According to a recent article in the San Gabriel Valley Tribune, for only the second time CalPERS was forced to dramatically reduce promised benefits because of a default.  In this case, the benefits were slashed by about 2/3rds for the job-training agency LA Works.

The agency was formed when the cities of West Covina, Azusa, Glendora and Covina created the joint-powers authority in 1979. However, they technically aren’t responsible for the welfare of the employees after LA Works was dissolved in 2014.  That these communities have not been forced to pony up the promised benefits is beyond me.

Please don’t think that this event couldn’t happen in a community near you. We’ve seen a number of public entities file for bankruptcy protection, freeze/terminate DB plans, and shift employees to glorified savings accounts (DC plans).

The U.S. Congress is gearing up for another debate on the “debt ceiling”.  The WSJ is reporting that Mitch McConnell has said that there is a zero chance that the U.S. won’t raise the current level.  However, we’ve seen what happens in Washington D.C., so assigning a zero probability to anything is rather foolish.

That there is even a debt level discussion highlights the fact that most Congressmen and Congresswomen have no understanding of how our monetary system works.  The U.S. government has a fiat currency, which it issues under monopoly conditions and floats it freely on international currency markets.

The following points are from a recent blog post by Professor Bill Mitchell, a leading proponent of Modern Monetary Theory:

• A currency-issuing government cannot run out of the currency it issues.
• A government can afford, in financial terms, anything that is for sale in its own currency.
• There is no financial constraint on government spending, where that government issues its own currency.

Also according to Mitchell, “In that context, it is 100% correct to say that all policy choices are political rather than reflect any intrinsic financial constraint.”

I’m disgusted by what is and has been happening in D.C., so let’s finally get away from the politics, and begin to focus on the needs of our people, which include, education, healthcare, affordable housing, retirement benefits (Social Security), etc.

In a recent article on Foxbusiness.com, it was reported that the U.S. has fallen three notches in the global retirement rankings.  Although disappointing it cannot come as a surprise to anyone in our retirement industry. For a country as rich as ours, we are doing very little for the majority of our workers.

The issue isn’t just the demise of the traditional DB pension plan leaving very few with access to these important retirement vehicles, but it is compounded by the fact that most employees working in small companies (those with fewer than 50 employees) don’t have any access to an employer-sponsored plan.  Furthermore, we have done an incredibly poor job of providing financial literacy in our public schools.  Given this fact, why would we think that there would be a positive outcome from the migration of workers from DB plans to DC plans when the burden to manage this effort falls on the individual?

The article highlights the fact that we are living longer, which places a greater burden on our employees to save more, but for the average worker, incomes haven’t kept pace with inflation during the last two decades. Furthermore, although the “average” American may be living slightly longer, we recently reported on the fact that life expectancy has actually declined for those in the 45-55-year-old cohort that don’t possess more than a high school degree.

You want to improve outcomes? Let’s start by creating an educational system that does a more effective job of giving students the skills to meet the needs of tomorrow’s employers – not yesterday’s! Furthermore, let’s start investing in job growth and improved wages so that the average American can actually set aside some money for a potential retirement. There is a certain level of income necessary just to live, let alone to save for retirement. Many Americans (most?) aren’t there today! Shameful!

GoLocalProv is reporting that the St. Joseph Health Services of Rhode Island
pension fund has filed for receivership — the filing puts thousands of
pensions at risk.

This is one of the largest pension failures in Rhode Island in recent
history. It will take months to determine the total financial impact on the
pensioners.

What hasn’t been reported is the curent funded status of the plan (liabilities minus assets) or what lead to the funding crisis.  Unfortuantely, we will likely see more of these actions, especially if the US equity market begins to crack.

We had a very interesting conversation with a plan sponsor prospect recently who was intrigued with the idea of beginning to derisk their DB plan but had been cautioned by their asset consultant that the strategy made no sense in this low interest rate environment.  We strongly disagree with the consultant’s conclusion.

First, and without question, every DB pension plan should have a glide path in place to derisk their plan as the funded ratio and funded status improves.  This does not mean you only do it as your plan’s funded ratio exceeds 90%.  It certainly means that a plan with a 90% funded ratio should have a very different asset allocation than one with a 50% funded ratio.  Unfortunately, because most plans are focused on the ROA, most plans striving for the same ROA will have very similar asset allocations.

