I can’t tell you how many times I heard those words uttered by my mom when I was a youngster, and it usually pertained to my eating habits! For instance, did I really need to consume the whole quart of milk and the entire, newly-opened bag of cookies? Probably not, but invariably I did.  Well, if my mom understood what many (most) non-corporate DB plans were doing today, she’d chastise them, too, and with good reason.

Regrettably, GASB allows public pension DB plans to discount their plan liabilities at the ROA, and not at a “market rate” such as FASB (AA corporate) or the more conservative mark-to-market rate, such as US Treasury STRIPS.   As you’ve heard us mention on numerous occasions, liabilities and assets don’t have the same growth rate, so it makes no sense to discount liabilities at the ROA.  Why does this matter? It matters a heck of a lot, and it is leading to inappropriate asset allocation decisions that are being exacerbated in this market environment.

I attended the Tri-State Institutional Investor Forum today at the Harvard Club.  It was a well-attended conference, with very good presenters, but as usual, the singular focus was on the asset side of the DB equation.  In attendance were several representatives from a very large public pension plan from a state near and dear to my heart. Each of this state’s representatives mentioned that their fund had a 7.9% ROA. They also mentioned that they weren’t particularly focused on the liabilities given GASB’s ridiculous accounting methodology, and as a result they didn’t have much exposure to traditional fixed income, as the low yield environment would be a “drag” on performance, as if the only thing that mattered was the yield?

However, what they did do was to “equitize” their fixed income exposure by allocating to high yield, emerging market debt, preferred securities, and other more exotic alternative sources of fixed income exposure, betting that these securities would presumably benefit from rising equity markets.  Unfortunately, our equity markets are not cooperating, and instead of holding higher quality, more liquid fixed income (Treasuries) that have rallied significantly (the yield on the US 10-year has fallen by more than 50 bps so far in 2016), these equity alternatives are under significant pressure. UGH!

So, again, I ask, “just because GASB permits liabilities to be discounted at the ROA, should plan sponsors do this?  NO! Asset allocation decisions undertaken in an attempt to achieve a 7.9% ROA are accomplishing little in terms of generating return, but are certainly a breeding ground for volatility and uncertainty. Public pension plans should pay some heed to their liabilities.  They should use the current funded status to drive asset allocation decisions and not some generic ROA objective that has nothing to do with how liabilities actually perform. As a plan gets closer to full funding, the plan should de-risk, and not subject the entire corpus to unnecessary risk-taking.

Just like me when I was a kid, these plans need to pause before they continue to gorge unnecessarily! In the case of these DB plans they are choking on the risk associated with an asset allocation policy designed to achieve the ROA, with little likelihood of getting the benefit that they desire.

Managing a pension plan is difficult!  Unfortunately, the task has been made more difficult by not having a complete picture of the plan’s true objective. What do I mean?

Well, as everyone knows, the big game is on Sunday, and much of the country will be glued to their seats watching Carolina and Denver play.  Just think what a different experience it would be if there was no scoreboard, and you didn’t know who was winning or losing. Can you imagine a team trying to run an offense without the knowledge as to whether they should become more aggressive (more passing) or conservative (3 yards and a cloud of dust)? How about a defense not knowing whether to blitz on every play or use 5-6 defensive backs to stop the big play?

Well, unfortunately for most of our plan sponsors this is what they experience all the time – at least 364 of 365 days (non leap years).  How is that possible? The most important piece of information that a plan sponsor can have is absent, missing, no where to be found! Plans only exist to meet a promise that has been made, yet that liability is only calculated once per year and usually received about 4 to 6 months in arrears.

Plans blindly manage asset allocation decisions versus a generic return on asset assumption (ROA), and I say generic because every liability stream is different, yet roughly 50% of public pensions use 7.5% as their objective.  How can that be?  Also, they assume that liabilities grow at the same rate as assets, but of course that isn’t correct. As we’ve seen during the last 15-16 years, liabilities have grown at nearly three times the rate as plan assets.  Wonder why we have a funding crisis?

By not knowing what the plan’s liabilities are it is impossible to adjust a plan’s asset allocation to reflect either improvement or deterioration in the funded ratio.  Plans experiencing improved funding should de-risk the portfolio (adopt that no hail Mary strategy), while plans struggling to improve funding might just need to get more aggressive.  Clearly, a one-size-fits-all ROA objective of 7.5% can’t be right.

