08.03.15
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Tsipras Fiddles While Greece Burns!

Unfortunately in this age of the 30 second soundbite we have a tendency to get bored with stories and events, often long before there has been resolution. This seems to be the case with Greece and it’s inclusion in the the Euro / Eurozone.

Most news reports these days are reporting that there is a “DEAL” already signed and sealed as it pertains to a third bail out for Greece when in fact, negotiations on a potential resolution only began last week.  Furthermore, key players, most notably the IMF, aren’t at the negotiating table, and they likely will stay away unless considerable debt relief is negotiated – not a very likely outcome.

While the negotiations begin, Greece’s economy is plunging further into depression. As reported earlier today, the seasonally adjusted purchasing managers’ index (PMI), fell to 30.2 in July from 46.9 in June. Any reading below 50 suggests contraction in the sector. Furthermore, new business decreased sharply in July, surpassing the previous record set in February 2012, while employment dropped for the fourth straight month in July, and at the steepest pace ever recorded during the 16-plus years of data collection. In addition, production dropped for the seventh straight month in July due to diminished output requirements as new orders plummeted and firms had difficulty in sourcing materials and semi-finished goods for use in the output process.

As if that isn’t bad enough, a quick recalculation of necessary funding for Greece raises the number from $92 billion to around $120 billion, which includes re-capitalizing the Greek banks. According to Mark Grant, the number for the banks is now about $43 billion, and it could be far worse as it appears that loans in default are growing at an alarming rate. Clearly, this will not sit well in Brussels and Berlin, and could bring about even more stringent demands than had been previously thought.

Given the plethora of depressing economic news, it isn’t surprising that the Greek stock market got destroyed today after reopening for the first time in five weeks since the beginning of the country’s capital controls and the announcement of the bailout referendum. The overall Athens Stock Exchange (ASE) index plunged by 22.87% as it opened. That leaves the market at a low not recorded since the middle of 2012.

According to an article in the LA Times, several key participants in the negotiations don’t hold out much hope for Greece’s economy even if a deal is finally completed.  Greece’s own prime minister, Alexis Tsipras, says he doesn’t really “believe in” the new bailout deal he’s hoping to secure for his country. Germany’s top finance official thinks a Greek exit from the euro currency would be better than another costly rescue package. As mentioned previously, even the International Monetary Fund (IMF) doubts a bailout will work without major debt relief from Athens’ creditors, few of which appear willing to offer any.

To hear these key players tell it, the rescue plan they’re currently concocting to save Greece from bankruptcy is either a bad idea or doomed to fail. Yet they’re pressing ahead anyway, despite the questions that their own public statements raise about their commitment to keeping Greece solvent, helping its economy grow and preserving its membership in the Eurozone.

08.03.15
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KCS August 2015 Fireside Chat – “Targeting Future Changes”

We are pleased to share with you the latest edition in the KCS Fireside Chat series.  This article touches on the burgeoning use of target date funds (TDFs).  However, all TDFs aren’t the same, and plan sponsors have an important responsibility to make sure that they stay on top of these funds from both an investment and fiduciary standpoint.  My colleague, Dave Murray, shares his expertise on these important investment vehicles.  Please don’t hesitate to reach out to us if we can provide any assistance.  Enjoy!

Click to access KCSFCAUG15.pdf

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07.30.15
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Future Contributions Into A DB Plan Should Be Considered An Asset Of The Fund

Recently, Mary Williams Walsh, NY Times, penned an article titled,

“Standards Board Struggles With Pension Quagmire”.

The gist of the article had to do with what role did the actuaries and actuarial accounting play in the current state of public pension funding. Many of the actuaries felt that they were pressed by politicians into reverse-engineering their calculations to achieve a predetermined result (contribution cost). “That can’t be good public policy,” said Bradley D. Belt, a former pension regulator, who is now the vice chairman of Orchard Global Capital Group.

According to Ms. Walsh, “he called for additional disclosures by states and cities, including the current value of all pensions promised, calculated with a so-called risk-free discount rate, which means translating the future benefits into today’s dollars with the rate paid on very safe investments, like Treasury bonds.”

Actuaries currently use higher discount rates, which complies with their professional standards but flies in the face of modern asset-pricing theory. Changing their practice to resolve this is one of the most hotly contested proposals in the world of public finance, because it would show the current market value of public pensions and probably make it clear that some places have promised more than they can deliver.

