Tag Archives: Asset allocation

03.19.15
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My plan was up 10% in 2014 – Was that Good?

We frequently receive updates in our email in-boxes about various pension funds and their returns in 2014, and not surprisingly the numbers vary quite a bit.  According to Wilshire’s TUCS comparisons, the average public pension plan was up 6.76% in 2014. However, we’ve seen some funds reporting returns closer to 10%.  It seems to us that a plan did better the more traditional the plan’s asset allocation, meaning more equities and fixed income, and less in alternatives, particularly hedge funds.

In most cases the announcement of a total return was hailed as good or bad depending on how it did relative to the plan’s return on asset assumption (ROA).  However, is that really the true objective? If a plan generated a 10% return and its ROA was 8% (49% of public plans have 8% as their ROA) it was reported as a great year.  However, what did the plan’s liabilities do in 2014? Since most sponsors and consultants assume that liabilities grow at the ROA, they would likely assess that 2014 was good on both the return and liability front.  Unfortunately, they would be wrong.

With the precipitous decline in US interest rates continuing through much of 2014, the average defined benefit plan had its liabilities grow more than 15% in 2014.  Given this fact, I’d say that any return that didn’t exceed liability growth was a poor year, with the average public pension (6.8%) doing quite poorly versus liability growth.

Can you imagine if you were playing a football game without a scoreboard? Let’s assume you are in the fourth quarter and you’ve scored 27 points.  How do you play your offense or defense? Do you get more conservative or aggressive? You don’t know, do you? Exactly! Well, this is how Pension America is playing the game.

A significant majority of DB plans only get a look at their liabilities every 1-2 years, and the results are usually presented with a 3-6 month lag.  It is quite difficult to have a responsive asset allocation when you don’t know whether or not you are winning the pension game versus your liabilities, just as it is impossible to play football if you don’t know how your opponent is performing.

At KCS we place liabilities and the management of plan assets versus those liabilities at the forefront of our approach to managing DB plans. Pension America has seen a significant demise in the use of DB plans, and we would suggest it has to do with how they’ve been managed. Focusing exclusively on the asset side of the equation with little or no regard to the plan’s  liabilities has created an asset allocation that is completely mismatched versus liabilities.  It is time to adopt a new approach before the remaining 23,000+ DB plans are all gone!

04.16.14
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U.S. Treasury STRIPS – The Naked Truth

At KCS, we have been sharing ideas with plan sponsors to reconfigure their existing fixed income exposure into an enhanced asset allocation framework that might just stabilize a plan’s funded status and contribution costs.  The motivation has been driven by the fear of rising interest rates.  Unfortunately, this fear has provided the impetus for many of our friends in the industry to shed exposure to domestic fixed income programs.  Stop!

Despite the near unanimous expectation that rates have to rise from these “historically low levels”, the fact is that interest rates have actually fallen rather significantly year to date.  In fact, the U.S. 10-year Treasury Bond has seen its yield fall by 37 bps (as of 4/15).  The KCS crystal ball is no clearer than that of any other market participant, so why “guess” where rates are going.

We think it would be advantageous for plan sponsors to reconfigure their existing fixed income exposure to include a separate, lower risk portfolio that matches near term benefit payments for the next 5-7 years depending on the current funded ratio of the plan and projected future contributions. This strategy will improve the plan’s liquidity, while extending the investing horizon for less liquid assets that we would use to support their active portfolio.

We have recommended that the lower risk portfolio be invested in U.S. Treasury STRIPS to match benefit payments.  However, that instrument’s name raises more questions than answers, and has often turned potential users off before the conversation really heats up.  We are here today to say that STRIPS, although misunderstood, are actually low risk, useful fixed income securities.

STRIPS is an acronym for “separate trading of registered interest and principal securities”. Treasury STRIPS are fixed-income securities, sold at a significant discount to face value and offer no interest payments because they mature at par, which is why they are so good at matching projected cash flows. Backed by the U.S. government, STRIPS, which were first introduced in 1985, offer minimal risk and some tax benefits in certain states, replacing TIGRs and CATS (…retired to the zoo?!) as the dominant zero-coupon U.S. security.

If you are concerned about your plan’s funded status, the direction of interest rates and / or the current composition of your fixed income assets, call us to discuss a new path forward. We are here and ready to help you!

03.26.14
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TIme for a New Gameplan?

TIme for a New Gameplan?

As we touched upon in our January, 2013 Fireside Chat, the Private, Public and Union pension deficit in America exceeds $4 trillion, when assets and liabilities are marked to market. Since 1999, pension asset growth has significantly underperformed liability growth and the return on assets (ROA), causing increased contribution costs and a national pension crisis. The true objective of any pension plan is to fund their liabilities (benefit payments) at low and stable contribution costs –with reduced risk through time.

Do you need a new game plan? We’ll explore the asset allocation issues sponsors face and offer solutions for underfunded plans.


 
01.15.14
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Asset Consulting Firms and Their Consultants Aren’t Commodities

The environment for asset consulting firms is quite challenging.  Historically, there have been few barriers to entry, and measuring the value-add provided by the asset consulting firm has been difficult to gauge.  As such, hiring decisions have often come down to price, with the low bidder more often than not winning the assignment.  For those firms fortunate to be given an assignment, the life cycle of the relationship is generally fairly long (about 7 years), as it usually takes a departure of the consultant or a major screw up before the relationship is terminated.  This practice has to change.

Given the current state of defined benefit plans in the US and abroad, this is not the time to fiddle while Rome burns. It is imperative that asset consultants be judged for the value that they bring to a relationship, and they should be compensated based on that value-add.  There are many services that consultants provide, but the importance to the success or failure of a plan varies widely.  Establishing the right plan benchmark is critical, and it isn’t the ROA. We believe that it should be the plan’s specific liabilities. The investment structure and asset allocation that flows from a greater knowledge of the liabilities are key decisions that drive most of the plan’s subsequent return. However, it seems to us that most of the time (80/20 rule) is spent on trying to identify value-added managers. Get the wrong asset allocation and the best performing managers in the weakest asset class won’t help you much.

Let’s see if the industry can refocus on the importance of DB plans, so that we can stabilize the retirements for both our private and public workers.  As such, let’s begin to evaluate consulting firms that can improve the funded ratio and funded status, while minimizing contribution costs. These are the important metrics when evaluating a consulting firm and their consultants.  Experience matters in this industry.  We pay great homage to it on the asset management side of the business.  Why isn’t this as critical when evaluating asset consultants?  Remember: asset consultants have a greater impact on your plan than any individual manager does!