The standard deviation associated with a combination of assets that might get you 7.5% in this environment is roughly 17.5%.  Are you comfortable living in an environment in which 68% of your annual observations ( 1 standard deviation) could have your plan up or down anywhere from 25% to – 10%? I don’t think so!  Yet that is exactly what is happening.

I encourage you to get greater clarity on your liabilities so that asset allocation and management structure decisions are based on fact and not some generic ROA that doesn’t have anything to do with liabilities. With greater clarity comes a more likely victory! Get a Custom Liability Index (CLI) so that you have a monthly view on your promised benefits.

We are pleased to share with you the latest article in the KCS Fireside Chat series. This article is titled “Greasing The Market Slide”.  We discuss what is currently happening within the Oil sector and what you should do as a DB plan sponsor and / or a DC participant.

Click to access KCSFCFeb16.pdf

As always, we hope that you find our insights helpful, and please don’t hesitate to reach out to us if we can be of any assistance to you.

Today was the day that I was supposed to be at FRA’s “Made In America” conference in Las Vegas.  Ironically, the title of our panel discussion is “Digging Out Of Your Underfunded Status”. There certainly is a lot of digging our going on in the Northeast, but regrettably it has little to do with funded ratios or funded status for Pension America.

The basis of my presentation today was to focus on the need to first stabilize the plan through some fairly simple steps, but one’s that throw common pension orthodoxy out the window. So in that regard, not simple at all, as we are finding that there is great reluctance (inertia) to change one’s approach.

At KCS, we are espousing a three step approach to setting DB pension plans on the right course to improved funding.  The process begins with a thorough analysis of the plan’s liabilities through the creation of a Custom Liability Index (CLI). This index utilizes readily available data from a plan’s actuary, but instead of getting an annual look at your liabilities through the actuarial report, a plan sponsor can get a monthly view through the CLI.  The CLI will showcase the growth rate, interest rate sensitivity, and the term-structure of the plan’s liabilities.

With this output, we can determine how much alpha is needed relative to the liabilities, not the plan’s stated return on asset objective (ROA), in order to close the funding gap over the modified duration of the plan’s liabilities. Furthermore, we can determine how much of the plan’s assets can be placed in the beta portfolio (a cash matched or duration matched strategy) to begin to immunize near-term liabilities.  The balance of the assets will be in the “alpha” portfolio with the goal, as stated before, of exceeding liability growth.

The final step in our process is to begin to implement our beta / alpha approach by converting the current fixed income portfolio, with all its credit and interest rate risk, into a more effective beta portfolio. With these three steps, the DB plan’s funded ratio will be stabilized, and the plan will now be on a glide path toward full funding, and contribution volatility will be lessened.

Unfortunately, current pension thinking would have one ratcheting up the ROA, jumping into new products / asset classes, trimming benefits, extending retirement age, lowering costs, etc., all in an attempt to stabilize the plan. Well, striving for the ROA has only lead to greater funding volatility, and given how the global markets have behaved so far in 2016, more volatility is not the medicine that we should be ingesting.

Click to access KCS4Q15.pdf

It seems almost silly that we are presenting you with a Fourth Quarter review for 2015 given what has transpired in the markets through the first 19 days of 2016.  However, we think that it is important that one understand that 2015 wasn’t as bad for pensions and Pension America as most people believe, and certainly not nearly as bad as 2014.

Why? Well, despite the significant underperformance of plan assets relative to DB plan ROA’s, assets actually modestly outperformed liability growth last year.  Thanks to Ron Ryan and his firm (Ryan ALM), we have a great understanding of what is happening to pension liabilities on a monthly basis, and you should, too. Unfortunately, most DB plans only get a yearly view on their liabilities, and then only valued at the ROA as the discount rate.

We hope that you continue to find our thinking on pension related issues useful.  As always, please don’t hesitate to call on us if we can be of any assistance.  You can also glean our insights from the KCS website, blog and social media accounts that are highlighted in the attached review.

May 2016 be a year filled with great health, much laughter, many friends, and peace!

Click to access KCS4Q15.pdf

The Kamp Family hopes that 2016 is a wonderful year for you, your family and friends.  May it be filled with much laughter, great health, calmer markets, and peace. 

Certainly global stock markets have gotten off to an ugly start in 2016.  Don’t panic! Maintain your long-term asset allocation policy, and since most equity-oriented assets have seen significant pullback, this means re-balancing back to policy normal levels. Why? There are significant regression to the mean tendencies in our markets, and as a reminder, it is much better to buy low and sell high.

