We are pleased to share with you the KCS quarterly review. Pension America continues to find difficult footing, as traditional approaches to asset allocation inject much risk for little reward. In this edition we discuss the market’s impact on plan liabilities, which continue to grow relative to plan assets.
As always, please don’t hesitate to reach out to us if we can provide any assistance to you or your participants.
There appears an article in today’s WSJ (Brexit adds to pension funds’ pain
http://on.wsj.com/2a0F3zJ), that is long overdue. “Brexit should be a wake-up call for pension plans because it means interest rates are going to stay low or go lower and it makes it even less likely [the plans] are going to achieve the 7.5% rate of return that most of them are assuming,” said former San Jose, Calif., Mayor Chuck Reed.
Rip Van Winkle slept for a shorter period of time than many plan sponsors and asset consultants have with regard to this issue. The continuing focus on the return on asset assumption (ROA) has lead to a significant mismatch between assets and liabilities, which continues to be exacerbated by the declining U.S. interest rates. The impact on private DB plans is more immediate than public funds (accounting differences between FASB and GASB), but both are hurt by their unwillingness to focus on plan liabilities as the primary objective.
Since KCS’s inception (8/1/11), we have frequently written and spoken on the subject of plan liabilities needing to be the plan’s primary objective. We recently presented the output from a project that we were asked to do for a large public pension plan. The project was to restructure the plan’s fixed income assets. With a focus on the plan’s liabilities, we put together a program that shortened duration (1/2 year), enhanced income (roughly +$750,000), reduced management fees (roughly -$500,000), improved liquidity, while insuring that the plan’s liabilities were covered for the next 10 years.
If this all seems too good to be true, we encourage you to reach out to us to find out more. Achieving the plan’s ROA doesn’t guarantee success. Focusing on your plan’s liabilities is a necessary path forward to improving funding success. Our beneficiaries are depending on all of us to secure the promised benefit.
At my weekly Rotary meeting (every Thursday morning, if you care to join me), I was introduced to a video that I’d like to share with you.
It is a terrific presentation from Simon Sinek on how great leaders inspire. The discussion revolves around the Why, How and What we do. For most of us, as you will hear, we focus on the What, but it is really the Why that is most relevant.
I have been fooling myself into believing that our clients, prospects and industry contacts truly know WHY KCS was formed nearly 5 years ago (8/1/11). Where has the time gone? But in reality, I’m sure that I / we have focused too much attention on the What and How, and not nearly enough on the WHY!
After nearly 30 years in the investment industry, I had an epiphany! I became more acutely aware of the impending U.S. retirement crisis. I am not sure why it took me that long to truly appreciate the magnitude of the problem, but it could have been that fact that for the 20 years prior to that moment I had been part of an investment management team focused on only a small sliver of a retirement portfolio (forest for the trees syndrome?). None-the-less, I should have been more in tune with the reality of the situation because my family was a living example of the crisis that was unfolding.
On one hand my Mom and Dad were enjoying a terrific retirement helped in large part by my Father’s participation in a defined benefit plan (DB), and also supported by a profit sharing plan and my Mom’s small 401(k). On the other hand, my mother-in-law was not as fortunate, as she had no DB plan and a rather insignificant 401(k) plan. As a single mom who worked many part-time jobs during her children’s early lives (3 daughters), “life got in the way”, and it impacted her ability to save for retirement, as it has for many in similar situations. Unfortunately, it never got any easier for her!
Today, we have a small portion of our private sector work force participating in a defined benefit plan (roughly 14%), and nearly 50% of our private sector employees don’t even have access to a retirement plan through their employer. Oh, how the times have changed from just 30 years ago when roughly 46% of our private sector labor force participated in a DB plan.
Furthermore, managing a retirement program is not easy, especially when one hasn’t been trained to handle that responsibility. We go to great lengths to make sure that plumbers, electricians, doctors, lawyers, etc. are licensed, but we expect individuals who have never taken an investment course to handle the management of their retirement program? Really?
Remember, defined contribution plans were initially used as supplemental income plans for high income earners. They were never intended to be anyone’s primary retirement vehicle. But, we are on a slippery slope as a nation by having nearly our entire private sector being asked to fund and manage their own program. Regrettably, but not surprisingly, the results have been disastrous. Oh, sure, there are examples of individuals who have amassed small fortunes, but they are very small subset. According to the National Institute on Retirement Savings (NIRS), 40 million American households (age 25-64) have no retirement accounts, and the typical working-age household has on average retirement savings of only $2,500!