Second, when the topic of de-risking is raised, most consultants immediately think of LDI strategies, that most often try to match durations at an average duration of the liability stream (usually 12-15 years). We would agree that sticking a bunch of fixed income assets out on the curve in order to try to match a segment of the liability stream doesn’t make much sense.  There is a lot of interest rate risk in this strategy, especially when one considers that there will likely still be a big mismatch between assets and liabilities given the average funded status of plans in this country.

What KCS and Ryan ALM espouse is a cash-matching strategy that immunizes the nearest retired lives, and extends out this strategy as the funded status improves. A cash matching immunization is a much more precise implementation than one that tries to match durations.  Currently, most DB plans have a decent exposure to domestic fixed income despite the low rates. With our strategy, one migrates that current fixed income into the immunization portfolio.  With this move, the plan sponsor reduces the interest rate risk, improves liquidity to meet future net cash flows, and extends the investing horizon for the remaining assets.

These residual assets are the growth assets whose job it is to beat liability growth and not the ROA.  As the growth portfolio meets with success, siphon the excess assets and port them to the immunized portfolio.  This migration of assets will be used to extend the glide path toward full funding.

Regrettably, most plans did not consider a de-risking strategy in the late 1990s when most public and private plans were well-funded.  This oversight has cost DB plans billions, if not trillions, in additional contributions and lost opportunity cost.

Lastly, plan sponsors who fear that this strategy will compromise their ability to earn a rate of return in excess of the ROA should know that the average yield on a cash-flow matched portfolio will likely be greater than the average yield on a Barclays Aggregate-type portfolio. Why? The immunized portfolio will have a yield advantage because most of the bonds will be BBB and A (still investment grade) thus enhancing a plan’s ability to meet the asset objective.

Many DB plans have been helped by returns during the last 8+ years of equity market returns, but despite these outsized gains, few plans are fully-funded.  Equity returns will likely be muted during the next decade.  Furthermore, another market decline similar in magnitude to the 2000-2002 and 2007-2009 corrections would likely drive many public plans to seek relief through defined contribution offerings, which would only exacerbate the retirement crisis unfolding in our country.

If you had any question as to the benefits provided by fiscal stimulus in a currency issuing country just look at the recent data coming from Japan.  Japan has produced strong economic growth despite maintaining low interest rates, low levels of unemployment, modest inflation, large fiscal deficits, and high public debt for decades.

For some time we’ve been concerned about the long-term impact of austerity in the Euro Zone, primarily because none of the countries are currency issuing entities. Austerity measures have certainly wreaked havoc on Greece’s economy, as well as others.  In our very humble opinion, the Euro is not sustainable in the current construct.

For more information on this subject, we would highly recommend that you read today’s blog by Bill Mitchell, an Australian economist, which can be found at http://bilbo.economicoutlook.net/blog/.

At a recent Opal Public Funds conference in Newport, RI, the conversation turned to fees, and specifically to performance fees for long-only mandates.  As usual, there seemed to be less acceptance of these fee structures for long-only products than there is for “alternative” product.  I don’t get it!  What’s the difference?

Why would any plan sponsor or consultant be willing to pay a long-only manager their full fee with absolutely no promise of delivering an excess return? One of the arguments raised was the “likelihood” that a manager would try to juice returns.  I don’t know about that argument. Why would any asset management firm jeopardize their entire franchise to try to earn a few extra shillings?  It doesn’t make sense!  Furthermore, why are you hiring that manager in the first place if you don’t trust them to be good shepherds of your money?

Years ago, when I was involved in the Invesco quant area, we had roughly 10% of our client mandates on some type of a performance fee schedule, and these weren’t just market-neutral, 130/30 or portable alpha clients. We actually encouraged our clients to use performance fees for long-on mandates, and not because we thought we might earn more in fees, as we calibrated the performance fee and asset-based fee at the targeted excess return. Our rationale was that it was better for the client, and thus, better for us in the long-term.

If a plan sponsor or consultant is leery of excess risk being injected into a product using a performance fee, just ask to see a list of all the returns and tracking errors for the clients in that particular product.  You don’t need to see the name of the client, but it will be pretty obvious if they are running your mandate more aggressively than they are the others.

One of the contributing factors in the movement to passive investing from active management has been the lack of “reward” for the fees paid.  Using a performance fee schedule, and we’d recommend a high watermark methodology as opposed to a moving average arrangement, is one way to ensure that you won’t be paying more than index fees for sub par active performance.

Don’t hesitate to reach out to us if you’d like to discuss this subject in greater detail.

