wouldn’t achieve the ROA objective. How’s that worked out? For the record, the S&P 500 through March 31, 2020 has achieved a 4.8% return for 20 years! Meanwhile, the Bloomberg Barclays Aggregate (it will always remain the Lehman Agg. to me) index is up 5.1% during that same 20-year period. Wow, bonds have actually outperformed equities by 0.3% per year for 20-years!

Furthermore, we’ve recently reported that the private equity markets are likely to see massive write-downs of their portfolio companies (33%-50%), as our economy has been shuttered. I have recently seen the results of a business survey conduced in Northern NJ that indicated that 45% of small businesses would not survive three more weeks and that 83% of businesses would be forced to close down if this situation were to extend to the end of June. Think about those jobs and wages lost and the impact on demand for goods and services.

The move to less liquid investments -private equity and debt, real estate, infrastructure, etc. – is also exacerbating the poor performance of pension funds that are forced to sell assets into this weakness in order to make benefit payments. As you know, it didn’t have to be this way. Are we finally going to get off this asset allocation roller coaster that I wrote about earlier this week? Defined contribution plans are NOT retirement vehicles, but if we don’t do a better job of managing DB plans, they will be the only game in town. Our plan participants, retirees, and the US economy will suffer the consequences.

I am tired of writing about the problems within our retirement industry, of which there are many. I need something positive to write about, but I’m having difficulty during this chaotic time finding such a topic. Perhaps we can get excited at the prospect that Congress is actually thinking about cobbling together a fourth stimulus proposal following the recent passage of the $2.2 trillion CARES legislation.

There are rumblings that members of the House are preparing to include the Butch Lewis Act (BLA) in the next round of support. The Critical and Declining plans (roughly 125) were already teetering on the brink of insolvency. The stock market’s recent terrible performance will only speed up the time frame to insolvency, while likely pushing many of the multiemployer plans that were deemed to be in “Critical” status into the Critical and Declining bucket. Support for these pension funds is absolutely critical, as nearly 1.4 million American retirees and active plan participants could lose a significant percentage of their earned benefit. Their contribution to our economy, through the monthly benefit payments, is huge. We can’t afford any more revenue and demand shocks to our economy at this time.

While my fingers are crossed that we might see some action to help these struggling plans, I am not holding my breath, as pension reform for multiemployer plans has been on going for years and years. Stay well and stay safe!

The following quote was from my November 5, 2019 blog of the same name. I had just returned from speaking at the IFEBP in San Diego on Enhanced Asset Allocation.

“I certainly don’t know when the next recession might occur, but it will. Do we really want to have these plans sitting with their highest equity exposure when it hits the fan? Shouldn’t we be looking for ways to reduce risk after a long cycle of outperformance?”

“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” Confucius

It should be fairly clear at this time that chasing return has created an environment of great uncertainty for Pension America. As Confucius suggests above, if the primary goal is paying the benefits that have been promised, then don’t change that important goal: adjust the action steps. Our industry has chased performance for decades with little success to show for the effort. Isn’t it finally time to adjust the approach?

Building a cash flow matching portfolio that secures those promised benefits would create far less anxiety for all participants involved in pensions. This approach would have worked beautifully during the first quarter when asset values plummeted and liquidity became scarce. Those “return-focused” assets that took it on the chin would now have time to recover, as the cash flow matching portfolio would have provided the necessary liquidity to meet the promised payouts.

I continue to be amazed by the asset allocation decisions of Pension America. The laser-like focus on the return on asset (ROA) assumption has placed pension plans on the asset allocation roller-coaster to hell! The picture above, which is the Star Jet roller-coaster at Seaside Heights, NJ following Superstorm Sandy, reminds me of the process. Plans ride the good markets up and then down repeating the process with every changing cycle until they get crushed and end up all wet. We need to finally get off this ride before all of Pension America collapses.

We are currently living through potentially the worst quarter of US equity market performance since 1987’s fourth quarter. I was working on Wall Street at that time – this feels worse! As the chart above highlights, we have had 29 10% or worse corrections since 1968. Three of those corrections were 48% or worse with two of them coming in just the last 2 decades. Remember that when markets fall 50%, they need to rebound by 100% just to get back to even. Regrettably, these market events have brought Pension America to its knees and driven many private sector pensions to the sidelines. The American worker has suffered as a result.

Are we finally going to see pension plans get back to the basics? Will we once again focus our attention on the promises that were made to the participants as the primary objective in managing a pension plan? Markets only trade at fair value accidentally, as they move from over-valued to under-valued. Let’s get away from trying to “guess” where we are in the market cycle and once again establish an asset allocation strategy that has two purposes. The first asset bucket is used to secure the promised benefits through a cash flow driven investing (CDI) approach to match the plan’s Retired Lives liabilities. The remaining assets can now be focused on the pension system’s long-term future liabilities that have been given the benefit of a longer-time frame in which to meet that future liability growth rate. Neither of these asset buckets has the ROA as its objective. Why should you?