But, if we are going to require DB plans to mark-to-market their fund’s liabilities, inflating future promised benefits, we should also include future contributions as an asset of the plan. Since many, if not most plans, have a legal obligation to fund the plan at an actuarial determined level or through negotiations, these contributions are likely to be made (NJ is one of the exceptions).

When valuing liabilities at “market” without taking into consideration future contributions, plans are artificially lowering their funded ratio, while negatively exacerbating their funded status. Most individuals (tax payers) would not understand the “accounting”, but they would certainly comprehend the negative publicity of a < 50% funded plan.

Most public pension plans derive a healthy percent of their assets through contributions.  Not reflecting these future assets in the funded ratio creates the impression that these funds are not sustainable, which for most public plans is not close to reality.

We need DB plans to be the backbone of the US retirement industry. Only marking to market liabilities without giving a nod to future contributions doesn’t fairly depict the whole story. We can do better.

07.29.15
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KCS Second Quarter 2015 Update

We are pleased to share with you the KCS Second Quarter Update.  As we previously reported through this blog, 2015 has been a better year for pension funding than 2014 was despite the lower market returns, as interest rates have backed up creating a negative growth rate for plan liabilities.  We hope that you find our update insightful. Have a wonderful day.

Click to access KCS2Q15.pdf

07.28.15
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XYZ’s AUM Up 4%, Add $5 billion – So What!

We are at that point in the quarterly cycle were the largest asset managers, and our industry watchdogs, are once again reporting AUM changes for the previous quarter and last 12 months.  So what! The question that we should be asking and that which should be reported is: “How does this growth or decline in AUM impact the strategy(ies) being managed by the aforementioned firms?”

In my humble opinion, assets are being concentrated among too few firms, and as a result of this asset growth, the products managed by these firms are far exceeding the natural capacity of these strategies.  Subsequently, clients end up paying active fees for, at best, index-like performance.  If that is going to be the result, buy cheap and not expensive beta – index!

Initially, significant asset growth has the potential of driving performance forward, as managers have to buy the same stocks that are in their portfolios.  However, watch out when asset growth levels off or worse, begins to decline, and managers are forced to sell a percentage of their holdings in stocks that remain in their portfolio(s).

Hiring an active manager is never easy, especially given the plethora of options.  However, just evaluating a firm based on its performance, people, philosophy and process is not enough. One needs to understand how the additional assets being received will impact that managers ability to maneuver / trade, especially if that manager is in a less liquid area of the capital markets, such as small cap value.  Every product has a natural capacity, and investment managers should manage to these levels and be transparent with their clients, especially as they near their target AUM.

As markets grow, so does the natural capacity.  But managing through capacity places the client’s interests behind those of the manager, and sets the managers business up for future failure when it becomes nothing more than another underperforming shop.

07.15.15
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Relax Plan Sponsors – 2015 is Much Better than 2014!

Many plan sponsors were under the impression that 2014 was a very good year for DB pension funding because the asset growth either met or exceed their plan’s return on asset assumption (ROA). We refuted those claims in blog posts in both March and May highlighting the fact that liability growth should be the primary plan objective, and not the ROA, and that liability growth far exceeded asset growth in 2014.

Well, we still believe that, and we are today sharing with you that the first six months of 2015 have been quite good for DB pensions.  Why? According to our strategic partner, Ron Ryan from Ryan ALM, liability growth has been negative in the US in 2015, as US interest rates have trended upward.  In fact, using Treasury STRIPS as a proxy for the risk-free rate, liabilities have fallen by nearly 3.7% through June 30th. If one uses AA Corporates as the discount rate, liability growth has fallen by 1.6%.

On the other hand, a 60% / 40% asset mix of the Russell 3000 Index (1.94%) and Barclays Aggregate Index (-0.10%) has returned 1.12% through the first six months. This result certainly appears anemic relative to the average public fund ROA of roughly 7.5%, but it is outpacing liability growth by as much as 4.8%. Funded ratios should be improving as a result of liability growth being exceeded.

Again, managing a pension plan is an incredibly challenging endeavor, made especially difficult when focusing on the wrong objective.  Asset allocation decisions made solely on the basis of performance versus the ROA can lead a plan down the wrong path. 2014 was a poor year, yet perceived to be quite good, while 2015 has been a hand-wringing year for many sponsors despite good outperformance for assets versus liabilities.