So WHY is there a KCS? Since our founding, our mission has been to try to get every household or individual an appropriate retirement, one much more like my parents. We prefer that DB plans be preserved, as we fear the social and economic ramifications from our society’s failure to provide a retirement system that supports our employees. As a society we are living longer, but what is the worth of a few more years of life if it is spent in abject poverty?
At KCS, we have shared with our readers the What and How we do what we do, and we are very happy to take the time to further educate you on our approach. Please know that we are different than most asset consultants because we don’t see the current industry practices creating a different outcome at this time. Failure to adjust ones approach may just lead to having a significant percentage of our elderly population (it is worse for women over the age of 65 than it is for men) experiencing a very difficult time in their “golden” years.
Just got back from presenting at the FPPTA conference KCS’s ideas on DB plans becoming more liability aware. We believe that a plan’s unique liabilities should be used to drive investment structure and asset allocation decisions.
We don’t believe that traditional asset allocation models are in the best interest of plan sponsors and their participants, as they inject too much risk into the process, especially in this market environment in which equity and bond valuations appear stretched.
Given the extremely low level of US interest rates (doesn’t mean that they can’t go lower), we would suggest that plans shorten duration and focus on matching near-term retired lives. It wouldn’t take too much of a back up in rates to have liability growth be negative. In that environment, a shorter-duration, cash-matched fixed income portfolio should easily outperform liability growth.
The cash-matched strategy will reduce interest rate sensitivity from your portfolio, improve liquidity to meet those near-term retired live benefit payments, and will extend the investing horizon for your growth (alpha) assets.
Let us know if you’d like to discuss this in greater detail. Happy Fourth of July Weekend!
We are pleased to share with you the latest edition in the KCS Fireside Chat series. In this article, Dave Murray, KCS’s Defined Contribution Practice Leader, brings you his perspective on the new Fiduciary Rule and it’s impact on the 401(k) space. I know that you’ll find Dave’s thoughts helpful.
Click to access KCSFCjul16.pdf
As usual, please don’t hesitate to reach out to us if we can be of any assistance to you regarding your retirement needs.
Defined benefit plans are once again being stressed today. Assets are getting whacked, while interest rates plummet, leading to significant growth in plan liabilities. In fact, liability growth is estimated to be about 15% year-to-date on a mark-to market basis (Ryan ALM), while assets are mostly flat to up marginally (at least until this morning).
Traditional approaches to asset allocation continue to reduce fixed income exposure, as asset consultants anticipate higher rates, while not being able to justify holding bonds at these “historically” low rates. Unfortunately, this action has lead to a huge asset / liability mismatch, that continues to put pressure on funded ratios, funded status and contribution costs as rates continue to fall.
At KCS we have been espousing a very different asset allocation model that allocates plan assets to beta and alpha buckets. In our approach we convert traditional fixed income into a liability beta portfolio eliminating interest rate sensitivity, while dramatically improving liquidity. In addition, this approach extends the investing horizon for the alpha assets which can now capture the liquidity premium that exists, but often isn’t captured through premature selling.
I am very much looking forward to speaking at the FPPTA conference next week, as I will be re-introducing this topic. DB Plans cannot afford to live with the excessive volatility associated with pursuing the ROA. NOW is time for change before the DB plan goes by the way of the dinosaur.
For anyone who follows the KCS blog on a regular basis you understand how concerned we are about the U.S. worker’s lack of retirement readiness. Unfortunately, we aren’t making much progress, and in fact, our ability to meet short-term obligations is getting strained too, let alone our long-term obligations (retirement).
In a recent poll conducted by Bankrate, 46% of Americans don’t have enough savings to cover 3 months of expenses, and more than 50% of them don’t have any emergency funds. Regrettably, 62% of our population couldn’t cover 5 months of expenses should they find themselves out of a job.
Competition for our discretionary income is fierce, as Americans are being asked to fund retirements (DC, as opposed to DB), greater health care expenses, and ever-expanding education costs, in an environment in which real incomes have been stagnant for quite some time. For those Americans who find themselves earning less than the median family income, life gets in the way, and it is proving very difficult to be able to cobble together an emergency fund. This, in an environment in which we are told that we are at “full employment” (4.7%), despite having 93 million age-eligible (16-65 year old) workers on the sidelines.
The demise of the traditional defined benefit plan is going to lead to profound social and economic ramifications in the next 15-20 years and beyond. Providing our students with greater financial literacy will help, but it isn’t a silver bullet. We need U.S. companies investing in their businesses and employees. It is through a growing economy, with real wage growth, that we can begin to ease some of the financial burden that most Americans are now facing.
