By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Despite the unofficial end of Summer (boy, that seemed fast), the PBGC was engaged in ARPA activity as we closed out August and gathered together to celebrate another Labor Day Weekend. We hope that yours was enjoyable and safe.

With regard to last week’s action, the Toledo Roofers Local No. 134 Pension Plan has joined the action by filing its initial application with the PBGC seeking Special Financial assistance (SFA). This Priority Group 2 plan (MPRA Suspension) is seeking $18.8 million for its 431 participants. As a reminder, the PBGC has 120 days in which to approve this application.

In other action, Gastronomical Workers Union Local 610 and Metropolitan Hotel Association Pension Fund were served a tasty morsel by the PBGC as its SFA application was approved. They have been awarded a grant of $31.1 million for the plan’s 2,624 participants. While the sponsors at Gastronomical Workers were devouring that news, we learned that Bricklayers Union Local No. 1 Pension Fund of Virginia had withdrawn its initial application. This Group 1 priority plan likely pulled the application given the updated rules provided by the PBGC last month. We’ll see what a refiling might mean in terms of additional SFA assets. The initial application was seeking an SFA grant of nearly $8.7 million to help support the plan’s 395 participants.

On the investing front, equities had a difficult week to end August continuing a challenging pattern that has been witnessed throughout 2022, while US interest rates continued to climb. Both of those developments would negatively impact the value of the SFA grant assets that weren’t defeased to meet benefits and expenses. September has historically been the most challenging investment month for equities. Let’s hope that history doesn’t repeat itself.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

There are few things that provide fairly certain outcomes within financial markets, especially during this period of high inflation and rising rates. In fact, there is only one asset class (bonds) that has a certain cash flow of income + principal (terminal value) that is known. Given these positive attributes, we believe that bonds are the perfect instrument to use for asset/liability management in defined benefit pensions. By cash flow matching asset cash flows (interest and principal payments) with liability cash flows (benefits and expenses), one creates as certain an outcome as we have in pension management bearing a very low probability of default (especially when investing in investment grade bonds).

Cash flow matching aka cash flow driven investing (CDI) has been a tool used by pension professionals since basically the dawn of the DB pension plan. It is also the foundational investment for both lottery systems and insurance companies that understand the benefits of matching asset cash flows to liability cash flows. The ultimate benefit of utilizing a CDI program is the “funding cost savings” are locked in as soon as the portfolio is constructed. We at Ryan ALM believe that the difference between the present value (PV) of asset cash flows and the future value (FV) of benefit payments is funding cost savings. Others in our industry argue that the savings are created by the time value of money and that other assets can potentially achieve a greater return and thus greater savings. That potential exists, but at what level of volatility? …and what certainty?

When constructing a cash flow matched portfolio, the difference between the assets PV and the liabilities FV (savings or reduced cost) is locked in on day one given the certainty of a bond’s cash flows. Other asset classes that lack a known income stream + a terminal value can’t claim to have the same known FV outcome. Sure, we can roll the dice with other assets, but at what potential cost should those assets produce a result within a “normal” expected range? It should be quite comforting to the plan sponsor and their advisors to know how a portion of the plan’s portfolio will behave, especially since it is providing the liquidity necessary to meet those liabilities.

Most defined benefit plans, if not all, have exposure to fixed income (bonds), but they are likely using the fixed income assets to outperform a generic index such as the Bloomberg Barclays Aggregate Index. These mandates have benefited tremendously from a 39-year decline in US interest rates. That wonderful tailwind has shifted and the stiff breeze blowing in the faces of fixed income investors is producing steep losses as US interest rates rise steadily. The US Federal Reserve has indicated that interest rates will continue to be elevated for the foreseeable future as they combat excessive inflation. Sure, you can roll the dice once more and “hope” that rates will stabilize and then fall, or you can utilize a time-tested investment strategy (CDI) that will produce a known FV outcome while providing additional benefits such as improving the fund’s liquidity and buying time for the remainder of the assets to grow unencumbered.

In markets that produce unknown outcomes every day, bringing a little certainty to the process is a breath of fresh air. You can claim that the difference in the PV and FV of our portfolios is nothing more than the time value of money, but I prefer the certainty of a CDI outcome over the potential of investing in other asset classes with uncertain outcomes. As a proof statement, if you bought US STRIPS to fund college expenditures decades ago and as a result, the $50,000 investment helped fund $200,000 in college costs, didn’t you “save” $150,000?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Investors hoping to get a Fed pivot on its rate policy were dealt a disappointment in August, as rates rose substantially across the yield curve. Short rates had risen in dramatic fashion throughout 2022 eventually creating an inverted yield curve. August’s activity revealed nearly parallel shifts across the curve resulting in a loss for the Bloomberg Barclays Aggregate index of -3.5%. On a year-to-date basis, the BB Agg is down >-11% through August. As a reminder, the worse annual return since 1982 for the index is -2.9% in 1994.