DB plan sponsors should be focused on their plan’s liabilities as the primary objective and not the ROA.  Allow KCS and Ryan ALM to create a custom liability index for your plan. It will provide you with a much greater understanding of how the liabilities are reacting to changes in the interest rate environment. It will also help you realize that 2015 is looking a lot better than your 2014 relative results!

07.01.15
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KCS Fireside Chat July 2015 – We’re Your Advocate

Happy Fourth of July!  May you have a safe and enjoyable holiday.

We are pleased to share with you the latest edition of the KCS Fireside Chat series. In this article we highlight, once again, the importance of the defined benefit plan as the primary retirement vehicle for our workers.

In recent weeks there have been several studies released / updated that highlight the sorry state of the US retirement industry.   Shockingly, 92% of working households for 25 to 64 year olds (according to the NIRS) are not on pace to save enough for retirement. The number is only slightly less scary (65%) when net worth is considered. Yet, DB plans continue to be targets for termination. We can and must do better as an industry.  Let us help you.

Click to access KCSFCJUL15.pdf

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06.30.15
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Market Volatility Giving You The Woollies?

I’ve witnessed many market declines during my more than 33 years in the investment industry, and I would be lying if I told you that I called the beginning, end, and ultimate magnitude of any of the sell-offs.  Market declines are part of the investing game.  But just knowing that isn’t enough, as unfortunately, they can have a profound impact on retirement plans and retirement planning, both institutional and individual, as they impact the psyche of the investors.

It is well documented how individuals tend to buy high and sell low. The market crash of 2007 – 2009 drove many individuals out of equities at or near the bottom, and many of those “investors” have kept their allocations to equities below 2007 levels. It hasn’t been that much better for the average institutional investor either.  We are aware of a number of situations (NJ for one) that plowed into expensive, absolute-return product at the bottom of the equity market only to see that portfolio dramatically underperform very inexpensive beta, as the equity markets have rallied since March 2009.

In some cases, the selling “pressure” was the result of liquidity needs, which lead to the tremendous explosion in the secondary markets for private equity, real estate, etc. in 2009.  The E&F asset allocation model, made so famous by Yale, was the undoing for many retirement plans, as the failure to secure adequate liquidity exacerbated market losses. Who knows whether the turmoil in Greece will lead to their exit (expulsion) from the Euro, but there is certainly heightened fear and volatility in the global markets? Are you currently prepared to meet your liquidity needs?

As we’ve discussed within both the Fireside Chats and on the KCS blog, the development of a hybrid asset allocation model geared specifically to your plan’s liabilities, can begin to de-risk your plan, while dramatically improving liquidity.  The introduction of the beta / alpha concept will provide plan sponsors with an inexpensive cash matching strategy that meets near-term benefit needs, while extending the investing horizon for the less liquid investments in your portfolio. By not being forced to sell into the market correction, your investments have a greater chance of rebounding when the market settles.

Traditional asset allocation models subject the entire portfolio to market movements, while the beta / alpha approach only subjects the alpha assets to volatility.  But, since one doesn’t have to sell alpha assets to meet liquidity needs given that the beta portfolio is used for that purpose, the volatility doesn’t matter. Don’t fret about Greece and its potential implications for the global markets and your plan. Let us help you design an asset allocation that improves liquidity, extends the investment horizon for your alpha assets, and begins to de-risk your plan, as the funded ratio and status improve.

06.26.15
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“The Truth Will Set You Free”

I continue to be perplexed, befuddled, mystified, and perhaps stumped by the reticence shown by plan sponsors and their consultants in wanting to know the value of the liabilities in their defined benefit plan on an on-going basis!

As a reminder, the defined benefit plan solely exists to provide a predefined benefit to past, present and future employees of the system in a cost effective manner such that contribution costs remain low and stable. Again, the plan exists to meet a liability.  It doesn’t exist to meet a return on asset assumption. Yet, plan sponsors spend 95% of their time worried about the assets in their plan and very little time on how liabilities are being impacted by market forces.

If two pension plans have widely differing fund ratios, say 100% and 60%, should they have the same asset allocation? No, they shouldn’t. They certainly shouldn’t have the same ROA objectives. Why would a plan sponsor of a well funded plan want to live with the volatility associated with an asset allocation designed to support a 60% funded plan?  Plan sponsors should adjust their asset allocation based on the plan’s funded ratio.