This is not to say that our markets are stable, that equity markets can’t fall further from these levels, but we would caution you on selling into this weakness only to lock in losses that are only on paper at this time.  Furthermore, although the US economy appears to be slowing (Atlanta Fed is forecasting a 0.8% Q4’15 GDP growth rate), we do not see a recession in the foreseeable future, and significant market corrections are usually driven by recessionary environments.

Unfortunately, most of us have become traders instead of investors, and that goes for holders of mutual funds and ETFs and not just individual stock pickers.  Given the significant pullback in stocks associated with energy (-21% to as much as -47%, depending on the market capitalization index) and commodities ( -32.9% in 2015), and those impacted by the hit to energy and commodities, including emerging markets (-14.6% in 2015), miners, transportation companies, and MLPs (-32.6% in 2015), there are some significant dislocations that might just provide very attractive long-term opportunities.

If you already have a policy allocation to some of the above mentioned instruments / exposures, re-balance back to policy.  If you don’t currently have exposure to these potential investments now is a great time to begin educating yourself on the products available to you.  Don’t worry, they’ve been beaten down so badly that you won’t miss the opportunity, if you don’t get into them today.  Happy hunting!

Happy New Year! May 2016 be filled with great health, much laughter, and prosperity.

We are pleased to share with you the latest edition of the KCS Fireside Chat series, in which we present three of our top blog posts from 2015 based on viewership and comments.

Click to access kcsfcjan16.pdf

As you’ve come to know, we are not shy about suggesting alternative approaches to standard DB pension orthodoxy. We believe that it is imperative that new thinking be given serious consideration based on the current state of Pension America.

Please don’t hesitate to call on us if we can be of any assistance to you.

First, my colleagues at KCS and I would like to wish you and your families a very Happy New Year filled with great health, lots of laughter, and much prosperity!

2015 is over, and as you will soon find out, it was not a good year for DB pension plans.  This marks the second consecutive year in which pension funds have missed their ROA targets.  However, unlike 2014 when plan assets also dramatically underperformed liabilities, 2015 will likely reveal that most total funds were flat to slightly UP versus their liabilities last year.

That said, funded ratios likely fell since liabilities aren’t marked to market while assets are, and funded status likely further deteriorated, which will negatively impact contribution costs.  What, if anything, are you going to do about this?  Unfortunately, this trend has been evident for more than 15 years now, and nothing seems to have been done.

Well, something needs to be done! Striving to achieve the ROA has lead to asset allocation decisions that have greatly increased volatility, but certainly not the probability of success.  Adopting a strategy that pays heed to a plan’s specific liabilities, in addition to the assets, will likely lead to a very different asset allocation, especially within traditional fixed income.

Are you ready to learn more?

Following two straight years of sub par performance for DB pensions versus their ROA target AND Plan Liabilities, 2016 is going to be the year that Pension America embraces derisking as a prudent approach to the day-to-day management of plan assets.

Derisking can be achieved by any DB plan whether that plan is fully funded, well funded or poorly funded.  The idea behind derisking is to achieve a greater knowledge of plan liabilities, then using that insight to develop a sounder approach to asset allocation, investment management structure and cash flow (liquidity) management.

How does one gain greater transparency of plan liabilities? Through the creation of a Custom Liability Index (CLI), which uses the output of the annual actuarial report, but unlike the actuarial output, the CLI’s information is made available monthly or quarterly depending on the frequency that the client desires. With this greater insight comes the ability to adjust the playbook to meet the challenges of the current environment.

With regard to those challenges, 2016 is looking very much like a year in which both equities and bonds will likely produce modest results, at best, making the achievement of the ROA an even more difficult objective.  Furthermore, the volatility associated with traditional asset allocation models can lead to wide fluctuations in the performance of assets versus liabilities putting further pressure on funded ratios and cash flow.

Given that the US Federal Reserve has already moved on interest rates, traditional active fixed income will likely struggle to achieve a return commensurate with portfolio’s yield.  Sponsors should seek an alternative approach that works for the plan and not against it. What might that be? The strategy that we would suggest is Cash Flow matching, which can be done far more inexpensively than traditional fixed income (10 bps versus 25-30 bps). We also believe that the cash flow matching strategy is superior to duration matching, and may result in significant cost reduction. Have we grabbed your attention yet?

Regrettably, traditional ROA-centric approaches have not worked.  It is time to move onto a different course.  One in which a plan sponsor has greater knowledge of their liabilities, and uses that information to dynamically drive a responsive asset allocation and liability matching. Let us help you make 2016 a superior year for your pension plan.