Based on the current strong employment picture with 315,000 jobs created, 5.2% annual wage growth, and a labor participation rate that grew 0.3% in August (62.4%), it is likely that the Federal Reserve needs to continue to aggressively elevate rates until it accomplishes its primary objective of reducing inflation. This action will continue to weigh on the performance of the US bond market. Fed Chairman Powell has admitted that the Fed’s policy will inflict pain on American families as the strong labor market needs to be tamed. In order to impact the labor market, US rates must rise substantially. Are fixed-income managers and their clients prepared?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

It isn’t often that pension plans receive a gift, but that is exactly what happened with the passage of the ARPA legislation in March 2021. The Special Financial Assistance (SFA) that is granted to eligible multiemployer plans is an incredible lifeline for many plans that were already or soon to become insolvent. That SFA “gift” should be treated as the precious resource that it is.

It is days like today, weeks like this last one, and years, like we are currently going through, that should remind everyone that markets don’t experience volatility only in one direction. Squandering any of the SFA grant in an attempt to potentially enhance the return and size of the pool is fiduciarily imprudent. I don’t mean to be on my soapbox, but I keep thinking of the 28 multiemployer plans that have already received the SFA in 2022, and I wonder just how bad the returns must be so far this year given what is transpiring in both the equity and fixed income markets.

Plan sponsors and their advisors should be looking to take risks within the legacy portfolio as those assets will benefit from the passage of time. The SFA portfolio is a sinking fund intended to be used to secure benefits (and expenses) chronologically for as long as that pool of assets lasts. The sequencing of returns is critically important. There is no mandate from the PBGC to defease the plan’s liabilities to secure those promised benefits, but there should be! The original Butch Lewis Act (BLA) had such a mandate. Local 138 Pension Trust Fund and Idaho Signatory Employers-Laborers Pension Plan were the first two recipients of the SFA grants in January 2022. I’d be very interested to know how those assets were invested. If they were only invested in investment grade bonds, as was required by the PBGC under the Interim Final Rules, those assets could be down >10% so far. That loss of principal will reduce the payment of future benefit payments, as US rates will likely continue to rise for the foreseeable future and are not likely to reverse course anytime soon.

For those plans that have only received the SFA payouts since the PBGC issued its Final Final Rules in July, a portion of the grant money (<33%) has likely been invested in equities. Both bonds and equities faced challenging markets in August. Again, the available assets to meet those promised benefits have unfortunately been reduced. As payouts are made from the SFA, losses will be more difficult to overcome as both a smaller pool of resources and less time to overcome the deficit will impact the performance of the SFA and its future growth. Don’t play games with this incredible gift. SECURE those promised benefits through cash flow matching (defeasance).

In an analysis that we just completed for an SFA recipient, we reported that we can defease and secure more than 10 years of pension liabilities through a cash flow matching strategy at a current yield in excess of 4.7%. That 10-year horizon buys plenty of time for the plan’s legacy assets to grow unencumbered. The risk of not achieving one’s objectives is dramatically reduced given a 10-year investing horizon. So, I once again ask, why take a risk with a precious resource such as the SFA grant and potentially reduce the benefit of this amazing financial gift?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I read the WSJ every day and have for most of my 40-year career. My reason for this post has less to do with the Journal than it has the subject matter. I am annoyed! Regular readers of this blog might respond by saying “what else is new, Kamp”! In this particular situation, the WSJ ran an article yesterday that questioned whether or not it was an appropriate time to retire. They mentioned the importance of the first 5 years (sequencing of returns) and the size of the annual distributions (4% rule), which were appropriate. But time after time writers use as an example $1 million in a retirement account. Who are we/they kidding? In the Journal article, the $1 million balance was associated with a 62-year-old who had just retired and they “wondered” whether this individual was going to be able to sustain their spending throughout a 30-year retirement. A dignified retirement – how pleasant!