A more fully funded plan should have a much more conservative asset allocation than a poorly funded program. However, in order to know what the funded ratio is, one needs a more accurate and current understanding of the value of the plan’s liabilities.  Currently, the only visibility on a plan’s liabilities is through the annual actuarial report, which tends to be provided 4-6 months delinquent. For many plans, they may still only have a view on year-end 2013 liabilities. We can assure you that liability growth has swung wildly in the last 17-18 months, as interest rates fell significantly in 2014, before backing up so far this year.

In a previous blog posting we discussed 2014’s performance for the average pension plan. We highlighted the fact that the average plan slightly underperformed the average ROA, and that based on that performance most sponsors likely felt that it was an okay year.  Unfortunately, that perception would be incorrect as liability growth easily outpaced asset growth in 2014.

In addition, had sponsors taken risk off the table in 1999 when most DB plans were over-funded, they would have adjusted their asset allocations toward fixed income and away from equities. Regrettably, more risk was put into the plans when fixed income allocations were dramatically reduced for fear that the lower yielding environment would reduce a plan’s ability to meet the ROA objective.  As you know, DB plans have missed the last 15 years of a bond bull market, while subjecting those plans to greater equity risk and two major market declines.

Clearly, liabilities and assets have different growth rates. Yet, the industry continues to believe that by achieving the Holy Grail ROA annually that everything will be fine. Unfortunately, that perception is false.

Would you be comfortable playing a football game in which you only knew your score (assets), but had no clue as to what your opponent was doing (liabilities)? How would you adjust your play calling or defense? I suspect that you wouldn’t play any game in which this scenario existed. Then why as an industry are we playing the pension game by only focusing on the assets with no understanding as to how your liabilities are doing?

We can win the pension game, WE NEED TO WIN THE PENSION GAME, but in order to do so we must utilize tools that provide us with all the information that we need to manage these plans more effectively.  Having greater clarity on the liabilities doesn’t have to be a bad thing!  What are you afraid of?

06.22.15
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Pension America – Taking Control Of One’s Destiny

For pension plan participants defined benefit plans (DB) must remain the backbone of the US Retirement Industry

The true objective of a pension plan is to fund liabilities (monthly benefits) in a cost effective manner with reduced risk over time. Unfortunately, it has been nearly impossible to get a true understanding of a plan’s liabilities outside of the actuary’s report, which is received by sponsors and trustees only on an annual basis, at best, and usually many months delinquent.

Fortunately, a plan’s liabilities can now be monitored and reviewed on a monthly basis through a groundbreaking index developed by Ron Ryan and his firm, Ryan ALM – The Custom Liability Index (CLI). The CLI is similar to any index serving the asset side of the equation (S&P 500, Russell 1000, Barclays U.S. Aggregate, etc.), except that the CLI measures your plan’s specific liabilities and not some generic liability stream. This critically important tool calculates the present value, growth rate, term-structure, interest rate sensitivity of your plan’s liabilities, and other important statistics such as, average yield, duration, etc. With a more transparent view of liabilities, a plan can get a truer understanding of the funded ratio / funded status.

The use of the CLI enables plan sponsors, trustees, finance officials, and asset consultants to do a more effective job allocating assets and determining funding requirements (contributions). The return on asset assumption (ROA), which has been the primary objective for most DB plans, should become secondary to a plan’s specific liabilities. Importantly, as the plan’s funded status changes, the plan’s asset allocation should respond accordingly.

Importantly, the CLI is created using readily available information from the plan’s actuary (projected annual benefits and contributions), and it is updated as necessary to reflect plan design changes, COLAs, work force and salary changes, longevity forecasts, etc. In addition, the CLI is an incredibly flexible tool in which multiple views, based on various discount rates, can be created. These views may include the ROA, ASC 715, PPA, GASB 67/68, and market-based rates (risk-free), with and without the impact of contributions.

Why should a DB plan adopt the CLI? As mentioned above, DB plans only exist to fund a benefit that has been promised in the future. As a plan’s financial health changes the asset allocation should be adjusted accordingly (dynamic). Without having the greater transparency provided by the CLI, it is impossible to know when to begin de-risking the plan. You’ve witnessed through the last 15 years the onerous impact of market volatility on the funded status of DB plans and contribution costs. Ryan ALM and KCS can help you reduce the likelihood of a repeat, and very painful, performance.