We are pleased to share with you the latest edition of the KCS Fireside Chat series.  In this article, we discuss once again Pension Obligation Bonds (POBs), but there is a twist.  Ryan ALM and KCS are working with key multi-employer executives to create legislation that would provide government guaranteed loans to critical and declining plans.  These loans, similar to POBs, would help close funding gaps for these poorly funded plans.  However, unlike traditional POBs, the proceeds must be used to immunize retired lives.  Enjoy!

It is hard to believe that Kamp Consulting Solutions, LLC (KCS) will be celebrating its sixth anniversary tomorrow (8/1).  It has been a very rewarding 6 years on so many levels! As we embark on year 7, we continue to focus on our mission to protect and preserve DB plans, as the primary retirement vehicle for both employers and employees.  We remain concerned about the decline in the use of DB plans, and the potentially harsh social and economic ramifications as a result of this trend.

As rewarding as these 6 years have been, it has also been very frustrating for the KCS team. Coming to the market as a new firm with a very different message and philosophy has been challenging.  We still believe that the primary objective of a DB plan is to meet the promise (liabilities) at the lowest cost, and not the ROA.  However, we are trying to change 50+ years of thinking, which has proven to be no easy feat!

As you can imagine, we owe a great deal to many people and organizations within the retirement industry that have supported our effort.  Most importantly, we’d like to thank our families who have been with us every step of the way.  There is no way that we hit the sixth-anniversary mark without their support, encouragement, and abundant patience.

As we look forward, we hope to have the opportunity to work with organizations that understand that change is absolutely necessary for the retirement industry at this time.  Doing the same old, same old hasn’t worked, and it isn’t likely to work in the future either!

Several members of the KCS consulting team returned from the Opal Public Funds conference in Newport, RI, encouraged that DB plan sponsors were starting to understand that measuring and monitoring a plan’s liabilities is as important as following the assets on a regular basis, if not more important!  The word liabilities, often absent during previous conferences, was mentioned quite often, and not just by us or Ron Ryan.

However, as encouraged as we were, we still are concerned that plan sponsors remain skeptical of what this greater transparency and awareness of the plan’s liabilities will do for them, especially for DB plans that are underfunded.  Well, how many aren’t, especially among public and multi-employer plans?

I guess that we shouldn’t be surprised given that most sponsors (and their consultants) still feel that achieving the return on assets assumption (ROA) is the primary objective, instead of funding the benefits at the lowest cost.   With a return focus, any mention of de-risking the plan immediately raises concerns about the plan’s ability to achieve that ROA target.  While in Newport, it became apparent that most plan sponsors only feel that it is appropriate to consider a de-risking strategy when a plan is 85%-90% funded.  Why?

One of the plan sponsor panelists during the conference shared that their plan had been 104% funded at one point, but was now 68% funded (on an economic basis?).  As we’ve highlighted, most plans were fully funded at the end of the ’90s, so this story is not unique, but it is disconcerting.  Especially when one considers that after 8+ years of an equity bull market and 35 years of a bond market that has been virtually in a falling rate environment, does it make sense to believe that DB plans can generate outsized returns over the next decade?

Wouldn’t it make more sense to reduce some of the risks in the portfolio, while securing the near-term retired lives, than to subject the entire corpus to the ups and downs of the capital markets?  A de-risking strategy will be unique to each plan, as each plan’s liabilities are like snowflakes. The funded status of the plan and the plan’s ability to contribute will determine how much of the plan will be shifted to defense from offense.

We encourage plan sponsors that currently have an allocation to active fixed income to use those assets to begin the process of de-risking.  The current interest rates sensitive portfolio will be converted into a cash matching strategy that will ensure that benefits are covered for the foreseeable future while extending the investing horizon for the balance of the growth assets, whose objective is to beat liability growth.

Furthermore, liabilities are highly interest rate sensitive (like bonds), and if the U.S. economy can ever begin to produce economic growth, generate some inflation and see rates rise, the present value of the liabilities may actually decline.  Importantly, in an environment of negative liability growth, assets do not need to achieve the ROA to begin to whittle away at the funding deficit.

We encourage you to begin to de-risk your DB plans before the markets take it upon themselves to significantly impact your current funded status.  One should begin this process with a goal to fully fund the plan within 10-15 years.  A 60% funded status plan will not be fixed overnight, but a 60% funded plan that gets hit with a 25% equity market decline could be out of business before the next bull market resumes!