Here’s my issue, most Americans don’t have access to a DB pension plan – very regrettable. Many Americans (roughly 30%) don’t have access to any employer-sponsored retirement vehicle including a defined contribution plan. For those that have access to one, the median balance according to Vanguard for a 55-64-year-old (as of June 2022) is a whopping $89,716. This is the median balance for participants in 1,700 vanguard plans covering 4.7 million workers. Where are all those millionaires? Remember, the median represents the 50th percentile, which means that 50% of those participants have less than $89,000. Furthermore, it does not include all the American workers who don’t have access to a retirement account.

It would be incredibly wonderful if the median 401(k) participant had $1 million in savings or for that matter net worth, but we know that the median net worth in this country is only $121,411. Why do we continue to play games using thresholds that aren’t close to being realistic? We have a retirement crisis that is only going to get worse, as the newer members of the Baby Boomer generation retire without a DB pension followed by all of the other cohorts. Instead of using the ink on unrealistic examples of retirement readiness, why don’t we invest the necessary time addressing our current failure to adequately prepare the American workforce for life during our golden years? Asking untrained individuals to fund, manage, and then disburse a retirement benefit without the appropriate skills is pure folly.

We don’t need 3 million greeters at Walmart, but that is what we are going to have when too few Americans can retire. Not being able to manage one’s workforce through a natural lifecycle creates another series of complications. The demise of the traditional DB plan is creating this mess! Too few Americans have the financial wherewithal to appropriately fund life after work. Growing burdens associated with housing, childcare, food/energy, education, healthcare, etc. are making it incredibly difficult for the average American to save. I am blessed with five children, who have each gotten wonderful educations and who are currently gainfully employed in good careers. Yet I witness often the struggles that they face trying to juggle the ridiculous cost of childcare, housing, etc. Something has to give! So, please stop showing examples of what retirement looks like with a $1 million balance. Let’s get realistic and highlight the fact that the 4% rule when applied to an $89,000 median account balance will provide the retiree with $3,560 per year. How dignified a retirement will that provide?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to provide our weekly update of plan activity related to the ARPA legislation. There were four developments last week, with three plans providing supplemental information to their applications following the PBGC’s release of the Final Final Rules. Those three plans were each a Priority Group 1 member including Local 365 UAW Pension Trust Fund, Management-Labor Pension Fund Local 1730 ILA Local, and 408 International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America Pension Plan. These three small funds were seeking to supplement their original SFA grants that totaled <$30 million for the roughly 5,200 plan participants.

Filing an initial application was Priority Group 2 member, International Association of Machinists Motor City Pension Plan, which seeks $64.8 million in SFA for their 953 plan participants. The PBGC has until 12/24/22 to render a decision on the application. Acceptance by the PBGC would provide a nice Christmas present under a lot of folks’ trees this year.

To date, 28 plans have received the SFA, with only one accepted application to be paid which is the Pension Plan of the Printers League – Graphic Communications International Union Local 119B, New York Pension Fund. That plan is expected to receive $90.6 million for its 1213 participants. It would be interesting to see how the 28 plans have invested the SFA proceeds to date. I imagine that several plans were keeping the assets in short-term securities while awaiting the PBGC’s final rules, but now that they’ve been released, investing activity should pick up. Given the Fed’s pronouncements last week, it continues to be an incredibly difficult environment for all asset classes.

We highly recommend that plans use fixed income cash flows (principal and income) to fund and cash flow match liability cash flows. Such a strategy will eliminate interest rate risk, as future values are not interest rate sensitive. Interest rate risk is by far the most prominent risk in today’s markets, and likely will be for quite some time as the Fed tries to tackle inflation. As a reminder, a fixed income strategy that isn’t used to defease pension liabilities is a total return-seeking strategy, which should be reserved for the 33% RSA bucket and not the 67% in investment-grade bonds.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Federal Reserve Chairman Powell has spoken and his comments have impacted equity markets today. His remarks should also finally dissuade investors of the idea that the Fed has accomplished its intended objective of tamping down inflation with little destruction to the economy and employment. Powell stated, “we must keep at it until the job is done.” According to the WSJ, “while the central bank’s steps to slow the rate of investment, spending, and hiring ““will bring down inflation, they will also bring some pain to households and businesses,”” Mr. Powell said in a speech at the Kansas City Fed’s annual symposium in Wyoming. ““Those are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”” Echoing Powell, St. Louis Fed President, James Bullard, said in an interview this morning “we need to have higher rates for longer”.