The Great Financial Crisis of 2007-2009 highlighted the need for liquidity in pension plans. The lack of liquidity that was witnessed as the result of moving significant assets into private market investments spawned the growth of the secondary markets, while driving asset prices lower as liquidity was forced where natural liquidity didn’t exist. Well, it doesn’t appear as if our industry learned much, if anything, from that crisis. As we’ve reported on several occasions, pension plan allocations to equities and equity-like products are at levels greater than where they were in 2007, alternative investment allocations are up, and guess what, liquidity is once again a challenge. Did we not learn anything?

I spoke before about 600 trustees (2 sessions) at the IFEBP in San Diego in October 2019. My topic was enhanced asset allocation strategies. As an aside, I’ve spoken on that subject at more than one dozen conferences in the last couple of years. I asked the members of the audience how many had been trustees when the GFC took place. I was pleased to see that well more than 50% of the audience had been long-tenured trustees. I also asked them if they remembered what they were thinking about in 2006 and early 2007 as it related to their pension systems. Were they thinking that a stock market crash was around the corner? More importantly, what are you thinking about now (10/19)? I challenged them to start thinking very hard because the bull market at that time was 10+ years old and we don’t know when or why a sell-off will occur, but it will happen – it always does.

I suspect that little was done to protect pension plans from seeing their funded status crushed during this recent crisis. I read with interest this morning an article in Chief Investment Officer magazine by Michael Katz titled, “It’s a Terrible Time for Pensions to Have Weak Liquidity” followed by “Market downturn could force some public pensions to sell assets for a loss.” Here we go again. Did we not learn anything?

The article went on to say that according to S&P, US public pension plans have an average of 1% of their portfolio assets held in cash and short-term investments to pay ongoing expenses, such as benefit payments and administrative costs. Well, that just isn’t good enough. Again, my feeling is that Pension America has been misdirected in focusing on return instead of the primary objective of securing the promised benefits.

Had pension plans adopted the cash flow driven investing (CDI) approach that Ron and I have spoken about for years, there would be no issue today. They would have the cash on hand to meet expenses, no interest rate risk, a longer investing horizon for the alpha assets, and no forced liquidity that would exacerbate the poor performance of their plan. Will this time be different? Will they actually adopt a new strategy or will we once again be discussing this liquidity issue in 2025?

I saw a brief article today in the WSJ regarding conversations that are taking place about possibly restricting the ability to short stocks in the U.S. I was extremely fortunate to be leading Invesco’s quant group during the Great Financial Crisis when the U.S. last restricted short selling. We were managing a series of products that utilized shorting techniques, and the restrictions were harmful, as we had about $3 billion in AUM in those strategies. I felt that it was a mistake back then and I continue to believe that it would be a mistake once again.

As a reminder, when selling a stock short, investors are hoping to sell high and then buy lower. Typically, an investor taking a short position does not own the shares prior to the transaction, but borrows the stock through a prime brokerage relationship from another investor. The risk to the short seller is that the security’s price increases, instead of falling, that triggers a loss when the investor must buy it back at a higher cost. There is also a cost to borrow the stock that is to be shorted. Depending on the demand for that issue, the rebate rate can be quite high. An investor needs to have a fairly high conviction that the price fall will exceed the cost to borrow.

I believe, as do many market participants, that the ability to short equities creates a more liquid and efficient market. There are many academic papers that support this claim. ““We shouldn’t be banning short selling,” Securities and Exchange Commission Chairman Jay Clayton said Monday in an interview on CNBC. “You need to be able to be on the short side of the market in order to facilitate ordinary market trading”” (WSJ). James Overdahl, the SEC’s Chief Economist from 2007-2010 was recently quoted as saying “what we found was, on net, it was harmful. There were many unintended consequences”. We have enough to be worried about at this time. Let us not had more hurdles.

Ron Ryan and I will be participating in a new webinar series hosted by the Opal Group. The series, titled “Pension Lessons Learned” will have at least 2 episodes. The first session slated for 2pm DST on Wednesday, April 15, is “Protection From Market Disruptions” and the second webinar in the series in slated for April 22nd at the same time, and it will address “Enhanced Asset Allocation” strategies. We hope that you will consider joining us.

As a reminder, the true objective of a pension plan is to secure benefits in a cost-effective manner. Regrettably, Pension America has gotten away from focusing on the primary objective and has instead chased the return on asset (ROA) assumption. This has lead to a dramatic increase in allocations to risk assets, created a poorer liquidity profile, and lead to greater uncertainty in achieving the securing of plan benefits.

We hope that you can join us for both sessions. You can check out the following links for more information on the Opal Group website and the instructions to register for these events.

Website: https://opalgroup.net/conference/pension-lessons-learned-2020/

Registration link: https://zoom.us/webinar/register/6015852510588/WN_PM4XlQuNR9aL7N78aDR4tQ

The financial security for so many Americans is directly correlated to the successful management of these important retirement vehicles. Continuing down the same asset allocation path has failed all of us. We need to take a path that is less traveled and one that might just return us to a route taken when pension plans were first introduced. Tune in – you won’t be disappointed!