I read the following from Joe Magnacca, CEO at Massage Envy, with great interest, and I wanted to share it with the KCS readership.
I’ll be the first to tell you that taking risks can be scary, whether it’s rebuilding a brand or embracing a new business model. But it’s vital to success in business.
Obviously, there is no formula for risk-taking, because every business, budget and leader is different. But, there are successful ways to take risks.
Be Revolutionary – Not Evolutionary
Risk is not just about embracing change, but having the courage to create it. I’ve found that people tend to understand that change needs to happen. For some leaders though, they are naturally risk-adverse, so they are challenged to drive the necessary change.
Being a catalyst for change means that you need to consider what happens to your business or a category in the next year and then three years from now and then five years from now. Having a vision of how the future of your business needs to look plus a willingness to take necessarily risks will allow you to implement change that will pay off in the future.
Do Not Fear Failure – But Prepare for It
Asking, “What’s the worst that can happen?” is a vital first step in evaluating risk. But it’s not a question to ask only in a rhetorical sense.
You actually need to consider all the contingencies and plan for what could happen. At the same time, you should also be planning for how to quickly scale your idea if it proves successful. I remember telling a previous team that the result of a risk was either going to put them in a position of affording a private jet – or they would be looking for a job. There’s nothing wrong with taking a flying leap. But just in case, have a parachute to fall back on.
Give Teams Permission to Think
A critical part of business risk-taking is giving your teams the confidence to think less traditionally.
Innovation is what encourages and grows people, so set the example of giving your team room to think outside of the box.
I don’t fight innovation, whether it comes from a change in technology, customer experiences or the services we provide. And that’s a huge motivator for employees when they know ideas – good, bad or ugly – have a fighting chance.
Taking risks will force you to become more creative, inventive and calculating than you ever imagined you’d be. But to see your brand come out on the other side, hopefully stronger, streamlined and more focused than ever before, makes it all worth it. (thank you, Joe)
How many plan sponsors continue to “tinker” with their ROA, moving in quarter point increments? How has that worked out? Have funded ratios improved? Contribution costs fallen? We would hazard a guess that incremental change has brought very little reward for the considerable effort put forth. Stop tinkering!
KCS has for years been talking about making asset allocation decisions based on the funded ratio and a plan’s liabilities, not on the ROA. It may be revolutionary to what has been done within the asset consulting business for years, but what do you have to lose? We’ve already seen substantial harm done to DB plans by inaction. Now is the time to try a different path. Let us help you improve your funded ratio, stabilize your fund’s contribution costs, and improve the long-term viability of your plan. Your beneficiaries can’t afford another shock to their plan.
We are pleased to share with you the latest article in the KCS Fireside Chat series. In this edition we explore that positives and negatives of the leveraged loan market. So many investors have been forced to chase yield given the low interest rate environment. However, does it make sense from a risk / return standpoint to access this product area?
Click to access KCSFCJun16.pdf
Please don’t hesitate to reach out to us if we can be of any assistance to you.
Today’s employment news should send shivers through the DB pension community! Expectations (hope?) of an interest rate rise in June / July have been thwarted, as the U.S. economy added only 38,000 jobs in May. UGH! Worse, the Labor Participation Rate fell 0.2% to 62.6% matching December 2015. In addition, March and April employment gains were revised down by 59,000. We haven’t seen a jobs report this weak since September 2010.
Fed Chairwoman Janet Yellen said a week ago that an increase in short-term interest rates would be appropriate “probably in the coming months” if the economy continues its upward trajectory. The strength of the labor market plays an important role in the Fed’s decision to adjust interest rates, alongside inflation and economic growth, which remain muted.
Well, it is highly unlikely that we will see a rate rise in June or July given this jobs report. For plan sponsors that were hoping to see a rate rise, which would reduce the present value of their plan’s liabilities (corporate plans under FASB), they will have to continue to live with very low rates. The U.S 10-year Treasury Bond has rallied 28/32nds on this news and the yield is at 1.705%.
For our retail clients, the low interest rate environment continues to constrain their returns from a moderate to conservative asset allocation profile, forcing many to eat prematurely into their principal or causing them to seek more aggressive (risky) investments to create some additional yield (HY, bank loans, etc.).
We have some ideas on how to navigate your portfolio in this environment. Don’t hesitate to reach out to us if you think that we can help you.
Ryan ALM Blog 