As we wrote in yesterday’s post, the Fed is far from done, and getting to an inflation level of around 2% will take much longer than most market participants are currently believing. We certainly don’t want to see demand for goods and services reduced or unemployment elevated, but we do understand that in order to combat the onerous impact of inflation aggressive action on interest rates is necessary. US interest rates need to be elevated until there is an inflation premium embedded in rates. We are far from that occurring today.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Let’s give a big thanks to the WSJ for today’s interview with Federal Reserve Bank of Atlanta President Raphael Bostic. It was a great conversation covering a number of important issues related to inflation and monetary policy while incorporating his views on where we are likely to go. As regular readers of our blog know, we’ve been addressing on a fairly regular basis inflation and the impact that it has on fixed income (bonds) and pension funding. There were two specific points raised during the WSJ conversation that echo our thoughts on the subject (confirmation bias in all its glory).

Bostic stated “but what I would say is I try to remind myself that for most people in our society, they don’t have any memories of living in a higher inflation environment, and so there really aren’t anchors of baselines for people to make—to focus on to have a sense of what a reasonable expectation of response will be over the longer run. So I just think there’s just a tremendous amount of uncertainty. People know there is going to be a response, but they don’t have any models in history to suggest that they know what that contour is going to look like. And so there’s just an unease that’s out there as we move forward.” He also said, “we have an imbalance between demand and supply. And as long as that persists, we’re going to have a higher inflation environment. So we’ve got to get that under control, and that’s going to involve some reduction in demand.”

What continues to surprise us, and we recently published a post on this subject, is the expectation that the Fed will have to ease in the near term. That they’ve somehow accomplished its objective. We remain resolute in expecting the Fed to raise rates until they get to a level of positive real rates relative to inflation (an inflation premium). Bostic also cited the current strength of the labor market. He mentioned “the tremendous job growth. We’re averaging, what, more than 450,000 jobs a month per month for 2022? That’s a really big number, and you know, it gave me comfort that we weren’t—that those—we could look through those GDP numbers.” As we’ve stated, you don’t get recessions in an environment of labor strength such as the one that we are experiencing today.

The concept of anchoring at a number that feels comfortable based on one’s prior experience is critically important to understand. Unless you are a 40-year veteran in this industry, you’ve not experienced the negative effects of outsized inflation and interest rates. It is quite amusing to read about the negative impact on demand of a Fed Fund’s Rate at 2.25% when it was >14% the last time we experienced an inflation rate above 8%, which was 4 months into my career. Has housing demand appeared to stall at this time? Yes. But for how long? People need a residence. Rental inflation continues to persist at untenable levels. The demand for housing will adjust to the current environment at some point just as it did for my family and friends who bought their first homes at interest rates that exceeded 11% in the early to mid-’80s.

Lastly, Bostic sees the Fed eventually getting to a Fed Funds Rate above 3.5%. Personally, I don’t see that level diminishing demand and tamping down inflation to a great extent, especially given the strength of the US labor market. In any case, the Fed is far from done, and getting to an inflation level of around 2% will take much longer than most market participants are currently believing.

by: Russ Kamp, Managing Director, Ryan ALM, Inc.

As we reported this morning, activity last week was limited to two plans that filed supplemented applications presumably in reaction to the PBGC’s Final Final Rules (FFR). Those two plans, the Graphic Arts Industry Joint Pension Plan and the Teamsters Local 617 Pension Plan, are seeking Special Financial assistance of $72.2 and $29.7 million, respectively in order to cover their combined 10,745 plan participants. As much as I’ve challenged the PBGC with regard to some of their FFR, they deserve a lot of credit for keeping the public informed of ARPA’s progress. Thank you!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Few people in our industry are working as hard as Ron Surz, President, of Target Date Solutions, to raise concerns about one of the industry’s most frequently used default options – target date funds (TDFs). In his most recent article, he points out that current near-retirees are losing more than those in their 20s. This is both shocking and unacceptable, and it is one more reason why DB pensions must be preserved for the masses.

As the chart above highlights, those in their 20s (the retirement year 2060), have lost “only” -7.9% during the last 12 months, while those retiring now or hoping to, have suffered an unacceptable -11.6% loss. Since the median account balance for those 55-64 (according to Vanguard) is only $84,714, a loss of -11.6% equates to a nearly $10,000 reduction in an already very inadequate retirement account. Asking untrained individuals to fund, manage, and then disburse a “retirement” benefit with little knowledge is just poor policy. However, when relying on the pros (TDF architects) doesn’t provide a superior outcome, we need to rethink that entire operation! Anything short of a monthly benefit paid through a pension-like system will continue to prove inferior.